‘X changes by ten, walk me through the three statements’ is the most reliable question in an investment banking interview, because it cannot be bluffed: either the numbers tie or they don’t. This deck assumes you know what the income statement, cash flow statement and balance sheet each show, but have never actually run an event through all three. The first three cards fix the method: the order, why the tax rate matters, and the balancing check. The middle cards take one event at a time, buying inventory, booking a sale, paying interest, a write-down, deferred tax, each worked in pounds at a 25% tax rate with the arithmetic shown. The last three combine events and add the IFRS wrinkle that catches UK candidates.
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Card 1 of 19
Your interviewer says ‘operating expenses go up by £40, tax rate 25%, walk me through the three statements.’ In what order do you go, and why that order?
Income statement first, then net income into the cash flow statement, then prove the balance sheet ties.
Always the same route. Income statement first, because that is where profit is worked out: pre-tax profit falls £40, tax falls £10 at 25%, so net income falls £30. Cash flow statement second, starting from that net income, then adjusting for anything in it that wasn’t cash and for working capital, the money tied up in unpaid bills and stock; here nothing needs adjusting, so cash falls £30. Balance sheet last: cash is down £30 on the asset side and retained earnings, the profit kept in the business, is down £30 on the equity side, so it balances. Each statement hands the next one the number it needs.
Card 2 of 19
You finish a walk-through and the interviewer asks ‘does it balance?’ Using £40 of revenue booked on credit at a 25% tax rate, show me the check you run before you answer.
The change in assets must equal the change in liabilities plus equity, and equity moves by net income.
Income statement: revenue up £40, tax up £10, net income up £30. Cash flow: start at £30, but the customer hasn’t paid, so the £40 sitting in receivables (money owed to you) is subtracted as working capital, leaving cash down £10, the tax you paid on profit you haven’t collected. Balance sheet: cash −10 and receivables +40 puts assets up £30, liabilities are unchanged, and retained earnings is up £30 from net income, so 30 = 0 + 30 and it balances. That equation is the check: if the two sides differ, you dropped a line somewhere, usually the cash figure.
Card 3 of 19
Ferrow Retail buys £30 of inventory and pays cash on the spot. Walk me through the three statements.
Buying inventory swaps one asset for another, so nothing hits the income statement until the goods are sold.
Income statement: nothing. Inventory is goods held for sale, and it only becomes an expense, cost of goods sold, when the goods are sold, so pre-tax profit, tax and net income are all unchanged. Cash flow statement: net income is zero, but inventory rising by £30 is cash tied up in working capital, so it is subtracted and cash falls £30. Balance sheet: cash is down £30 and inventory is up £30, both assets, so total assets are flat, liabilities and equity are untouched, and 0 = 0 + 0 balances. No tax effect, because nothing touched profit.
Card 4 of 19
A week later Ferrow sells that £30 of inventory to a trade customer for £50, payable in 30 days. Tax rate 25%. Walk me through it.
Revenue and cost of goods sold both hit profit, but cash only moves by the tax until the customer pays.
Income statement: revenue up £50, cost of goods sold up £30, so pre-tax profit rises £20, tax rises £5 and net income rises £15. Cash flow statement: start at £15, subtract the £50 increase in receivables because the customer hasn’t paid, add back the £30 fall in inventory because those goods were paid for last week, so cash falls £5, the tax bill. Balance sheet: cash −5, receivables +50, inventory −30, so assets are up £15, liabilities unchanged, retained earnings up £15, and 15 = 0 + 15 balances.
Card 5 of 19
Thirty days on, the customer pays Ferrow the £50 it owes. What moves?
Collecting a receivable converts one asset into cash and touches nothing on the income statement.
Income statement: nothing, because the revenue was recognised when the sale was made, not when the money arrived; booking it again would count the same sale twice. Cash flow statement: net income is unchanged, receivables fall by £50, and a falling receivable is a working capital release, so cash rises £50. Balance sheet: cash +50, receivables −50, total assets flat, liabilities and equity untouched, so it balances at 0 = 0 + 0. Across the three Ferrow cards, the £15 of profit and the £15 of cash have now caught up with each other, which is the whole point of accrual accounting.
Card 6 of 19
On 1 January, Calder Foods pays £24 up front for a year’s rent on a warehouse. Tax rate 25%. Walk me through the day of payment and then the year as a whole.
A prepayment is an asset on the day you pay, and turns into an expense a month at a time.
Day of payment: nothing on the income statement. You have bought twelve months of future use, an asset called a prepaid expense, so cash falls £24 and prepaids rise £24, assets flat, balanced. Over the year the prepaid is released as rent expense, £2 a month: for the full year, rent of £24 cuts pre-tax profit £24, tax falls £6 and net income falls £18. Cash flow: start at −18, add back the £24 fall in prepaids, so cash rises £6, the tax saved. Balance sheet: cash +6, prepaid −24, assets −18, retained earnings −18, balances. Over the whole year, cash −18 and profit −18.
Card 7 of 19
Overton Digital sells a £120 annual software subscription and the customer pays the whole year on day one. Tax rate 25%. Walk me through the receipt, then the year.
Cash in advance is a liability called deferred revenue until delivery, then it turns into revenue.
Receipt: nothing on the income statement, because Overton hasn’t delivered anything yet. It owes the customer a year of service, so deferred revenue, a liability, rises £120, and cash rises £120 as a working capital source. Balance sheet: cash +120, liabilities +120, balances. Over the year £10 a month is recognised: revenue for the full year is £120, tax £30, net income £90. Cash flow: start at 90, subtract the £120 fall in deferred revenue because that cash arrived earlier, so cash falls £30, the tax. Balance sheet: cash −30, deferred revenue −120, retained earnings +90, and −30 = −120 + 90 balances.
Card 8 of 19
Northbay Logistics buys a £100 sorting machine for cash on 1 January and depreciates it straight-line over five years. Tax rate 25%. Walk me through the purchase and the first year.
Capex skips the income statement and sits in investing cash flow, then depreciation drips through profit.
Purchase: nothing on the income statement, because the machine is an asset that will be used for years, not an expense. Cash flow: £100 goes out under investing activities, the section for buying and selling long-lived assets. Balance sheet: cash −100, equipment +100, balances. Year one depreciation is £100 over five years, £20: pre-tax profit falls £20, tax falls £5, net income falls £15. Cash flow: start at −15, add back the £20 because it is a non-cash charge, so cash rises £5. Balance sheet: cash +5, equipment −20, assets −15, retained earnings −15, balances. After the year, cash is −95 and equipment +80.
Card 9 of 19
Halstead Foods draws £100 on a bank loan on 1 January and repays it in full on 31 December, ignoring interest. Walk me through both legs.
Borrowing and repaying principal are financing cash flows that swap cash for debt and never touch profit.
Drawdown: nothing on the income statement, because borrowing is not income and repaying is not an expense. Cash flow: £100 comes in under financing activities, the section for money raised from or returned to lenders and shareholders. Balance sheet: cash +100, debt +100, and 100 = 100 + 0 balances. Repayment is the mirror image: no income statement effect, £100 out under financing, cash −100 and debt −100, balances again. The only thing that ever reaches profit is the interest charged for the time the money was borrowed, which is the next card.
Card 10 of 19
Halstead pays £10 of interest on that loan during the year. Tax rate 25%. Walk me through it, and tell me what the interest really costs.
Interest is tax-deductible, so £10 of interest costs the company £7.50 of cash after the tax saving.
Income statement: interest expense of £10 sits below operating profit, pre-tax profit falls £10, tax falls £2.50, net income falls £7.50. Cash flow statement: start at −7.50 and there is nothing to adjust, because the interest was paid in cash and the tax saving was real, so cash falls £7.50. Under US GAAP that sits in operating cash flow; IFRS allows a choice, which gets a card of its own later. Balance sheet: cash −7.50, retained earnings −7.50, balances. The after-tax cost, 10 × (1 − 25%) = 7.50, is why debt is called cheaper than it looks.
Card 11 of 19
Talbrook Industries has £20 of spare cash. The board is choosing between paying a £20 dividend and buying back £20 of its own shares. Walk me through each, and tell me what differs.
Dividends and buybacks both leave the income statement alone and reduce cash and equity by the same amount.
Neither touches the income statement, because they are payments to owners rather than costs of running the business, so there is no tax effect for the company either. Cash flow: £20 out under financing either way. Balance sheet: cash −20 on the asset side and equity −20, so −20 = 0 − 20 balances in both cases. The difference is which equity line moves: a dividend reduces retained earnings, while a buyback creates treasury stock, a negative equity line for shares the company has bought back. A buyback also cuts the share count, so earnings per share rise even though net income hasn’t moved.
Card 12 of 19
Overton Digital grants employees £12 of stock-based compensation this year, and the interviewer says treat it as tax-deductible at 25%. Walk me through it.
Stock-based comp is an expense that cuts profit, but no cash leaves, so it is added back and lands in equity.
Income statement: the £12 is a compensation expense, so pre-tax profit falls £12, tax falls £3, net income falls £9. Cash flow: start at −9, add back the full £12 because employees were paid in shares rather than cash, so cash rises £3, the tax saving. Balance sheet: cash +3, so assets are up £3; on the equity side retained earnings falls £9 and additional paid-in capital, the line for value contributed by shareholders, rises £12, so equity is up £3 and 3 = 0 + 3 balances. Real-world tax timing is messier, but the drill assumes a deduction now.
Card 13 of 19
Windmere Foods finds £20 of stock that has gone past its sell-by date and writes it down to zero. Tax rate 25%. Walk me through it.
A write-down is a non-cash expense: profit falls after tax, cash rises by the tax saved, inventory shrinks.
Income statement: the £20 write-down is booked as an expense, usually inside cost of goods sold, so pre-tax profit falls £20, tax falls £5, net income falls £15. Cash flow: start at −15, add back the £20 because nothing was paid, the goods simply lost value, so cash rises £5. Balance sheet: cash +5, inventory −20, assets −15, retained earnings −15, balances. Show the add-back once only, either as a non-cash charge or through the inventory line in working capital, never both. Under IFRS a later recovery in value can be written back up; under US GAAP the write-down is permanent.
Card 14 of 19
Kestrel Components sells an old press with a book value of £40 for £50 in cash. Tax rate 25%. Walk me through it.
The gain hits profit, but the full proceeds land in investing, so the gain comes out of operating cash flow.
Income statement: the gain is proceeds minus book value, £50 − £40 = £10, so pre-tax profit rises £10, tax rises £2.50, net income rises £7.50. Cash flow: start at 7.50, subtract the £10 gain from operating activities because it isn’t operating cash, then show the full £50 of proceeds under investing, so cash rises 7.50 − 10 + 50 = £47.50. Balance sheet: cash +47.50, equipment −40, assets +7.50, retained earnings +7.50, balances. The subtraction exists so the £50 is counted once, in investing, instead of partly in operating as well.
Card 15 of 19
At year end, Bramwell & Co. has earned its staff a £20 bonus that won’t be paid until February. Tax rate 25%. Walk me through the year-end statements.
An accrued expense cuts profit now and sits as a liability, so cash actually rises by the tax saved.
Income statement: the bonus was earned this year, so accrual accounting books the £20 expense now, pre-tax profit falls £20, tax falls £5, net income falls £15. Cash flow: start at −15, then add back the £20 because it hasn’t been paid; an accrued liability rising is a working capital source. Cash rises £5, the tax saving, assuming the drill treats the bonus as deductible when accrued. Balance sheet: cash +5, so assets +5; accrued liabilities +20 and retained earnings −15, so liabilities plus equity is +5 and 5 = 20 − 15 balances. Profit down while cash is up, which is why the two never move together.
Card 16 of 19
Halverson Industries depreciates a machine £20 a year in its accounts, but the tax authority lets it deduct £40 this year. Tax rate 25%. Walk me through it, including the deferred tax.
Faster tax depreciation cuts cash tax now, and the difference is parked as a deferred tax liability for later.
The income statement uses book depreciation: £20 of expense, tax expense falls £5, net income falls £15. But the tax return deducts £40, so cash tax actually falls £10. The £5 gap is a deferred tax liability, a debt to the tax authority that comes due later, once the tax deductions run out. Cash flow: start at −15, add back the £20 of depreciation, add the £5 increase in the deferred tax liability because that tax was expensed but not paid, so cash rises £10. Balance sheet: cash +10, equipment −20, assets −10; deferred tax liability +5, retained earnings −15, so −10 = 5 − 15 balances.
Card 17 of 19
Two at once: in the same year, Meridian Health invoices £40 of services that remain unpaid at year end and records £16 of depreciation. Tax rate 25%. Walk me through it.
Run both events through the income statement together, then adjust once per non-cash and working capital item.
Income statement: revenue +40 and depreciation −16, so pre-tax profit rises £24, tax rises £6, net income rises £18. Cash flow: start at 18, add back the £16 of depreciation because it is non-cash, subtract the £40 increase in receivables because the customer hasn’t paid, so cash falls £6, the tax bill on uncollected profit. Balance sheet: cash −6, receivables +40, equipment −16, so assets are up £18; liabilities unchanged; retained earnings +18, and 18 = 0 + 18 balances. The discipline is to do the income statement once for both events, then take the adjustments one at a time and add them up.
Card 18 of 19
Quick one: name a single change that has no effect on the income statement but reduces cash. Then tell me the family it belongs to.
Swapping cash for another asset, or using cash to shrink a liability or equity, never touches profit.
Buying a machine is the classic answer: cash falls, equipment rises, and profit is untouched until depreciation starts. The family is everything that happens on the balance sheet only. Cash for another asset: buying inventory, prepaying rent, capex. Cash to shrink a liability: repaying debt, paying down a supplier. Cash to shrink equity: dividends, buybacks. The mirror family matters just as much, an income statement hit with no cash leaving: depreciation, a write-down, stock-based comp, an accrued bonus. Interviewers use the pair to test whether you have really separated profit from cash, which is what the whole drill is for.
Card 19 of 19
Your comps sheet has a UK company reporting under IFRS next to a US one. Where does each put the £10 of interest it paid on the cash flow statement, and why does that matter?
US GAAP puts interest paid in operating cash flow but IFRS allows operating or financing, so check first.
Under US GAAP, interest paid is always operating. Under IAS 7, the IFRS cash flow standard, a company chooses operating or financing for interest paid, as long as it is consistent. With £10 of interest at 25% tax, total cash falls £7.50 either way, but the US company shows operating cash flow of −7.50, while an IFRS company that picks financing shows operating +2.50 (the tax saving) and financing −10. That changes any free cash flow built from operating cash flow, so read the policy note before comparing. IFRS 18, effective from 2027, largely removes the choice by moving interest paid into financing for most companies.
Reading is not the same as remembering. Study this deck with scheduled review so the cards come back before you forget them.