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I've been asked the question in multiple finance interviews recently and have answered the cash flow b/c investors want to know how much cash a business generates to grow the company, payback debt, etc. However, some people think balance sheet is better cause it tells you the "financial health" of a company for which I can see the argument as well.

What do you guys think?

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Comments (14)

  • ibhopeful532's picture

    There is no strict "correct" answer. You can make decent arguments for all three. It really depends on what the goal is in analyzing a company (are you trying to buy it? invest equity? buy its bonds?) But by convention, I think generally it goes something like this:

    1) Cash flow
    2) P/L
    3) Balance Sheet

    Cash flow is probably the most important because it allows you to see how readily a company can meet its debt and interest payments. A company can have a strong P/L, but at the end of the day, if a lot of the revenue generated is from accounts receivable, the company can still fail to meet its debt obligation. "Cash is king".

    P&L is important because it gives you an idea how profitable the company is overall. Via P/L you can look at its margins and other ratios to see how it does in terms of generating profit relative to other players in the industry.

    Balance sheet is probably the third statement you'd want to look at. It's more of a "long-term" view, or track record of how the company is doing.

    fwiw, I think bankers tend to look at P/L the most when doing analysis of a company.

  • jaclee317's picture

    It really depends on what you're looking for because, as you already know, no one statement tells the whole story. Although the information in the CF statement might be the most important (net profit without cash is useless, and cash flow determines value), you also have to remember that you technically don't need it separately because you can indirectly construct one using both the balance sheet and income statement (using beginning and ending balances from the BS). When they ask you to pick two, that's what they want you to say (i.e. pick BS and IS because you can make CF), but you can also probably mention that for this question too.

    The "financial snapshot" feature of the balance sheet summarizes a company's capital structure, various account balances, and short term vs. long term items. The income statement statement tells you about its profitability (breakdown of revenues and expenses). You can tell both aspects are very important because ratios often use numbers from both statements. Overall, I think the interviewer is looking for your reasons/analysis more than the actual answer.

    If you ask me (if eliminating CF statement): Although it depends on the nature of the business, I would say generally most investors care more about trends in the income statement items (sales, gross profit, operating profit/EBIT, income from continuing operations, net income, and EPS) compared to most balance sheet items. On the IS, it's easy to what's operating vs. non-operating, and of course to pinpoint which items are non-recurring.

  • rrrrr01's picture

    If a restructuring banker is asking go with balance sheet. For everyone else, you'll be safe with cash flow. Also if you get asked for two go with balance sheet and income statement - you can derive cash flow from those two.

  • PowerMonkey's picture

    Cash is king baby. When looking at a company, you look at all three, however what you really look at for most deals is a modified cashflow combined with a debt structure.

    That being said in an interview you can say any of them.

    --There are stupid questions, so think first.
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  • squawkbox's picture

    Definitely Cash Flow

    The income statement is prone to "errors" from accounting conventions.

    For example, whenever Apple sells an iPhone --> it can only recognize 3/24 of the revenue for the phone in the current quarter.

    However they are still being paid cash for the phones from AT&T (ignoring A/R).

    So their net income on the P/L is grossly understated. Go look at Apple's Operating Cash Flow and compare it to net income. Look at "Change in Liabilities"...this is Deferred Revenue (i.e. iPhone Sales).

    Another example is Burger King vs. McDonalds. Burger King trades at a discount to McDonalds based on forward earnings --> however you will see that Burger King spends most of its operating cash flow each year on Capex (building new restaurants)

    Therefore, the actual cash flow available to investors is greatly diminished because Burger King depends on building new restaurants to boost earnings.

  • LeggoMyGekko's picture

    if you had only 1 choice of the 3. hands down - cash flows statement.

    if you had a choice of 2 of the 3. income statement and balance sheet. you can construct the cash flows statement from the 2.

  • jason's picture

    wow guys all the responses in this thread have been very good and well articulated. Just wondering where everyone learned to articulate these ides/thoughts like this. Would a first year analyst be expected to lay out the logical reasoning in this fashion?

  • CompBanker's picture

    If you have the option to choose 2 of the 3, be sure to ask the clarifying question: "Do I have access to the 2 statements I choose for all time periods?" You can't create a cash flow statement from the IS and a single balance sheet.

    CompBanker

  • WestHudson's picture

    Cash Flow is king!!! Also, most balance sheets go out for like 2 periods so I'm sure you'd have enough to construct a cash flow statement.

  • In reply to jason
    bigmonkey31's picture

    jason:
    wow guys all the responses in this thread have been very good and well articulated. Just wondering where everyone learned to articulate these ides/thoughts like this. Would a first year analyst be expected to lay out the logical reasoning in this fashion?

    you should be able to articulate this in an interview. I have definitely gotten this question a couple times.

  • NoLongerActiveHere's picture

    Cash flow for me here followed by BS

  • swagon's picture

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  • jaclee317's picture