I just totally goosed this answer on an interview. Oh well.
If you sell a widget for $10 that has a gross profit of 60%, and you pay your employee $2, AND you have no tax, interest, or D&A, how does it flow through the three cash flow statements?
I believe the answer is
Income statement
- $10 revenue
- $10 revenue * 60% gross profit = $6 gross profit
- $6 gross profit - $2 employee expense = $4 EBITDA
- No tax, interest, or D&A = Net Income of $4
Cash Flow statement 1. Net income of $4 = FCF because there's no noncash interest expense, D&A, etc.
Balance Sheet 1. Cash goes up by $8 because although you've made a sale of $10, you pay employee $2 2. Inventory goes down by $4 because that's 3. Add $4 NI to retained earnings to get increase in shareholder equity of $4 Balance
Am I right? Am I wrong? Would love some help. Thanks.
Ignore my previous comment, forgot to take inventory into account. Seems good.
Not the OP but shouldnt your cash be up by 8? 4 from NI, and also 4 from the decrease in inventory, which increases your cash flow.
Ok I got it:
Assets: Cash is up by 4; cash is up by 8 from the cash flow statement, but you decrease 4 from the decrease in inventory, which is an asset SE: up by 4
You also have to adjust for the change in inventory in the CFS. OP is right that cash increases by 8, not because of the expense, but because you add back the inventory as a non-cash adjustment.
Understood, I see my mistake now on the CFS. Thank you.
Income Statement
sales up $10, COGS up $4 = $6 gross profit.
$2 employee expense = $4 operating profit. With no tax, interest, D&A, this is also EBITDA and net income
CF Statement
net income is up $4, you add back the $4 from inventory under operating therefore, net cash is up $8.
Balance Sheet Cash is up $8 but inventory is down $4, total assets up $4. This balances be net income is $4 and rolls into retained earnings.
Thank you very much
Why do you add back $4 from inventory when getting to cash form operating activities? Why is it just not NI?
I thought you go from NI and then add back non-cash items like D&A, Noncash interest expense, and change in NWC?
Oh, wait - can you confirm actually that the $4 from inventory is actually part of NWC? Assets down by 4 (because of decrease in inventory) so change in NWC up by 4?
And why is it inventory = 4?
For a question like this, do you automatically assume the $2 employee expenses is not direct Labour therefore not included in COGS? I feel like this should be something that should be clarified.
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