Contrast FCF vs NI; choose one statement
Overview
This question evaluates financial statement analysis skills—specifically reconciling net income to free cash flow, identifying accounting and working-capital red flags, and selecting which single statement best informs credit risk, profitability trends, and cash runway, thereby testing valuation, solvency, and financial-modeling competency in the Statistics & Math domain. It is commonly asked because interviewers probe both conceptual understanding and practical application of accrual versus cash accounting, the effects of non‑cash charges, capex and working‑capital movements on valuation, and awareness of which metrics (for example FCF margin, interest coverage, and current ratio) become unreliable or unobtainable when only one statement is available.
An asset-heavy company reports rising net income while free cash flow (FCF) is negative for three straight quarters. a) Explain when and why FCF can be a superior indicator to net income for valuation, solvency, and dividend safety. Quantify the reconciliation from NI to FCF (non-cash charges, working-capital changes, capex) and show a brief numeric example. b) Identify at least two concrete red flags where NI looks healthy but FCF indicates risk (e.g., revenue recognition timing, capitalized costs, ballooning receivables), and one scenario where FCF can be temporarily misleading. c) If you could access only one statement—Balance Sheet (BS), Income Statement (IS), or Cash Flow (CF)—for evaluating the business, which would you choose for: i) credit risk, ii) profitability trend, and iii) cash runway? For each choice, list three critical risks and missing pieces of information you cannot assess without the other two statements, and how you would approximate them (e.g., using footnotes or ratios). Name specific metrics that become impossible or unreliable (e.g., FCF margin, interest coverage, current ratio).