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hardFinancial Analyst interview question

What red flags would you look for when reviewing the quality of a company earnings?

What the interviewer wants to hear

  • Profit growing much faster than operating cash flow
  • Receivables or inventory growing faster than sales
  • Frequent one-off items, changes in accounting policies or estimates
  • Related-party transactions and capitalised expenses
  • Auditor qualifications, delayed filings, management turnover

Model answer

My first test is cash: if net income keeps growing but operating cash flow does not, something needs explaining. I look at receivable days and inventory days; if they rise faster than sales, revenue may be pulled forward or stock may be unsaleable. I check for recurring one-off items, because restructuring costs every year are not one-off, and for changes in accounting policies or estimates, such as longer asset lives that reduce depreciation. I look at what is being capitalised, for example development costs or interest, which moves expenses off the income statement. Related-party sales and loans, especially in promoter-led groups, need careful review. Finally, I read the auditor report and notes for qualifications or emphasis of matter, and watch for delayed filings or frequent changes of auditor or CFO. Any one flag is not proof, but several together justify deeper due diligence.

Can you answer it under time pressure?

Take a timed hard round and get scored on every answer.

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