Accounting and Financial Analysis
Accounting foundations
Candidates must understand the accounting equation (Assets = Liabilities + Equity), double-entry bookkeeping, the chart of accounts, and the accounting cycle from source documents to financial statements. Know the elements of financial statements and the qualitative characteristics of useful information: relevance, faithful representation, comparability, verifiability, timeliness, understandability.
Financial analysis
Master the main ratio families: liquidity (current, quick), solvency (debt-to-equity, interest coverage), profitability (gross margin, return on assets, return on equity), and activity (inventory turnover, receivables turnover, asset turnover). Understand horizontal and vertical analysis and the DuPont decomposition of ROE into margin × turnover × leverage.
Traps in questions
- Mixing liquidity (ability to meet short-term obligations) with solvency (long-term).
- Using average vs closing balances inconsistently in turnover ratios - state the convention.
- Assuming a high current ratio is always good; excessive inventory or receivables may signal inefficiency.
- Forgetting that ROE can be inflated by leverage without improved profitability.
Worked example
Current assets 600, current liabilities 300 → current ratio 2.0. If inventory is 200, quick ratio = (600 − 200)/300 = 1.33. A current ratio of 2.0 with quick ratio of 1.33 shows liquidity is partly tied up in inventory - a candidate must interpret, not just compute.