If you’re a graduate chasing a career in consulting, chances are you’ll come across a case interview. Case interviews allow you to demonstrate how you think - your ability to understand a problem, break it down into its requisite parts, analyse them and communicate a solution. Check out Case Interview 101 to find out more about what a case interview is and seven tips on what to do in a consulting case interview. Right now, it’s time for you to get familiar with these six business terms that you absolutely must know before your case interview.
It’s important to remember that consultants come from all different walks of life. And by that, what we mean to say is that not everyone has a business background. So, if you don’t have a commerce, business, finance, accounting or strategy degree, never fear! Consulting is about logical, rational and analytical thinking with creative flair.
However, it is worth understanding a few fundamental business basics so you’re not resorting to ‘Please Explain’ throughout the entire case interview. So, here is our quick ‘Business 101’ guide to ‘things you ought to know.’
When we talk about revenue, what we are referring to is the amount of money a company makes. At its simplest, revenue is calculated by multiplying the price at which goods and services are sold by the number of units or amount sold within a time period. For example, say a coffee shop makes 100 coffees a day and sells them each for $3. The revenue that the coffee shop makes is, therefore, $300 a day. Over a year their revenue would be $109, 500. This assumes of course, they sell the same number of coffees every single day for the entire year.
As you can see, there are two ‘levers’ of revenue here – the price and volume sold. If a business wanted to increase its revenue, it may consider either raising its price, attracting new customers or increasing the number of coffees bought by existing customers. It may do a combination of all these things.
Often a business will have more than one type of revenue stream. In our coffee example, the coffee shop may also make money by selling food, catering for lunches at nearby offices or displaying art for sale on its walls. In consulting speak, we call these ‘revenue drivers’. Typically, you will find that one driver is more dominant than another.
You will often hear revenue called the ‘top line’ or ‘gross income’ figure. This is because it is the amount of money that the company receives during a specific period. It does not take into account the costs of running the business itself.
It is common during the case interview to consider how a business might make money. After all, this is what a business is set up to do! Whether an organisation is seeking to launch a new product or service, enter a new industry or geographic market, it must consider how it will generate revenue.
As a consultant-to-be, you will be making a number of assumptions about how the business operates. In our coffee shop example, we assumed that the number of coffees sold every day remained the same. Would this really be true in real-life? It’s here that you can have a bit of fun and apply some logical thinking. For example, a coffee shop that’s in the middle of the CBD may be busiest during the week compared to the weekends or over the Christmas break.
The opposite may be true for a coffee shop on the beach. When making assumptions be careful about what it is you are actually assuming and be sure to take a step back and look at the bigger picture. At the same time, don’t over complicate things. If you need to make a simplifying assumption so that you can move on, that’s perfectly ok. Just state that you are doing exactly that and check in with your interviewer.
A good way to practice ahead of the case is to think about organisations you interact with regularly and ask yourself, ‘How does this business make money?’. Whether that is your local coffee shop down the road, or companies such as Spotify, Telstra, Westfield or Google, consider what their different revenue drivers might be.
Spotify, a digital music service, for example, allows users to stream music for free if they are willing to listen to advertisements, alternatively, they offer users a subscription fee for a premium service. If you were given a company like Spotify during a case interview, you may be asked to estimate their revenue. You would need to make assumptions for example about how many users they have, what proportion of users are free vs. paid, how much it costs to subscribe, the different rates of subscription (e.g., student vs. regular vs. family accounts), how many advertisers they have and what their advertising rates are.
See if you can break down each of these assumptions in a logical way to come up with a final revenue number – and then see how it compares to the real-life thing! Don’t forget, it’s not about the ‘right’ number, it’s about the thinking process.
Expenses refer to the costs of running a business. They are the opposite of revenue. For example, for our coffee shop to make its coffees it must buy all the materials required including coffee beans, milk and sugar. The coffee shop must also pay its employees to make the coffee and serve customers.
Expenses may be further divided into fixed and variable costs. Fixed costs refer to those which are independent to output – that is, no matter how many coffees our coffee shop makes, the shop must still pay rent (a fixed amount), the lease of the coffee machine and other equipment.
In contrast, variable costs refer to those that do vary with output. For example, the more coffees we make, the more coffee beans, milk and sugar we will need to buy. Similarly, if the coffee shop grows and as a result, we make more coffees, we will also likely have to hire more staff.
Just like revenue, when you’re practising for the case interview, consider what’s going on the ‘other side’ i.e. what types of costs that business may be incurring. In our Spotify example, costs include streaming, music licensing and royalties, hosting, product development, sales and marketing and employee wages. For each of these you would need to come up with a logical explanation of what these costs may be and be able to justify your assumptions.
Let’s work through the potential streaming costs, as an example. What do we need to know to make these calculations?
First, we need to consider how long an average user listens to Spotify every day. Well, the average user may listen to Spotify part of the way to/from work or school, and perhaps a little bit during their day. As a conservative estimate, we can assume that this is about an hour a day.
We may then ask ourselves, what does this actually mean in terms of streaming? You may not know anything about streaming and it is ok at this point to ask the interviewer for some guidance. Suppose the interviewer tells you that streaming is in kilobits per second and that an average user would stream 160 kilobits per second.
This means we can then calculate per user that they are streaming 160*60*60 = 576, 000 kilobits per day. The interviewer at this point may suggest we convert this to megabytes, indicating that 1 kilobit =0.000125 megabytes (MB). Once we crunch the numbers, we will find that per user, they are streaming 72MB per day.
We then need to make some assumptions about how many Spotify users there are in total. After some guesswork about countries that Spotify is in and what proportion of the country would have access to the Internet and be of the demographic that would listen to Spotify, we may come up with a total of about 100 million give or take. (Actually, the latest we heard was that the number of Spotify active users is actually much higher and more around the 150 million mark but for simplicity, we’ll go with 100 million).
If we assume that all these users are listening for an hour per day, that’s 100 million users x 72MB = 7.2 billion MB per day or 7.2 million GB per day of streamed day (where 1MB = 0.001 GB).
To continue with estimating the streaming costs, we would then have to find out how much it would cost to stream per GB. Again, you are not expected to be familiar with streaming so you may ask for guidance at this point. Let’s say we find out that it costs about $0.10 per GB. So, 7.2 million*0.10 = $720, 000 per day in streaming costs.
Now, we basically pulled these numbers out of a hat and have no idea if this is actually correct or not. The point is, it doesn’t matter. So long as along the way we have justified each assumption to the satisfaction of ourselves and the interviewer, then the end number doesn’t really matter.
It does however, pay to look at that number and consider if it makes sense. Perhaps paying $720, 000 per day in streaming costs is actually outrageous and we should backtrack a little to adjust some of our earlier assumptions. For example, is it really accurate to assume that every single user is listening to Spotify an hour a day? Maybe we can adjust that number to one in five instead. Are streamling costs really at $0.10 per GB or is that too high? As you can see, it does pay to sanity check your end result.
It’s also worth checking what the original question was. Did your interviewer ask you about the costs over a day, a month or a year? Be sure to adjust and calculate accordingly. Often the numbers can get quite large as you can see in this example. Be mindful of your zeros and the difference between your millions and billions!
And then we come to profit. Profit therefore is calculated as revenue less expenses, which is why it is often referred to as the ‘bottom line’. It is the aim of every business to have its revenue higher than its expenses and therefore, a positive profit. Any profit that is made can either be invested back into the business so that it continues to grow, for example, in buying new equipment or hiring more staff, or paid out to investors of the business.
Profit is also often called net income as it is the amount that is ‘left over’ after all the necessary expenses are subtracted for that period. This includes the cost of doing business, depreciation, interest, taxes and other expenses. This number is typically found on a company’s income statement and indicates how profitable the company is over a period of time. If the net income number is negative, this shows that the company has suffered a loss (called a ‘net loss’).
As a company varies in size, it is sometimes appropriate to consider the profit margin of a company when comparing one to another. This is calculated as a percentage of sales or revenue.
During the business case, we are typically seeking to reach a conclusion about what a company should do. A way to evaluate this is to consider how much it makes in terms of net income or profit. For example, how much money will it make it if it launches that new product line or if it enters that new geographic market?
As we know now that revenue less expenses equals profit, we can begin to better evaluate a company’s options by deep diving into each.
This is where being systematic and structured helps. Rather than jumping from revenues back to expenses and back again in a ‘brainstorming’ fashion, it is easier to do all revenue items in one go together, then move on to expenses. You will likely be making notes or doing this on a whiteboard, so we suggest being super clear in the way you write it down as well. There’s nothing worse than scrawled words and numbers hastily written down and then not being able to understand them. If you are working on a whiteboard for example, then you use one side of the board to calculate revenues, and the other side to calculate expenses. When you get to your total revenue and total expenses number, you can then calculate your net income or profit at the very bottom of the board.
It seems straightforward enough but we know that in the heat of an interview, it’s easy to just start writing and then realise halfway through you’ve run out of room or you’ve confused yourself about which number is a revenue or expense item. Here’s an example of how you might set out your numbers (note, we haven’t filled in the table but this is just to give you an idea!):
The income statement brings together the revenue, expenses and profit altogether. The purpose of the income statement is to provide a snapshot of the company’s financial performance over a specific accounting period. It is also referred to as the profit and loss statement – as it provides details into exactly that! The income statement begins with sales and then works its way down to net income.
It can be helpful to look up a few income statements to understand how they are laid out. You can usually find them in the annual report of any publicly listed company. Again, you’re not expected to have an accounting or finance background for the purposes of the case interview but it can be insightful to understand what the revenue and expense line items might be for a company – and to give you a few clues about things to think about when doing your own case practice!
Another important financial statement for any company is its balance sheet. A balance sheet provides a snapshot of the organisation’s financial position at a given point in time. More specifically, it gives an idea as to what a company owns and owes, and the amount invested by its shareholders. In other words, the balance sheet represents the economic resources the company has, including the claims that creditors and equity holders have on those resources. It can help a company work out its working capital (the money required to fund day-to-day operations) and business liquidity (how quickly it is able to pay current debts). This gives an overall indication of the financial health of the business.
The balance sheet is ‘balanced’ in that it adheres to the following formula: Assets = Liabilities + Equity
Assets refer to the economic resources that a company uses to run its business. Assets are typically further categorised by how ‘liquid’ they are, that is, how easily they can be converted to cash. Those that are more liquid are known as ‘current assets’ as opposed to ‘non-current’ or ‘long-term’ assets.
Current assets include for example cash, accounts receivable and inventory. Non-current assets include, for example, fixed assets such as land, machinery, equipment and buildings and intangible assets such as intellectual property or goodwill.
Liabilities are the debts of the company or what the company owes to outside parties. In other words, liabilities are the claims that creditors have on the company’s resources.
A company may have debts because it has borrowed money to buy new equipment or to run their business for example, bills it must pay suppliers. Similar to assets, liabilities can be subdivided into current and non-current. Current liabilities are those that are due within one year and include for example, rent, tax, utilities, wages, dividends payable and interest. Non-current liabilities include long-term debt and deferred tax liabilities.
Equity is calculated as assets less liabilities. It represents the net worth of a company or the claims that the investors have on the company’s resources. For example, like a creditor, an investor may provide cash to a company to run their business. However, unlike a loan made by a creditor, an equity holder’s investment is not guaranteed as a company does not promise to pay back their investors a specific amount over a specified period of time. Instead, an investor’s return is often contingent on the operating performance of a company.
It is not common that you will be given a balance sheet during a case interview but there have definitely been some instances such that we thought it was helpful to go through it here. It is important to remember that a balance sheet on its own is simply a snapshot in time. It must be compared to previous periods in order to understand a company’s trends. Instead, if you are presented with a balance sheet during a case interview, think about why you are given this information and how it is relevant to the problem at hand.
The statement of cash flows basically shows how much cash is coming in and out of a business. It helps to determine the short-term viability of a company, particularly its ability to pay its bills. Cash inflows include for example cash from ongoing operations and external investment sources. Cash outflows refer to cash paid for business expenses and other investment activities.
Cashflows in the cash flow statement are categorised as either cashflows from operating activities; cashflows from investing activities; or cashflows from financing activities.
Between the balance sheet, the income statement and the statement of cash flows, you will be able to get a pretty good picture of a company’s financial position and performance. Again, remember the interview is not about demonstrating you are the best accountant ever. Instead, if you are presented with any one of these statements, ask yourself what information are you being shown, why and how it is relevant to the case.