Foundations in Financial Planning SM Education Program Professional Module 2 Financial Statements & Cash Flow Management

©2012, College for Financial Planning, all rights reserved.

Learning Objectives

2–1: Describe the purpose or use of a statement of financial position or a cash flow statement.

2–2: Identify components of a statement of financial position or a cash flow statement.

2–3: Calculate an individual’s net worth on a given date or an individual’s net inflow for a period ending on a given date.

2–4: Analyze a statement of financial position or a cash flow statement to determine the status of an individual’s financial health.

2–5: Define a financial ratio or the use of a given ratio.

2–6: Identify a standard guideline (rule of thumb) related to a financial ratio.

2–7: Describe credit or a type of credit.

2–8: Identify factors a lender uses to evaluate a potential borrower.

2–9: Identify appropriate levels of debt.

2–10: Identify the items that are used to develop a budget.

2-2

Questions To Get Us Warmed Up

2-3

Statement of Financial Position

This financial statement is also known as a balance sheet.

Purpose

to provide a static snapshot of a person’s financial status as of a certain date and at a specific point in time

Components

Assets – Liabilities = Net Worth 2-4

Cash Flow Statement

Purpose

to summarize cash inflows and cash outflows over a past (dynamic) time period (such as a year)

Components

Inflows – Outflows = Net Inflow (or Outflow) 2-5

Analysis of Financial Statements

• • • • • • •

Evaluate:

Emergency fund Debt level Savings pattern Asset diversification Retirement planning Income tax issues Other areas?

2-6

Liquidity (Solvency) Ratio

Guideline

Have three to six months of expenses in an emergency fund.

Basic Liquidity  Ratio Cash and cash equivalent Monthly (liquid) expenses assets 2-7

Liquid Assets to Net Worth Ratio

Guideline

15% or higher Liquid Assets to Net Worth Ratio  Liquid assets Net worth 2-8

Savings Ratio

Guideline

10% or higher Savings Ratio  Savings ( and investment s ) Gross income 2-9

Debt-to-Asset Ratio

•

Guideline

50% or lower Debt to Ratio Asset  Total debt Total assets 2-10

Debt-to-Income Ratio

Guideline

35% or lower Debt to Income Ratio  Annual debt repayments Annual take home pay 2-11

Non-Mortgage Debt-to-Income Ratio

Guideline

15% or lower Non Debt mortgage to Income Ratio  Annual non mortgage debt Annual take home repayments pay 2-12

Net Invested Assets to Net Worth Ratios Guideline

50% or higher Net investment Net worth assets ratio to  Net investment Net worth assets 2-13

Credit & Debt

• • • •

Advantages/Uses

Necessity Convenience Immediate gratification Emergency • •

Potential Problems

Overspending Cost 2-14

Qualifying for Credit: 5 C’s

• • • • • Character Capital Capacity Collateral Conditions 2-15

Types of Credit

• • •

Installment/Closed-end/Long-term

Mortgages o o o fixed rate conventional government o variable rate (ARM) Auto loans Student loans • •

Revolving/Open-end/Short-term

Credit cards Overdraft protection 2-16

Buying vs. Leasing

Factors: Cost and convenience

• • Auto leasing Open-end: may require payment of difference between value and resale Closed-end: may have mileage surcharge • • Renting versus home ownership Reasons to rent Reasons to buy a home 2-17

Consumer Credit Laws

• • • • • • • Truth in Lending Act Fair Credit Reporting Act Fair Credit Billing Act Equal Credit Opportunity Act Fair Debt Collection Practices Act Fair Credit and Charge Card Disclosure Act 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act 2-18

Bankruptcy Law

• • • Consumer Credit Counseling Services Chapter 7 (full liquidation) o o almost all debts erased file only once every six years Chapter 13 (repayment) o o freeze debt level attempt to pay back most/all debt 2-19

Acceptable Debt Levels

• • • •

Debt-to-asset ratio:

50% or lower

Debt-to-income ratio:

35% or lower

Nonmortgage debt-to income ratio:

15% or lower 2-20

Creating a Budget

This is also known as a pro forma cash flow statement.

Purpose

to project income and expenses over a future period of time (year)

Components

Inflows – Outflows = Net Projected Inflow (Outflow) 2-21

Uses of a Budget

• • • • Spend money more wisely.

Live within current income.

Plan for large expenditures.

Set aside money for financial goals.

2-22

Budget Mechanics

• • • Listing budget items Recording Monitoring 2-23

Question 1

Which one of the following items would not be found on a statement of financial position? a.

auto note balance b.

c.

d.

annual IRA contribution vested retirement benefits mortgage balance 2-24

Question 2

The debt-to-income ratio measures which of the following debt measures?

I.

mortgage debt II.

III.

IV.

non-mortgage debt consumer debt revolving debt a.

I only b.

c.

d.

I and III only II and IV only I, II, III, and IV 2-25

Question 3

• • • • • • • Bob Humphrey’s financial situation is as follows: Cash/cash equivalents: $15,000 Short-term debts: $8,000 Long-term debts: $133,000 Tax expense: $7,000 Auto note payments: $4,000 Invested assets: $60,000 Use assets: $188,000 What is Bob’s net worth?

a.

b.

c.

d.

$111,000 $122,000 $137,000 $263,000 2-26

Question 4

Which one of the following debt-to-asset ratios would be considered to be safe?

a.

less than 50% b.

c.

d.

greater than 50% less than 62% greater than 65% 2-27

Question 5

a.

b.

c.

d.

Of the following types of debt, which one provides the greatest tax benefit to the individual consumer with regard to interest paid on the debt?

auto loan debt credit card debt home mortgage debt student loan debt 2-28

Question 6

Which one of the following items of consumer legislation allows the consumer to correct errors found on their credit report?

a.

b.

c.

d.

Fair Debt Collection Practices Act Equal Credit Opportunity Act Consumer Credit Protection Act Fair Credit Reporting Act 2-29

Foundations in Financial Planning SM Education Program Professional Module 2 End of Slides

©2012, College for Financial Planning, all rights reserved.