Personal Financial Statements

1
Chapter 4

• Personal Financial Statements
• (Preparation and Analysis)

2
Financial Statements Provide Information About

• Financial resources available to client
• How resources were acquired
• What the client has accomplished financially
  utilizing these resources

3
Personal Financial Statements

• Balance Sheet
• Income Statement
• Statement of Cash Flows
• Statement of Changes in Net Worth

4
Financial Statements are Used

• By clients to benchmark goal achievement
• By planners to help clients set financial
  direction
• By creditors lenders to make decisions to
  extend, continue, or call indebtedness

5
Balance Sheet Terms

• Asset
• Liability
• Net Worth

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Asset Categories Classifications

• Cash and Cash Equivalents
• Liquidity easily converted to cash
• Current Assets converted within a year
• Investment Assets
• Held for growth and/or income
• Personal Use Assets
• Long-lived assets
• Used to maintain quality of life

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Asset Categories Classifications

• Cash and Cash Equivalents
• Checking, savings, MM accts
• CDs, tax refunds, CVLI (current use)
• Investment Assets
• Stocks, bonds, mutual funds
• CVLI (not current use)
• Real estate, collectibles, business interests
• Retirement accounts annuities

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Asset Categories Classifications

• Personal Use Assets
• Primary residence
• Vacation home
• Automobiles
• Recreational vehicles
• HH items
• Jewelry

9
Liability Categories Classifications

• Current Liabilities
• Current portion of mortgage
• Utilities
• Credit cards
• Insurance premiums
• Taxes due
• Medical bills due repair bills due etc.

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Liability Categories Classifications

• Long-Term Liabilities
• Primary residence mortgage
• Vacation home mortgage
• Other mortgages (2nd)
• Auto loans
• Student loans
• Other loans

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Information Sources

• Bank Statements
• Investment account statements
• Life insurance statements
• RE purchase agreement
• Mortgage notes
• Car and other notes
• Credit card statements
• Employer benefit statements
• Appraisals

12
The Income and Expense Statement

• Is a summary of the clients income and expenses
  during an interval of time, usually one year
• May focus on realized transactions, and if so,
  helps compare to budgeted financial goals
• Should prepare actual and budget

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Income Statement Terms

• Income
• Employment
• Salary W2/tax return
• Investment
• Interest/dividends -- 1099
• Other

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I/S Terms - expenditures

• Savings
• Expenses
• Fixed recur every month
• House payment
• Car payment
• Insurance premium
• Child support/daycare/etc.
• Variable
• Food
• Utilities
• Discretionary
• Vacation/entertainment/gifts

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The Statement of Cash Flows

• For a given period, the statement of cash flows
• Shows the inflows and outflows and the net change
  in cash between two balance sheets
• Identifies the changes in some of the accounts
  from one balance sheet to the next

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Statement of Cash Flows Classifications

• Cash Flows from Operations
• Cash Flows from Investing Activities
• Reclassify savings
• Purchase/sale of assets
• Cash Flows from Financing Activities
• Proceeds from additional borrowings
• Reclassify principal payments

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Ratio Analysis

• The key to ratio analysis is
• Does the ratio get to the answer for the question
  asked?
• Is there some standard or benchmark to determine
  whether the result is appropriate for this
  particular client?

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Ratio AnalysisThe Objective

• The objective of ratio analysis is twofold
• To gain additional insight into the financial
  situation and behavior of the client
• To generate questions for the client to answer to
  further gain such insight

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Types of Ratio Analysis

• Liquidity ratios emergency fund ratio and
  current ratio
• Emergency Fund Ratio Liquid Assets/Monthly
  nondiscretionary expenses
• Target ? 3-6 months
• Current Ratio Current Assets/Current
  Liabilities
• Target 1.1 2.1

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Types of Ratio Analysis

• Debt ratios total debt to net worth, long-term
  debt to net worth, debt to total assets,
  long-term debt to total assets
• No targets
• Quality debt (mtg) low quality (credit card)
• Matching duration with benefit created

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Types of Ratio Analysis

• Monthly housing cost/Gross monthly income ? (mortgage lenders)
• Housing cost Princ Int RET Ins
• Housing Cost Other Debt Pymt/Gross Monthly
  Income ?

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Performance Ratios - Savings

• Annual Savings / Annual Gross Income
• Annual Savings / Annual Gross Income
• Savings Personal Employer related
• BK ? 10 at 30 15 at 40
• Discretionary CF Savings/Annual Gross Income

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Performance Ratios - Investments

• Rate of Return on Investment
• (EI BI Savings Gifts)/ Avg Investment
• Average Investment (EI BI)/2
• Investment Assets / Gross Income
• 10 at normal retirement
• 3-4 x, 10 years prior to retirement
• 1, 20 years prior to retirement

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Vertical Growth Analysis

• Vertical analysis
• Balance sheet each item presented as a percent
  of total assets
• Income statement each item presented as a
  percent of total income
• Growth analysis
• Calculates the growth rate of certain financial
  variables over time using TVM tools

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Limitations of Financial Statement Analysis

• Inflation
• Use of estimates
• Few benchmarks for individuals

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Sensitivity Analysis Risk Analysis

• Sensitivity analysis allows the manipulation of
  numerators and denominators by small increments
  to determine the impact on the ratio
• Risk analysis examines the uncertainty of cash
  flows to the individual
• Income risk
• Expenditure risk