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FINANCIAL STATEMENTS AND CASH MANAGEMENT

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FINANCIAL STATEMENTS AND CASH MANAGEMENT What is the relationship between income and “investment margin”? What type of automotive vehicle is the most popular among U.S. millionaires? FROM DAVE RAMSEY.COM Proper financial management is 80% behavior and 20% knowledge. (almost verbatim)

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slide2

What is the relationship between income and “investment margin”?

  • What type of automotive vehicle is the most popular among U.S. millionaires?
  • FROM DAVE RAMSEY.COM
  • Proper financial management is 80% behavior and 20% knowledge.
  • (almost verbatim)
  • Our budget always failed. The failures stemmed from the fact that we would create a budget and then try to live on it every month. That worked fine until life smacked us around, throwing the budget completely out of whack.
  • Now, we create a new budget every single month. We spend out paychecks on paper BEFORE we actually get them.
slide3

DAVE RAMSEY’S SEVEN BABY STEPS TO FINANCIAL FREEDOM

  • $1,000 to start an emergency fund.
  • Pay off all debt (excluding home) using the debt snowball.
  • 3 to 6 months of expenses in savings.
  • Invest 15% of household income into Roth IRAs and pre-tax retirement plans.
  • College funding for children.
  • Pay off home early
  • Build wealth and give.
slide4

BUDGETING AND CASH MANAGEMENT

  • WHAT IS A BUDGET?
  • Many financial planners never use the term “budget. Instead, they use “cash flow management.”
  • An estimate of how much money will be received and spent for
  • various purposes within a given time frame.
  • HOW CAN IT BE USED?
  • A budget has little value unless a comparison is made of actual
  • results with expected results.
  • WHEN SHOULD BUDGETS BE USED?
  • SHOULD ALL FAMILIES HAVE A BUDGET?
  • When there is a need to measure periodic progress
  • toward a specific goal.
  • 2. When income and expenditures are complex.
  • When there is a need to communicate a planning strategy
  • to others.
  • When there is a need to provide incentives (rewards) for
  • meeting a budget.
  • 5. Monitoring the performance of an investment.
slide5

GUIDELINES FOR BUDGETS

Must be flexible.

Usually covers a calendar year on a month by month basis.

Must be simple, short and understandable.

(Eliminate extraneous information).

Do not strive for absolute accuracy.

Tailor the budget to specific goals and objectives.

Include all sources of income

Divide expenses into fixed and discretionary.

Highly Irregular Cash Flows

Develop more than one budget:

1. using lowest income and highest expenses

2. reasonable (most probable) expectations of cash flows

3. highest income and lowest expenses (best case scenario).

slide6

PERSONAL FINANCIAL STATEMENTS

Property not owned is not shown on financial statements, e.g.

property in trust for someone else.

Joint ownership—only the proportionate interest should be

shown.

Real estate should be carried at market value less the cost of

selling the property.

Joint ownership—only the proportionate interest should be

shown.

Business valuation—is very difficult, especially if it is a minority

interest.

Any material transactions costs to convert to cash should be

shown separately. For example, a vested pension worth

$800,000 should show the tax to be paid when the money is

taken.

Receivables should be shown at a discounted value.

Life insurance cash values must show outstanding policy loans,

if any.

slide7

EMERGENCY FUND

PURPOSE

TYPE OF INVESTMENTS

AMOUNT

Emergency Fund Ratio

Liquid assets / Total monthly household expenses

Often a ratio of at least 3X is called for.

Notice that this ratio differs somewhat from the typical

rule of thumb of 6 months income.

slide8

THE THREE “C’s” OF CREDIT

1. CAPACITY

Ability to repay the debt.

2. CHARACTER

Will the borrow repay the debt—what is his credit history?

3. COLLATERAL

Is the creditor protected if the borrower defaults?

slide9

FINANCIAL RATIOS

1. Current Ratio

Should be greater than 1X.

2. The Debt Ratio

Total debt / Total assets

Young people may have high ratios, such as 80%,

but older people often have ratios of 50% of less.

3. Debt to Income Ratio

Installment debt (credit cards, car loans, etc. not counting

real estate) / Net income

Generally 10% or less is great. 20% or more can be a

yellow light for a lender. The lower the better.

slide10

4. Front-end Ratio

Monthly housing expense / gross monthly income

The monthly housing expense is PITI (principal, interest, taxes and insurance). Homeowner’s association dues and mortgage insurance premiums should be added if applicable.

The denominator (gross income) is income before taxes.

The traditional rule of thumb is that the ratio should not exceed 25%, but some lenders go higher.

slide11

5. Back-end Ratio

Total monthly debt payments / monthly gross income

The numerator includes PITI but also other monthly debt payments.

35% - 40% is the usual limit.

HOW TO HANDLE DEBT PROBLEMS?

1. Realistic budgeting

2. Credit counseling from a reputable organization

3. Debt consolidation

Usually points are charged. Interest is deductible.

4. Bankruptcy

5. (Divorce?)

slide12

BANKRUPTCY

Stays on your credit report for 10 years. It usually does not erase child support, alimony, fines, taxes, and some student loans. Some assets might be exempt from bankruptcy, e.g., home, cars, working tools, etc.

Chapter 7 (straight bankruptcy) liquidates all assets that are not exempt.

Chapter 13 allows the filer to keep most property if they establish a court-approved repayment plan of

3-5 years.

slide13

THE NEW BANKRUPTCY LAW (Became effective October, 2005).

CHAPTER 7

1. MEANS TEST

Clients no longer have easy access to Chapter 7

protection. They have to pass a complete means test to

qualify for Chapter 7. Those that fail may consider

Chapter 13.

2. HOMESTEAD EXEMPTION

Regardless of the amount of the state exemption, homestead exemptions are now capped at $125,000

if the client has resided in the home less than 3 years and four months.

3. TIME BETWEEN FILINGS

Cannot file for another 8 years (increased from 6 years)

slide14

CHAPTER 13

1. LONGER REPAYMENT PLANS

Now up to 5 years

2. TIME BETWEEN FILINGS

A client cannot file another Chapter 13 within 4 years of a

Chapter 7 or two years of a prior Chapter 13.

OTHER PROVISIONS

1. MANDATORY CREDIT COUNSELING

Filers must complete both credit counseling and financial

management education from a nonprofit agency approved by the US Trustee program

2. NEW PROTECTIONS

The new law protects IRA and 529 plans.

3. MORE NONDISCHARGEABLE DEBTS

Now includes student loans from nongovernmental and profit

making organizations, certain purchases of luxury items, and

certain recent loans.

slide15

CREDIT RATINGS

CREDIT RATING AGENCIES

The main agencies are Experian, TransUnion, and Equifax.

They all use the same formula developed by Fair, Isaac, Inc.

The formula is proprietary and confidential. Different scores

are produced by different agency because they don’t all use the

same data.

Lenders rely heavily on these scores.

slide16

WHAT DETERMINES THE CREDIT SCORE

35% Payment history. (Pays on time, adverse records, etc.)

30% Amount owed (percentage of available credit)

15% Credit history (age of the accounts—the older the better)

10% The type of credit on record.

10% Number of recently opened accounts.

Missing even a single payment could cost 100 points.

slide17

TIME LIMITS ON REPORTING

Bankruptcy information is reported for 10 years.

Information about criminal convictions has no time limit.

Credit information for more than $150,000 of credit or life insurance

has no time limit.

Defaults on student loans is reported for 7 years.

Unpaid judgments and lawsuits can be reported for 7 years of until

the statute of limitations runs out, whichever is longer.

(Some travel, entertainment, gas, local retailers, and credit unions

do not report to any credit rating agency).

slide18

AVERAGE CREDIT SCORES

Ages US NC SC

18-29 637 630 623

30-39 654 645 638

40-49 675 666 657

50-59 697 691 683

60-69 722 719 711

70+ 747 743 738

slide19

What is a “good” score? It varies by lender.

Some say 700, some 750, some 680.

Generally anything over 700 is a good score.

The average in the South Atlantic states,

Florida to PA, is 675.

slide20

$150,000 30 year fixed loan on 8/30/05

Your Credit Your Interest Your Monthly

Score Rate Payment

750 – 850 5.44% $846

700 – 750 5.66% $867

680 – 699 5.84% $884

660 – 679 6.05% $904

640 – 659 6.48% $946

620 – 639 7.03% $1,001

Daily updates are available at:

“myfico.com/FICOCreditScoreEstimator/AboutScores.aspx

$1,001 - $846 = $155 per month or $1,860 per year.

The present value of $1,860 per year for 30 years at 6% is about

$25,600.

slide21

FACTORS THAT GO INTO BORROWING ABILITY

Late payment history

Late payments, collections, and bankruptcies hurt the

most. Every payment that is 30 days overdue is shown.

Delinquencies remain for 7 years. Some bankruptcies

remain for 10 years. Unpaid tax liens remain for 15 years.

Inquiries remain for 2 years.

The number of open accounts. Closing accounts can

never help your credit score, and may hurt it. Too many

open accounts can hurt your score, but once you have

opened the accounts, your have done the damage.

The age of the accounts. Generally, the older the accounts,

the better the score. This means paying off old accounts

might be a negative because it can make your credit history

look younger than it actually is.

slide22

Debt / limit ratios

Debt should be kept at less than 50% of the limit.

Number of inquires

Applying for new credit is generally what hurts your score.

Too many inquiries may signify to lenders that you are extending

yourself too much. “Soft inquiries” do not hurt your credit.

These are personal inquires from yourself and inquiries made by

lenders when they send you an offer of credit.

Factors other than your Credit Score

Lenders sometimes consider other factors such as income,

assets, etc. Note that these things are not included in a credit

score.

slide23

DEVELOPING AND MAINTAINING

GOOD CREDIT

What can you do to quickly improve your

credit score?

Nothing.

Credit repair

Incorrect facts in a report can be disputed, but the retailer is very much in

control.

Pay bills on time

Keep balances low.

Pay off debt rather than moving it around.

Inquire at least once each year

You can get 1 free credit report each year, but this does not include

a credit score.

Apply for and open new accounts only as needed.

slide24

What is the difference between a “credit score” and an

“insurance score”?

IDENTITY THEFT

You may need to:

1. Contact one of the credit agencies.

2. View credit reports

3. Write a victim statement

4. Contact creditors of tampered accounts

5. Contact law enforcement

6. Contact FTC

7. Change all account passwords

8. Notify the Office of the Inspector General if your social

security number has been fraudulently used

9. Change your driver’s license number

10. Contact utility companies

slide25

IDENTITY THEFT INSURANCE

Coverage typically costs from $20 to $100 a year, as a rider to a

basic homeowner’s policy or as a stand-alone purchase.

What does it cover?

Insurance cannot protect you from becoming a victim of identity theft

and does not cover direct monetary losses incurred as a result

of identity theft. It simply covers some of the expenses you will

incur to deal with the problem, such as the costs of making

phone calls and copies, mailing documents and possibly legal bills.Some policies won’t cover legal fees or lost wages due to time

away from work.

Deductible?

They generally range from $100 to $250, but some are as high

as $1,000. And the average victim spends less than $1,500 to

recover from ID Theft, according to the FTC.

slide26

Alternatives to Insurance?

You may be able to get ID theft protection for free. American

Express, for example, makes its identity theft assistance

available to all cardholders for free. It gives you round-the-clock

telephone access to company representatives who will “help

you determine if your identity has been stolen, navigate the

recovery process, and protect yourself in the future.”

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