Chapter 4
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Chapter 4. Personal Financial Statements (Preparation and Analysis). Financial Statements Provide Information About:. Financial resources available to client How resources were acquired What the client has accomplished financially utilizing these resources. Personal Financial Statements.

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Chapter 4

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Chapter 4

Chapter 4

Personal Financial Statements

(Preparation and Analysis)

Chapter 4: Personal Financial Statements


Financial statements provide information about

Financial Statements Provide Information About:

  • Financial resources available to client

  • How resources were acquired

  • What the client has accomplished financially utilizing these resources

Chapter 4: Personal Financial Statements


Personal financial statements

Personal Financial Statements

  • Balance Sheet

  • Income Statement

  • Statement of Changes in Net Worth

Chapter 4: Personal Financial Statements


Financial statements are used

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

Chapter 4: Personal Financial Statements


Balance sheet terms

Balance Sheet Terms

  • Asset

  • Liability

  • Net Worth

Chapter 4: Personal Financial Statements


Asset categories classifications

Asset Categories & Classifications

  • Cash and Cash Equivalents

    • Liquid – easily converted to cash

    • Convert to cash within a year

  • Investment Assets

    • Held for growth or income

  • Personal-Use Assets

    • Long-lived assets

    • Used to maintain quality of life

Chapter 4: Personal Financial Statements


Liability categories classifications

Liability Categories & Classifications

  • Current Liabilities

    • Credit card debt & unpaid bills

  • Long-Term Liabilities

    • Debts of larger assets

Chapter 4: Personal Financial Statements


Valuation of assets liabilities

Valuation of Assets & Liabilities

  • Assets valued at FMV

  • Liabilities represent principal owed

Chapter 4: Personal Financial Statements


Sample balance sheet

Sample Balance Sheet

Chapter 4: Personal Financial Statements


The income and expense statement

The Income and Expense Statement

  • Summary of client’s income and expenses over a period of time, usually one year

  • May focus on realized transactions, and if so, helps compare to budgeted financial goals

  • May be prepared in advance and used for budgeting or projections

Chapter 4: Personal Financial Statements


Income statement terms

Income Statement Terms

  • Income

    • Employment

    • Investment

    • Other

  • Savings

  • Expenses

    • Fixed

    • Variable

    • Discretionary

Chapter 4: Personal Financial Statements


Sample income statement

Sample Income Statement

Chapter 4: Personal Financial Statements


The statement of changes in net worth

The Statement of Changes in Net Worth

  • Summarizes noncash flow changes in net worth not recorded on the income statement.

Chapter 4: Personal Financial Statements


Statement of changes in net worth transactions

Statement of Changes in Net Worth Transactions

  • Changes in value for assets due to appreciation or depreciation

  • If an asset other than cash is exchanged for some other assets

  • If assets other than cash are received by gift or inheritance

  • If assets other than cash are given to charities or noncharitable donees

Chapter 4: Personal Financial Statements


Sample statement of changes in net worth

Sample Statement of Changes in Net Worth

Chapter 4: Personal Financial Statements


Ratio analysis

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?

Chapter 4: Personal Financial Statements


Ratio analysis the objective

Ratio Analysis—The 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

Chapter 4: Personal Financial Statements


Types of ratio analysis

Types of Ratio Analysis

  • Liquidity ratios – emergency fund ratio and current ratio

  • Debt ratios – total debt to net worth, long-term debt to net worth, debt to total assets, long-term debt to total assets, housing costs to gross income, housing and debt payments to gross income

  • Performance ratios – savings ratios and investment performance ratios

Chapter 4: Personal Financial Statements


Emergency fund ratio

Emergency Fund Ratio

EFR = Current Assets

Monthly Nondiscretionary Expenses

Target of 3 to 6 months

Chapter 4: Personal Financial Statements


Current ratio

Current Ratio

CR = Current Assets

Current Liabilities

Target of 1.0 to 2.0

Chapter 4: Personal Financial Statements


Lending ratios

Lending Ratios

  • Housing Costs (Mortgage payment + Property tax + Homeowners insurance) to Gross Income

    • Target of ≤ 28%

  • Housing and Debt Payments (i.e. credit card, auto loan) to Gross Income

    • Target of ≤ 36%

Chapter 4: Personal Financial Statements


Savings ratios

Savings Ratios

  • Rate of Savings = Annual Savings

    Annual Gross Income

    Target of ≥ 10% (age dependent)

  • Discretionary Cash Flow + Savings to Gross Income

    Target of ≥ 10%

Chapter 4: Personal Financial Statements


Investment ratios

Investment Ratios

  • Income on Investments =

    Income from Investments

    Average Invested Assets

  • ROI = EI – BI – Additional Investments

    Average Invested Assets

    Target of 9 to 12%

  • Investment Assets to Gross Income

Chapter 4: Personal Financial Statements


Vertical growth analysis

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

Chapter 4: Personal Financial Statements


Limitations of financial statement analysis

Limitations of Financial Statement Analysis

  • Inflation

  • Use of estimates

  • Few benchmarks for individuals

Chapter 4: Personal Financial Statements


Sensitivity analysis risk analysis

Sensitivity Analysis & Risk Analysis

  • Sensitivity analysis allows manipulation of input variables by small increments to determine the impact on the ratio

  • Risk analysis examines the uncertainty of cash flows to the individual

    • Business or investment risk

    • Financial risk

Chapter 4: Personal Financial Statements


Budgeting

Budgeting

  • A process of projecting, monitoring, adjusting and controlling future income and expenditures.

    • Savings and Consumption Habits

Chapter 4: Personal Financial Statements


Debt management

Debt Management

  • Home Mortgages

    • Fixed-Rule Mortgages

    • Variable-Rate Mortgages or Adjustable-Rate Mortgages (ARMs)

    • Balloon Mortgages

Chapter 4: Personal Financial Statements


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