Chapter #5

The amount of cash available after such targeted investing (retirement or down payment on a house) is called?

net cash flow

Expenses can be divided into?

nondiscretionary and discretionary items

types of household activities?

operating, financing, and investment activities

What is a balance sheet, and why is it important?

A balance sheet is a financial statement that presents household assets and liabilities as of a point in time. It is important because it can present an accurate picture of the household's financial position, particularly when it is based on the fair market value of its assets.

What is a cash flow statement, and why is it important?

A cash flow statement is a presentation of the household's cash inflow and outflow for a period of time, often a year. Cash flow is the lifeblood of household planning and a detailed statement helps to establish the financial operating health of the household.

functional cash flow statement?

A cash flow statement that separates cash flows by type of household activity

Contrast a functional and a traditional cash flow statement.

A functional cash flow details cash flow by type of household activity. A traditional cash flow statement only breaks things into inflows and outflows. They both use and provide the same statistics as represented by the net cash flow figure.

What are reasons that a person may have a poor net cash flow yet be considered to be in good financial health?

A person can have a poor cash flow but still be in good financial health when: a) Job-related cash flow is growing materially while expenses are flattish. b) The reason for the negative cash flow is large yearly outlays on capital expenditure items necessary to make the household more healthy. An example could be full-time attendance for an MBA.c) Debt repayments are the principal reason for the negative flow.

What is a pro forma statement? What is its use?

A pro forma statement is one that contains projections. Its goal is to understand today the financial implications of anticipated future actions. It serves as a strong basis for current planning moves.

Contrast the views of finance and accounting on recording operating results.

Accounting attempts to portray a pairing of income and expenses to arrive at a proper representation of profits for a period. It includes noncash items such as accruals, depreciation and annuitization. For finance only cash matters and there is no attempt to get at a profit figure. The goal is an explanation of cash flow for the period.

Is an increase in debt a plus or minus from a cash flow standpoint? Explain.

An increase in debt is a plus from a cash flow standpoint. That is because it provides the household with a source of funds. The fact that the debt provided represents a future obligation that must be paid off is not recognized in a current cash flow statement. It would be shown on the balance sheet, of course.

In which ways is Household accounting similar to a basic finance principles? how is the different from GAAP?

Changes in cash generally determine results for a period. Under GAAP, the business attempts a proper matching of revenues and expenses. Its goal is a fair presentation of business results for a period—say, within a year. Its results can involve cash and noncash items for a particular period.

Retirement investments?

Financial assets in individual or company plans.

Finance and accounting are different disciplines, which have alternative ways of presenting transactions and results. Formal accounting employs?

GAAP (generally accepted accounting principles)

What is household equity, and how do you calculate it?

Household equity is the net worth of all the assets and liabilities associated with the household. Household equity is calculated by the difference of Assets less Liabilities.

In your opinion, which presents results more fairly, finance or accounting? Explain.

In an ideal world perhaps accounting's profitability would provide a good benchmark for results for a period. However, inevitably judgment and self-interest can enter into results done under accounting's generally accepted accounting principles. Accounting has indirectly acknowledged the problem of bias by requiring that balance sheets be stated principally on a cost basis, easily measurable rather than fair market value which is more useful but leaves more room for judgment.Finance makes no attempt at a profit standard but its cash flow benchmark is more objective since net cash flow figures for the year can be easily checked by using a cash figure at the beginning of the year less a cash figure at the end of the year. Both have their place in analysis. However finance's cash flow while still not as prominent as GAAP is gaining in popularity.

separate rate definition? example?

Increases in salaries, particularly among younger workers, are projected using a separate rate Investment income can be projected based on an assumed return. Insurance costs are based on contractual rates, and mortgage interest and principal payments also are stated in that contract.

What is the major difference between household accounting and business accounting?

One of the major differences between household accounting and business accounting is that households use a cash basis whereas businesses use the accrual basis of accounting.

Why segregate a balance sheet by type of asset and type of liability?

Segregation by type of assets and liabilities can better assess household availabilities versus household needs. For example the amount of money set aside in retirement plans can serve as a benchmark for availability for retirement use particularly when other financial assets are targeted for other needs. Segregation also provides an easier method of analysis by function and allows the household to see how much of their equity comes from each major area.

Outline some expenses of a pro forma statement that cannot use inflation to project their growth and indicate what rate should be used.

Some expenses that cannot use inflation to project growth or indicate rate on a pro forma include: a) Insurance - Actual contracted for figures or anticipated future rates based on projected expense patterns. b) Mortgage Interest - Fixed-rate mortgages lead to declining interest and increasing debt repayments. Adjustable-rate mortgages would have the same dynamics if the current interest rate is assumed to be indicative of the future rates. c) Vacations - Current plansd) Gifts and charitable contributions - Current intente) Taxes - Taxable income and anticipated changes in the tax code f) Capital Expenditures - Plan for capital outlaysg) Debt - Contracted for repayment schedule

Detail the sections of a functional cash flow statement.

The sections of a functional cash flow statement include: a) Income b) Non-discretionary expenses c) Discretionary expenses d) Capital expenditures e) Financing activities f) Target outlays g) Net cash flow

Elaborate on the two approaches to making projections for a cash flow statement.

The two approaches to the cash flow statement are the common rate and the separate rate. The common rate is the rate of increase in household expenses and often uses the inflation rate. The separate rate is used for certain inflows and outflows that cannot be determined by inflation such as salary, insurance costs and investment income.

Human-related assets definition?

a broader term that includes other forms of resources in addition to human assets that are omitted from the balance sheet.

net working capital?

a figure reached by subtracting current liabilities from current assets.

Balance sheet definition?

a statement of financial position at a given point in time

traditional cash flow statement?

all inflows and outflows of cash are grouped together

capital expenditures under GAAP are treated as? for households?

an asset on the balance sheet, not as an expense on the income statement. For households, cash outflow on cash flow statement at fair market value

discretionary expense?

are those you choose to make, principally because you get pleasure from them. Examples are entertainment, eating out, and vacation outlays. The difference between income and expenses is the cash flow from operations.

marketable investments definition? examples?

assets that are traded publicly ex: stocks and bonds

Investments are separated into?

capital expenditures and financial investments

Household results for a period are provided on a _______ statement, whereas business results are given on an ________ statement.

cash flow; income

Investment assets are expressed on the balance sheet at their?

current value

Household equity, another name for household net worth, is the?

difference between its assets and liabilities

cash flow statement is perhaps the single best measurement of the? why?

financial performance of a household -it represents how much cash has been generated over a period of time

The most prominent asset for the household is typically the future income stream of its wage earners, called

human assets

liabilities definition? examples?

items the household owes ex: Credit card debts, taxes outstanding, and mortgage debt are all liabilities.

Finally, GAAP generally requires that businesses record transactions on the balance sheet at? how do households?

original cost less accumulated depreciation. Households generally record assets at their fair market value.

capital expenditures definition? examples?

outlays on household-related matters that provide benefits beyond the current year - form of investment - cars, furniture, fixtures, and appliances.

financing activities definition?

responsible for the cash flows that come from changes in debt

income examples?

salary, investment returns, and other sources of operating cash

balance sheet is aka?

statement of financial position

what are pro forma statements?

statements that include projections

savings definition?

the cash left over after your operating, capital expenditure, and debt activities. It is also known, for financial statement purposes, as cash flow, representing prior cash inflows minus cash outflows.

There are two principal approaches to making projections for a cash flow statement, what're they?

the common rate and the separately estimated rate or amount.

operating activities definition?

the day-to-day financial functions of the household. (income and expenses)

what is a nondiscretionary expense?

the household's overhead items such as interest expense, rent, household, Page 115food, clothing, and taxes - largely fixed costs

depreciation definition?

the projected reduction in asset value due to wear and tear or obsolescence. It is a tax-deductible expense on the business income statement.

common rate definition?

the rate of annual increase that many household expenses share. - that increase is often based on an assumed future inflation rate

current assets definition? examples?

those that are expected to be or can be converted into cash in the current year. EX: checking accounts, money market funds, and refunds due such as those on catalog purchases

household assets examples?

vehicle, furniture, and appliances