FIN 4710 Exam 1

Two-Step/Three-Panel Approach

A step-by-step approach where the client's actual financial situation is compared against benchmark criteria. It stresses the management of risk, seeks to avoid financial dependence, and promotes savings and investing to achieve financial independence.

What is a financial plan?

A written document that sets out a list of recommendations to achieve a set of goals and objectives based on the client's current financial situation

Life Cycle Approach Phases

Asset Accumulation Phase, Conservation (risk management) Phase, and Distribution (gifting) Phase

Discuss how assets and liability values are reflected on the balance sheet.

Assets reflect their fair market value while liabilities are stated at their current outstanding balance as of the date of the balance sheet.

Internal info: Qualitative information definition & examples

Attitude or belief including attitude on working vs retiring or spending vs saving. Gather education goals, retirement goals, risk tolerance, savings goals, etc.

Discuss the difference between income and savings contribution categories listed on the income statement.

Income is recurring money earned by the client such as a salary, interest, dividend, pension, retirement account withdrawals, or business income. Savings contributions is money saved by the client through an account such as a 401(k) plan, 403(b) plan, 457(b) plan, IRA, education savings, reinvested dividends, interest, or capital gains,

External info: Planner should identify external information at inception of engagement including:

Interest rates, housing market, job market, investment market, business cycle, local insurance costs, local cost of living, expected inflation rates, and current/expected income/gift/estate tax rates, + more

Internal Info: Quantitative information definition & examples

Is measurable and includes the client's age, income, # of children, death benefit of life insurance policies, etc. Gather age, education, insurance policies, current bank + investment accounts, taxes, retirement + employee benefits, estate planning, etc.

What is an advantage to using the pie chart approach with clients?

It helps the client to see pictorially and to understand where their assets are deployed in cash, in investment assets, or for maintaining their current lifestyle in retirement.

Debt to Total Assets Ratio

Total Debt/Total Assets

Strategic Approach

Uses mission, goal, and objective approach considering internal and external environment and may be used with other approaches.

What are some of the questions that a balance sheet pie chart will answer?

What percentage of total assets are in the form of: cash & equivalents investment assets personal use assets current liabilities long-term liabilities net worth

What are the liquidity ratios used in the financial statement and ratio analysis approach?

Liquidity ratios, Debt ratios, Ratios for financial security goals, and performance ratios

Define the emergency fund ratio.

a measure of how many months of non-discretionary expenses the client has in the form of cash and cash equivalents or current assets. The emergency fund ratio equals cash and cash equivalents divided by monthly non-discretionary cash flows.

Define the savings rate.

a measure of the amount a client is saving towards their retirement goal. equals savings plus the employer match divided by gross pay. It is worth noting that this includes any employee and employer contributions.

If a client pays attention to every spoken word and asks for an explanation of words, the client's learning style is likely:

that of a verbal learner and graphics may be supplemented with very carefully selected words

Metrics Approach

uses quantitative benchmarks that provide rules of thumb for a measurement of where a client's financial profile should be.

Housing Ratio 1

Housing Costs / Gross Pay <= 28%

List the four debt ratios used in the financial statement and ratio analysis approach.

Housing Ratio 1, Housing Ratio 2, Debt to Total Assets ratio, and Net Worth to Total Assets ratio

Housing Ratio 2

(Housing Costs + Other Debt Payments) / Gross Pay <= 36%

Elements of an engagement letter:

1. Define the parties to the agreement 2. A description of the mutually agreed upon terms 3. The time horizon for the work to be completed 4. A description of the fees & costs 5. The obligations & responsibilities of each party

Financial Planning Process

1. Establish & define client relationships 2. Gather client data 3. Analyze & evaluate client's financial status 4. Develop & present financial planning recommendations 5. Implement financial plan recommendations 6. Monitor plan

What are some of the questions that an income statement pie chart will answer?

1. What percentage of gross pay is the client paying in taxes 2. What percentage of client's gross pay are they saving 3. What percentage of client's gross pay goes to insurance 4. What percentage of gross pay is spent on basic housing costs 5. What percentage of the client's gross pay is spent on debt repayments

What is an engagement letter?

A legal agreement (contract) between a pro org and a client that defines their business relationship. It should define the parties to the agreement, specific services to be provided, duration, methods of communication, expected frequency of contact, and the conditions where the agreement can be terminated.

two-step approach

Covering the risks and saving and investing

Current Ratio Formula

Current Assets / Current Liabilities >= to 1

List and define the major categories on the assets side of the balance sheet.

Cash and Cash Equivalents are highly liquid assets that are cash or can be converted into cash within 12 months. These are safe investments that are unlikely to lose value such as a certificate of deposit. Investment Assets include appreciating assets or assets that are held to accomplish one or more financial goals. This includes retirement accounts, brokerage accounts, education funds, cash value in life insurance, and business ownership interests. Personal Use Assets are assets that maintain a client's lifestyle such as personal residences, automobiles, boats, vacation homes, and collectibles.

Strategic Approach

Characterized by a client mission statement, a set of goals, and set of objectives to focus on the needs driven by the client.

Life Cycle Approach

Data Collection is quick, simple and relatively non threatening to the client

Return on Investments

Ending Investments - (Beg. Investments + annual savings) / Beg. Investments

Define personal financial planning.

Personal financial planning is the process of formulating, implementing, and monitoring financial decisions into an integrated plan that guides an individual or family to achieve their financial goals

Pie Chart Approach

Provides a visual representation of how the client allocates financial resources. (can include a benchmark to compare to client's balance sheet or income sheet)

List and define the liabilities categories on the balance sheet.

Short-Term or current liabilities are obligations expected to be paid within one year. This includes bills incurred but not yet paid, unpaid taxes, outstanding medical bills, and unpaid credit card bills. Long-Term Liabilities are obligations die that are expected to be paid beyond the next 12 months. These are usually larger financial purchases, and these obligations are amortized over years. Examples of this are primary residence loans, automobile loans, and student loans.

Cash flow approach

Takes the annual current income statement and adjusts the cash flows by forecasting what they would be after implementing all of the planning recommendations

Define and discuss the net worth category listed on the balance sheet.

The net worth of client is the assets minus the liabilities listed on the balance sheet. This is an important consideration because it represents an absolute dollar amount reflective of a client's financial position. A positive net worth can imply that a client has done a good job investing and managing debt while a negatives net worth can indicate that the client is potentially facing bankruptcy.

Present value of goals approach

This approach considers each short-term, intermediate-term, and long-term goal, determines their respective present value, then sums all of these together and treats the sum as an obligation (liability) that is then reduced by current resources of investment assets and cash and cash equivalents.

cash flow approach

This approach takes an income statement approach to recommendations. It uses the three-panel approach and uses a pro forma approach (as if) "to purchase" the recommendations thus driving down the discretionary cash flow. Next, positive cash flows or the sale of assets are identified to finance the recommendations which were purchased.

Phrases such as "see what I mean" and "imagine that" suggests that the planner should use (when discussing with the client):

charts, graphs, and other visual aids

Define housing ratios 1 and 2.

equals housing costs divided by gross pay. If this ratio is less than or equal to 28 percent, the person will qualify for a conventional mortgage at a favorable rate. This ratio helps determine if the amount of income and housing debt that a client is carrying is appropriate and affordable. equals housing costs plus other debt payments divided by gross pay. If this ratio is less than or equal to 36 percent, the borrower will likely qualify for a conventional loan at a favorable rate. This ratio includes housing ratio 1 plus all other debt and determines if the total amount of debt that a client is carrying is appropriate for a given level of income.

Define net discretionary cash flow.

equals income minus savings, expenses, and taxes. It represents the amount of cash flow available after all savings, expenses, and taxes have been paid.

Discuss the difference between discretionary and non-discretionary cash flows.

expenses that can be avoided in the event of loss of income Fixed monthly obligations and expenses that must be met regardless of loss of income

What is the purpose of the statement of net worth?

explain changes in net worth between two balance sheets by reporting financial transactions that are not reported on the income statement or other financial statements.

What is the purpose of the cash flow statement?

explain how cash and cash equivalents were used or generated between the period of two balance sheets.

Define vertical and horizontal analysis as comparative financial statement tools.

lists each line item on the income statement as a percentage of total income and presents each line item on the balance sheet as a percentage of total assets. The restated percentage is known as a common size income statement or balance sheet and allows a financial planner to compare trends for each percentage over time. lists each item as a percentage of a base year and creates a trend over time. For example, on the income statement, income may be stated over a 10 year period from 2010 to 2020, but is reflected as a percentage of 2010 income.

Net Worth to Total Assets Ratio

net worth/total assets

Financial Statement and Ratio Analysis Approach

provides an opportunity to assess the client's strengths, weaknesses, and deficiencies when the client's ratios are compared to benchmark metrics. usually follows the pie chart approach and provides the planner with the actual ratios with which to compare the benchmarks in the metrics approach.

Metrics Approach

provides quantitative example benchmarks for the financial planner and client to use as guidance for achieving comprehensive financial goals and objectives