Fundamentals - Financial Statements and Analysis

Current Ratio

- The current ratio is a measure of a client's ability to meet short-term obligations. - Current assets include cash and cash equivalents and marketable securities such as certificates of deposit less than 12 months in maturity, money market, savings, cash and accounts receivable. - Current liabilities include credit cards and short-term debts due in less than 12 months. - Current Ratio = Current Assets ÷ Current Liabilities.

Assets - 3 categories

1. Cash & Cash Equivalents, or Current Assets Examples include: cash, checking, money market, CD (12 months or less maturity). • • Includes laddered CDs set to mature every 6 months. Includes anything that the client expects to convert to cash within one year. • Does not include EE savings bonds. 2. Invested Assets Examples include: stocks, bonds, mutual funds, retirement accounts, business ownership and any assets maturing in greater than 12 months. 3. Current Use Assets Examples include: personal residence, car, furniture, boat and clothing. • Include any assets used to maintain the client's lifestyle.

Liabilities - 2 categories

1. Current Liabilities are: - Obligations that are due within the next 12 months. - It excludes interest unless already incurred. • For example, includes credit cards, taxes payable and any unpaid bills such as utilities, cable, cell phone bills, etc. 2. Long-Term Liabilities are: - The remaining balance on any outstanding debt beyond 12 months. • For example, includes the outstanding balance on a loan for the client's house, car, boat or any other outstanding loan.

Which of the following is not a current asset or current liability? 1. Laddered CDs maturing within the year. 2. Credit card debt. 3. EE savings bonds. 4. IRA. 5. Taxes payable. a) 1, 2, 3, and 5. b) 3 and 4. c) 1, 2, 3, 4 and 5. d) 1, 2 and 4.

Answer: B EE savings bonds are not considered a current asset. An IRA and EE savings bonds are consid-ered an invested asset. All other are considered a current asset or current liability.

During the data gathering phase of the financial planning process, a client provides a statement of cash flows to a CFP® certificant. This financial statement will provide the certificant with an understanding of all of the following except: a) 401(k) savings contributions. b) Income taxes payable. c) Variable expenses. d) Discretionary cash flow.

Answer: B Income taxes payable would be listed as a current liability on the balance sheet (statement of financial position). All others would be listed on the statement of cash flows.

Housing - 28%Ratio

Monthly Housing Costs (P+I+T+I) Monthly Gross Income Ratio should be 28% or less - P = Principal - I = Interest - T = Taxes (Property) - I = Homeowners Insurance

As a rule of thumb, it is best if consumer debt does not exceed: A: 20% of net income. B: 20% of gross income. C: 3 to 6 months of expenses. D: 36% of gross monthly income.

The correct answer is A. This is a rule of thumb, along with the others that recommend housing debt be limited to 28% of gross income, and total debt not to exceed 36% of gross income.

Housing & All Other Debt Ratio

- 36% Ratio Monthly Housing Costs (P+I+T+I) + All Other Recurring Debt Payments Monthly Gross Income - P = Principal - I = Interest - T = Taxes (Property) - I = Homeowners Insurance - All other recurring debt includes: auto, student loans, boat, credit card and any other type of monthly debt.

Assuming the following transactions, what was the change in net worth? • Purchased $10,000 of furniture on credit cards. • Stocks in a brokerage account increased by $5,000. • Spent $2,000 in cash on a vacation to Aruba. • Purchased a $30,000 car with 10% down in cash and financed the remaining portion. a) $0. b) <$2,000>. c) $3,000. d) $5,000

Answer: C • Purchased $10,000 of furniture on credit cards: - Personal Use Asset (PUA) + $10,000 - Liabilities +$10,000 = 0 change in net worth • Stocks in a brokerage account increased by $5,000: - Invested Assets +$5,000 - Liabilities 0 = Net Worth +$5,000 • Spent $2,000 in cash on a vacation to Aruba: - Current Assets -$2,000 - Liabilities 0 = Net Worth - $2,000 • Purchased a $30,000 car with 10% down in cash and financed the remaining portion: - Current Assets -$3,000 + PUA+ $30,000 - Liabilities +$27,000 = 0 change in Net Worth

Jennifer's net worth increased from $600,000 to $750,000 this year. During the year she inherited $50,000 in stocks and bonds. Jennifer earned a salary of$80,000 and saved $10,000 of her salary in her 401(k) plan. Jennifer contributed $3,000 to her IRA, from her checking account. She also used $5,000 from her money market to purchase new bedroom furniture. Her investments grew by $75,000. Assuming these are all of her transactions, what was the reduction in liabilities? a) $5,000. b) $10,000. c) $15,000. d) $20,000. e) $25,000.

Answer: C Assets - Liabilities = Net Worth Start with increase to Net Worth + $150,000 Subtract out known increases: Inheritance - $50,000 401(k) Savings - $10,000 Investments - $75,000 The Net $15,000 remaining in the increase can be attributed to a reduction in liabilities

Six months ago, a client purchased a new bedroom suite for $6,500. For purposes of preparing accurate financial statements, this purchase would appear as a (an): (CFP® Certification Exam-ination, 11/94) 1. Use asset on the client's net worth statement. 2. Investment asset on the client's net worth statement. 3. Variable outflow on a client's historic cash flow statement. 4. Fixed outflow on the client's cash flow statement. a) 1, 2 and 3. b) 1 and 3. c) 2 and 4. d) 4 only. e) 1, 2, 3, and 4. Answer: B 1. Use asset on the client's net worth statement. aka balance sheet Absolutely! 2. Investment asset on the client's net worth statement. Not an investment asset. 3. Variable outflow on a client's historic cash flow statement. Must use this answer. 4. Fixed outflow on the client's cash flow statement. Not a recurring outflow. The answer must include 1 and cannot include 2, therefore, the correct answer is B. Note: In this question the CFP Board is using Cash Flow Statement as the Statement of Income and Expenses

B 1. Use asset on the client's net worth statement. aka balance sheet Absolutely! 2. Investment asset on the client's net worth statement. Not an investment asset. 3. Variable outflow on a client's historic cash flow statement. Must use this answer. 4. Fixed outflow on the client's cash flow statement. Not a recurring outflow. The answer must include 1 and cannot include 2, therefore, the correct answer is B. Note: In this question the CFP Board is using Cash Flow Statement as the Statement of Income and Expenses

Debt Ratios

• Consumer debt payments should not exceed 20% of NET income. • Housing debt should be less than or equal to 28% of GROSS income. • Housing plus all other recurring debt should be less than or equal to 36% of GROSS income.