Fundamentals of Financial Planning Chapter 4

Cash Flows from Operations

Accounts for changes to current assets and current liabilities on the balance sheet - excluding cash

Balance Sheet Formula

Assets = Liabilities + Net Worth or Assets - Liabilities = Net Worth

Financial Statement includes:

Vertical Analysis, Horizontal Analysis, and Ratio Analysis

net worth

total assets minus total liabilities -explains changes in net worth that do not affect cash (appreciation, depreciation), gifts/inheritances

Statement of Cash Flows

-Captures transactions that impact cash -helps explain changes to net worth between 2 years of balance sheets -includes gifts, taking out a loan, or buying and selling stocks/cars, etc -does NOT include depreciation, inheritances of property/gifts of property

Ratio Analysis

-Gain additional insight into the financial situation and behavior of the client -Generate questions for the client -highlights potential areas for further analysis

Limitations to Financial Statement Analysis

-Limitations include inflation, estimated assets, few benchmarks for personal -important to conduct sensitivity analysis to changing assumptions (regarding rates and investment return, etc.) -Monte Carlo analysis helps measure probability of assumptions

Horizontal Analysis

-Lists each item as a percentage of a base year and creates a trend over time -highlights area to potentially problematic trends

Vertical Analysis

-Lists each item on the INCOME STATEMENT as a percentage of total income -Lists each item on the BALANCE SHEET as a percentage of total assets -restated percentage is known as common size income statement or balance sheet

Financial Statement Analysis

-how well does the client manage debt -how well is the client progressing toward financial goals -what is the client's ability to meet short-term goals -historical perspective NOT predictive of future

Statement of Income and Expenses

-represents all income earned or expected to be earned by the client + savings - all expenses (Variable and fixed) results in ---Net discretionary Cashflow -does not include purchase or sale of an asset -employer contributions or gifts ONLY Monthly and RECURRING income and expenses

3 tips for budgeting

1. Be realistic with spending behavior 2. Budget a line item for miscellaneous expenses 3. Being successful takes practice

Budget Process

1. Establish Goals 2. Determine Client's income 3.Determine expenses (fixed and variable) 4. Determine whether net discretionary cash flow is positive or negative 5. Present expenses as a percentage of income for the time period being presented

Two Primary Financial Statements

Balance Sheet and Statement of Income and Expenses

Liabilities

Current debt (without interest) and Long-Term owed

Cash Flow from Financing Activities

Captures how cash was used or generated through acquiring or repaying debt

Cash Flows from Investing Activities

Captures how cash was used or generated through purchasing or selling of invested assets and personal use assets.

Which 3 sections are in the Statement of Cash flows?

Cash Flow from Operations, Cash Flow from Investing Activities, Cash Flow from Financing Activities

Assets

Cash and Cash Equivalents, Investment Assets, and Personal Use Assets

Examples of Cash and Cash Equivalents

Cash, checking, money market, CD 12 (mos or less) any asset that will be converted to cash within a year

Supporting financial statements

Statement of Self-Worth and Statement of Cash Flows

Examples of Investment

Stocks, bonds, mutual funds, retirement accounts, business

Personal Use Assets

includes the client's residence, automobiles, boats, recreational real estate, and personal effects such as furnishings, clothes, jewelry, and similar assets -assets like the client's house are always valued at fair market value on the balance sheet