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12. List what should be reflected on forecasted financial statements.

Forecasted financial statements should reflect inflation adjusted income and expenses, implementation of recommendations, and any other adjustments such as incurring or retiring debt. Thorough forecasting includes preparing financial statements dated one year, three years, and five years out.

9. Define net discretionary cash flow.

Net discretionary cash flow is the amount of cash flow available after all savings, expenses, and taxes have been paid. The net discretionary cash flow formula from the income statement is: Income - Savings - Expenses - Taxes = Net Discretionary Cash Flow.

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

Net worth represents the total equity that a client has accumulated. The total equity is calculated by subtracting the client's liabilities from assets (assets - liabilities = net worth). A high positive net worth may indicate a client has been successful at managing savings, investments, and debt. A negative net worth implies the client is insolvent (the inability to meet debt as it becomes due).

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

Assets listed on a balance sheet are reflected at their fair market value as of the date of the balance sheet. Liabilities are listed with their current outstanding principal balance owed as of the date of the balance sheet. Footnotes to the balance sheet should be reviewed to determine if additional meaningful information regarding the valuation of assets or liabilities is given.

18. Define housing ratios 1 and 2.

Housing ratios 1 and 2 are debt ratios that are established by the banking industry to determine if debt is affordable. Housing ratio 1 determines if the amount of income and housing debt (principal, interest, taxes, and insurance) is appropriate and affordable. The benchmark for housing ratio 1 is less than or equal to 28 percent. Housing ratio 2 determines if the total amount of debt (principal, interest, taxes, insurance, and other debt payments) is appropriate for the level of income. The benchmark for housing ratio 2 is less than or equal to 36 percent.

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

Income is a recurring income statement inflow represented by client salary, interest income, dividend income, pension income, retirement account withdrawals, and business income. Recurring savings contributions are income statement outflows represented by 401(k) plan, 403(b) plan, or IRA savings, education savings, reinvested dividends, and any other type of savings account.

20. Define performance ratios.

Performance ratios calculate the return that a client is receiving on assets, net worth, and investments. Common performance ratios used in financial planning include the return on assets, return on net worth, and return on investments.

16. Define ratio analysis.

Ratio analysis is the process of calculating key financial ratios and comparing those ratios to benchmarks. The financial planner then makes an evaluation regarding any financial deficiencies.

6. List and define the common forms of property ownership.

Sole ownership is complete ownership of property by one individual who possesses all ownership rights whereas tenancy in common is ownership of an undivided, but not necessarily equal, interest in the entire property by two or more related or unrelated persons. Joint tenancy with right of survivorship (JTWROS) is typically how spouses own joint property where the decedent's interest transfers to the joint tenants outside of the probate process. Tenancy by the entirety is similar to property owned JTWROS between spouses (property is automatically transferred to the surviving spouse upon death). Community property is a civil law statutory regime where married individuals own an equal undivided interest in all property accumulated during their marriage.

2. List and define the liabilities categories on the balance sheet.

The balance sheet has two categories listed on the balance sheet, namely, short-term (current) liabilities and long-term liabilities. Short-term liabilities represent current obligations that are due and payable within the next twelve months. Long-term liabilities represent financial obligations that are due and payable beyond the next twelve months. Note that any interest expense on a loan obligation that is not yet due and payable is not included in the principal balance reflected on the balance sheet.

11. What is the purpose of the cash flow statement?

The cash flow statement explains how cash and cash equivalents were used or generated between two balance sheets. The statement reports nonrecurring cash transactions that are not reported on the income statement. The major sections of the cash flow statement reflect how cash was used or generated from investment activities (e.g., cash inheritances) and financing activities (e.g., paying credit card balances). The cash flow statement is considered a supplementary financial statement as compared to the two principal statements (the balance sheet and the income statement).

17. Define the emergency fund ratio.

The emergency fund ratio is a liquidity ratio that measures how many months of non-discretionary expenses the client has in the form of cash and cash equivalents or current assets. The benchmark for the emergency fund is 3-6 months to cover non-discretionary cash flows (expenses). The emergency fund can be used in the event of job loss, for the elimination period on a disability policy, or for unexpected expenses.

8. Define the expense category of the income statement and give examples of variable and fixed expenses.

The expense category of the income statement contains recurring expenses that are paid by the client for the period covered by the statement. Fixed expenses are not discretionary over the short term and include mortgage payments, automobile loan payments, boat loan payments, and student loan payments. Variable expenses are more discretionary over the short term and include entertainment expenses, vacation expenses, travel expenses, and charitable contributions.

5. List documents that a client can provide to the financial planner as sources of information to properly prepare financial statements.

The financial planner can request the following documents as reliable source documents to prepare financial statements: • Bank statements • Brokerage statements, • Loan amortization schedules • Tax returns • Life insurance policy statements • W-2s • Credit card statements, and • Billing statements

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

The major categories listed on the assets side of the balance sheet include (1) cash and cash equivalents, (2) investment assets, and (3) personal use assets. Cash and cash equivalents represent highly liquid assets that are either cash or can be converted to cash within the next twelve months. Investments assets represent appreciating assets or those assets that are being held to accomplish financial goals (e.g., retirement accounts, brokerage accounts, education savings, or cash value of a life insurance policy, etc.). Personal use assets are those assets that are used to maintain lifestyle (e.g., personal residence, automobiles, furniture, clothing, vacation home etc.).

13. What is a financial planner's purpose in creating a client's budget?

The purpose of creating a budget is to evaluate a client's spending and saving behavior, and to establish a spending and saving plan that assists the client in attaining financial goals.

14. Define and explain the purpose of financial statement analysis.

The purpose of financial statement analysis is to measure the client's progress towards attaining financial goals, meeting short-term obligations, and managing debt. The analysis is conducted by utilizing vertical, horizontal, and ratio analysis. Trends revealed in the analysis can help the financial planner identify if the client is moving forward towards attaining financial goals.

19. Define the savings rate

The savings rate is a ratio for financial security goals that measures the amount a client is saving towards a retirement goal. The savings rate calculates savings, reinvestments, and employer retirement match as to gross pay. The savings rate benchmark comparison is dependent upon the client's age. For example, the average savings rate for a client 25-35 years of age is 10-13 percent of annual gross income.

10. What is the purpose of the statement of net worth?

The statement of net worth explains changes in net worth between two balance sheets. The statement reports financial transactions that are not listed on any other financial statement. Examples of transactions listed on the statement of net worth include (1) giving or receiving property other than cash, (2) inheriting property other than cash, (3) employer contributions to retirement savings accounts, and (4) appreciation or depreciation of assets. The statement of net worth is not needed for most clients and is considered a supplementary financial statement as compared to the two principal statements (the balance sheet and the income statement).

15. Define vertical and horizontal analysis as comparative financial statement tools.

Vertical analysis lists each line item on the income statement as a percentage of total income. Vertical analysis of the balance sheet presents each line item as a percentage of total assets. This process creates a common size income statement and balance sheet where comparison of changes in percentages can reveal trends over time. Horizontal analysis lists each line item as a percentage of a base year and reveals a trend over time. For example, income can be stated over a five year period and is reflected as a percentage of the first year's income. Horizontal analysis can be conducted for each line item on the income statement and balance sheet to reflect trends and progress towards financial goals.