1. Personal Financial Statements (Preparation and Analysis)
Chapter 4
Personal Financial Statements
(Preparation and Analysis)
Chapter 4: Personal Financial Statements

2. Financial Statements Provide Information About:
Financial resources available to client
How resources were acquired
What the client has accomplished financially utilizing these resources
Chapter 4: Personal Financial Statements

3. Personal Financial Statements
Balance Sheet
Income Statement
Statement of Changes in Net Worth
Chapter 4: Personal Financial Statements

4. Financial Statements are Used:
By clients to benchmark goal achievement
By planners to help clients set financial direction
By creditors & lenders to make decisions to extend, continue, or call indebtedness
Chapter 4: Personal Financial Statements

5. Balance Sheet Terms Asset Liability Net Worth
Chapter 4: Personal Financial Statements

6. Asset Categories & Classifications
Cash and Cash Equivalents
Liquid – easily converted to cash
Convert to cash within a year
Investment Assets
Held for growth or income
Personal-Use Assets
Long-lived assets
Used to maintain quality of life
Chapter 4: Personal Financial Statements

7. Liability Categories & Classifications
Current Liabilities
Credit card debt & unpaid bills
Long-Term Liabilities
Debts of larger assets
Chapter 4: Personal Financial Statements

8. Valuation of Assets & Liabilities
Assets valued at FMV
Liabilities represent principal owed
Chapter 4: Personal Financial Statements

9. Sample Balance Sheet
Chapter 4: Personal Financial Statements

10. The Income and Expense Statement
Summary of client’s income and expenses over a period of time, usually one year
May focus on realized transactions, and if so, helps compare to budgeted financial goals
May be prepared in advance and used for budgeting or projections
Chapter 4: Personal Financial Statements

11. Income Statement Terms
Employment
Investment
Other
Savings
Expenses
Fixed
Variable
Discretionary
Chapter 4: Personal Financial Statements

12. Sample Income Statement
Chapter 4: Personal Financial Statements

13. The Statement of Changes in Net Worth
Summarizes noncash flow changes in net worth not recorded on the income statement.
Chapter 4: Personal Financial Statements

14. Statement of Changes in Net Worth Transactions
Changes in value for assets due to appreciation or depreciation
If an asset other than cash is exchanged for some other assets
If assets other than cash are received by gift or inheritance
If assets other than cash are given to charities or noncharitable donees
Chapter 4: Personal Financial Statements

15. Sample Statement of Changes in Net Worth
Chapter 4: Personal Financial Statements

16. Ratio Analysis The key to ratio analysis is:
Does the ratio get to the answer for the question asked?
Is there some standard or benchmark to determine whether the result is appropriate for this particular client?
Chapter 4: Personal Financial Statements

17. Ratio Analysis—The Objective
The objective of ratio analysis is twofold:
To gain additional insight into the financial situation and behavior of the client
To generate questions for the client to answer to further gain such insight
Chapter 4: Personal Financial Statements

18. Types of Ratio Analysis
Liquidity ratios – emergency fund ratio and current ratio
Debt ratios – total debt to net worth, long-term debt to net worth, debt to total assets, long-term debt to total assets, housing costs to gross income, housing and debt payments to gross income
Performance ratios – savings ratios and investment performance ratios
Chapter 4: Personal Financial Statements

19. Emergency Fund Ratio EFR = Current Assets
Monthly Nondiscretionary Expenses
Target of 3 to 6 months
Chapter 4: Personal Financial Statements

20. Current Ratio CR = Current Assets Current Liabilities
Target of 1.0 to 2.0
Chapter 4: Personal Financial Statements

21. Lending Ratios
Housing Costs (Mortgage payment + Property tax + Homeowners insurance) to Gross Income
Target of ≤ 28%
Housing and Debt Payments (i.e. credit card, auto loan) to Gross Income
Target of ≤ 36%
Chapter 4: Personal Financial Statements

22. Savings Ratios Rate of Savings = Annual Savings Annual Gross Income
Target of ≥ 10% (age dependent)
Discretionary Cash Flow + Savings to Gross Income
Target of ≥ 10%
Chapter 4: Personal Financial Statements

23. Investment Ratios Income on Investments = Income from Investments
Average Invested Assets
ROI = EI – BI – Additional Investments
Target of 9 to 12%
Investment Assets to Gross Income
Chapter 4: Personal Financial Statements

24. Vertical & Growth Analysis
Vertical analysis:
Balance sheet – each item presented as a percent of total assets
Income statement – each item presented as a percent of total income
Growth analysis:
Calculates the growth rate of certain financial variables over time using TVM tools
Chapter 4: Personal Financial Statements

25. Limitations of Financial Statement Analysis
Inflation
Use of estimates
Few benchmarks for individuals
Chapter 4: Personal Financial Statements

26. Sensitivity Analysis & Risk Analysis
Sensitivity analysis allows manipulation of input variables by small increments to determine the impact on the ratio
Risk analysis examines the uncertainty of cash flows to the individual
Business or investment risk
Financial risk
Chapter 4: Personal Financial Statements

27. Budgeting
A process of projecting, monitoring, adjusting and controlling future income and expenditures.
Savings and Consumption Habits
Chapter 4: Personal Financial Statements

28. Debt Management Home Mortgages Fixed-Rule Mortgages
Variable-Rate Mortgages or Adjustable-Rate Mortgages (ARMs)
Balloon Mortgages
Chapter 4: Personal Financial Statements