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

2. Financial Statements Provide Information
Financial resources available to client
How resources were acquired
What the client has accomplished financially using these resources

3. Personal Financial Statements
Statement of financial position
Personal statement of cash flows
Statement of changes in net worth

4. Use of Financial Statements
By clients to benchmark goal achievement
By planners to help clients set financial direction
By creditors and lenders to make decisions to extend, continue, or call indebtedness

5. Statement of Financial Position
Assets
Liabilities
Net worth

6. Asset Categories and Classifications
Current assets
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

7. Liability Categories and Classifications
Current liabilities
Credit card debt and unpaid bills
Long-term liabilities
Debts of larger assets

8. Valuation of Assets and Liabilities
Assets valued at fair market value
Liabilities represent principal owed

9. Nelson Statement of Financial Position as of 01/01/2011

10. Nelson Statement of Financial Position as of 01/01/2011 (cont)
Notes to financial statements:
Assets are stated at fair market value.
The ABC stock was inherited from Dana’s aunt on November 15, 2004.
Her aunt originally paid $20,000 for it on October 31, 2004.
The fair market value at the aunt’s death was $12,000.
Liabilities are stated at principal only.
H= husband; W = wife; JT = joint tenancy

11. Nelson Statement of Financial Position as of 12/31/2011

12. Nelson Statement of Financial Position as of 12/31/2009 (cont)
Notes to financial statements:
Assets are stated at fair market value.
The ABC stock was inherited from Dana’s aunt on November 15, 2004.
Her aunt originally paid $20,000 for it on October 31, 2004.
The fair market value at the aunt’s death was $12,000.
Liabilities are stated at principal only.
H= husband; W = wife; JT = joint tenancy

13. Personal Statement of Cash Flows
Summary of client’s income and expenses over 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

14. Personal Statement of Cash Flows Terms
Income
Employment
Investment
Other
Savings
Expenses
Fixed
Variable
Discretionary

15. Nelson Personal Statement of Cash Flows 2011 (1 of 2)

16. Nelson Personal Statement of Cash Flows 2011 (2 of 2)

17. Statement of Changes in Net Worth
Summarizes non-cash flow changes in net worth not recorded on the income statement

18. Statement of Changes in Net Worth Transactions
Changes in value of assets resulting from appreciation or depreciation
If an asset other than cash is exchanged for 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

19. Nelson Statement of Changes in Net Worth (1 of 2)

20. Nelson Statement of Changes in Net Worth (1 of 2)

21. Financial Analysis of Personal Financial Statements
Keys to ratio analysis:
Does the ratio answer the question asked?
Is there some standard or benchmark to determine whether the result is appropriate for this particular client?

22. Ratio Analysis—The Objective
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 further gain such insight

23. Types of Ratio Analysis
Liquidity ratios—emergency fund ratio and current ratio
Debt ratios and debt analysis—total debt to net worth, long-term debt to net worth, total debt to total assets, long-term debt to total assets, consumer debt ratio—Non-housing monthly debt service to monthly gross income, monthly housing costs to monthly gross income, monthly housing costs and other debt repayments to monthly gross income
Performance ratios—savings ratio, discretionary cash flows plus savings to gross income, income on investments, rate of return on investments and investment assets to gross income

24. Target of three to six months
Emergency Fund Ratio
Target of three to six months

25. Current Ratio
Target of 1.0 to 2.0

26. Lending Ratios
Monthly housing costs (mortgage payment + property tax + homeowners insurance) to monthly gross income
Target of ≤28%
Monthly housing and other debt repayments to monthly gross income
Target of ≤36%

27. Savings Ratios
Personal savings and employer contributions to annual gross income
Target of ≤10% (age dependent)
Discretionary cash flow + savings to gross income
Target of >10%

28. Investment assets to annual gross income
Investment Ratios
Target of 9−12%
Investment assets to annual gross income

29. Vertical and Growth Analysis
Vertical analysis:
Statement of financial position—each item presented as a percentage of total assets
Personal statement of cash flows—each item presented as a percentage of total income
Growth analysis:
Calculates the growth rate of certain financial variables over time using time value of money tools

30. Limitations of Financial Statement Analysis
Inflation
Use of estimates
Few benchmarks for individuals

31. Sensitivity Analysis and Risk Analysis
Sensitivity analysis allows manipulation of input variables by small increments to determine the effect on the ratio
Risk analysis examines the uncertainty of cash flows to the individual
Business or investment risk
Financial risk

32. Budgeting
Process of projecting, monitoring, adjusting, and controlling future income and expenditures
Savings and consumption habits

33. Debt Management Home mortgages Fixed-rate mortgages
Variable-rate mortgages or adjustable-rate mortgages (ARMs)
Balloon mortgages