Financial Statements and Cash Flow Flashcards
Net Worth
Net Worth = Assets – Liabilities
Assets = Liabilities + Net worth
Liabilities = Net worth - Assets
Cash/cash equivalents
- cash
- savings accounts
- checking accounts
- CDs close to maturity
- money market deposit account (bank) * Laddered CDs
- money market mutual fund (security)
Investments
- variable and fixed annuities
- pensions, IRAs, Roth IRAs
- business interests
- mutual funds
- real estate owned for investment purposes
- stocks/bonds
- collectibles owned for investment purposes
Note: Life insurance cash values are technically not cash equivalents because life insurance companies may delay distributing such funds for up to 6 months (delay clause).
Use assets
- home
- vacation home
- personal property
- automobiles or recreational vehicles
- collectibles for personal enjoyment
Note: Assets are generally shown at fair market value. Fair Market Value (FMV) reflects what buyers
are willing to accept presuming neither is forced into the transaction
Liabilities
*credit card balance(s) * auto loan balances
* personal loans
Statement of Financial Position (Balance Sheet)
Net Worth Statement
- Assets value and liabilities value
Statement of Cash Flow
When a question asks the amount of clients’ savings, assume that any funds not allocated to expenses
will be savings (Inflows − Outflows = Savings).
- Inflows and Outflows
Inflows (same as gross income)
- Salary(ies)
- Interest and dividend income
- Capital gains
- Alimony received
- Rental income
- Social Security benefits
- Trust fund income
- Child support
- Inheritance
- Gifts
Fixed outflows (little to no flexibility)
- Note payments / car payments
- Mortgage payments, rent
- Insurance premiums (life, health)
- Property tax
- Alimony paid
Variable outflows (some flexibility)
*Food
* Car maintenance
* Clothes
* Utilities
* Entertainment
* Vacation
* Gifts
* Charity
* Home maintenance
* Miscellaneous
Taxes
- Income taxes (federal and state)
- FICA taxes and self-employment taxes
The relationship between the balance sheet and the cash flow statement
If the cash flow statement indicates a cash surplus in the current period. This will increase the net worth amount by the same.
- Because the savings is coming from cash flow (new money in), their net worth would increase by this amount
Business financial statements
The balance sheet, income statement, and statement of cash flow can be used to valuate a business
Book value
Book value reflects the corporate balance sheet. The book value of assets minus the book value of
liabilities is the net worth of the business.
Capitalization of income
The projected flow of income from a business can be converted into a present value amount. The formula for capitalized value is as follows (not provided on formula sheet):
Capitalized Value =
Annual Income/
Capitalization Rate
Capitalized Value
Annual Income/
Capitalization Rate
Pro forma statement
A pro forma statement projects the expected profitability or return of the next year or longer (the future).
It estimates the excess of income over expenses. It allows the owner of the business to plan investment
or spending of the projected excess. At year end the actual financial statements can be compared with
the pro forma statement to see if the financial projections were realized. Ethical conduct requires a
disclaimer indicating that proforma projections may or may not be achieved.
Budgeting
Budgeting estimates the amount of money to be received and spent for various purposes within a given time frame. Many people may not record income and spending activity. Budgets make clients feel constrained.
How long a period should a typical family budget cover?
Twelve months is typical, but shorter time periods can be used if annual income and expenses cannot be estimated
* Make it flexible
* Make it simple
* Keep it long enough – typically 1 year
* Estimate unknowns
* Modify a sample budget to fit the client * Estimate variables
Emergency fund
The emergency fund should be invested in the following vehicles with high accessibility and minimal
principal fluctuation including:
* checking accounts (excluding funds to be utilized for necessary expenses*)
* government money market accounts
* savings accounts
* CDs if close to maturity ≤ 90 days
* laddered CDs ≤ 6 months
Emergency Fund Calculation Note
*If the current checking account balance exceeds the normal monthly expenses, subtract one month of
expenses. If the normal monthly expenses exceed the funds in the checking account, ignore the negative number. For example, if normal monthly expenses are $8,000 and the clients only have $6,000 in their checking account, then the checking account balance can’t be allocated for the emergency fund.
However, don’t subtract $2,000.
The amount needed is 3-6 months of fixed and variable expenses and real estate taxes if
Use 3 months if
* Single with second source of income
* Married, both work and have similar wages
* Married, only one spouse works but has
second source of income
… Use 6 months if…
* Single wage earner
* Married, only one spouse works
What are generally considered to be second sources of income?
One party receives alimony
* One party is significantly wealthy
* One party has a large trust fund providing income and rights of withdrawal of principal
Debt management ratios
Housing expenses: (PITI* or rent) should reflect ≤ 28% of gross income (most tested)
Total monthly debt: should reflect ≤ 36% of gross income (maybe tested)
Consumer debt: should reflect ≤ 20% of net income (probably not tested)
* PITI stands for Principal, Interest, Taxes (property only), and Insurance (homeowners only)
Housing expense is the most important ratio. Total monthly debt includes housing expense, auto loans,
credit card debt, etc.
