Lesson 4 Flashcards
What is a Balance Sheet
evaluates a client’s financial position at a “snapshot” in time. A balance sheet reflects, in detail, the following basic accounting equation:
Assets (Owns) = Liabilities (Owes) + Net Worth
Assets
refer to items the client owns and can be broken up into:
1) Cash and Cash Equivalents
2) Investment Assets
3) Personal Assets
Liabilities
what the client owes in relation to past spending and are classified in two categories:
Current Liabilities - Maturity < or = 12 months
Long-Term Liabilities - Maturity > 12 months
Net Worth
The difference between assets and liabilities is Net Worth.
Net Worth = Assets – Liabilities
Liquidity Ratios
measure the ability to meet short term or current liabilities.
Debt Ratios and Debt Analysis
indicate how well a person manages debt.
Performance Ratios
assess the client’s goal progress and investment returns in light of how much risk they are taking.
Emergency Fund Ratio
How many months of non-discretionary cash flows can a client cover with current liquidity?
Benchmark is 3-to-6 months.
Current Ratio
Can client meet short-term obligations should current liabilities all come due immediately?
Cash (and equivalents) divided by current liabilities
Good Debt
- The interest rate is relatively low in comparison to expected inflation and expected investment returns.
- The expected payback period is much less than asset’s expected economic life.
Reasonable Debt
where the payback period is longer or the returns on the debt are no doubt positive:
- 30 Year Mortgage with moderate rate
- Student Loans
Bad Debt
high interest rates, and debt that is generally not well managed. Bad debt can involve high interest rates or when the economic life of a purchase is exceeded by the associated debt payback period.
Debt to Asset Ratio
Total DEbt/Total Assets
House Ratio 1 (basic)
Housing Costs/Gross Pay <28%
House Ratio 2 (broad)
(Housing Costs + Other Debt Payments)/Gross Pay <36
