Mod 3: Financial Statements, Cash Flow Management, and Financing Strategies

Question 1

Three major asset categories

Answer 1

1) Cash and Cash Equivalents
2) Invested Assets
3) Personal Use Assets

Question 2

What items do “Inflows” include?

Answer 2

• gross salaries and wages
• interest and dividend income
• rental income
• tax refunds
• other amounts received by the client

Question 3

How should “Outflows” be divided?

Answer 3

• savings and investments
• fixed outflows
• variable outflows

Question 4

A planning tool that projects the anticipated inflows and outflows for a future period

Answer 4

Pro Forma Cash Flow Statement

Question 5

The ratio of monthly consumer debt payments to monthly net income.

Answer 5

Consumer Debt Ratio

Question 6

1) Monthly consumer debt payments should not exceed ______% of net monthly income.
2) What is this benchmark known as?

Answer 6

1) 20%

2) Nonmortgage debt-to-income ratio

Question 7

Housing Cost Ratio (Equation)

Answer 7

= monthly housing costs / monthly gross income

Question 8

What do “housing costs” include? (debt ratio purposes)

Answer 8

• rent or mortgage payment (P+I+taxes+insurance)

- association fees

Question 9

1) Monthly housing costs should not exceed ______% of gross monthly income.
2) What is this benchmark known as?

Answer 9

1) 28%

2) Front-end Ratio

Question 10

Consumer Debt Ratio (Equation)

Answer 10

= monthly consumer debt payments / monthly net income

Question 11

Total Debt Ratio (Equation)

Answer 11

= total monthly debt / monthly gross income

Question 12

What does “total debt” include for the purposes of the total debt ratio?

Answer 12

*recurring debts

• monthly housing costs
• consumer debt payments
• monthly alimony
• child support
• maintenance payments

Question 13

1) Total debt should not exceed _____% of gross monthly income.
2) What is this benchmark known as?

Answer 13

1) 36%

2) Back-end Ratio

Question 14

This ratio represents the ability of an individual to service short-term liabilities in case of a financial emergency.

Answer 14

Current Ratio

Question 15

Current Ratio (Equation)

Answer 15

= current assets / current (short-term) liabilities

Question 16

This ratio compares the value of investment assets (excluding equity in a home) with net worth.

Answer 16

Net-Investment-Assets-to-Net-Worth Ratio

Question 17

What is a purpose of the Net-Investment-Assets-to-Net-Worth Ratio?

Answer 17

To show how well a client is advancing toward their capital accumulation goals.

Question 18

9 Common Financial Strengths

Financial Strengths & Weaknesses

Answer 18

1) Adequate savings (particularly for retirement)
2) Appropriate emergency fund
3) Appropriate net worth–given client goals
4) Well-defined financial goals
5) Excellent cash flow management skills (including proper debt management skills)
6) Appropriate investments given client risk tolerance, time horizon, and goals
7) Appropriate insurance coverage
8) Valid and current estate planning documents
9) Employment status stable or promising

Question 19

9 Common Financial Weaknesses

Financial Strengths & Weaknesses

Answer 19

1) Insufficient savings (particularly for retirement)
2) Inadequate emergency fund
3) Low net worth–given client goals
4) Financial goals that are not defined or are unrealistic
5) Poor or improper cashflow management skills
6) Investments that are not aligned with risk tolerance, time horizon, and goals
7) Insufficient amount or no insurance coverage
8) Lack of estate planning documents
9) Unfavorable employment status

Question 20

7 Common Steps in Developing a Budget

Answer 20

1) Identify financial goals and determine what is required to meet them
2) Estimate income
3) Estimate expenses
4) Compare income and expenses to determine if expected expenses are equal to or less than expected income.
5) If expenses are too high, attempt to identify potential sources of additional income or areas in which expenses may be reduced.
6) Present each category of income and expense as a percentage of the total for ease in year to year comparisons.
7) Establish a process at the end of each month to review the budget and make adjustments.

Question 21

2 Popular Debt Reduction Strategies

Answer 21

1) The Snowball Technique

2) The Avalanche Technique

Question 22

5 Credit Score Categories and Their Weightings

Answer 22

1) Payment History: 35%
2) Amounts Owed: 30%
3) Length of Credit History: 15%
4) New Credit: 10%
5) Credit Mix: 10%

Question 23

Under a “leasing option” what 3 costs are generally involved?

Answer 23

1) Periodic rent obligation
2) Cost of the renter’s insurance policy on his personal property (if renter chooses to purchase such as policy)
3) Cost of utilities

Question 24

What is a key feature to an FHA mortgage?

Answer 24

A very low initial down payment, and sometimes lower interest rates because of the federal government’s guarantee of repayment.

Question 25

Key features of VA loans (Mortgages)

Answer 25

• Federal Guarantee of repayment

- In certain cases, no downpayment and no PMI required

Question 26

1) What are mortgage loans made by commercial lenders in the private sector?
2) What are these loans also known as?

Answer 26

1) Conventional Mortgage Loans

2) Conforming Loans

Question 27

Have a level interest rate for the term of the loan and a fixed payment amortization schedule.
(Mortgage)

Answer 27

Fixed-Rate Mortgages

Question 28

1) When the agreed-upon monthly payment is less than the accruing interest charges and unpaid interest is added to the mortgage balance, increasing the debt.
2) What type of mortgages can allow for this to occur?

Answer 28

1) Negative Amortization

2) Adjustable-rate Mortgages (ARMs)

Question 29

What type of client might an adjustable rate mortgage (ARM) be suitable for?

Answer 29

A client who wants lower initial monthly payments and does not anticipate remaining in the home for a long time.

Question 30

A mortgage in which the borrower makes fixed payments, which are based upon the established interest rate for a long-term mortgage. However, payments are made only for a short duration–frequently five or seven years–and then the borrower is required to pay off the remainder of the mortgage in a lump sum.

Answer 30

Balloon Mortgage

Question 31

A mortgage that is payable over a long time period, such as 30 years, and has a fixed interest rate. The payments are lower for the first few years of mortgage repayment, then they adjust to a higher fixed payment that continues for the remainder of the loan.

Answer 31

Graduated Payment Mortgage

Question 32

A client who has a stable cash flow (and anticipates one in the future) and who wants to have a predictable mortgage payment each month should choose what type of mortgage?

Answer 32

Conventional Fixed-Rate Mortgage

Question 33

This type of mortgage may be appropriate for people who anticipate increases in income with some certainty, enabling them to afford a higher payment in the future than they can currently afford.

Answer 33

Graduated Payment Mortgage

Question 34

This type of mortgage may be appropriate for borrowers who plan to sell or refinance in the first 5 years after borrowing.

Answer 34

Ballon Mortgage

Question 35

Reflects client’s financial activity over time

Answer 35

Cash Flow Statement