Personal Financial Statements

1. Personal Financial Statements • First step in Financial Planning Analysis. • Nomenclature: • Balance Sheet – AICPA calls this “Statement of Financial Condition” • Income Statement – “Cash Flow Statement” • When monitoring the plan, the Statement of Financial Condition will show if progress has been made. • The Cash Flow Statement will help identify causes of shortfalls and increases over projections.

2. “Your Mileage Will Vary” • Some clients regularly keep up statements of net worth. • Other clients may not even have an idea of how to prepare one. • Whichever client you have, the personal financial statement is essential as your method of assessment of performance. • The AICPA had established standards for Personal Financial Statements. Examples follow.

3. Things the Financial Planner May Need to Prepare Personal Financial Statements • Income tax returns • Real estate and personal property tax returns • The client’s accountant • Bank records, including checking and savings account statements, loan balance statements, etc. • The client’s attorney • Stock brokers' statements • Property and life insurance records • A listing of safe deposit box contents • The client Clients may bring you these!

4. The Statement of Net Worth Some planners like to divide Investments into Tax-deferred (such as IRAs and 401(k) plans), Tax-free, and Taxable.

5. Tips on Preparing the Statement of Financial Condition • List assets from most liquid to least liquid. • Balance sheet identity for personal statements is • Net Worth = Assets – Liabilities • On personal statements, assets are always carried at Fair Market Value (include cost basis and after-tax value in notes). • Liabilities include accrued interest that has not been paid. • When you get to the analysis stage, most often use-assets such as personal residence, jewelry, furs, and antiques will not be available for investment. You may want to prepare a second statement of condition that isolates the use-assets and gives an adjusted net worth, which may be labeled investment assets.

6. Notes are an Integral Part of the Personal Financial Statements • Notes include such information as interest rate and maturities of CDs and bonds, interest rates and maturities on loans, information on dependent deductions on income tax, etc. – anything that would be material to understanding the client’s financial condition. • Err on the side of too many notes, rather than too few.

7. Statement of Cash Flow and Taxable Income • This is continued on next slide. • There is a blank illustration in your book that you can copy. • TIP: It is a good idea to start now to build up your personal files of worksheets and templates.

8. Remainder of Cash Flow Statement While this version is more complex to prepare than the simple Cash Flow Statement, it is also more informative. Once done, it is easy to update.

9. Tips on Preparing the Cash Flow Statement • Either in the format above or in notes, show taxes as part of cash flow. • In the analysis stage of financial planning, you will look at this document to see if you can minimize the taxes, therefore the more tax information the better. • Definitely indicate cash flows that are possibly one time flows. Note how this works with the budget.

10. Personal Financial Statements and Loans • Lenders often ask for personal financial statements for loans. Often they ask for it to come from the client’s accountant. • It is suggested that you supply the client’s accountant with the personal financial statements that you have prepared to assist him or her. • By working together with the accountant, you establish your professionalism and develop a rapport that can lead to referrals.

11. The Personal Financial Statements Will Be Useful • For budgeting • For loans and qualified investments • For determining capital needs analysis for insurance • For projecting future income and cash flow • For continuing assessment of performance

12. Fair Market Value • Some assets are difficult to evaluate and will require appraisals. • Real estate is particularly hard to evaluate without an appraisal. For use assets, such as a personal residence, a starting appraised value plus an adjustment for the general change in prices in the area may suffice for a few years. • If there has been substantial change, an appraisal may be necessary to secure the needed property insurance. Always check the FMV against the insurance.

13. Valuing Businesses • Closely held businesses are difficult to value. There are special valuation experts who do jut this, and the fees are high. • A quick way to evaluate is the “Capitalization (Cap) Rate.” • The cap rate assumes that the profit of the business can be viewed as the interest on the value of the business.

14. Valuing Businesses (cont’d) • Choosing the correct cap rate can sometimes be done by comparison to publicly-held companies in the same business. • Note the many pitfalls with the Cap Rate method: • Rate too low=> too high a valuation. • Rate too high => too low a valuation. • Salaries and rents between owner and company may be either too low or too high, distorting income. • Not appropriate for all business investments.

15. AICPA Guidelines on Personal Financial Statements • Reflect assets and liabilities on an accrual rather than cash basis. • Assets and liabilities should be presented by order of liquidity and maturity. • Statements should include only the proportionate interest of a joint or community property owner. • If a business interest comprises a significant portion of a client’s total assets, it should be segregated and shown separately from other investments.

16. AICPA Guidelines on Personal Financial Statements (cont’d) • If real estate or a business interest is encumbered with a large debt, that debt should be presented separately from the asset. • Assets should be presented at estimated current values. Likewise, liabilities should be shown at their estimated current amounts. • Any material transaction costs (such as commissions) should be considered.