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The Statement of Financial Position (SFP) and the Cash Flow Statement (CFS) are the
two basic financial statements used by many financial planners to evaluate the
financial condition of their clients. The purpose of this section is to discuss
these two personal financial statements.
Statement of Financial Position
Also
known as the balance sheet, the Statement of Financial Position (SFP)
identifies your assets, liabilities and net worth as of a specific date - often
December 31st. Using the accounting equation established long ago
that Assets = Liabilities + Net Worth, the SFP provides a financial snapshot as
of a certain point in time. Comparison of successive SFPs over time assists in
identifying trends in one's financial condition because the SFP reflects the
results of personal financial activities up to the current date.
Assets
are identified first on the SFP and are listed at their estimated market values.
Simply stated, an asset is something that has financial value to its owner. While
there are numerous types of personal assets, they are generally separated into
three categories on the SFP: cash and cash equivalents, invested assets and use
assets:(1)
-
Cash and Cash Equivalents - typically this category of assets includes cash
in checking and savings accounts, certificates of deposit with short-term
maturities such as 90 days or less and money market accounts.
-
Invested Assets - this category typically includes stocks and bonds including mutual funds,
investment real estate such as rental property, certificates of deposit with
longer-term maturities, balances in retirement accounts such as a 401(k) or an
individual retirement account even though some portion of the account balances
may be in cash, an ownership interest in a business, etc.
-
Use Assets - one's car, residence, furniture, clothing, recreational assets such
as a boat or mountain cabin, personal computer, etc.
Liabilities,
which are debts owed, are identified next with shorter-term liabilities
generally listed first followed by longer-term liabilities. Common examples of
shorter-term liabilities include unpaid credit card balances and auto loans. This
type of debt is normally relatively small and is intended to be repaid quickly.
A common longer-term liability is a residential mortgage because it is normally
paid off over many years. Liability dollar amounts shown on the SFP are the
outstanding principal balances as of the date of the SFP.
The
last category on the SFP is net worth - the dollar amount by which the market
value of one's assets exceeds, hopefully, the amount of outstanding liabilities.
As an accountant would say, Assets - Liabilities = Net Worth. Ideally, your
amount of net worth increases over time but this is not always the case. For
example, during the early 1990s, the market value of many homes in the United
States temporarily declined because of weakness in the national economy. Or
your children may now be in college which requires you to draw down savings to pay
for those expenses. Lastly, you have retired and have begun using financial
assets to fund your retirement. In each of these three examples, net worth
would be expected to decline.
When
reviewing one's net worth over time to identify progress in achieving personal
financial goals, it is helpful to understand what is causing one's net worth to
increase or decrease. Then you can determine whether you need to make any
mid-course corrections so to speak. For example, if net worth is declining or
rising very slowly because you are spending too much and living beyond your
means, cutting back on living expenses is a prudent step to take. Or if net
worth is rising because of the increasing market value of your stock portfolio,
recognize that the market value of stocks can fluctuate widely over time with
no guarantee of increasing value. Only by selling one's investments such as
stocks does a 'paper profit' become a realized one.
Cash Flow Statement
This
is the second statement used by financial planners and is also known as the
statement of revenues and expenses. The Cash Flow Statement (CFS) reflects cash
receipts and disbursements over a period of time - normally one year.
Cash
receipts include all monies received such as gross wages, interest and dividend
income, tax refunds, withdrawals from savings, income from rental property and
other cash inflows.
Disbursements
of cash are generally divided into three categories: fixed disbursements,
variable disbursements and savings/investments. (2)
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