PFM-Global-Chapter-1

Chapter 1: Personal Financial Situation You will learn the overall financial management process that you have to follow while advising your clients & how to prepare the financial statements of a person. Money cannot buy happiness but it can for sure buy things and bring situations which can lead to happiness. In our day to day life, many individuals tend to take money management very lightly. They may curse bad luck, stars, fengshui or ancestors for bad financial condition but on the contrary majority (if not all) of the financial problems are there because of bad or mostly no Financial Planning. At a very basic level, personal financial management simply means gaining an understanding of your financial situation in order to make the most of your assets in day-to-day life and in planning for your future goals. Having a moderate knowledge of financial things is the first priority for anyone and then one must consult financial professionals to assess and plan for a healthy financial life and stay in control of money. As a financial planner you can help your clients managing money smartly and in a planned way which would lead them to following advantages: Income : Analysing their income to know how much they'll have to put toward basic expenses, taxes, etc. Cash Flow : Managing spending and planning ahead to make the most of their income. Savings : Building Savings, emergency fund & high liquidity investments Investment : Making a plan to help their capital grow over time & creating a passive income Assets : Acquiring valuable assets (or investments) with low risk and limited liability. Liability : Keeping their liabilities low and not falling prey to bad loans Networth : Growing their networth consistently Family Security : Understanding the risks and mitigate the risks by keeping family safe (through insurance and other means). Standard of Living : Prudent financial decisions leading to a good lifestyle Financial Know how : Grow their own knowledge & understanding of finance Ongoing Advice : A lifelong guidance on all financial matters for better decision making Personal Financial Statements Personal Financial Statements are the most fundamental tools to help anyone plan & achieve the financial goals. The Personal Financial Statements are like the route maps or GPS which will help to arrive at the desired financial destination. A personal financial statement is a document, or set of documents, that outlines an individual’s financial position at a given point in time. It is usually composed of three sections: CFP Level 1 - Module 1 - Personal Financial Management - Global Page 1

Balance Sheet – The way any company or business would have a balance sheet, so does any individual too. The balance sheet is a statement of Financial Position of the client at a given point of time. Cash Flow Statement – Again similar to any business, an individual too needs to account for the cash coming in and cash going out/expenses. This statement of cash in-out is known as Cash Flow Statement. Budget – When you set a goal, you need to budget and plan your expenses. The budget is the part which stands for the plan of expenses from your earnings. Very Few individuals have all the money required to achieve 100 percent of their objectives. As a result, as a financial professional, while working with the client, you must prioritize goals and develop a strategy based on that prioritization. Conflicts in priorities are almost certain to arise, and you must evaluate ways to address those conflicting demands on a client’s cash flow. Personal Financial Management Process Regardless of each person or family's goals, there is a six-step procedure to help plan, prepare and execute short- and long-term financial plans. You can remember the 6 steps of Financial Planning Process with the acronym EGADIM, which stands for the following: 1. Establish – Client Advisor Relationship 2. Gather – Client data & goals 3. Analyze – Client’s financial status 4. Develop - Plan & Alternatives 5. Implement – Recommended Plans 6. Monitor – Review & Monitor the progress CFP Level 1 - Module 1 - Personal Financial Management - Global Page 2

As a financial professional, you should gather information that is both Quantitative and Qualitative. Quantitative data are number based and include things such as asset and liabilities, cash flows, value of insurance policies, value of current investments, retirement age, tax bracket etc. Qualitative data are concept based and include things such as family, lifestyle, goals, risk profile, anticipated lifestyle changes, including those pertinent to income and expenditures. As a Financial Planner, FPSB categorises your knowledge on the following areas: 1. Financial Planning Principles, Process and Skills 2. Financial Management 3. Tax Principles and Optimization 4. Investment Planning / Asset Management 5. Risk Management and Insurance Planning 6. Retirement Planning 7. Estate Planning and Wealth transfer 8. Integrated Financial Planning CFP Level 1 - Module 1 - Personal Financial Management - Global Page 3

Process of Financial Management of Clients Clients should be given a financial plan which is understandable, relevant and is in accordance with their financial goals. The flow chart below explains the steps in financial management process. CFP Level 1 - Module 1 - Personal Financial Management - Global Page 4

No. EGADIM What it includes What it includes 1 Establish Stage Build rapport with client Know about client & his family win trust & create comfort Define how you can help achieve goals 2 Gather Stage Quantitative Information Client's Assets & Liabilities Client's Cash flow, income & obligations Information needed to prepare Budget Prepare Networth, Cash flow & Budget Qualitative Information Propensity to save Define spending behaviour Client's attitute towards debt 3 Analysis Stage Assess Client's Situation Whether Client is living within means Define issues wrt clients assests & liabilities Define client's contingency funds Compare cash mgmt strategies Check Emergency Fund Adequacy Identify & Evaluate Strategies Impact of changes in income & expenses Identify conflicts on cash flow Define financial alternatives 4 Develop Stage Develop financial mgmt strategies Evalaute pros & cons of strategies Optimise strategies to make recommendation Prioritize action Steps 5 Implement Stage Bring expenses in sync with Budget Make recommended investments Follow the timelines advised Adhere to discipline of planning 6 Monitor Stage Monthly - Quick check Quarterly - Review check Yearly - Health Check Repeat CFP Level 1 - Module 1 - Personal Financial Management - Global Page 5

The three parts of the Personal Financial Statements as we studied above are : o Balance Sheet o Cash Flow statement o Budgets Now let us understand the 3 parts of the Personal Financial Statements in detail. Balance Sheet In business or in personal finance, a critical piece in assessing the current situation is the balance sheet. Often referred to as the “statement of financial condition,” the balance sheet is a snapshot of what you have and what you owe at a given point in time. Like a typical balance sheet, a Client’s Personal Balance Sheet also has 2 sections – Assets & Liabilities. The balance sheet is a list of assets, debts or liabilities, and Net Worth, with their values. In business, assets are resources that can be used to create income, while debt and equity are the capital that financed those assets. Thus, the value of the assets must equal the value of the liabilities and the Net worth. Net worth = Assets – Liabilities Or Assets = Net worth +Liabilities Or Liabilities = Assets – Net worth Assets of a person typically comprises of :  Cash (in the bank, deposits, in hand)  All investments (mutual funds, stocks, bonds etc)  Home value (the resale value of your home)  Automobile value (the resale value of your car)  Personal Property Value (resale value of jewellery, household items, etc)  Other assets Liabilities of a person typically comprises of :  Home loans  Mortgage  Car loans  Student loans  Any other personal loans  Credit card balances CFP Level 1 - Module 1 - Personal Financial Management - Global Page 6

ASSETS Savings Accounts 75,000 Cash/Cash Equivalents Cash in hand 35,000 Life insurance cash value 9,000 Invested Assets Total Cash Assets 1,19,000 Use Assets Stocks portfolio 3,00,000 Bond portfolio 40,000 Mutual funds portfolio 1,20,000 Pension Funds 60,000 Total Invested Assets 5,20,000 House 55,00,000 Cars 10,00,000 Personal property Total Use Assets 70,000 65,70,000 ASSETS TOTAL 72,09,000 LIABILITIES AND NET WORTH Liabilities 38,00,000 7,00,000 Home Loan Balance 35,000 Car loans balance 45,35,000 Personal Loan balance Total Liabilities 26,74,000 Net Worth 72,09,000 LIABILITIES & NETWORTH This is just a sample template. You need to add or remove more assets & liabilities in the above template for each client. Let’s understand the 3 types of assets in detail so that you can classify them rightly. CFP Level 1 - Module 1 - Personal Financial Management - Global Page 7

Assets for an Individual Liquid Assets Invested Asstes Use Assets Cash or cash All investments made All such assets which equivalents which can such as stocks, mutual one buys, uses & be liquidated funds, bonds, consumes for lifestyle (meanining which can commodities, real such as car, farm house, be converted into cash estate (not the house furnitues, jewelery etc immediately are known where you live), are termed as Use as Liquid Assets. derivatives etc Assets All Assets generally are represented on balance sheet at their current fair market value (FMV). FMV is the amount a buyer would be willing to pay if those assets are to be sold. Also, the Balance sheet or net worth statement typically identifies the asset’s owner (e.g., individual, husband, wife, partners, business, trust, etc.). For jointly-held assets, the net worth statement (e.g., joint tenancy, tenants in common, community property, etc.) also identifies the ownership status. There can be a financial transaction which may impact the net worth and vice versa there can be a financial transaction which may not impact the net worth at all. Example when transaction affects Net worth: Client uses credit cards to take a trip, his net worth decreases because of an added liability with no corresponding increase in assets. If the trip costs 50,000, and client pays 10,000 in cash and charges the rest to a credit card, his assets decrease by 10,000, his liabilities increase by 40,000, and his net worth is reduced, in total, by 50,000. Example when transaction does not affect Net worth: Client has a net worth of 20,00,000. If client buys a car for 6,00,000 , pays 2,00,000 in cash, and takes out a car loan for the remainder of 4,00,000. So his Use assets will increase by 6,00,000 where as Cash will reduce by 2,00,000 ( net increase of 4 lacs in assets) and also liabilities will go up by 4,00,000 (on account of the car loan taken). So the net impact on net worth for this transaction would be zero. Liabilities Liabilities are merely what you owe or have to pay. Liabilities include current bills, payments to be done, EMIs to be paid for loans of assets like cars and houses, credit card balances, and other loans. Liabilities are defined as : CFP Level 1 - Module 1 - Personal Financial Management - Global Page 8

Short term – which are to be paid in less than a year Long term – which are to be paid in more than a year time Contingent liabilities - which may occur, depending on the outcome of a future event or uncertainty Networth The difference between assets and liabilities of a person is his Net Worth. The net worth statement is also known as a balance sheet or statement of financial position. Simply, it is a record of a person’s assets and liabilities (but not cash flows – that’s another type of statement we will explore later). The formula to calculate Networth of a person as discussed above is : Net Worth = Assets – Liabilities Net worth is a measure of your client’s financial position because it basically shows what he would be left with if you sell all of his assets to pay all of his debts. Every financial move client makes should be aimed at increasing his net worth. This means either increasing assets, or decreasing liabilities. Negative Networth Since net worth is equal to total assets minus liabilities so if for a person the total amount of liabilities are more than the total value of assets he owns, then the networth would come in minus. This is called negative Networth. In today’s time young people often fall prey to ambitious plans and luxurious lifestyle and a few years later if you assess them, you find them with a Negative Networth. This is because the often carry substantial amounts of loans, debts, credit card and personal loans. Cash Flow Statement Out of the 3 Parts of Personal Financial Statement ( Balance Sheet, Cash Flow Statement & Budgets), we have discussed Balance Sheet above. Cash Flow Statement will be explained in Chapter 3 . Budgets Out of the 3 Parts of Personal Financial Statement (Balance Sheet, Cash Flow Statement & Budgets), we have discussed Balance Sheet above. Budgets will be explained in Chapter 4. ********************************************************************************* CFP Level 1 - Module 1 - Personal Financial Management - Global Page 9