Financial Statement and Cash Flow Analysis
Personal financial statements
The balance sheet (net worth statement) lists assets and liabilities at a point in time; net worth = assets − liabilities. The cash flow statement tracks inflows and outflows over a period. Know the difference: a car purchase is an asset swap on the balance sheet but a cash outflow on the cash flow statement.
Ratios
Master the standard ratios: current ratio (liquid assets ÷ current liabilities), emergency fund (liquid assets ÷ monthly expenses, target three to six months), savings rate (savings ÷ gross income), debt-to-income (total debt payments ÷ gross income), housing ratio (housing costs ÷ gross income, typically ≤28%), and consumer debt ratio (≤20%). Investment assets to net worth measures progress toward long-term goals.
Worked example
A client has $18,000 in liquid assets, $4,500 in monthly expenses, and $3,000 in monthly debt payments on $9,000 gross monthly income. Emergency fund = 18,000 / 4,500 = 4 months (adequate). Debt-to-income = 3,000 / 9,000 = 33% (near the 36% guideline). The planner would flag the debt load, not the emergency reserve.
Traps
Questions mix gross and net income, or ask which statement an item belongs on. Distinguish liquid from investment assets, and remember that a mortgage payment has both interest (cash flow) and principal (balance sheet) components.