Financial Management
Financial Management tests your ability to read a client's balance sheet and cash flow, compute the ratios lenders use, and make financing and saving decisions on an after-tax, opportunity-cost basis.
Statements and what they measure
- Net worth statement: assets at fair market value minus liabilities. Appreciating assets (home, cottage) belong here, not in cash flow.
- Cash flow statement: income minus expenses. Mortgage principal repayment is not an expense; it is a balance-sheet transfer. Interest is an expense. Mixing these two is the single most common computational error.
Ratios the exam expects
- Savings rate = savings / gross income (target 10%+); some texts use net income, so read the question.
- Emergency fund: 3–6 months of essential expenses, longer for variable income.
- GDS ≤ 32%: (mortgage principal and interest + property taxes + heating + 50% of condo fees) / gross annual income.
- TDS ≤ 40%: GDS items + all other debt payments / gross annual income.
- Debt-to-asset and consumer debt service ratios flag over-leverage.
Credit and borrowing
Credit scores weight payment history (~35%) and utilization (~30%) most heavily. Debt reduction strategy (highest rate first) outperforms purely psychological ordering. Lease versus buy decisions require comparing the present value of lease payments against the purchase price net of residual value, not just the monthly payment.
Worked example
Gross income $120,000. Mortgage $2,300/month, taxes $350, heating $150, condo fees $400, car loan $450, credit card minimum $100.
GDS = (2,300 + 350 + 150 + 200) × 12 / 120,000 = 36,000 / 120,000 = 30% - within 32%. TDS = (3,000 + 450 + 100) × 12 / 120,000 = 42,600 / 120,000 = 35.5% - within 40%.
Only half the condo fee is counted. The credit card payment is used, not the balance. Net income is never used in GDS/TDS.
Traps
- Counting a credit card balance instead of its minimum payment.
- Including 100% of condo fees or excluding heating.
- Treating the full mortgage payment as an expense in the cash flow statement.
- Using after-tax income in lending ratios.
- Ignoring the tax on interest when comparing debt repayment to investing - repaying a 7% credit card beats most after-tax investment returns.