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FPWMP: Cash Flow, Budgeting, and Debt Management

FPWMP · Work through your exam, one topic at a time.

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Cash Flow, Budgeting, and Debt Management

Cash Flow, Budgeting, and Debt Management

This domain tests whether you can build and read a personal financial statement, calculate the ratios lenders and planners actually use, and give debt advice that is both mathematically and behaviourally sound.

Core tools

  • Net worth statement: assets at fair market value minus liabilities at outstanding balance. It is a snapshot; cash flow is the film.
  • Cash flow statement: income minus fixed and variable outflows. A surplus funds goals; a deficit must be closed before any investing advice is credible.
  • Liquidity ratio = liquid assets ÷ monthly expenses. A three-to-six month reserve is the usual benchmark, longer for variable income or single-earner households.
  • Debt service ratios: gross debt service (housing costs ÷ gross income) commonly capped near 28–32%; total debt service (all debt payments ÷ gross income) near 36–40%.
  • Savings rate = savings ÷ gross income. In the early years it drives projections more than investment return does.

Debt strategy

  • Interest is front-loaded in amortisation, so extra principal payments early save the most.
  • Avalanche (highest rate first) minimises total interest; snowball (smallest balance first) maximises adherence. Recommend avalanche, but allow snowball when follow-through is the binding constraint.
  • Compare loans on effective annual rate, not advertised nominal rate, and include fees.

Worked example

Gross monthly income $8,000. Housing (principal, interest, taxes, heat) $2,200; car loan $450; card minimum $150. GDS = 2,200 ÷ 8,000 = 27.5% - inside a 32% cap. TDS = (2,200 + 450 + 150) ÷ 8,000 = 35.0% - inside a 40% cap. A new $400 consolidated payment raises TDS to 40.0%, exactly at the ceiling with no cushion. Correct advice: retire the card balance first. It consumes 5% of gross income and carries the highest rate in the household, so every dollar sent elsewhere earns less than it costs.

Traps that cost marks

  • Using net (take-home) income in the denominators - lenders use gross.
  • Counting only the minimum payment and ignoring the compounding cost of revolving debt.
  • Advising investment contributions while a high-rate balance is outstanding.
  • Omitting irregular expenses such as insurance premiums, taxes, and vehicle maintenance from the budget.
  • Treating a one-off bonus as recurring income in the cash flow plan.