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- Chapter 5
Financial Statements
Analysis
1
- Chapter Goals
Recognize the importance of financial statements to
PFP.
Produce and evaluate a balance sheet.
Construct a cash flow statement.
Compare finance and accounting based techniques.
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- The Balance Sheet
Balance sheet: A statement of financial position at a
given point in time.
The balance sheet consists of all assets, liabilities,
and net worth.
Current assets: Assets that are expected to be or
can be converted into cash in the current year.
Marketable investments: Assets that are traded
publicly.
Household assets: Assets used in day-to-day
household activities.
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- The Balance Sheet, cont.
Human assets: The future income stream of
household’s wage earners.
Because they cannot be sold, human assets are not
usually placed on balance sheets.
Human-related assets: Other forms of resources in
addition to human assets that are omitted from the
balance sheet.
The term human-related is used because the value
is derived from human- related work efforts or human
relationships.
For example, human related assets include pension
plans that pay out yearly income upon retirement.
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- The Balance Sheet, cont.
Liabilities: Items that the household owes.
Credit card debts, taxes outstanding, and mortgage
debt are liabilities.
Liabilities can be split into current and long term,
based on whether they are due within one year or
beyond that period.
The mortgage payment due within the year is
expressed as a current liability.
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- The Balance Sheet, cont.
Household equity (household net worth): The
difference between its assets and liabilities.
Household equity can be relatively small or even
negative when household members are young and
college debt and other obligations are high.
Net worth generally increases as marketable
investments increase.
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- The Balance Sheet, cont.
Example:
Tricia had a $20,000 savings account, owned a car
valued at $12,000, and owed $9,000 that she had
borrowed to help finance the car.
Her net worth is:
Assets $32,000
Liabilities $(9,000)
Net Worth $23,000
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- The Balance Sheet, cont.
Sample budget sheet:
ASSETS LIABILITIES
Current Assets Current Liabilities
Checking Accounts Credit Card Debt
Money Market Funds Other Current Debt
Refund Due on Returned Clothing Current Portion
Total Current Assets Total Current Liabilities
Marketable Investments Long-Term Liabilities
Bonds and Bond funds Mortgage
Stocks and Stock Funds Other Long-Term Debt
Total Marketable Investments Total Long-Term Liabilities
Pension Assets Total Liabilities
401(k) Plans
IRAs
Total Pension Assets
Real Estate
Home
Total Real Estate
Household Assets
Autos
Furnitures and Fixtures
Total Household Assets
Other Assets EQUITY
Jewelry
Stamp Collection Household Equity
Total Other Assets Total Equity
Total Assets Total Liabilities and Equity
8
- The Balance Sheet, cont.
Budget sheet items can be summarized as follows:
9
- The Cash Flow Statement
Cash flow statement: A statement that represents
how much cash has been generated over a period of
time.
The word “flow” indicates that it measures results
between two periods, say between the end of last
year and the end of this year.
The cash generated is simply the difference between
the cash at the beginning and end of the period.
The cash flow is determined by totaling the sources
of cash - cash inflows - and subtracting the uses of
cash - cash outflows.
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- The Cash Flow Statement, cont.
Functional cash flow statement: A cash flow
statement that separates cash flows by type of
household activity.
Use of a functional cash flow statement permits clear
description of household results for the period and
easy comparison with other periods.
The functional cash flow statement It is structured as
a blend of the business income statement and its
cash flow statements.
There are three basic types of activities: operating,
financing, and investment activities. These are
discussed next.
11
- The Cash Flow Statement, cont.
Example of a functional
cash flow statement
(continues on next slide):
2006 2007 2008 2009 2010
Operating Activities
Income
Salary
Business
Investment
Other
Total Income
Expenses
Non Discretionary
Housing Upkeep
Health Care
Insurance
Interest
Alimony
Food
Clothing
Transportation
Personal
12 Taxes
Total Non Discretionary Expenses
- The Cash Flow Statement, cont.
(continued Cash Flow Before Discretionary Activities
from Discretionary
Recreation-Entertainment
previous Personal
Vacations
slide): Gifts and Charitable Cont.
Hobbies
Interest
Other
Total Discretionary Expenses
Cash Flow From Operating Activities
Capital Expenditures
Discretionary
Non Discretionary
Total Capital Expenditures
Financing Activities
Total Repayments
Additional Debt
Total Financing Activities
CASH FLOW
Targeted for Retirement
Targeted for Other
13 NET CASH FLOW
- Operating Activities
Operating activities: The day-to-day financial
functions of the household.
Unlike a business income statement, the household
statement is recorded on a strict cash basis.
The operations segment can be segregated into
cash inflows and outflows that we will call income
and expenses.
– Income consists of salary, investment returns,
and other sources of operating cash.
– Expenses can be divided into nondiscretionary
and discretionary items.
The difference between income and expenses is
14 cash flow from operations.
- Operating Activities, cont.
Nondiscretionary expenses: The household’s
overhead items such as interest expense, rent,
household, food, clothing, and taxes.
Nondiscretionary expenses are largely fixed costs
that cannot be altered easily or quickly
Discretionary expenses: Expenses the household
choose to incur to derive pleasure. Examples are
entertainment, eating out, and vacation outlays.
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- Capital Expenditures
Capital expenditures: Outlays on household related
matters that provide benefit beyond the current year.
We display capital expenditures separately because
these cash outflows don’t occur regularly.
Including capital expenditures with other costs can
distort the operating figures.
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- Financing Activities
Financing activities: The cash flows that come from
changes in debt.
– Borrowing money has a favorable impact on cash
flow because it increases the cash available.
– Repaying debt has a negative effect on cash flow
because it reduces cash resources.
People sometimes confuse lower debt with having
higher cash flow for that period.
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- Savings
Savings: The cash left over after operating, capital
expenditure, and debt activities.
Savings are also known, for financial statement
purposes, as cash flow representing prior cash
inflows minus cash outflows.
Investments that are not in the form of capital
expenditures are treated as part of the savings
section.
Savings can be intended for specific purposes such
as retirement or a down payment on a home.
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- Savings, cont.
Net cash flow: The amount of cash available after
targeted savings.
When the net cash flow figure is negative it can be
due to targeted investing. Alternatively, the figure
may be positive only because of borrowing during
the period.
Savings applied to investing are reported as
marketable securities in the balance sheet.
Savings left in cash are reported as cash at period-
end on the balance sheet.
Balance sheet cash at the end of the period less
cash at the beginning of the period equals net cash
flow on the cash flow statement for that time frame.
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- Traditional Household Cash Flow
Statement
In practice:
– Many people use a cash flow statement that
groups all inflows and outflows together.
– Paydown of debt and interest payments are
lumped together.
– Income tax payments are often placed at the
bottom, just before the net cash flow figure.
This approach is a traditional cash flow statement.
– Advantage: simplicity and custom.
– Disadvantage: Less useful as an analytical
document for financial planners and individuals.
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