©2015, College for Financial Planning, all rights reserved.

Session 2Cash Flow & Balance Sheet Planning

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMFinancial Plan Development Course

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2-2

Get to Know David & Nancy

Appendix A – pp. 127–129 (easier to read)

• What is important here?• What are the goals?• What analysis do we need to do?• How does this conflict with your values?

2-3

David & Nancy continued

pp. 128-129

2-4

Developing the Scope of Engagement

To develop our scope of engagement, define their goals:

• You would like assistance in creating an efficient strategy for managing current debt.

• You want all debt paid off prior to retirement.

• Other than college loans and Autumn’s car at graduation, you do not see any additional expenses in the next five years that cannot be met by current budgeted expenses.

• Only potential issue is that you are worried you may need to replace deck but hope you can postpone or use possible stock option if needed (3-year vesting, up to 20% of salary).

• You would like advice on how to balance investing, debt reduction, and college within current budget constraints.

• Prior to unemployment, you had three months of reserves but would like to build six months.

2-5

The Financial Planning Process

Systematic Financial Planning

Analyze & Evaluate the Client’s Financial Status

Develop Comprehensive Plan &Present Recommendations

Implement the Plan

Monitor the Plan, Implementation,& Goal Progress

Determine and Quantify the Planning Needs

Document and Evaluate Current Planning Efforts

Establish & Define the Relationship

Gather Data &Frame Goals and Objectives

Review Prospective Planning Strategies

Develop Client-based Recommendations

Analyze Current Situation

· Identify and Select Best Strategies to Meet Need

· Frame Recommendation Into: Who, What, When, Where, Why, How and How Much

EGAD I’M … going to pass!

Know each step and parts of each step!

2-6

Dudella Net Worth Statement

Analysis on David & Nancy:

• What stands out to you?

• What is your process for tracking potential issues?

2-7

Dudella Current Cash Flow

2-8

After Data Organization

• Once you have organized and audited data, apply brain!

• What broad issues do you see?

• What issues could devastate the clients’ financial security?

• What efficiency issues do you see?

• What can’t you tell until you do more analysis?

• What additional information is needed?

• Where are the clients’ blind spots and what will they ignore that you need to help them see?

• Software is good for analyzing the large issues (e.g., goal achievement and some risk assessment). It doesn’t identify details causing problems (e.g., efficiency strategies, tax and cash flow consequences); that’s the planner’s job.

2-9

Cash Flow Analysis

You must start with what funds your client has easily available that you can work with and track as you go.

My Clients - Dudellas Your Clients - Dowlers

Did not save during past two years

After-tax savings you can reallocate: $9,900

Now have $24,000 to reallocate: Annual tax refunds or changed withholding available to reallocate to meet goals:

$5,000

First year only inheritance: $5,500

Tax Refund this year: $5,600

Starting point: $24,000

Starting Point: $26,000

After 1st year: $24,000 After 1st year: $14,900

2-10

Enough money?Dudella Potential Issues*• Education

• Car

• Retirement (David’s match?)

• Debt restructure and repayment

• 5 yr. ARM paid off by retirement

• Emergency funds

• Life insurance

• Disability

• P & C

• Investment management

• Estate & legal documents

* from the scope of engagement client letter

Dowler Potential Issues

• What will you be addressing?

In both cases, you won’t know if

there is enough money to accomplish goals until the issues, potential solutions,

and costs are analyzed.2-11

Emergency Reserves

What should you suggest:• Target: somewhere between 3–6 months• Vehicle: taxable, after tax, etc.• Timing: 1 year–3 years to complete?

How will it impact cash flow:• Advantages,

disadvantages, alternatives

• How do you prioritize?

2-12

Dudella Emergency Reserves

pp. 143-144

2-13

Dowler Emergency Reserves

Include discussion of having Roth contributions in money market until reserves reach six months then shifting.

2-14

Dowler Emergency Reserves

• Would your client understand the issue and consequence of not addressing?

• Is the recommendation clear and actionable?

• Do the advantages and disadvantages give the client enough information to make an informed decision?

• Is the alternative a realistic one?

• This is from your executive summary. You might decide to change it; what would influence your decision? 2-15

Debt Management

Dudellas’ Calculations Dowlers’ Calculations

Nonmortgage debt-to-income:(Annual nonmortgage MINIMUM payments/Annual Net Income)$19,356/$110,202 = 17.56%

What did you get?

Nonmortgage debt to income?

Front-end ratio: (PITI/Gross Income)$14,232 (PI) + $3,708 (Taxes) + $1,284 (Ins.) = $19,224/$156,172 = 12.31%

Front-end ratio?

Back-end ratio: (all debt/Gross Income)($19,356 + $19,224) = $38,580/$156,172 = 24.7%

Back-end ratio?

These are favorable, but short employment time makes refinancing unfavorable.

How do Dowlers stand compared to rules of thumb? Favorable or unfavorable refinancing opportunities?

Debt Management Rule of ThumbNonmortgage debt-to-income ratio

20% or less of net monthly income

Front-end ratio28% or less of gross monthly income

Back-end ratio36% or less of gross monthly income

2-16

Possible Debt Strategy: Dudellas

Consider: using home equity line to restructure more expensive debt (credit cards).

2-17

Possible Debt Strategy

Consider: Roll part of old 401(k) into new company and take 5-year loan to pay off credit card debt.

2-18

Possible Debt Strategy

Consider looking for lower interest rate credit cards. You may now be eligible for some 0% or low introductory rates for 12 months and transfer any balances that you can pay off in that 12-month period or be prepared to restructure debt again in one year.

2-19

Preparing the Recommendation

What else do you need to know before recommending?• Any calculations to do?

• Any information to gather?

• What will you recommend?

I chose 401(k) option, reasons:• Credit score impact to help mortgage

refinance

• They are not clients who will rebuild debt if cash flow is freed up unless he loses his job (they would have to tap into qualified plans anyway)

• They receive interest

• Education costs will be adding to debt

• Lots of other issues to address with cash flow

2-20

Specific Recommendations (Draft)

Recommendation

• Your next three years will require significant outflows as you fund college. I recommend you acquire a 401(k) loan for these credit card balances utilizing a 5-year repayment plan. Once college funding has been accomplished, you can quickly retire this debt. When options vest, use to pay off 401(k) debt and fund reserves.

• Advantages: Your account will be credited with the interest you are paying less administrative fee. Your payments will be $630, which will increase cash flow $1,332. Your credit score will improve, which could help with refinancing and student loan rates.

• Disadvantages: If you leave the company, the entire amount is taxable income in the year of the event. You jeopardize funds earmarked for retirement. Your asset allocation would be impacted. If a crisis occurs, you could have declared bankruptcy and kept funds.

• Alternatives: Look for lower credit card rates and combine with use of home equity line when you qualify.

2-21

Think Through Impact

Use 401(k) loan to pay off credit cards

2-22

Your Turn – Dowler Debt?What would improve their cash flow and long-term position?

2-23

MortgageDudella mortgage• 5-year adjustable rate mortgage

(since rates are expected to increase above current levels)

• Refinancing to a fixed loan may not be possible due to current debt, although debt ratio is within acceptable ranges. Rules are more strict and credit costs higher if ratio is close.

• Home values have increased this year and maybe up 10% since they last checked value. They may meet 20% equity requirement. Need closing costs from bank and 1-2 years’ income history.

Address this now or add to agenda/discussion for within a year when they will have built reserves and/or moved or paid down debt?

Dowler mortgage • Higher than current rates

• Great credit score and long employment history

• Have cash to pay closing costs if desired and first month’s expenses

Want your advice on which option to take

2-24

Are your calculations right?

2-25

Track Cash Flow as You Go

Try different combinations

May shift emergency fund build up to front load and then reduce in 2015, but still lots of issues to address and not sure about cash flow yet. Year 2016 has problem and would not pass! 2-26

Dowler Cash Flow So Far:

• Your total may be different from other students’ due the mortgage selected.

• You may change your mind about the mortgage by the end of class.

• You may change emergency reserves too!

2-27

Savings RatiosDudellasDavid’s 401(k): $3,603

David’s employer match: $3,603

David’s stock purchase: $3,603

Nancy’s 401(k): $ 900

Nancy’s employer match: $ 900

Total: $12,609

$156,172

Savings ratio: 8.07%

Dowlers

Total: ? Total income: $152,196

2-28

Next Class

2-29

©2015, College for Financial Planning, all rights reserved.

Session 2End of slides

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMFinancial Plan Development Course