enstemmigt

FINANCIAL STATEMENTS AND CASH MANAGEMENT

1. What is the relationship between income and “investment margin”?

2. What type of automotive vehicle is the most popular among U.S. millionaires?

FROM DAVE RAMSEY.COMProper financial management is 80% behavior and 20% knowledge.

(almost verbatim)Our budget always failed. The failures stemmed from the fact that we would create a budget and then try to live on it every month. That worked fine until life smacked us around, throwing the budget completely out of whack.

Now, we create a new budget every single month. We spend out paychecks on paper BEFORE we actually get them.

DAVE RAMSEY’S SEVEN BABY STEPS TO FINANCIAL FREEDOM

1. $1,000 to start an emergency fund.

2. Pay off all debt (excluding home) using the debt snowball.

3. 3 to 6 months of expenses in savings.

4. Invest 15% of household income into Roth IRAs and pre-tax retirement plans.

5. College funding for children.

6. Pay off home early

7. Build wealth and give.

BUDGETING AND CASH MANAGEMENTWHAT IS A BUDGET?Many financial planners never use the term “budget. Instead, they use “cash flow management.”

An estimate of how much money will be received and spent for various purposes within a given time frame.

HOW CAN IT BE USED?A budget has little value unless a comparison is made of actual results with expected results.

WHEN SHOULD BUDGETS BE USED? SHOULD ALL FAMILIES HAVE A BUDGET?1. When there is a need to measure periodic progress

toward a specific goal.2. When income and expenditures are complex.3. When there is a need to communicate a planning strategy

to others.4. When there is a need to provide incentives (rewards) for

meeting a budget.5. Monitoring the performance of an investment.

GUIDELINES FOR BUDGETSMust be flexible.Usually covers a calendar year on a month by month basis.Must be simple, short and understandable.

(Eliminate extraneous information).Do not strive for absolute accuracy.Tailor the budget to specific goals and objectives.Include all sources of incomeDivide expenses into fixed and discretionary.

Highly Irregular Cash Flows Develop more than one budget:

1. using lowest income and highest expenses2. reasonable (most probable) expectations of cash flows3. highest income and lowest expenses (best case scenario).

PERSONAL FINANCIAL STATEMENTS

Property not owned is not shown on financial statements, e.g.property in trust for someone else.

Joint ownership—only the proportionate interest should be shown.

Real estate should be carried at market value less the cost of selling the property.

Joint ownership—only the proportionate interest should be shown.

Business valuation—is very difficult, especially if it is a minority interest.

Any material transactions costs to convert to cash should be shown separately. For example, a vested pension worth $800,000 should show the tax to be paid when the money is taken.

Receivables should be shown at a discounted value.

Life insurance cash values must show outstanding policy loans, if any.

EMERGENCY FUND

PURPOSE

TYPE OF INVESTMENTS

AMOUNT

Emergency Fund Ratio Liquid assets / Total monthly household expenses

Often a ratio of at least 3X is called for. Notice that this ratio differs somewhat from the typical

rule of thumb of 6 months income.

THE THREE “C’s” OF CREDIT

1. CAPACITYAbility to repay the debt.

2. CHARACTERWill the borrow repay the debt—what is his

credit history?

3. COLLATERALIs the creditor protected if the borrower

defaults?

FINANCIAL RATIOS

1. Current RatioShould be greater than 1X.

2. The Debt RatioTotal debt / Total assets

Young people may have high ratios, such as 80%, but older people often have ratios of 50% of less.

3. Debt to Income Ratio Installment debt (credit cards, car loans, etc. not counting real estate) / Net income

Generally 10% or less is great. 20% or more can be a yellow light for a lender. The lower the better.

4. Front-end RatioMonthly housing expense / gross monthly

income

The monthly housing expense is PITI (principal, interest, taxes and insurance). Homeowner’s association dues and mortgage insurance

premiums should be added if applicable.

The denominator (gross income) is income before taxes.

The traditional rule of thumb is that the ratio should not exceed 25%, but some lenders go higher.

5. Back-end RatioTotal monthly debt payments / monthly gross income

The numerator includes PITI but also other monthly debt payments.

35% - 40% is the usual limit.

HOW TO HANDLE DEBT PROBLEMS? 1. Realistic budgeting 2. Credit counseling from a reputable organization 3. Debt consolidation

Usually points are charged. Interest is deductible. 4. Bankruptcy 5. (Divorce?)

BANKRUPTCY

Stays on your credit report for 10 years. It usually does not erase child support, alimony, fines, taxes, and some student loans. Some assets might be exempt from bankruptcy, e.g., home, cars, working tools, etc.

Chapter 7 (straight bankruptcy) liquidates all assets that are not exempt.

Chapter 13 allows the filer to keep most property if they establish a court-approved repayment plan of 3-5 years.

THE NEW BANKRUPTCY LAW (Became effective October, 2005).

CHAPTER 7 1. MEANS TEST

Clients no longer have easy access to Chapter 7 protection. They have to pass a complete means test to qualify for Chapter 7. Those that fail may consider Chapter 13.

2. HOMESTEAD EXEMPTIONRegardless of the amount of the state exemption,

homestead exemptions are now capped at $125,000if the client has resided in the home less than 3 years and four months.

3. TIME BETWEEN FILINGSCannot file for another 8 years (increased from 6 years)

CHAPTER 13 1. LONGER REPAYMENT PLANS

Now up to 5 years

2. TIME BETWEEN FILINGSA client cannot file another Chapter 13 within 4 years of aChapter 7 or two years of a prior Chapter 13.

OTHER PROVISIONS 1. MANDATORY CREDIT COUNSELING

Filers must complete both credit counseling and financialmanagement education from a nonprofit agency approved by the US Trustee program

2. NEW PROTECTIONSThe new law protects IRA and 529 plans.

3. MORE NONDISCHARGEABLE DEBTSNow includes student loans from nongovernmental and profitmaking organizations, certain purchases of luxury items, and certain recent loans.

CREDIT RATINGS

CREDIT RATING AGENCIES

The main agencies are Experian, TransUnion, and Equifax.

They all use the same formula developed by Fair, Isaac, Inc.The formula is proprietary and confidential. Different scoresare produced by different agency because they don’t all use the same data.

Lenders rely heavily on these scores.

WHAT DETERMINES THE CREDIT SCORE

35% Payment history. (Pays on time, adverse records, etc.)

30% Amount owed (percentage of available credit)

15% Credit history (age of the accounts—the older the better)

10% The type of credit on record.

10% Number of recently opened accounts.

Missing even a single payment could cost 100 points.

TIME LIMITS ON REPORTING

Bankruptcy information is reported for 10 years.

Information about criminal convictions has no time limit.

Credit information for more than $150,000 of credit or life insurance has no time limit.

Defaults on student loans is reported for 7 years.

Unpaid judgments and lawsuits can be reported for 7 years of until the statute of limitations runs out, whichever is longer.

(Some travel, entertainment, gas, local retailers, and credit unionsdo not report to any credit rating agency).

AVERAGE CREDIT SCORES

Ages US NC SC

18-29 637 630 62330-39 654 645 63840-49 675 666 65750-59 697 691 68360-69 722 719 71170+ 747 743 738

What is a “good” score? It varies by lender.

Some say 700, some 750, some 680.

Generally anything over 700 is a good score. The average in the South Atlantic states, Florida to PA, is 675.

$150,000 30 year fixed loan on 8/30/05

Your Credit Your Interest Your Monthly Score Rate Payment

750 – 850 5.44% $846 700 – 750 5.66% $867 680 – 699 5.84% $884 660 – 679 6.05% $904 640 – 659 6.48% $946 620 – 639 7.03% $1,001

Daily updates are available at:“myfico.com/FICOCreditScoreEstimator/AboutScores.aspx

$1,001 - $846 = $155 per month or $1,860 per year.The present value of $1,860 per year for 30 years at 6% is about$25,600.

FACTORS THAT GO INTO BORROWING ABILITY

Late payment history

Late payments, collections, and bankruptcies hurt the most. Every payment that is 30 days overdue is shown. Delinquencies remain for 7 years. Some bankruptcies remain for 10 years. Unpaid tax liens remain for 15 years. Inquiries remain for 2 years.

The number of open accounts. Closing accounts cannever help your credit score, and may hurt it. Too many open accounts can hurt your score, but once you haveopened the accounts, your have done the damage.

The age of the accounts. Generally, the older the accounts, the better the score. This means paying off old accounts might be a negative because it can make your credit history look younger than it actually is.

Debt / limit ratiosDebt should be kept at less than 50% of the limit.

Number of inquiresApplying for new credit is generally what hurts your score.Too many inquiries may signify to lenders that you are extending yourself too much. “Soft inquiries” do not hurt your credit. These are personal inquires from yourself and inquiries made by lenders when they send you an offer of credit.

Factors other than your Credit ScoreLenders sometimes consider other factors such as income, assets, etc. Note that these things are not included in a credit score.

DEVELOPING AND MAINTAINING GOOD CREDITWhat can you do to quickly improve your credit score?

Nothing.

Credit repairIncorrect facts in a report can be disputed, but the retailer is very much in control.

Pay bills on time

Keep balances low.

Pay off debt rather than moving it around.

Inquire at least once each yearYou can get 1 free credit report each year, but this does not include a credit score.

Apply for and open new accounts only as needed.

What is the difference between a “credit score” and an “insurance score”?

IDENTITY THEFTYou may need to: 1. Contact one of the credit agencies. 2. View credit reports 3. Write a victim statement 4. Contact creditors of tampered accounts 5. Contact law enforcement 6. Contact FTC 7. Change all account passwords 8. Notify the Office of the Inspector General if your social

security number has been fraudulently used 9. Change your driver’s license number 10. Contact utility companies

IDENTITY THEFT INSURANCE

Coverage typically costs from $20 to $100 a year, as a rider to a basic homeowner’s policy or as a stand-alone purchase.

What does it cover?Insurance cannot protect you from becoming a victim of identity theft and does not cover direct monetary losses incurred as a resultof identity theft. It simply covers some of the expenses you will incur to deal with the problem, such as the costs of making phone calls and copies, mailing documents and possibly legal bills.Some policies won’t cover legal fees or lost wages due to time away from work.

Deductible?They generally range from $100 to $250, but some are as high as $1,000. And the average victim spends less than $1,500 to recover from ID Theft, according to the FTC.

Alternatives to Insurance?

You may be able to get ID theft protection for free. American Express, for example, makes its identity theft assistance available to all cardholders for free. It gives you round-the-clocktelephone access to company representatives who will “help you determine if your identity has been stolen, navigate the recovery process, and protect yourself in the future.”