Financial Planning Week 3- Analyzing your Client’s Current Financial Situation

Cash Flow

The movement of money in and out over a period of time

Cash Inflows

Income received (salary, gifts, refunds, etc.)

Cash Outflows

Expenses paid (rent, food, debt, subscriptions)

Cash Flow Formula

Cash Inflows − Cash Outflows = Net Cash Flow

Net Cash Flow Surplus

When inflows > outflows

Net Cash Flow Deficit

When outflows > inflows

Disposable Income

Income available after mandatory payroll deductions

Double-Counting Rule

Do NOT include payroll deductions again if using net income

Payroll Deductions

Income tax, CPP, EI

Fixed Expenses

Costs that stay the same monthly (rent, phone plan)

Variable Expenses

Costs that change monthly (food, gas, entertainment)

Irregular Expenses

Periodic large expenses (tuition, insurance, taxes)

Budget

A plan for how income will be spent

Seven-Step Budgeting Process

• 1 Set goals

• 2 Estimate income

• 3 Pay yourself first

• 4 Evaluate expenses

• 5 Record spending

• 6 Review patterns

• 7 Adjust

Pay Yourself First

Savings are prioritized before spending

Savings Ratio Formula

• Monthly:

  • Savings Ratio = Monthly Savings ÷ Monthly Gross Income

• Annual:

  • Savings Ratio = (Surplus + Annual Savings) ÷ Gross Annual Income

Savings Ratio Benchmark

10% of gross income

Emergency Fund

Money set aside for unexpected expenses

Emergency Fund Ratio (EFR) Formula

Total Liquid Assets ÷ Total Monthly Expenses

Emergency Fund Benchmark

3 to 6 months of expenses

Gross Debt Service Ratio (GDSR) Formula

PITH ÷ Gross Monthly Income x 100

GDSR Benchmark

35%

Total Debt Service Ratio (TDSR) Formula

(PITH + Other Debt Payments) ÷ Gross Monthly Income

TDSR Maximum Limit

40%

Mortgage Qualification Rule

GDSR (35%) and TDSR (40%) must stay within limits

Debt

Service that requires repayment with interest

Good Debt

Debt that builds long-term value (education, mortgage)

Disruptive Events to Cash Flow

Unexpected events that cause unplanned expenses

Unexpected Events Example

Roof repairs, major car fixes

Irregular Expense Risk

Large periodic financial outflows

Unrealistic Budget Risk

Overly strict or too loose budgets fail

Surplus Strategy

Place surplus in TFSA

TFSA Benefit

Tax-free growth and liquidity

Cash Flow Surplus Strategy

Save, invest, or pay down debt

Cash Flow Deficit Strategy

Cut spending, increase income, restructure debt

Annual Surplus Formula

Monthly Surplus × 12

Precision Rule

Monthly values may use two decimals

Cash Flow Focus

Tracks movement of disposable income

Budget Failure Cause

Unrealistic or unmanaged spending

What is the formula for Net Worth?

Net Worth = Assets − Liabilities

What is the formula for Current Ratio?

Current Ratio = Liquid Assets ÷ Current Liabilities

What is the formula for Debt Ratio (Textbook Definition)?

Debt Ratio = Liabilities ÷ Net Income

What is the formula for Debt Payments Ratio?

Debt Payments Ratio = Monthly Credit Payments ÷ Take-Home Pay

What is the formula for Cash Flow Surplus/Deficit?

Surplus / Deficit = Cash Inflows − Cash Outflows

What does a Net Worth Statement show?

A client’s financial position at a single point in time; measures wealth and tracks progress over years

What are examples of asset classes?

Cash (chequing, savings), Fixed income (bonds, GICs), Equities (stocks, ETFs)

What are key considerations for asset allocation?

Balance between growth and stability, consider at-risk/illiquid assets, and tax efficiency (RRSP, TFSA)

What is included in debt analysis?

Type of debt (mortgage, credit card, LOC), total debt amount, and trends over time

How does lifecycle stage affect Net Worth and financial planning?

Younger clients: higher debt, building assets, investing phase; Older clients: lower debt, wealth preservation, retirement planning

Example: Diane earns $6,000/month and Jack earns $4,000/month. Household disposable income ≈ $7,601/month. Monthly expenses = $7,360. What is the monthly and annual surplus?

Monthly Surplus = $241; Annual Surplus ≈ $2,894. Recommendation: place surplus in TFSA for liquidity + tax-free growth

What is the recommended Current Ratio benchmark?

≥ 2

What is the recommended Debt Ratio benchmark (textbook definition)?

≤ 0.5

What is the recommended Debt Payments Ratio benchmark?

< 20%

How should you interpret a Savings Ratio less than 10%?

Not saving enough; consider reducing discretionary spending or increasing income

How should you interpret a GDSR > 35%?

Housing costs are too high relative to income; risk of overleveraging, may impact mortgage approval

How should you interpret an Emergency Fund Ratio (EFR) less than 3 months?

Insufficient liquidity to cover unexpected events; prioritize building emergency savings

What is Non-Discretionary Spending?

Essential expenses: mortgage, rent, utilities, groceries, insurance

What is Discretionary Spending?

Non-essential expenses: entertainment, dining out, luxury items

What is Gray Area Spending?

Expenses that can be reasonable or excessive depending on lifestyle, e.g., food, transportation. Example: $700/month food = reasonable; $2,000/month food = lifestyle concern