Case Application: Financial Statement Cash And Debt Analysis

Case Application Financial Statement Cash And Debt Analysissolvean

Case Application: Financial Statement, Cash, and Debt Analysis Solve/answer case application questions 1-10. Use Balance Sheet & Pro Forma Cash Flow Template for Questions 1 and 5. Balance Sheet - Richard called and said that he had compiled a list of assets and would send it. It came a few days later. His assets included a home worth $300,000, approximately $350,000 in securities, two cars worth $40,000 with loans of $15,000 against them, and other assets including jewelry (worth $5,000), art ($5,000), and furniture ($7,000). Richard and his wife had money market funds of $2,000, a bonus due of $5,000 net of taxes, and credit card payments due of $12,000. Their house had a $130,000 mortgage. He said to assume that his salary will rise 6 percent a year, and his investment income is 11 percent a year (the investment loss came a year ago). His expenses should rise 3 percent a year except for medical, which will grow at a rate of 6 percent yearly, and taxes, which will grow at about 7 percent a year. Cash Flow - Richard said he was not worried about the losses taken. He would make them up, but Monica insisted that they save additional monies. He wanted to know what I recommended to help him save. He said he knew Monica was secretly putting away part of her household money into an account in her own name. Richard came in with his cash flow statistics below. Inflows ($) Outflows ($) Salary 100,000 Investment Income 8,000 Food 5,000 Clothing 8,000 Health Care 6,000 Transportation 2,000 Personal 3,000 Recreation 4,000 Cars, Entertainment 9,000 Hobby 1,000 Gifts & Charity 2,000 Insurance 6,000 Taxes 26,000 Debt - Richard and Monica have diametrically opposite points of view on debt. Richard views debt as an opportunity to generate cash to make up for past investment losses. He has asked you whether he should remortgage his house and place the proceeds in the stock market. He says the present time may be appropriate to refinance because market rates for mortgage loans of 6.5 percent are well below his mortgage rate of 8 percent. He wants to use an adjustable rate that provides an even lower 4 percent rate for the first year with rates thereafter 2 percent above the five-year Treasury rate. Richard wants a 30-year mortgage because he said he doesn’t expect “to go anywhere”—and the annual repayments would be low. He said he was thinking about buying a new car. While the existing one worked well, he was tired of it. If cash flows get tight, he isn’t at all averse to using credit card debt. He says that whereas credit card rates are high, the overall impact is not great and “people manage to pay money back.” Monica has listened quietly to Richard with a pained expression on her face, occasionally shaking her head. She says she is afraid of taking on more debt and wants a budget to limit spending of all types. Case Application Questions: 1. Construct the balance sheet. 2. Would you tell Richard and Monica that it was strong? Why? 3. Complete the balance sheet section of the plan. 4. What recommendations would you have to help them save more? 5. Construct their cash flow statement for this year and the next two years. 6. What do the future cash flow figures indicate? 7. Complete the cash flow section of the plan. 8. What do you think of Richard’s idea of borrowing to place money in the stock market? 9. Do you think the couple should refinance their mortgage? 10. Complete the debt and future budgeting part of the plan.

Paper For Above instruction

In this analysis, we explore Richard and Monica's financial situations through constructing detailed balance sheets and cash flow statements, evaluating their financial strength, and providing strategic recommendations for their savings, debt management, and overall financial planning. The goal is to offer insights that can facilitate better financial decisions and secure their financial future.

1. Construction of the Balance Sheet

The initial step involves assembling a comprehensive balance sheet based on the assets and liabilities provided. Richard's assets include a primary residence valued at $300,000, securities worth about $350,000, two cars valued at $40,000 with a $15,000 loan against them, jewelry ($5,000), art ($5,000), and furniture ($7,000). Additional assets include money market funds totaling $2,000 and a $5,000 bonus net of taxes. The liabilities include a $130,000 mortgage, credit card debt of $12,000, and car loans totaling $15,000. Summing up these figures results in a net worth indicative of their overall financial health.

Assets:

• Home: $300,000
• Securities: $350,000
• Cars: $40,000 (less $15,000 loan)
• Jewelry: $5,000
• Art: $5,000
• Furniture: $7,000
• Money Market Funds: $2,000
• Bonus: $5,000

Liabilities:

• Mortgage: $130,000
• Car Loans: $15,000
• Credit Card Debt: $12,000

Net worth is calculated by subtracting total liabilities from total assets, yielding a snapshot of their financial standing.

2. Financial Strength Evaluation

Based on their assets and liabilities, Richard and Monica's financial position appears reasonably strong, with significant assets offsetting liabilities. The substantial equity in their home and securities suggests resilience. However, the high monthly expenses and debt levels warrant caution. Their ability to service debts comfortably, without substantial liquid assets beyond their emergency funds, indicates moderate financial strength. Their focus should be on increasing savings and reducing high-interest debt to bolster this position further.

3. Completing the Balance Sheet for the Financial Plan

The finalized balance sheet incorporates projected changes, including expected income growth and expense increases. Assets such as securities are assumed to appreciate at approximately 11% annually, while expenses are forecasted to grow at specified rates. Adjustments for potential refinancing or additional debt should be reflected here to provide an accurate baseline for planning.

4. Recommendations for Increasing Savings

To enhance savings, advisable strategies include establishing automated transfers into savings accounts, reducing discretionary expenses like entertainment and gifts, and prioritizing high-interest debt payments. Incorporating tax-advantaged savings vehicles such as IRAs or 401(k)s could also improve long-term accumulation. Adjusting spending habits and creating a detailed budget can help them allocate more funds toward building an emergency reserve and future investments.

5. Construction of Cash Flow Statement

For this year, Richard's income streams include a $100,000 salary and $8,000 investment income, totaling $108,000. Outflows encompass mortgage and home maintenance ($20,000), food ($5,000), clothing ($8,000), healthcare ($6,000), transportation ($2,000), personal and recreation expenses, among others, summing to approximately $82,000. Net cash flow indicates a surplus, which can be redirected into savings.

Projected cash flows for the following two years incorporate annual inflation rates on income and expenses, with salary increasing by 6%, investment income by 11%, and expenses by varying rates. This financial projection illustrates trends and helps identify potential shortfalls or surpluses.

6. Future Cash Flow Implications

The forecasted cash flows suggest increasing income, which, if managed prudently, can significantly enhance their savings capacity. However, rising expenses, particularly healthcare and taxes, could strain their budget if not controlled. Maintaining a disciplined savings plan and considering debt repayment strategies are essential to ensure positive cash flow over the long term.

7. Completing the Cash Flow Section of the Plan

This involves detailing inflows, outflows, and net savings, including debt repayments and interest payments. Strategies to optimize cash flows include reducing discretionary spending, refinancing existing debts at lower rates, and planning for irregular expenses such as medical costs. Monitoring cash flows regularly can help adapt to changing circumstances and maintain financial stability.

8. Evaluating Borrowing to Invest in the Stock Market

Richard's proposal to remortgage and invest in equities carries significant risk. Leveraging debt to invest can amplify gains but also magnifies potential losses—particularly volatile during market downturns. Given their current liabilities and risk appetite, it's advisable to prioritize debt reduction and savings over speculative investments, unless for diversification and long-term growth within a balanced portfolio.

9. Recommending Mortgage Refinance

Refinancing at a lower interest rate, especially with the proposed adjustable-rate mortgage, could reduce monthly payments and free up cash for savings or debt repayment. However, the variable rate risks, particularly after the initial low-rate period, require careful consideration. Their long-term stability, current interest rates, and potential future increases should inform this decision. Overall, if it aligns with their risk tolerance and financial goals, refinancing could be beneficial.

10. Debt Management and Future Budgeting

Developing a comprehensive debt reduction plan, prioritizing high-interest debts such as credit cards, and establishing an emergency fund are crucial. Regularly reviewing their budget, setting clear savings targets, and controlling discretionary spending will foster financial discipline. Incorporating future projections ensures they can adjust their plans proactively to maintain financial health and achieve their long-term objectives.

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