CFP - General Principles of Financial Planning (15% of the exam) - Section B.8

Financial statements

Preparing and interpreting a personal statement of financial position and a cash-flow statement, classifying assets and liabilities, and computing and interpreting ratios such as emergency fund, debt-to-income, housing cost and savings ratios from a client's figures.

Personal financial statements

Practice question for this objective

Free sampleGeneral Principles of Financial Planningmedium

Dana, 35, has non-discretionary monthly living expenses of 6,200 dollars. Her accounts hold 9,400 dollars in chequing, 22,600 dollars in a savings account and 12,000 dollars in a money market fund, all available on demand without penalty. She also has 60,000 dollars in her employer 401(k), from which any withdrawal before age 59 and a half would be taxable and penalised, and an untouched home equity line of credit with 15,000 dollars of available borrowing. Measuring her emergency fund in months of non-discretionary expenses covered by liquid assets, what figure should the planner report?

A5.2 months
B7.1 months Correct
C9.5 months
D16.8 months

Measure the emergency fund using only assets convertible to cash without tax, penalty or lender permission, divided by monthly non-discretionary expenses. The emergency fund measure divides liquid assets by monthly non-discretionary expenses. Liquid assets here are chequing of 9,400 dollars, savings of 22,600 dollars and the money market fund of 12,000 dollars, which total 44,000 dollars. Dividing 44,000 by 6,200 gives 7.096, reported as 7.1 months. The 401(k) is excluded because reaching it costs tax and a penalty at Dana's age, and the home equity line is excluded because available credit is a liability facility rather than an asset she holds.

Why A is wrong: This counts only the 9,400 dollar chequing and 22,600 dollar savings balances, giving 32,000 dollars divided by 6,200 dollars. The money market fund is available on demand without penalty and therefore belongs in liquid assets.

Why B is correct: Liquid assets of 9,400 plus 22,600 plus 12,000 come to 44,000 dollars, and 44,000 divided by 6,200 is 7.1 months, using only assets Dana can convert to cash immediately without tax or penalty.

Why C is wrong: This adds the 15,000 dollars of available credit on the home equity line to the 44,000 dollars of liquid assets. Unused borrowing capacity is not an asset the client owns, and a lender can reduce or freeze the line at the moment it is needed.

Why D is wrong: This adds the 60,000 dollar 401(k) balance to the 44,000 dollars of liquid assets. A retirement account reachable only through a taxable and penalised early withdrawal fails the liquidity test used for an emergency fund measure.

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Exam traps in General Principles of Financial Planning

Answers that look right on this material and are not. Each one is a distractor from a different question in the CFP bank for this domain.

His housing ratio of 35 percent and his total debt service ratio of 50 percent both exceed the guidelines
Why it is wrong: These figures come from dividing by take-home pay of 5,600 dollars, which is a reasonable instinct for affordability work but not the base the stem specifies, and lending guidelines of 28 and 36 percent are set against gross income.
Estimate the missing balance from the dividend income shown on the couple's tax return and complete the projection.
Why it is wrong: Reconstructing a figure looks resourceful and may even land close, but an assumption invented by the planner is not client information. The clients would then be relying on a projection built on a number they never confirmed.
The 11,200 dollars of interest appears as a cash outflow on the cash flow statement, while the 4,800 dollars of principal is treated as a transfer that never touches the cash flow statement.
Why it is wrong: This borrows an accrual accounting idea that principal repayment merely shifts value between balance sheet accounts. A personal cash flow statement is prepared on a cash basis, so every dollar leaving the client's bank account, including the 4,800 dollars, is an outflow.

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