Introduction to financial planning

Module 1

Introduction to Financial Planning

Certified Financial Planner Module 1: Introduction to
Financial Planning

This session will help you understand

• Financial Planning- the concepts and implementation

• Regulatory, ethical and professional aspects of financial planning.

• Cash flow planning and budgeting.

• Personal Asset management.

• Financial Statement analysis and mathematics.

• Economic Environment and indicators.

• Forms of business ownership.

• Ways of taking legal title to property.

Certified Financial Planner Module 1: Introduction to Financial Planning

Financial Planning
• Process of meeting life’s goals by efficient management of your
financial resources
• Process involves defines short-term and long-term goals and
prioritizing and Assessing current financial situation and
commitments

Role of Financial Planning

Defining and prioritizing
Defining and prioritizing Accessing current Deciding where you want
Accessing current Deciding where you want
short & long term goals finances & commitments
finances & commitments to be in the future
to be in the future
short & long term goals

Identifying realistic
Identifying realistic
Putting the plan into
Putting the plan into
Monitoring Performance
Monitoring Performance strategies to achieve the
strategies to achieve the
action
action goals
goals


The Financial Planning process involves 6
steps:
2.Establishing and
2.Establishing and
1.Monitoring the
1.Monitoring the 3.Gathering Client Data &
3.Gathering Client Data &
Defining the client-
Defining the client-
recommendations
recommendations Goals
Goals
Planner relationship
Planner relationship

The Financial Planner The Financial Planner The Financial Planner
should: should: should
Discuss his objectives & Analyze information
expectations Obtain information &
documents
Discuss the services available Identify problems &
opportunities across each major
Clarify responsibilities and time Help your client “refine” or financial planning discipline
frame crystallize goals
Finance – Asset & Liability
Finalize the scope of the Structure, Cash Flows
engagement Help your client develop an
understanding of his/ her Investment Taxation –
Determine the fee/compensation values & attitudes
arrangement Ordinary and Income

Risk Management –
Insurances & Asset Protection

Law – Estate, Charitable &
Legacy Planning


The Financial Planning process involves 6
steps:
5.Developing and
5.Developing and
4.Analysing and
4.Analysing and 6. Implementing the
6. Implementing the
Presenting Financial
Presenting Financial
Evaluating Financial
Evaluating Financial Financial plan
Financial plan
Planning
Planning
Status
Status recommendations
recommendations
Recommendations/
Recommendations/
Alternatives
Alternatives

The Financial Planner The Financial Planner The financial planner
should: should: and the client should:

Prepare & present a Assist the Client or manage Review changes in personal
personalized financial plan the process as defined in the circumstances
Engagement Agreement
Establish a review cycle Review and evaluate impact of
changing tax laws

Review and Discuss changing
life circumstances

Make periodic adjustments or
recommendations as necessary


Objectives of Financial Planning
• Emergency Funding: To accumulate liquid assets to fund the short-
term financial needs.

• Protection against personal risks: To provide for personal risks such
as premature death, sudden disabilities, medical emergencies and
so on.

• Special needs funding: to accumulate savings to fund special needs
• higher education for children,
• wedding expense for each of the children,
• a lump sum for the down-payment deposit for a condominium
(apartment),
• an overseas holiday tour for the family and so on.


Objectives of Financial Planning

• Capital accumulation for
• Education funding.
• Retirement funding.
• General investment fund.

• Reduction of tax burden
• During one’s life time

• After death for income accruing to the heirs.

• Estate planning
• Investment and property management


How to make Financial Planning work:

• Set measurable goals

• Understand effects of financial decisions on other financial issues

• Periodically Re-evaluate Financial Plans

• Start as early as possible and start with what you have got

• Take charge of the financial planning engagement

• Look at the big picture – It is more than just retirement planning or tax
planning

• Don’t confuse financial planning with investing

• Don’t expect unrealistic returns on investments

• Don’t wait until a money crisis to begin financial planning


Establishing the Client- Planner
Engagement


Responsibilities: Client & Planner

Client Planner

• Express concerns, hopes and •Evaluating client’s financial and
goals
other needs
• Do not procrastinate
•Explaining financial concept and
• Be honest with your answers to
questions clarify client goal
• Live within your current •Analyzing client circumstances
income and do not live up to or and prepare financial plan
beyond it
•Implementing and monitoring
• Be open to formulating a
financial plan and identifying financial plan
strategies to reach goals and
objectives


Gathering Client Data and Determining
Goals and Expectations

Certified Financial Planner Module 1: Introduction to
Financial Planning

Data obtained from Client- 2 types

• Quantitative Data-
• May be described as statements of fact.
• A client's name, date of birth and salary are some
examples.

• Qualitative Data-
• These may be defined as ‘relevant information that is not
factual in nature’.
• More difficult to obtain and define.
• Relates more to personal and social attitudes of the client.
• Examples : attitude to risk, future employment prospects


Data Collection Form
• Very useful tool to obtain useful qualitative &
quantitative information from the client.

• Should contain at least the following sections:
• Personal Details
• Basic Financial Details
• Cash Flow
• Insurance
• Estate Planning
• Qualitative information
• Attitude to risk


Personal Details
Personal details should include the following:
• Name
• Date of birth
• Employment history
• Health/family history
• Family structures
• Legal structures
• Employee benefits


Basic Financial Details
• Financial planner should gather detailed information on client’s
financial assets & Liabilities
• Planner should ensure that they have a full list of the real and
estimated value of assets. Identify what is real and which has been
estimated.
• Note the date of acquisition of the assets and the purchase price.
• Be sure to differentiate between ' lifestyle', or personal assets and
investment assets wherever possible


Cash Flows

• Related to Income Sources & expenditures of the client.
• More rigorous approach required in this area, as only rough
estimates usually provided by client.
• Financial planners mostly use an expense calculator to
assist clients in calculating their domestic budget.
• Main elements typically found an expense calculator are
housing, transport, health, education and personal.


Insurance

• The financial planner should find out which insurance policies the
client has in force

• Should include life insurance, asset protection, income protection,
disability cover, and trauma / critical illness cover.

• In addition the financial planner should identify the level of
insurance protection over fixed assets.


Estate Planning

• The financial planner should confirm that client has a
current, valid will and that its location is known.

• Similarly the financial planner should confirm whether
the client is aware of the benefits of having relevant
powers of attorney in place for all those in the family
with assets.


Some tips for better data gathering

• Start with personal questions, rather than their
financial position

• Ask open ended questions

• Listening Skills

• Avoid negative non-verbal communication at all times


Goal Setting

• Financial Planning process begins with Goal Setting

• Goals may be short term (take less than 12 months to achieve) or
long term (take more than 12 months to achieve)

• Goals may be focused and specific (establishing a budget) or
comprehensive (retirement planning)

• Goals sometimes compete for available Funds; they sometimes
overlap; and sometimes interact

• Goals must be an extension of your values


Goal Setting
Goals must be SMART

- Specific

- Measurable

- Action Oriented

- Realistic

- Time Bound


Analyzing Client Objectives, Needs &
Financial Situation


Clients seek advice from financial
planners to

• Simplify investments by having someone else do the paperwork
• Reduce tax paid
• Ensure appropriate application of a windfall gain;
• Protect against time off work due to sickness, accidents, or
untimely death;
• Overcome lack of savings or rising debt obligations
• Have a second opinion on a financial plan developed by them;


Financial Objectives
Needs and Wants
• The process of 'mutually-defining' is essential to
determine what activities may be necessary to proceed
with the client engagement.

• Personal values and attitudes shape a client's goals and
objectives and the priority placed on them.

• Wants and Needs are two different things.
• 'Wants‘ are desires or things 'hoped for'; 'needs' are
requirements or things.


Clients Needs can be categorized into

• Protection Needs – The need to protect assets against losses

• Safety Needs - the need to accumulate funds for expenses
("saving to spend" needs) as well as to provide a liquid source
of funds for financial emergencies. Also a temporary
"parking place" for funds to be invested elsewhere in the
near future.

• Income Needs - the need to receive a constant, consistent
cash flow from assets.

• Growth Needs - the need to invest funds in wealth building
or appreciation oriented products to achieve longer term,
capital-intensive goals, such as education or retirement


Identifying the Client’s Attitude to Risk

• Quantitative information may not be sufficient for a financial
planner to formulate strategies for the client

• Qualitative information is required to understand the client’s
appetite for risk

• Planner should evaluate the client's grasp on general knowledge on
financial matters

• When the financial planner begins the process of strategy selection
within the plan, it is critical to understand the client's attitude to
risk.


Analysis of relevant information
Personal Details: The main points to consider are :
• The age and life expectancy of the income earner in relation to
the likelihood of death or disablement;
• The gender of client and any dependants;
• The effects of smoking and
• The number and status of dependants

Other information which requires in-depth analysis
includes:
• Health/family history
• Family structures
• Legal structures


Analysis of relevant information
Financial Details:
• Analyze the assets and liabilities: Financial planner must
analyze assets & Liabilities situation of client to formulate
financial plan.
• Sources of Income: A tax return is a good basis to cover all
aspects. Note also any employer-provided perquisites.
• Expenditure of the client: Using the budget form, try to
isolate discretionary from non-discretionary expenses.
• The purpose of isolating these expenses is to find out what
the basic requirements are.


Developing Appropriate Strategies


Developing Strategies
The following things need to be kept in mind:
• Clients Risk Tolerance
• Assessment of Option
• Research Analysis & Modelling
• Draft Financial Plan
• Implementation of Plan
• Monitor and evaluate soundness of Recommendation
• Make recommendations to Accommodate New or
Changing Circumstances


Client’s Risk Tolerance
There are three types of clients for whom risk tolerance
assessment is particularly difficult.

• Clients who have the willingness to take risks, but don’t have
the financial ability.
• Clients who have the financial ability but don’t have the
willingness to take risks.
• All other clients


Client’s Risk Tolerance

• Selecting appropriate insurance coverage and determining
investment suitability depend on the planner’s ability to assess risk
tolerance

• Risk tolerance has four distinct aspects. An analysis of client risk
tolerance involves an evaluation of four risk concepts: propensity,
attitude, capacity and knowledge


Dimensions of Risk Tolerance

• Risk propensity: The clients’ attitude toward risk can be
determined by reviewing their real-life decisions in financial
situations.

• Risk attitude: The clients’ willingness to incur financial risk

• Risk capacity: The client’s financial ability to incur risk

• Risk knowledge: The client’s understanding of risk


Development of Strategies
• Six main strategic : cash flow and budgeting, investment planning,
taxation planning, investment planning, risk management &
insurance planning and estate planning.

• Wide range of alternative strategies available within each area.

• Only a comprehensive plan taking into consideration all the
strategic areas can help in achieving the client’s goals.


The Strategy Development Process

Check that you have
Check that you have
all the information
all the information

Secure the client’s
Secure the client’s
current financial position
current financial position

Establish the client’s goal
Establish the client’s goal
and financial concern
and financial concern

Recommendations to
Recommendations to
meet client's desired
meet client's desired
future financial position
future financial position


Drafting the Financial Plan
• Using data collected via various sources of data collection,
financial planner to draft the financial plan.

• The plan should be in a lucid language so client can
understand

• Financial planning software can be used for this purpose,
however, these should not be used in isolation for
developing the plan.


Essentials Components of a written financial
plan

• Executive summary/ financial plan summary
• Statement of current situation and financial objectives
• Assumptions
• Financial planning strategy
• Specific recommendations
• Projections
• Services, fees and commissions
• Summary of recommendations
• Action to proceed
• Authority to proceed/Letter of engagement
• Disclosures


Implementing and Monitoring the
financial Plan


Implementing and monitoring the
financial plan
Implementing the plan:
• Implementation of the plan is the next step in the process.
• A financial plan is useful to the client only if it is put into action.
• Financial planner to assist the Client or manage this process as
defined in the Engagement Agreement

Monitoring the plan- The Financial Planner and the Client should:
• Conduct periodic reviews when:
• Changes in personal circumstances
• Changing tax laws
• Changing life circumstances
• Make periodic adjustments or recommendations as necessary


Financial planning review

• The financial planner should establish a client file and a system for
periodic review and revision.

• The financial planner to monitor performance of investments,
changes in tax laws & regulations (the general economic
environment) and also evaluate new financial products for possible
inclusion.

• Financial planner to regularly evaluate the plan with respect to
any changes in the client’s situation.


Financial planning review

The following issues can be expected at this step:

• Have the client or the planner agreed to have the
recommendations and the client’s financial progress monitored
periodically?

• If so, does the planner review and evaluate changing
circumstances and make new recommendations based on the
changes, as and when it is appropriate?


Need for financial planning review

Regular reviews are necessary for :
• Changes in personal circumstances- Plans may need to be revised
for reasons such as loss of a job, addition of a new family member
and so on.

• Changes in the external environment- Changes in regulations,
economic and market conditions may warrant changes in the
financial plans

• Product related factors- To find out if the product recommended
to the client is still applicable to his needs.


Steps in the financial planning review

The review process should take the following steps:

• Measuring the performance of the implementation vehicles;

• Update information on the client’s personal and financial
situation;

• Examine the impact of economic, tax or the financial environment
on the effectiveness of the plan.


Benchmarking Performance & updation of
plans

• Setting a performance benchmark helps track progress made
towards the goal. The type of benchmarks to be used is important.
• These are important indicators for both the client and the financial
planner. They trigger off action that may be required
• The review process will help in identification of areas which need
changes to be made.
• Situation may require focus on a particular goal to shift or
abandonment of goals.
• A new plan should then be presented to the client, incorporating
such changes.


To summarize…

• Soundness of a comprehensive financial plan is based on how well
the individual chosen strategies complement each other.

• There are six fundamental strategy areas that should be addressed

• The options chosen as recommendations to the client from each of
these categories should work together to enhance the client's
overall financial position, both now and in the future.


Regulatory Requirements for CFP
Certificants


Certification requirements
• Student Member Requirements
• The Association of Financial Planners requires certain
declarations acceptance as Student Members.

• These disclosures are given on registration for the program.

• Candidates should fill in the required details. Students from
any discipline, including undergraduates can apply for CFP™
certification.

• The work experience criterion is not necessary to enroll for the
program.


Modules: The CFP™ certification is granted to individuals who have
demonstrated technical competency, enabling them to write (to
international standards) a comprehensive and detailed financial plan
for an individual.

The certification covers six India-localized course modules as
follows:
Module 1: Introduction to Financial Planning
Module 2: Risk Management and Insurance Planning
Module 3: Retirement Planning and Employee Benefits
Module 4: Investment Planning
Module 5: Tax Planning and Estate Planning
Module 6: Financial Plan Construction


CFP™ Certification Requirements:
Candidates have a maximum of seven years to complete
the certification process.

For certification, you are required to meet the following
four initial certification requirements (known as the
four "Es").
• Education
• Examination
• Experience
• Ethics


Ethical and Professional Consideration


Professional Standards

• Professional Standards have been adopted by the Financial
Planning Standards Board (FPSB), India to provide Code of Ethics
and Rules of Professional Conduct to all its Members.

• The Standards consists of two parts: Code of Ethics and Rules of
Professional Conduct.


The Code of Ethics
• The Code of Ethics are statements expressing in
general terms the ethical and professional ideals
expected of members

• The Rules of Professional Conduct are derived from the
tenets embodied in the Code of Ethics. As such, the
Rules set forth the standards of ethical and
professionally responsible conduct expected to be
followed in particular situations


The Code of Ethics
• Code of Ethic 1 – Integrity
Members shall observe high standards of honesty in conducting their
financial planning business and shall offer and provide financial planning
services with integrity.

• Code of Ethic 2 – Objectivity
Members shall disclose to the client any limitation on their ability to
provide objective financial planning services.

• Code of Ethic 3 – Competence
Members shall provide competent financial planning services and maintain
the necessary knowledge and skill to continue to do so in those areas in
which the Member is engaged.

• Code of Ethic 4 – Fairness
Members shall provide financial planning services in a manner that is fair
and reasonable.


The Code of Ethics
• Code of Ethic 5 – Confidentiality
Members shall not disclose any confidential client information without the
specific consent of the provider of that information unless compelled to
by law or as required to fulfill their legal obligations.

• Code of Ethic 6 – Professionalism
Members shall ensure their conduct does not bring discredit to the
financial planning profession.

• Code of Ethic 7 – Diligence
Members shall act with due skill, care and diligence in providing financial
planning services.

• Code of Ethic 8 – Compliance
Members must maintain knowledge of and comply with the Constitution of
the AFP, the AFP's Code of Ethics and Rules of Professional Conduct and all
applicable laws, rules and regulations of any government, government
agency, regulatory organization, licensing agency or professional
association governing the members' professional activities.


Rules of professional conduct
There are a number of rules of professional conduct that have
been set for CFP Candidates. These relate to the following broad
categories:

• Rules that Relate to the Code of Ethic of Integrity
• Rules that Relate to the Code of Ethic of Objectivity
• Rules that Relate to the Code of Ethic of Competence
• Rules that Relate to the Code of Ethic of Fairness
• Rules that Relate to the Code of Ethic of Confidentiality
• Rules that Relate to the Code of Ethic of Professionalism
• Rules that relate to the Code of Ethic of Diligence
• Rules that related to the Code of Ethics of Compliance


Assessment of Risk & Client Behavior


Risk Assessment

• Risk profiling: A method of determining clients’ attitude to risk

• This technique involves asking the client a prescribed series of
questions whose answers are designed to produce a value or point
on a scale that indicates the client’s risk acceptance.

• It is sound practice to discuss the nature of various investment
risks with the client so that the data you gather is based on a full
client understanding of those risks.


Risk Tolerance
• Assessing client risk tolerance is one of the most important and
most nebulous, activities for financial planners.

• Selecting appropriate insurance coverage & determining
investment suitability depend on planner’s ability to assess risk
tolerance. However, no definitive standard for evaluating risk
tolerance has emerged.

• There are three types of clients for whom risk tolerance
assessment is particularly difficult.
• The first type consists of clients who have the willingness to incur risk,
but don’t have the financial ability.
• The second type consists of clients who have the financial ability to
incur risk but don’t have the willingness.
• The third type consists of all other clients.


Risk Propensity
• Risk propensity The client’s attitude toward risk can be
determined by reviewing the client’s real-life decisions in financial
situations.

• For example, Clients who carry too little insurance or hold highly
risky assets are risk tolerant.

• But, Clients often make financial decisions without fully
understanding their impact. The client may be underinsured
because of simple procrastination or ignorance of the nature of the
risks they face.

• Sometimes they keep in their portfolios assets that were obtained
by inheritance or marriage, and may retain assets for family,
sentimental or tax reasons.


Risk Attitude
• Risk Attitude: The clients willingness to incur financial
risks.

• Planners should use a scientifically designed
questionnaire that directly addresses risk attitude.

• Among the types of questionnaire items used to
evaluate attitude are the following:


Risk Attitude
• Ranking investment objectives

• Allocating a make-believe windfall among various investment
options

• The level of thrill or anxiety felt after making financial decisions

• Selecting the preferred risk/return trade-off from a set of possible
alternatives

• Specifying the odds that would be required to entice the
respondent to accept a bet with a specified amount of gain or loss

• Specifying the rate of return that would be required to entice the
respondent to accept a bet with a specified set of odds.


Risk Capacity
• Risk Capacity: The client’s financial ability to incur risks, starting with the
client’s age and family responsibilities.

• Considers amount & stability of income relative to fixed & discretionary
expenses.

• Analysis of the balance sheet- asset allocation and portfolio
diversification, risk exposure in the portfolio, and the size and payment
structure of the liabilities and other contractual commitments are also
done.

• Portfolio goals and constraints (including time horizons) and the need for
current income, capital preservation and growth are part of the risk
capacity evaluation.

• An often forgotten aspect of capacity is the adequacy of the client’s
insurance coverage, which protect clients from some financial risks, thus
allowing them to take other financial risks.


Risk Knowledge

• Risk knowledge: The client’s understanding of risk.

• It is presumed that, Clients are more likely to make
informed financial decisions if they understand the nature of
risk and their exposure to it

• Further, clients who understand risk are less likely to panic
if investments do not perform upto expectations.


Importance of Risk Assessment

• The planner can find out if their client’s financial situation allows
them to take greater risks.

• If their financial situations allow them to take greater risks, they
will be more willing to do so.

• For clients whose risk capacity is low relative to attitude, planners
can point out factors that will improve risk capacity, based on the
assessment of risks.


Cash Flow Planning and Budgeting


Cash Flow Planning And Budgeting

• Short-term cash flow planning

• Cash budgeting

• Preparing monthly household budget

• Long-term cash flow planning


Cash Flows
• Cash flows for an individual client mean his or her income and
expenditure.
• An efficient management of cash flows is aimed at generating
surplus income by budgeting or controlling the client’s income and
expenditure.

• Personal financial planning consists of three general activities:
• Controlling day-to-day financial affairs to enable you to do the things
that bring you satisfaction and enjoyment.
• Choosing and following a course toward medium and long term
financial goals such as buying a house, sending your kids to college, or
retiring comfortably.
• Building a financial safety net to prevent financial disasters caused by
catastrophic illnesses or other personal tragedies.


Top ten features of a successful
budget
• Put expenses into categories that fit personal situation and spending
habits of the client, not somebody else’s.

• Project incomes accurately.

• Have enough categories to give a meaningful picture of where money goes
and where costs can be cut, but don’t make it too expansive.

• Include expenses that don't occur on a monthly basis, such as vehicle
maintenance, homeowners insurance, personal property taxes, service
contracts, etc.

• Regularly review categories to determine if more or fewer are needed,
review expenses, and brainstorm about ways to trim costs in each
category.


Some things to keep in mind while
budgeting
• Track and record expenditure and spending: Cash disappears
quickly and if you don't write down everything you spend it on,
you'll have a distorted look at your spending.

• Align item for savings so you treat a contribution to your savings
account just as you would a bill you owe.

• Have realistic written goals: Without goals, your budget is just a
pair of handcuffs.

• Identify spending patterns: This may identify expensed you may
not have been aware of when you weren't tracking your spending


Why do people keep cash?

• Transaction motive: Cash for day-to-day routine transactions such
as buying daily groceries.

• Precautionary motive: Keeping cash as a precaution against
unforeseen events and emergencies.

• Speculative motive: Keeping cash for investing in securities when
the right time arises.

• Compensation motive: A minimum balance is needed to avail of
bank accounts, credit cards, ATM cards, personal loans etc.


MONITORING, EVALUATION AND COMPLIANCE OF
BUDGETS:
• Budgeting and complying with the budget is important

• Budget needs to be evaluated & monitored on a continuous basis to find
out variations.

• A statement of variances may need to be prepared, which, shows variance
from budgeted figures, with reasons thereof and specific measures taken
to address them.

• These variances may as a result of an error in budgeting the figures due to
some wrong assumptions about economic indicators or ignoring some
associated expenses with a particular head.

• Financial planners should ensure that there is a continuous compliance
with the budget estimates to facilitate clients to meet their short-term
and long-term financial goals.


Personal Use Asset Management


Financing of Personal Assets
Following are the main types of personal assets financing
instruments:
• Home loans
• Mortgages
• Leases
• Refinancing
• Hire-purchase
• Consumer loans
• Credit cards


Mortgage Loans
There are six different types of mortgages:

• Simple Mortgage.
• Mortgage by conditional sale.
• Usufructuary mortgage.
• English mortgage.
• Mortgage by deposit of title deeds.
• Anomalous mortgage


Types of Mortgages
Mortgage by
Mortgage by Usufructary
Usufructary English
English
Simple Mortgage
Simple Mortgage conditional sale
conditional sale Mortgage
Mortgage Mortgage
Mortgage

Property stands
Property stands
absolutely
absolutely
Possession stands
Possession stands transferred to the
transferred to the
transferred
transferred mortgagee with aa
mortgagee with
Involves
Involves to the mortgagee
to the mortgagee covenant to repay
covenant to repay
A mortgage without
A mortgage without an ostensible sale
an ostensible sale and rents and profits
and rents and profits the mortgage
the mortgage
the transfer of
the transfer of to start with
to start with from the property
from the property money on aacertain
money on certain
any property.
any property. which becomes
which becomes can be enjoyed by
can be enjoyed by date by the
date by the
absolute on default
absolute on default the mortgagee till
the mortgagee till mortgagor,
mortgagor,
payment of the
payment of the when the
when the
mortgage money
mortgage money property will be
property will be
re-transferred to the
re-transferred to the
mortgagor.
mortgagor.


Types of Mortgages
Mortgage by deposit
Mortgage by deposit Anomalous Mortgage
Anomalous Mortgage
of title deeds
of title deeds

The security for the
The security for the A simple mortgage
A simple mortgage
money is intended
money is intended giving an added right to
giving an added right to
to be created by
to be created by take possession in
take possession in
deposit of the
deposit of the case of defaults of
case of defaults of
title deeds or papers
title deeds or papers payment becomes an
payment becomes an
of the property ..
of the property anomalous mortgage.
anomalous mortgage.


Lease Financing
• Lease financing enables the renting or leasing of assets rather than
buying the assets.

• Items like cars, consumer durables, computers or a house may be
leased.

• Generally leases are of two types:
• Operating Lease: A short-term lease. The possession of asset
returns to the owner or the lessor at the end of the lease term.

• Finance Lease: here the lessee has an option to buy the asset
at the end of the lease tenure. Generally for a longer period.


Personal Financial Statement Analysis


• Analysis of client’s financial condition is necessary to help him/
her
• better manage financial resources,

• develop effective spending patterns consistent with
consumption and investment goals, and

• to guard against excessive use of debt.

• Sources of information for Personal Financial Statement Analysis
• Bank passbook or statements

• Return of income filed and Form 16A

• Other statements- Other sources of information include bills
received, insurance policies, fixed deposit statements and
other investments.


Each of these ratios should provide information that is either
predictive or diagnostic about the client’s financial situation.

The ratios we will suggest provide information about the following six
aspects of the client’s financial situation:
• Liquidity
• Debt
• Risk exposure
• Tax burden
• Inflation protection
• Net worth


Calculation of ratios

Basic Liquidity Ratio = Liquid assets/ Monthly
expenses

Expanded Liquidity Ratio = Liquid Assets and
Other Financial Assets / Monthly Expenses

Liquid Asset Coverage Ratio = liquid asset / total
debt

Solvency Ratio = liquid and other financial
assets / total debt

Current Ratio = liquid assets / non- mortgage debt


Calculation of ratios
• Life insurance coverage ratio = net worth + death
benefits of principal wage earner / salary of principal
wage earner
• Effective income tax ratio = income tax liability / total
realized increases in net worth
• Inflation hedge ratio = equity, tangible and personal
assets /net worth
• Net cash flow ratio = 1 – Realized Decreases in net
worth
Realized Increases in net worth
• Net worth growth ratio = net increase in net worth /
net worth at beginning of the year


Economic Environment and Indicators


Importance of Economic and Business
Environment
• Significant implications on the financial plans and
recommendations.

• Recommendations depend on a number of assumptions about the
future performance of the economy.

• Financial planners should always keep a track of economic
environment to make reasonable assumptions.

• A thorough understanding of economic environment helps in
reviewing the existing financial plans.


ECONOMIC FACTORS: GNP & GDP

Gross National This is the value of output of goods and services
This is the value of output of goods and services
Gross National produced by Indian companies, regardless of whether
Product (GNP)
Product (GNP) produced by Indian companies, regardless of whether
the production is inside or outside the India
the production is inside or outside the India

Gross Domestic The value of output of goods and services produced
The value of output of goods and services produced
Gross Domestic in the country, regardless of whether businesses are
Product (GDP)
Product (GDP) in the country, regardless of whether businesses are
owned and operated by Indians or foreigners.
owned and operated by Indians or foreigners.

-
profits on

= +
profits on
Gross National
Gross National Gross Domestic
Gross Domestic Indian owned
foreign owned
Product (GNP)
Product (GNP) Product (GDP)
Product (GDP) businesses
businesses
outside India


GDP
GDP is the measure of total value of final goods and services produced in
the domestic economy each year. The following is often used

GDP=
GDP= C + II + G +
C+ +G+ (X- M)
(X- M)
C = personal consumption spending on goods and services
C = personal consumption spending on goods and services

I I= Private sector fixed capital expenditure
= Private sector fixed capital expenditure

G = Government expenditure
G = Government expenditure

(X-M)= Net of export receipts (X) and import payments (M)
(X-M)= Net of export receipts (X) and import payments (M)

The relationship highlights actual rupee expenditure for goods and services
produced in the economy for measuring GDP.
This equation includes all key players involved in the economy – consumers /
households, business (private sector) and government.
For living standards to rise in India, GDP must grow at a faster rate than the
population. This way, there is greater quantity of goods and services per person.


Example:
The following information is available for an economy.
Consumption (C) = Rs 3000
Private Investment (I) = Rs 500
Government Expenditure (G) = Rs 2000
Exports (E) = Rs 1000
Imports = Rs 1500
Calculate the GDP for the economy?

Answer:
GDP = 3000 + 500 + 2000 + (1000-1500)
= 5500 – 500
= 5000


BUSINESS CYCLES- Phases
• The recurrent periods of economic growth and recession are
business cycles.
• They represents a pattern of business expansion and
contraction over a number of years.
• The global integration of Indian economy has increased the
importance of business cycle for decision-making.

• Expansion/ upswing/ recovery: upturn in
business activity

• Peak/ Boom: over production and buildup of
excessive inventory

• Downswing/ recession: characterized by a
reduction in output and investment

• Trough: recession bottoms and production
levels off


INFLATION/ DEFLATION
• A situation of rising prices.

• The most popular measure of inflation in India is change in the
Whole Price Index (WPI) over a period of time.

• The WPI is an index measure of the wholesale prices of a selected
basket of goods and services in the economy.

• The WPI is expressed as a percentage with reference to some base
year, according to a formula

• WPI= (aggregate price for current year/aggregate price for the
base year)* 100

• An alternative measure is consumer price Index, which is
concerned with the consumer market for goods and services. There
is a considerable co-movement between these two indices with the
CPI tending to follow the WPI with a lag.


Types of Inflation
Result of aasteady increase in aggregate demand
Result of steady increase in aggregate demand
Demand Pull Inflation
Demand Pull Inflation for goods and services when the economy
for goods and services when the economy
is unable to adequately fill this demand.
is unable to adequately fill this demand.

Result of aahigher cost factor of production
Result of higher cost factor of production
Cost Push Inflation
Cost Push Inflation being passed along to the consumer
being passed along to the consumer
in the form of higher prices.
in the form of higher prices.

Producers exerting aastrong influence on
Producers exerting strong influence on
Administered Prices
Administered Prices the price of the product because
the price of the product because
of aalack of competition.
of lack of competition.

Inability to solve the simultaneous problems of
Inability to solve the simultaneous problems of
Stagflation
Stagflation economic stagnation and inflation
economic stagnation and inflation
through the use of monetary and fiscal policies.
through the use of monetary and fiscal policies.
This occurs when high rates of inflation
This occurs when high rates of inflation
and high rates of unemployment happen
and high rates of unemployment happen
simultaneously.
simultaneously.


MONETARY POLICY AND INTEREST RATES
& FISCAL POLICY.

• Fiscal Policy: controls level of government spending and raises
revenue through taxation.

• Monetary Policy: controls through regulation of interest rates, the
money supply and inflation in the domestic economy.

• The Reserve Bank of India (RBI) controls and influences the
economy by means of monetary and credit policy.

• The Monetary and Credit Policy relate to the attempt to control
the money supply and demand-led hence inflation in the economy.


Fiscal policies of the government
Fiscal policy deals with spending, borrowing and taxes and has a
major influence on raising debt and on interest rates.

It is based on revenue and outlays, revenue income from taxation,
sale of government assets and borrowings.

Goals of fiscal policy goals include:
• Maximum employment.
• Minimizing the impact of the business cycle.
• A growing economy.
• Stable or gradually rising prices


INTEREST RATES / YIELD CURVE

Monetary policy of the RBI aims to stabilize the economy
through regulation of the money supply.

Monetary policy acts upon interest rates and these in turn
affect the level of investment undertaken in the
economy.


Long-term interest rates are influenced by

• Inflationary expectations are added to the real interest rate
required to get the interest rate.

• Real interest rate required

• Term of maturity –longer the maturity, higher the rates as greater
risk is associated with long-term than with the short-term
investment.

• Borrowers’ characteristics- interest rates also depend on the risk
profile of the borrowers. Interest rates on secured loan will be less
than that of on the unsecured loans.


CRR and SLR
• Short term interest rates, are influenced by the bank rate and the
cash reserve ratio (CRR) and the statutory liquidity ratio (SLR).

• CRR is the cash reserve which banks are required to keep with the
RBI ; SLR is the proportion of funds that banks need to keep in
Government Securities

• The CRR is currently 5.5% while the SLR is 25%.


EQUITY INVESTMENT AND REAL RETURN

• Equity Stockholders share in profits and control business with their
voting rights

• Common stockholders may be called the owners of the corporation.

• Stockholders also share in losses and are liable to creditors of the
corporation but only to the extent of their investment.


Categories of Common Stock

Growth Income Cyclical Defensive Blue Chip
Stocks Stocks Stocks Stocks Stocks

Good Earning Stocks in Stock which One which The least risky
Potential and companies fluctuates declines less form of stock.
very low yield whose earnings widely over than most in a These are the
because the are good, but swings in the general stocks of older,
company is are not business cycle. downturn of well-
reinvesting the growing much This is the the market. established
bulk of its stock of It is usually companies,
earnings in companies income stock which have
expansion. whose sales proved that
and earnings they can earn
vary greatly. profits.

Besides these, we have speculative stocks - Stocks of new, small firms whose chances
for success are not great (mining stocks, etc.). An investor should not place money in
these stocks if they cannot afford to lose it during bad times.


Preferred Stock
• Preferred stock is a type of stock issued by a corporation that gives
some kind of preference to the purchasers.
• The preferred stockholder will not only receive a fixed dividend, but
will also have the opportunity for capital appreciation.
• Types of Preferred Stock Include:

Non-
Non-
Cumulative
Cumulative Participating
Participating Convertible
Convertible
Cumulative
Cumulative
Dividends If no dividends If earnings Can be
accumulate from suffice, the exchanged for
are paid in
prior years. preference common stock or
prior years,
When the shareholder will other securities
company The corporation also share in the same
declares is not liable for equally, the company or
dividends, those such failure to dividend paid to other
in arrears pay dividends common share companies, at
receive back holders the option of the
dividends stockholder


Financial Mathematics


The Time Value of Money

• The Interest Rate
• Simple Interest
• Compound Interest
• Amortizing a Loan
• Compounding More Than Once per Year


TIME allows you the opportunity to
postpone consumption and earn INTEREST


Types of Interest
Simple Interest
Interest paid (earned) on only the original amount, or
principal, borrowed (lent).

Compound Interest
Interest paid (earned) on any previous interest earned, as
well as on the principal borrowed (lent).


General Future Value Formula
FV1 = P0(1+i)1
FV2 = P0(1+i)2

General Future Value Formula:
FVn = P0 (1+i)n
or FVn = P0 (FVIFi,n) -- See Table


General Present Value Formula
PV0 = FV1 / (1+i)1
PV0 = FV2 / (1+i)2

General Present Value Formula:
PV0 = FVn / (1+i)n
or PV0 = FVn (PVIFi,n) -- See Table


Annuity
The future value of an ordinary annuity can be viewed as
occurring at the end of the last cash flow period, whereas
the future value of an annuity due can be viewed as
occurring at the beginning of the last cash flow period


Steps to Solve Time Value of Money Problems

Read problem thoroughly
Create a time line
Put cash flows and arrows on time line
Determine if it is a PV or FV problem
Determine if solution involves a single CF, annuity
stream(s), or mixed flow
Solve the problem
Check with financial calculator (optional)


Frequency of Compounding

General Formula:
FVn = PV0(1 + [i/m])mn
n: Number of Years m:
Compounding Periods per Yeari: Annual
Interest Rate FVn,m: FV at the
end of Year n
PV0: PV of the Cash Flow today


Effective Annual Interest Rate

Effective Annual Interest Rate
The actual rate of interest earned (paid) after adjusting
the nominal rate for factors such as the number of
compounding periods per year.

(1 + [ i / m ] )m - 1


COMPARISON OF INVESTMENT RETURNS

NET PRESENT VALUE
NPV = Present value of future cash flows
NPV = A0 + A1 + A2 + ………….. + An

(1+r)0 (1+r)1 (1+r)2 (1+r)n
Where,
NPV = Net present value
At = cash flow occurring at the end of year t (t = 0,1,2, ……, n)
r = discount rate
n = period of cash flows


IRR
The internal rate of return of a project is the discount
rate which makes its net present value equal to zero. It
is the discount rate in the equation
0= A0 + A1 + A2 + ………….. + An
(1+r)0 (1+r)1 (1+r)2 (1+r)n
In the net present value calculation we assume that the
discount rate (cost of capital) is known and determine
the net present value of the project. In the internal
rate of return calculation, we set the net present value
equal to zero and determine the discount rate (internal
rate of return) which satisfies this condition.


PAY BACK PERIOD
• The payback period is the length of time required to recover the
initial cash outlay on the project. According to the payback
criterion, the shorter the payback period, the more desirable the
project.

• The accounting rate of return, also called the average rate of
return, is defined as Profit after tax/ Book value of investment

• The numerator of this ratio is the average annual post tax profit
over the life of the investment and the denominator is the average
book value of fixed assets committed to the project.


Financial Functions Using Microsoft Excel

• FV
FV(rate,nper,pmt,pv,type)
• Rate is the interest rate per period.
• Nper is the total number of payment periods in an annuity.
• Pmt is the payment made each period; it cannot change over the
life of the annuity. Pmt must be entered as a negative number.
• Pv is the present value, or the lump-sum amount that a series of
future payments is worth right now. If pv is omitted, it is assumed
to be 0 (zero). PV must be entered as a negative number.
• Type is the number 0 or 1 and indicates when payments are due. If
type is omitted, it is assumed to be 0 which represents at the end
of the period. If payments are due at the beginning of the period,
type should be 1.


• PV
• PV(rate,nper,pmt,fv,type)
• Rate is the interest rate per period. For example, if you obtain an
automobile loan at a 10 percent annual interest rate and make monthly
payments, your interest rate per month is 10%/12, or 0.83%. You
would enter 10%/12, or 0.83%, or 0.0083, into the formula as the rate.
• Nper is the total number of payment periods in an annuity. For example,
if you get a four-year car loan and make monthly payments, your loan
has 4*12 (or 48) periods. You would enter 48 into the formula for nper.
• Pmt is the payment made each period and cannot change over the life of
the annuity. Pmt must be entered as a negative amount.
• Fv is the future value, or a cash balance you want to attain after the last
payment is made. Fv must be entered as a negative amount.
• Type is the number 0 or 1 and indicates when payments are due. If type is
omitted, it is assumed to be 0 which represents at the end of the
period. If payments are due at the beginning of the period, type should
be 1.


• NPV
NPV(rate,value1:value29),+cash investment
• Rate is the rate of discount over the length of one period.
• value1: value29 are 1 to 29 periods representing income.
• +cash investment represents the cash investment for the project.

Example: =NPV(F9,C10:C14),+C9
F9 contains the required rate of return
C10:C14 contains the postive cash flow generated by the project
each period
+C9 contains the cash investment required by the project.
The cash investment must be entered as a negative amount.



• RATE
RATE(nper,pmt,pv,fv,type,guess)
Nper is the total number of payment periods in an annuity.
Pmt is the payment made each period and cannot change over the
life of the annuity.
Pmt must be entered as a negative amount.
Pv is the present value that the future payment is worth now. Pv
must be entered as a negative amount.


Fv is the future value, or a cash balance you want to attain after the last
payment is made. If fv is omitted, it is assumed to be 0 (the future value
of a loan, for example, is 0).
Type is the number 0 or 1 and indicates when payments are due. If type is
omitted, it is assumed to be 0 which represents at the end of the
period. If payments are due at the beginning of the period, type should
be 1.
Guess is your guess for what the rate will be. If you omit guess, it is
assumed to be 10 percent. If RATE does not converge, try different
values for guess. RATE usually converges if guess is between 0 and 1.
• NPER
• NPER(rate, pmt, pv, fv, type)
• Rate is the interest rate per period.
• Pmt is the payment made each period; it cannot change over the life of
the annuity. Pmt must be entered as a negative amount.
• Pv is the present value, or the lump-sum amount that a series of future
payments is worth right now. Pv must be entered as a negative amount.


• Fv is the future value, or a cash balance you want to attain after
the last payment is made.
• Type is the number 0 or 1 and indicates when payments are due. If
type is omitted, it is assumed to be 0 which represents at the end
of the period. If payments are due at the beginning of the period,
type should be 1.
• PMT
• PMT(rate,nper,pv,fv,type)
• For a more complete description of the arguments in PMT, see PV.
• Rate is the interest rate for the loan.
• Nper is the total number of payments for the loan.
• Pv is the present value, or the total amount that a series of future
payments is worth now; also known as the principal.
• Fv is the future value, or a cash balance you want to attain after
the last payment is made. If fv is omitted, it is assumed to be 0
(zero), that is, the future value of a loan is 0.


IRR

• IRR
• IRR(values,guess)
• Values is an array or a reference to cells that contain
numbers for which you want to calculate the internal
rate of return.
• · Values must contain at least one positive value and
one negative value to calculate the internal rate of
return.
· IRR uses the order of values to interpret the order of
cash flows. Be sure to enter your payment and income
values in the sequence you want.
· If an array or reference argument contains text,
logical values, or empty cells, those values are ignored.
• Guess is a number that you guess is close to the result
of IRR.


Question
Sundram expects to pay out the following in the next few
years:
• End of Year 1 Rs.10,000

If Sundram wants to cater to these cash flows, how much
should he have now, assuming an annual rate of 5%?

Ans:53,220.57


Forms of Business Ownership



• Sole Proprietorship
• Partnership
• Limited Liability Companies
• Trusts
• Foundations
• Professional Association
• Cooperative Societies


Sole Limited Co-operative
Partnership
Proprietorship Company Societies

General Partnership • Liability of the • Enterprise owned and
• Owned by an controlled by the
individual. • Owned by 2 or more stockholders are
people working in it.
partners limited to the
• The individual is • Each member has
amount invested equal control- 1 man 1
in charge of all • Partners are equally
by them. vote.
operations. and personally liable
• Enjoys advantages • Anyone who fulfills
• The personal for debts. qualification criteria
of perpetual life
property is • The personal property can join.
span.
attached. is attached. • Profits can be retained
in business or
• Can be a • In a limited distributed
disadvantage if partnership- Partner’s proportionately
the owner is liability is limited to • Member should
unable to money invested. primarily benefit from
continue the business participation
• Limited partner not
business • Interest on loan/ share
involved in decision capital limited in some
making specific way


Corporations Professional Trade
Trusts Associations Associations

• Created to hold assets for • Corporations are • Formed to protect • An association of
the benefit of certain chartered interests of individuals or
persons or entities, • Incorporation professionals they companies in a
managed by a trustee on represent. specific business or
certificate needs to be
behalf of the trust filed. • Virtually every trade/ industry organized
• Founded by persons called profession has such to promote common
• Subject to laws of the an association.
Thrusters, settlers and/ or state in which they interests.
donors, who execute a • Most of these are
operate • A particular sector
registered under The
written declaration of • Continuous life span or class of business
Societies Registration
trust – outlines terms and may face the same
• Total worth divided into Act- 1860.
conditions of operation problems- to seek
shares of stock • There is a
solutions for these,
• Each share represents registration fee.
they may form
unit of ownership • The memorandum of
themselves into a
society will define
trade association.
the objects of the
association. • CII and ASSOCHAM
are some examples


Foundations

• Can be formed by 7 or more members associated for any
purpose as is described in Section 20 of the Act.

• Formed by filing a Memorandum of Association with the
registrar of Joint Stock Company

• The property belonging to a society registered under this
Act, if not vested in trustees, shall be deemed to be vested,
in the governing body of such society, and in all civil and
criminal proceedings, may be described as the property of
the governing body of such society by their proper title.


Franchising
• Franchising is something of a halfway house, lying
somewhere between entrepreneurship and
employment.

• It holds many of the attractions of running a small
business; at the same time eliminating some of the
risks.

• For example, the failure rate for both franchisers and
franchisees is much lower than for the small business
sector as a whole.


Distributorship
• Could be for a particular product, such as a make of car.

• Sometimes referred to as an agency, but there are differences
between these two concepts.

• Both parties are legally independent, (as vendor and purchaser)

• The purchaser, in exchange for certain exclusive territorial rights,
helped by the vendor's advertising, promotion and/ or, training of
staff, will be expected to hold adequate stock and maintain the
premises in a way that reflects well on the vendor's product or
service.


Ways of taking legal title to property


Transfer of Property

• A transfer may be by way of sale, exchange, gift, lease,
mortgage or actionable claim.

• Prior to 1882 no law existed which really governed
activities of transfer of properties in India

• Since then the law relating to the transfer of properties
by is codified in the Transfer of Property Act, 1882.


Transfer of Property Act, 1882 (TOPA)
Contains provisions that define:

• What is transfer of the property,

• Person competent to transfer,

• Conditions restraining the transfer,

• Transfer for the benefit of unborn person,

• Transfer in perpetuity for the benefit of public,

• Conditional transfer, etc.


Transfer of Property
• Transfer of possession from one person to another.

• TOPA contains specific provisions regarding such transfer.

• As per the Act, 'transfer of property' means an act by which a
living person conveys property to one or more other living
persons, or to himself and one or more other living persons.

• The Act may be done in the present or for the future

• A living person may include an individual, company, association,
or body of individuals, whether incorporated or not.

• Under the Act, property of any kind may be transferred, unless
prohibited by any law for the time being in force.


What cannot be transferred?
• The chance of an heir-apparent succeeding to an estate,
• The chance of a relation obtaining a legacy on the death of a
kinsman, or any other mere possibility of a like nature.
• A mere right of re-entry for breach of a condition subsequently
cannot be transferred to anyone except the owner of the property
affected thereby.
• An easement cannot be transferred apart from the dominant
heritage.
• An interest in property restricted in its enjoyment to the owner
personally.
• A right to future maintenance, in whatsoever manner arising,
secured or determined.


What cannot be transferred?
• A mere right to sue cannot be transferred.

• A public office cannot be transferred, nor can the salary of a
public officer, whether before or after it has become payable.

• No transfer can be made:
o in so far as it is opposed to the nature of the interest affected
thereby, or
o for an unlawful object or consideration within the meaning of
section 23 of the Indian Contract Act, 1872 (9 of 1872), or
o to a person legally disqualified to be transferee.

• Stipends allowed to military, naval, air-force and civil pensioners
of the government and political pensions cannot be transferred.


What can be transferred?

• Nothing in this section shall be deemed to authorize a
tenant having an untransferable right of occupancy, the
farmer of an estate in respect of which default has
been made in paying revenue, or the lessee of an
estate, under the management of a Court of Wards, to
assign his interest as such tenant, farmer or lessee.


Introduction to financial planning

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