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  1. Your Financial Statements and Plan

    Chapter 2
  2. Financial Planning 101 Could this happen to you?
  3. Mapping Out Your Financial Future Financial plans – roadmaps that show you where you stand financially Personal Financial Statements – let you know where you stand financially Budgets – detailed short-term financial forecasts; compare estimated income with estimated expenses
  4. Personal Financial Statements Planning tools Help identify potential financial problems Help you make better-informed financial decisions
  5. Balance Sheet Describes your financial position at a given point in time Helps you track progress in building up assets and reducing debt
  6. Income and Expense Statement Measures financial performance over time Tracks income earned, as well as expenses made, during a given period Use it to compare your actual expenses with budgeted amount
  7. Budgets Forward looking Allows you to monitor and control spending Microsoft Money Budgeting Envelope Budgeting
  8. Special Planning Concerns Managing two incomes—do benefits outweigh costs? Benefits: added income, additional employee benefits Costs: childcare, taxes, clothing, dry cleaning, transportation, lunches
  9. Employer/Employee Benefits Employer/employee benefits May include: health, life, disability, and long-term care insurance; Pension/profit sharing; Supplemental retirement (401K), dental and vision care, child care, elder assistance care, educational assistance, subsidized food service Flexible-benefit (cafeteria) plans – employer allocates a certain amount of money to each employee and then employee “spends” money on benefits s/he chooses
  10. Major Life Changes First job Marriage Children Death of family member Divorce Change in health Loss of job Change in economy
  11. Types of Financial Plans/Planners: Commissioned salespeople who work for financial institutions. Fee-only financial planners who work for the individual client. Planners who charge both fees and commissions, depending on the products and services offered. Computerized financial plans prepared by financial institutions.
  12. What Do Financial Planners Do? Help their clients articulate their long- and short-term financial goals Systematically plan for their clients’ financial needs Help implement various aspects of their clients’ financial plans
  13. Choosing a Financial Planner Unlike accounting and law, the field is still largely unregulated Critical to thoroughly check out a potential financial advisor Visit CFP board web site Check with your state securities and exchange commission Video
  14. Time Value of Money:Putting a Dollar Valueon Financial Goals A dollar today is worth more than a dollar received in the future because it can be invested to earn interest.
  15. Types of TVM Calculations: Single sum—one lump sum investment with no more additions or subtractions. Annuity—a series of equal payments made at fixed time intervals for a specified number of periods.
  16. Ways to Calculate TVM: Formulas Tables (see Appendices A-D) Financial calculators Spreadsheets (ex: Excel) Internet calculators (search on “calculators”)
  17. Future Value The value to which an amount today will grow if it earns a specific rate of interest over a given period. Compounding—the interest earned each year is left in the account and becomes part of the principal on which interest is earned
  18. The Rule of 72 Easy way to calculate how long it will take for your money to double Divide the number 72 by the percentage rate you are earning on your investment Number of years to double money = 72 Annual compound interest rate
  19. Present Value The amount you would have to invest today at a given interest rate over the specified time period to accumulate the future amount. “Discounting” is the reverse of compounding and is the process of working from the future value back to the present value.
  20. Balance Sheet A statement of your financial position at one point in time.
  21. Balance Sheet Equation: Liabilities Assets = + Net Worth *or Net Worth = Assets - Liabilities
  22. Balance Sheet ASSETS LIABILITIES What you own: checking acct. car investments jewelry furniture What you owe: car loan credit card balances education loans unpaid monthly bills NET WORTH (Subtract total liabilities from total assets to determine net worth.)
  23. Types of Assets Liquid Assets – cash or instruments that can readily be converted to cash Investments – assets acquired to earn a return rather than provide a service. Real and personal property – tangible assets we use everyday Real property – immovable property (land and anything affixed to it; usually appreciates Personal property – movable property (cars, appliances, jewelry) Fair market value – price it can reasonably be expected to sell for in open market
  24. Types of Liabilities Current or short-term – debt currently owed and due within 1 year Open account credit obligations – outstanding balances against established credit lines Long-term – debt due 1 year or more Only the latest outstanding loan balance should be shown as a liability on balance sheet Only principal should be listed; not the interest.
  25. Net Worth Represents the amount of money left after selling all your owned assets at their fair market values and paying off all your liabilities Typically increases over the life cycle of an individual or family
  26. The Concept of Solvency: If your net worth is POSITIVE, you are SOLVENT and have enough assets to cover your financial obligations. If your net worth is (NEGATIVE), you are INSOLVENT and do not have enough assets to cover your financial obligations.
  27. The Income and Expense Statement A measure of your financial performance over a given time period.
  28. Income and Expense Statement: Total Income – Total Expenses = CASH SURPLUSOR (CASH DEFICIT)
  29. Income: Cash IN   Wages and salaries (Gross amount) Bonuses Interest and dividends Child support Tax refunds Gifts
  30. Expenses: Cash OUT    FIXED Rent or mortgage payment Cable TV Insurance VARIABLE Dry cleaning Recreation Eating out
  31. CASH SURPLUS (DEFICIT): If your income exceeds your expenses, you have a CASH SURPLUS. If your expenses exceed your income, you have a (CASH DEFICIT).
  32. How We Spend Our Income
  33. Using Your Personal Financial Statements Maintain a good recordkeeping system Prepare financial statements periodically (many people update statements every 3-6 months) Track financial progress
  34. Ratio Analysis Financial ratios allow you to: Track progress toward your financial goals Evaluate your financial performance over a period of time
  35. Balance Sheet Ratios Solvency Ratio Shows the state of your net worth at a given point in time. Indicates your potential to withstand financial problems. Total net worth Total assets
  36. Example: $41,420  $147,175 = .28 or 28% The larger this ratio, the greater the financial cushion to protect against insolvency. This family could withstand a 28% decline in asset value before they would be insolvent.
  37. Liquidity Ratio Measures your ability to pay current debts with existing liquid assets. Current is defined as needing payment within one year. Liquid assets Total current debts
  38. Example: $2,225  $22,589 = .099 or 9.9% The higher this ratio, the longer the existing liquid assets can cover the yearly living expenses. This family could last about 1.2 months or 1/10th of a year on their existing liquid assets.
  39. Income & Expense Statement Ratios Savings Ratio Shows the percentage of after-tax income being saved during a given period. Cash surplus Income after taxes
  40. Example: $11,336  ($73,040 – $15,430) = 0.197 or 19.7% The higher this ratio, the greater the amount of after-tax income being saved. This family is doing much better than the national average of 5–8%.
  41. Debt Service Ratio Indicates ability to repay loan obligations promptly with before-tax income. Total monthly loan payments Monthly gross income
  42. Example: $1,807  $6,807 = .266 or 26.6% The lower this ratio, the less the difficulty in making monthly loan payments. This family’s ratio is under 35% and would probably be considered at a manageable level.
  43. Preparing & Using Budgets Budget A short-term financial planning report that helps you achieve your short-term financial goals. Achieving your short-term goals then helps you achieve your longer-term goals.
  44. Budgets help you: Monitor and control finances. Allocate income to reach goals. Implement system of disciplined spending. Reduce needless spending. Achieve long-term financial goals.
  45. The Budgeting Process Estimate income Don’t include loans Use take-home pay Estimate expenses Use current price levels and increase them by a percentage that reflects anticipated inflation Finalize the cash budget Balanced budget – total income equals or exceeds total expenses Deal with deficits
  46. What should you do if you have monthly deficits? Shift expenses from months with deficits to months with surpluses. Use savings, investments, or borrowing to cover temporary deficits.
  47. What should you do if you end the year in a deficit? Liquidate savings/investments Borrow to cover the deficit Cut low priority expenses; alter spending habits Increase income
  48. Deficit spending causes you to Deplete an existing asset Incur more debt Or both! Deficit spendingDECREASESyour Net Worth!
  49. Things to remember about a budget: Use a Budget Control Schedule to compare your budgeted figures to your actual figures and determine the variances. Continually update your budget based upon the actual figures. Always try to keep your budget balanced or, even better, at a surplus.
  50. THE END!