CHAPTER 2:   YOUR FINANCIAL STATEMENTS AND PLANS
Mapping Out Your  Financial Future <ul><li>Financial planning facilitates: </li></ul><ul><li>Greater  wealth   </li></ul><...
Financial plans, budgets and statements facilitate financial planning! <ul><li>Link future goals and plans with actual res...
The Interlocking Network of Financial Plans & Statements * evaluate and plan major outlays * reduce taxes * establish savi...
* evaluate and plan major outlays * reduce taxes * establish savings and investment programs * manage credit * secure adeq...
Special Planning Concerns : <ul><li>1. Dual income families </li></ul><ul><li>2. Employee benefit choices </li></ul><ul><l...
Types of Financial Planners: <ul><li>Commissioned salespeople  who work for financial institutions. </li></ul><ul><li>Fee-...
Financial Planning Designations <ul><li>Certified Financial Planner (CFP):  Requires a comprehensive education in financia...
Choosing A Financial Planner <ul><li>Largely unregulated industry (be careful with the self-claimed financial planners) </...
Time Value of Money: Putting a Dollar Value on Financial Goals A dollar today is worth more than a dollar received in the ...
Types of TVM Calculations: <ul><li>Single sum —one lump sum investment with no more additions or subtractions. </li></ul><...
Ways to Calculate TVM : <ul><li>Formulas </li></ul><ul><li>Tables (see Appendices A-D) </li></ul><ul><li>Financial calcula...
Future Value <ul><li>The value your invested money will grow to become earning a specific rate of interest over a given ti...
Calculating the Future Value of a Single Sum: <ul><li>Example :  What will $5000 grow to become if invested at 10% for 6 y...
Calculating the Future Value of an Annuity: <ul><li>Example :   What would you accumulate if you could invest $5000  every...
Present Value <ul><li>The amount needed today to invest at a specific rate of interest over a given time period to accumul...
Calculating the Present Value of a Single Sum <ul><li>Example :   </li></ul><ul><li>You wish to accumulate a retirement fu...
<ul><li>Tables </li></ul><ul><li>(Find Present Value Factor for 25 years and 7% in Appendix C) </li></ul><ul><li>PV = FV x...
Calculating the Present Value of an Annuity Example :   Your rich uncle wishes to give you a sum of money today to use for...
<ul><li>Tables </li></ul><ul><li>(Find Present Value Annuity Factor for 4 years and 7% in Appendix D.) </li></ul><ul><li>P...
Balance Sheet <ul><li>A statement of  </li></ul><ul><li>your financial position  </li></ul><ul><li>at one point in time. <...
Balance Sheet Equation : <ul><li>Liabilities Assets = + Net Worth </li></ul>
Balance Sheet ASSETS LIABILITIES (Fair Market Value of Assets) (Payoff Amount of  Loans and Debts) NET WORTH (Your Equity ...
Balance Sheet ASSETS LIABILITIES <ul><li>What you own : </li></ul><ul><li>checking acct. </li></ul><ul><li>car </li></ul><...
The Concept of Solvency : <ul><li>If your net worth is  POSITIVE , you are  SOLVENT  and have enough assets to cover your ...
The Income and Expense Statement <ul><li>A measure of your  </li></ul><ul><li>financial performance  </li></ul><ul><li>ove...
Income and Expense Statement : <ul><li>Total Income  –  Total Expenses = </li></ul><ul><li>CASH SURPLUS   OR </li></ul><ul...
Income :  Cash IN          <ul><li>Wages and salaries </li></ul><ul><li>Bonuses </li></ul><ul><li>Interest and dividend...
Expenses :  Cash OUT         <ul><li>FIXED </li></ul><ul><ul><li>Rent or mortgage payment </li></ul></ul><ul><ul><li>Ca...
CASH SURPLUS (DEFICIT) : <ul><li>If your income exceeds your expenses, you have a  CASH SURPLUS .   </li></ul><ul><li>If y...
66%
Using Your Personal Financial Statements <ul><li>Maintain  a good recordkeeping system </li></ul><ul><li>Prepare  financia...
Ratio Analysis <ul><li>Financial ratios allow you to: </li></ul><ul><li>Track  progress toward your financial goals </li><...
Balance Sheet Ratios <ul><li>Solvency Ratio </li></ul><ul><li>Shows the state of your net worth at a given point in time. ...
<ul><li>Example : </li></ul><ul><li>$41,420    $147,175 = .28 or 28% </li></ul><ul><li>The larger this ratio, the greater...
<ul><li>Liquidity Ratio </li></ul><ul><li>Measures your ability to pay current debts with existing liquid assets. </li></u...
<ul><li>Example : </li></ul><ul><li>$2,225    $22,589 = .099 or 9.9% </li></ul><ul><li>The higher this ratio, the longer ...
<ul><li>Savings Ratio </li></ul><ul><li>Shows the percentage of after-tax income being saved during a given period. </li><...
<ul><li>Example : </li></ul><ul><li>$11,336    ($73,040 – $15,430) = </li></ul><ul><li>0.197 or 19.7% </li></ul><ul><li>T...
<ul><li>Debt Service Ratio </li></ul><ul><li>Indicates ability to repay loan obligations promptly with before-tax income. ...
<ul><li>Example : </li></ul><ul><li>$1,807    $6,807 = .266 or 26.6% </li></ul><ul><li>The lower this ratio, the less the...
Preparing & Using Budgets <ul><li>Budget   </li></ul><ul><li>A short-term financial planning report that helps you achieve...
Budgets help you: <ul><li>Monitor  and  control  finances. </li></ul><ul><li>Allocate  income to reach goals. </li></ul><u...
The Budgeting Process <ul><li>Estimate income </li></ul><ul><li>Estimate expenses </li></ul><ul><li>Finalize the cash budg...
What should you do if you have  monthly  deficits? <ul><li>Shift expenses from months with deficits to months with surplus...
What should you do if you end the  year  in a deficit? <ul><li>Liquidate savings/investments </li></ul><ul><li>Borrow to c...
Deficit spending   DECREASES your Net Worth! Deficit spending causes you to Deplete an existing asset, Incur more debt  – ...
Things to remember about a budget : <ul><li>Use a  Budget Control Schedule  to compare your budgeted figures to your actua...
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Fin442_ch2.ppt

  1. 1. CHAPTER 2: YOUR FINANCIAL STATEMENTS AND PLANS
  2. 2. Mapping Out Your Financial Future <ul><li>Financial planning facilitates: </li></ul><ul><li>Greater wealth </li></ul><ul><li>Financial security </li></ul><ul><li>Attainment of financial goals </li></ul>
  3. 3. Financial plans, budgets and statements facilitate financial planning! <ul><li>Link future goals and plans with actual results </li></ul><ul><li>Provide direction, control and feedback </li></ul>
  4. 4. The Interlocking Network of Financial Plans & Statements * evaluate and plan major outlays * reduce taxes * establish savings and investment programs * manage credit * secure adequate insurance * implement retirement program * facilitate estate distribution FINANCIAL PLANS
  5. 5. * evaluate and plan major outlays * reduce taxes * establish savings and investment programs * manage credit * secure adequate insurance * implement retirement program * facilitate estate distribution FINANCIAL PLANS * monitor and control income, living expenses, purchases, and savings on a monthly basis BUDGETS feedback Actual financial results * balance sheet * income & expenditures statement FINANCIAL STATE- MENTS feedback
  6. 6. Special Planning Concerns : <ul><li>1. Dual income families </li></ul><ul><li>2. Employee benefit choices </li></ul><ul><li>3. Major life changes, such as: </li></ul><ul><li>First job </li></ul><ul><li>Marriage </li></ul><ul><li>Children </li></ul><ul><li>Death of family member </li></ul><ul><li>Divorce </li></ul><ul><li>Change in health </li></ul><ul><li>Loss of job </li></ul><ul><li>Change in economy </li></ul>
  7. 7. Types of Financial Planners: <ul><li>Commissioned salespeople who work for financial institutions. </li></ul><ul><li>Fee-only financial planners who work for the individual client. </li></ul><ul><li>Planners who charge both fees and commissions, depending on the products and services offered. </li></ul><ul><li>Computerized financial plans prepared by financial institutions. </li></ul>
  8. 8. Financial Planning Designations <ul><li>Certified Financial Planner (CFP): Requires a comprehensive education in financial planning </li></ul><ul><li>Chartered Financial Consultant (ChFC): Financial planning designation for insurance agents </li></ul><ul><li>Certified Trust & Financial Advisor (CTFA): Estate planning and trusts expertise, found mostly in the banking industry </li></ul><ul><li>Personal Financial Specialist (PFS): Comprehensive planning credential only for CPAs </li></ul><ul><li>Chartered Life Underwriter (CLU): Insurance agent designation, often accompanied by the ChFC credential </li></ul>
  9. 9. Choosing A Financial Planner <ul><li>Largely unregulated industry (be careful with the self-claimed financial planners) </li></ul><ul><li>Tips on choosing a financial planner: </li></ul><ul><ul><li>Know what you want </li></ul></ul><ul><ul><li>Talk to others (get referrals) </li></ul></ul><ul><ul><li>Interview several planners </li></ul></ul><ul><ul><li>Check the planner’s background </li></ul></ul><ul><ul><li>Get it in writing </li></ul></ul><ul><ul><li>Receive regular statements </li></ul></ul><ul><ul><li>Reassess the relationship regularly </li></ul></ul>
  10. 10. Time Value of Money: Putting a Dollar Value on Financial Goals A dollar today is worth more than a dollar received in the future because it can be invested and earn interest.
  11. 11. Types of TVM Calculations: <ul><li>Single sum —one lump sum investment with no more additions or subtractions. </li></ul><ul><li>Annuity —a series of equal payments made at fixed time intervals for a specified number of periods. </li></ul>
  12. 12. Ways to Calculate TVM : <ul><li>Formulas </li></ul><ul><li>Tables (see Appendices A-D) </li></ul><ul><li>Financial calculators </li></ul><ul><li>Spreadsheets (ex: Excel) </li></ul><ul><li>Internet calculators (search on “calculators”) </li></ul>
  13. 13. Future Value <ul><li>The value your invested money will grow to become earning a specific rate of interest over a given time period. </li></ul><ul><li>The process of growing today’s present value to a larger future value by applying compound interest is known as “compounding.” </li></ul>
  14. 14. Calculating the Future Value of a Single Sum: <ul><li>Example : What will $5000 grow to become if invested at 10% for 6 years? </li></ul>Tables (Find Future Value Factor for 6 years and 10% in Appendix A) FV = PV x Factor $5000 x 1.772 = $8,860 Calculator (Set on 1 P/YR and END mode.) 5000 +/- PV 6 N 10 I/YR FV $8,857.81
  15. 15. Calculating the Future Value of an Annuity: <ul><li>Example : What would you accumulate if you could invest $5000 every year for the next 6 years at 10%? </li></ul>Tables (Find Future Value Annuity Factor for 6 years and 10% in Appendix B) FV = PMT x Factor $5000 x 7.716 = $38,580 Calculator (Set on 1 P/YR and END mode.) 5000 +/- PMT 6 N 10 I/YR FV $38,578.05
  16. 16. Present Value <ul><li>The amount needed today to invest at a specific rate of interest over a given time period to accumulate the desired future amount. </li></ul><ul><li>“Discounting” is the reverse of compounding and is the process of working from the future value back to the present value. </li></ul>
  17. 17. Calculating the Present Value of a Single Sum <ul><li>Example : </li></ul><ul><li>You wish to accumulate a retirement fund of $300,000 in 25 years. If you can invest at 7%, what single lump-sum deposit must you make today in order to achieve your goal? </li></ul>
  18. 18. <ul><li>Tables </li></ul><ul><li>(Find Present Value Factor for 25 years and 7% in Appendix C) </li></ul><ul><li>PV = FV x Factor </li></ul><ul><li>$300,000 x .184 = </li></ul><ul><li>$55,200 </li></ul><ul><li>Calculator </li></ul><ul><li>(Set on 1 P/YR and END mode.) </li></ul><ul><li>300000 +/- FV </li></ul><ul><li> 25 N </li></ul><ul><li>7 I/YR </li></ul><ul><li>PV $55,274.75 </li></ul>
  19. 19. Calculating the Present Value of an Annuity Example : Your rich uncle wishes to give you a sum of money today to use for the next 4 years of college. If you need $10,000 a year and will leave the remainder invested at 7%, how much should you tell him you need?
  20. 20. <ul><li>Tables </li></ul><ul><li>(Find Present Value Annuity Factor for 4 years and 7% in Appendix D.) </li></ul><ul><li>PV = PMT x Factor </li></ul><ul><li>$10,000 x 3.387 = </li></ul><ul><li>$33,870 </li></ul><ul><li>Calculator </li></ul><ul><li>(Set on 1 P/YR and END mode.) </li></ul><ul><li>10000 +/- PMT </li></ul><ul><li>4 N </li></ul><ul><li>7 I/YR </li></ul><ul><li>PV $33,872.11 </li></ul>
  21. 21. Balance Sheet <ul><li>A statement of </li></ul><ul><li>your financial position </li></ul><ul><li>at one point in time. </li></ul>
  22. 22. Balance Sheet Equation : <ul><li>Liabilities Assets = + Net Worth </li></ul>
  23. 23. Balance Sheet ASSETS LIABILITIES (Fair Market Value of Assets) (Payoff Amount of Loans and Debts) NET WORTH (Your Equity Portion)
  24. 24. Balance Sheet ASSETS LIABILITIES <ul><li>What you own : </li></ul><ul><li>checking acct. </li></ul><ul><li>car </li></ul><ul><li>investments </li></ul><ul><li>jewelry </li></ul><ul><li>furniture </li></ul><ul><li>What you owe : </li></ul><ul><li>car loan </li></ul><ul><li>credit card balances </li></ul><ul><li>education loans </li></ul><ul><li>unpaid monthly bills </li></ul><ul><li>NET WORTH </li></ul><ul><li>(Subtract total liabilities </li></ul><ul><li>from total assets to </li></ul><ul><li>determine net worth.) </li></ul>
  25. 25. The Concept of Solvency : <ul><li>If your net worth is POSITIVE , you are SOLVENT and have enough assets to cover your financial obligations. </li></ul><ul><li>If your net worth is ( NEGATIVE ) , you are INSOLVENT and do not have enough assets to cover your financial obligations. </li></ul>
  26. 26. The Income and Expense Statement <ul><li>A measure of your </li></ul><ul><li>financial performance </li></ul><ul><li>over a given time period. </li></ul>
  27. 27. Income and Expense Statement : <ul><li>Total Income – Total Expenses = </li></ul><ul><li>CASH SURPLUS OR </li></ul><ul><li>(CASH DEFICIT) </li></ul>
  28. 28. Income : Cash IN    <ul><li>Wages and salaries </li></ul><ul><li>Bonuses </li></ul><ul><li>Interest and dividends </li></ul><ul><li>Child support </li></ul><ul><li>Tax refunds </li></ul><ul><li>Gifts </li></ul>
  29. 29. Expenses : Cash OUT    <ul><li>FIXED </li></ul><ul><ul><li>Rent or mortgage payment </li></ul></ul><ul><ul><li>Cable TV </li></ul></ul><ul><ul><li>Insurance </li></ul></ul><ul><li>VARIABLE </li></ul><ul><ul><li>Dry cleaning </li></ul></ul><ul><ul><li>Recreation </li></ul></ul><ul><ul><li>Eating out </li></ul></ul>
  30. 30. CASH SURPLUS (DEFICIT) : <ul><li>If your income exceeds your expenses, you have a CASH SURPLUS . </li></ul><ul><li>If your expenses exceed your income, you have a ( CASH DEFICIT ) . </li></ul>
  31. 31. 66%
  32. 32. Using Your Personal Financial Statements <ul><li>Maintain a good recordkeeping system </li></ul><ul><li>Prepare financial statements periodically </li></ul><ul><li>Track financial progress </li></ul>
  33. 33. Ratio Analysis <ul><li>Financial ratios allow you to: </li></ul><ul><li>Track progress toward your financial goals </li></ul><ul><li>Evaluate your financial performance over a period of time </li></ul>
  34. 34. Balance Sheet Ratios <ul><li>Solvency Ratio </li></ul><ul><li>Shows the state of your net worth at a given point in time. </li></ul><ul><li>Indicates your potential to withstand financial problems. </li></ul>Total net worth Total assets
  35. 35. <ul><li>Example : </li></ul><ul><li>$41,420  $147,175 = .28 or 28% </li></ul><ul><li>The larger this ratio, the greater the financial cushion to protect against insolvency. </li></ul><ul><li>This family could withstand a 28% decline in asset value before they would be insolvent. </li></ul>
  36. 36. <ul><li>Liquidity Ratio </li></ul><ul><li>Measures your ability to pay current debts with existing liquid assets. </li></ul><ul><li>Current is defined as needing payment within one year. </li></ul>Liquid assets Total current debts
  37. 37. <ul><li>Example : </li></ul><ul><li>$2,225  $22,589 = .099 or 9.9% </li></ul><ul><li>The higher this ratio, the longer the existing liquid assets can cover the yearly living expenses. </li></ul><ul><li>This family could last about 1.2 months or 1/10th of a year on their existing liquid assets. </li></ul>
  38. 38. <ul><li>Savings Ratio </li></ul><ul><li>Shows the percentage of after-tax income being saved during a given period. </li></ul>Income & Expense Statement Ratios Cash surplus Income after taxes
  39. 39. <ul><li>Example : </li></ul><ul><li>$11,336  ($73,040 – $15,430) = </li></ul><ul><li>0.197 or 19.7% </li></ul><ul><li>The higher this ratio, the greater the amount of after-tax income being saved. </li></ul><ul><li>This family is doing much better than the national average of 5–8%. </li></ul>
  40. 40. <ul><li>Debt Service Ratio </li></ul><ul><li>Indicates ability to repay loan obligations promptly with before-tax income. </li></ul>Total monthly loan payments Monthly gross income
  41. 41. <ul><li>Example : </li></ul><ul><li>$1,807  $6,807 = .266 or 26.6% </li></ul><ul><li>The lower this ratio, the less the difficulty in making monthly loan payments. </li></ul><ul><li>This family’s ratio is under 35% and would probably be considered at a manageable level. </li></ul>
  42. 42. Preparing & Using Budgets <ul><li>Budget </li></ul><ul><li>A short-term financial planning report that helps you achieve your short-term financial goals. </li></ul><ul><li>Achieving your short-term goals then helps you achieve your longer-term goals. </li></ul>
  43. 43. Budgets help you: <ul><li>Monitor and control finances. </li></ul><ul><li>Allocate income to reach goals. </li></ul><ul><li>Implement system of disciplined spending. </li></ul><ul><li>Reduce needless spending. </li></ul><ul><li>Achieve long-term financial goals. </li></ul>
  44. 44. The Budgeting Process <ul><li>Estimate income </li></ul><ul><li>Estimate expenses </li></ul><ul><li>Finalize the cash budget </li></ul><ul><li>Deal with deficits </li></ul>
  45. 45. What should you do if you have monthly deficits? <ul><li>Shift expenses from months with deficits to months with surpluses. </li></ul><ul><li>Use savings, investments, or borrowing to cover temporary deficits. </li></ul>
  46. 46. What should you do if you end the year in a deficit? <ul><li>Liquidate savings/investments </li></ul><ul><li>Borrow to cover the deficit </li></ul><ul><li>Cut low priority expenses; alter spending habits </li></ul><ul><li>Increase income </li></ul>
  47. 47. Deficit spending DECREASES your Net Worth! Deficit spending causes you to Deplete an existing asset, Incur more debt – Or both!
  48. 48. Things to remember about a budget : <ul><li>Use a Budget Control Schedule to compare your budgeted figures to your actual figures and determine the variances. </li></ul><ul><li>Continually update your budget based upon the actual figures. </li></ul><ul><li>Always try to keep your budget balanced or, even better, at a surplus. </li></ul>

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