Financial plans, budgets and statements facilitate financial planning!
Link future goals and plans with actual results
Provide direction, control and feedback
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
* 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
Special Planning Concerns :
1. Dual income families
2. Employee benefit choices
3. Major life changes, such as:
Death of family member
Change in health
Loss of job
Change in economy
Types of Financial 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.
Financial Planning Designations
Certified Financial Planner (CFP): Requires a comprehensive education in financial planning
Chartered Financial Consultant (ChFC): Financial planning designation for insurance agents
Certified Trust & Financial Advisor (CTFA): Estate planning and trusts expertise, found mostly in the banking industry
Personal Financial Specialist (PFS): Comprehensive planning credential only for CPAs
Chartered Life Underwriter (CLU): Insurance agent designation, often accompanied by the ChFC credential
Choosing A Financial Planner
Largely unregulated industry (be careful with the self-claimed financial planners)
Tips on choosing a financial planner:
Know what you want
Talk to others (get referrals)
Interview several planners
Check the planner’s background
Get it in writing
Receive regular statements
Reassess the relationship regularly
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.
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.
Ways to Calculate TVM :
Tables (see Appendices A-D)
Spreadsheets (ex: Excel)
Internet calculators (search on “calculators”)
The value your invested money will grow to become earning a specific rate of interest over a given time period.
The process of growing today’s present value to a larger future value by applying compound interest is known as “compounding.”
Calculating the Future Value of a Single Sum:
Example : What will $5000 grow to become if invested at 10% for 6 years?
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
Calculating the Future Value of an Annuity:
Example : What would you accumulate if you could invest $5000 every year for the next 6 years at 10%?
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
The amount needed today to invest at a specific rate of interest over a given time period to accumulate the desired future amount.
“Discounting” is the reverse of compounding and is the process of working from the future value back to the present value.
Calculating the Present Value of a Single Sum
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?
(Find Present Value Factor for 25 years and 7% in Appendix C)
PV = FV x Factor
$300,000 x .184 =
(Set on 1 P/YR and END mode.)
300000 +/- FV
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?
(Find Present Value Annuity Factor for 4 years and 7% in Appendix D.)
PV = PMT x Factor
$10,000 x 3.387 =
(Set on 1 P/YR and END mode.)
10000 +/- PMT
A statement of
your financial position
at one point in time.
Balance Sheet Equation :
Liabilities Assets = + Net Worth
Balance Sheet ASSETS LIABILITIES (Fair Market Value of Assets) (Payoff Amount of Loans and Debts) NET WORTH (Your Equity Portion)
Balance Sheet ASSETS LIABILITIES
What you own :
What you owe :
credit card balances
unpaid monthly bills
(Subtract total liabilities
from total assets to
determine net worth.)
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.
The Income and Expense Statement
A measure of your
over a given time period.
Income and Expense Statement :
Total Income – Total Expenses =
CASH SURPLUS OR
Income : Cash IN
Wages and salaries
Interest and dividends
Expenses : Cash OUT
Rent or mortgage payment
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 ) .
Using Your Personal Financial Statements
Maintain a good recordkeeping system
Prepare financial statements periodically
Track financial progress
Financial ratios allow you to:
Track progress toward your financial goals
Evaluate your financial performance over a period of time
Balance Sheet Ratios
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
$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.
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
$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.
Shows the percentage of after-tax income being saved during a given period.
Income & Expense Statement Ratios Cash surplus Income after taxes
$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%.
Debt Service Ratio
Indicates ability to repay loan obligations promptly with before-tax income.
Total monthly loan payments Monthly gross income
$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.
Preparing & Using Budgets
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.
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.
The Budgeting Process
Finalize the cash budget
Deal with deficits
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.
What should you do if you end the year in a deficit?
Borrow to cover the deficit
Cut low priority expenses; alter spending habits
Deficit spending DECREASES your Net Worth! Deficit spending causes you to Deplete an existing asset, Incur more debt – Or both!
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.