Gj11e ch02

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Chapter 2 of Finance 8, Gitman !0th Edition

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Gj11e ch02

  1. 1. © 2008 Thomson South-Western YOUR FINANCIAL STATEMENTS AND PLANS CHAPTER 2
  2. 2. 2-2 Mapping Out Your Financial Future Financial planning facilitates:  Greater wealth  Financial security  Attainment of financial goals
  3. 3. 2-3 Financial Plans, Budgets And Statements  Link future goals and plans with actual results  Provide direction, control and feedback
  4. 4. 2-4 The Interlocking Network of Financial Plans & Statements
  5. 5. 2-5 Special Planning Concerns 1. Dual income families 2. Employee benefit choices 3. Major life changes, such as:  First job  Marriage  Children  Death of family member  Divorce  Change in health  Loss of job  Change in economy
  6. 6. 2-6 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.
  7. 7. 2-7 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.
  8. 8. 2-8 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.
  9. 9. 2-9 Ways to Calculate TVM  Formulas  Tables (see Appendices A-D)  Financial calculators  Spreadsheets (ex: Excel)  Internet calculators (search on “calculators”)
  10. 10. 2-10 Future Value  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.”
  11. 11. 2-11 Calculating the Future Value of a Single Sum Example: What will $5000 grow to become if invested at 10% for 6 years?
  12. 12. 2-12 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 a Single Sum
  13. 13. 2-13 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%?
  14. 14. 2-14 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 Calculating the Future Value of an Annuity
  15. 15. 2-15 Present Value  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.
  16. 16. 2-16 Calculating the Present Value of a Single Sum Example: 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?
  17. 17. 2-17 Tables (Find Present Value Factor for 25 years and 7% in Appendix C) PV = FV x Factor $300,000 x .184 = $55,200 Calculator (Set on 1 P/YR and END mode.) 300000 +/- FV 25 N 7 I/YR PV $55,274.75 Calculating the Present Value of a Single Sum
  18. 18. 2-18 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?
  19. 19. 2-19 Tables (Find Present Value Annuity Factor for 4 years and 7% in Appendix D.) PV = PMT x Factor $10,000 x 3.387 = $33,870 Calculator (Set on 1 P/YR and END mode.) 10000 +/- PMT 4 N 7 I/YR PV $33,872.11 Calculating the Present Value of an Annuity
  20. 20. 2-20 Balance Sheet A statement of your financial position at one point in time.
  21. 21. 2-21 Balance Sheet Equation Liabilities Assets = + Net Worth
  22. 22. 2-22 ASSETS LIABILITIES (Fair Market Value of Assets) (Payoff Amount of Loans and Debts) NET WORTH (Your Equity Portion) Balance Sheet
  23. 23. 2-23 ASSETS What you own: •checking acct. •car •investments •jewelry •furniture Balance Sheet
  24. 24. 2-24 ASSETS LIABILITIES What you own: •checking acct. •car •investments •jewelry •furniture What you owe: •car loan •credit card balances •education loans •unpaid monthly bills Balance Sheet
  25. 25. 2-25 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.) Balance Sheet
  26. 26. 2-26 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. 27. 2-27 The Income and Expense Statement A measure of your financial performance over a given time period.
  28. 28. 2-28 Income and Expense Statement Total Income – Total Expenses = CASH SURPLUS OR (CASH DEFICIT)
  29. 29. 2-29 Income: Cash IN  Wages and salaries  Bonuses  Interest and dividends  Child support  Tax refunds  Gifts
  30. 30. 2-30 Expenses: Cash OUT  FIXED Rent or mortgage payment Cable TV Insurance  VARIABLE Dry cleaning Recreation Eating out
  31. 31. 2-31 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. 32. 2-32 How We Spend Our Income
  33. 33. 2-33 Using Your Personal Financial Statements  Maintain a good recordkeeping system  Prepare financial statements periodically  Track financial progress
  34. 34. 2-34 Ratio Analysis Financial ratios allow you to:  Track progress toward your financial goals  Evaluate your financial performance over a period of time
  35. 35. 2-35 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. 36. 2-36  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 Liquidity Ratios
  37. 37. 2-37 Savings Ratio  Shows the percentage of after- tax income being saved during a given period. Income & Expense Statement Ratios Cash surplus Income after taxes
  38. 38. 2-38  Indicates ability to repay loan obligations promptly with before-tax income. Total monthly loan payments Monthly gross income Debt Service Ratio
  39. 39. 2-39 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.
  40. 40. 2-40 Using Budgets  Monitor and control finances.  Allocate income to reach goals.  Implement system of disciplined spending.  Reduce needless spending.  Achieve long-term financial goals.
  41. 41. 2-41 The Budgeting Process  Estimate income  Estimate expenses  Finalize the cash budget  Deal with deficits
  42. 42. 2-42 If You Have Monthly Deficits  Shift expenses from months with deficits to months with surpluses.  Use savings, investments, or borrowing to cover temporary deficits.
  43. 43. 2-43 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
  44. 44. 2-44  Depletion of an existing asset,  More debt –  Or both  DECREASES net worth Deficit Spending Results In
  45. 45. 2-45 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.

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