Lecture on introduction to finance

1. Lecture 1
PERSONAL
FINANCIAL
PLANNING

2. Objectives
Outline Outline the steps involved in developing your
financial plan
Explain Explain how financial planning affects your cash
flows
Identify Identify the key components of a financial plan
Explain Explain how personal finance enhances your
wealth

3. Personal Financial Planning
• Personal finance also referred to as personal financial planning,
is the process of planning your spending, financing, and investing to
optimize your financial situation.
• A personal financial plan specifies your financial goals and describes
the spending, financing, and investing plans that are intended to
achieve those goals.

4. Enhancement of Wealth
• Poor personal finance decisions can cause you to borrow excessively, to the point at which
you might not be capable of repaying your debt.
• Many bankruptcies are the result of some simple personal finance decisions that lack
common sense.
• Each personal finance decision that you make will typically have an impact on either your
future income or your debt in a manner that can be measured.
• Therefore, you can measure the potential benefits (such as how your income might
increase) versus the potential cost (how your debt might increase) due to a personal
finance decision.

5. Example

7. Components of a Financial Plan
Budgeting and tax planning
Managing your liquidity
Financing your large purchases
Protecting your assets and income (insurance)
Investing your money
Planning your retirement and estate

8. Budgeting Planning
Budget planning also referred to as budgeting is the process
of forecasting future expenses and savings.
That is, it requires you to determine how you spend money, the
amount of money to spend, and how much to save.
Your spending decisions are critical, because they determine
how much of your income can be used for other purposes.

9. Budgeting Planning (Cont.)
• The first step in budget planning is to evaluate your current financial
position by assessing
your income,
your expenses,
your assets (what you own),
and your liabilities (debt, or what you owe).
You can measure your wealth by your net worth. Your net worth is
the value of what you own minus the value of what you owe.

10. Budgeting Planning (Cont.)
 As you save money, you increase your assets and therefore increase your
net worth.
Budget planning enables you to build your net worth by setting aside part
of your income to either invest in additional assets or reduce your liabilities.
Note:
• “big spenders”: They focus their budget decisions on how to spend most
or all of their income, and therefore have little or no money left for saving.
• “big savers”: They set a savings goal and consider spending their income
received only after allocating a portion of it toward saving.

11. Budgeting Planning (Cont.)
 A key part of budgeting is estimating the typical expenses that you
will incur each month. If you underestimate expenses, you will need
more cash inflows (money that you receive) than you expected to
cover your cash outflows (money that you spend).
 Achieving a higher level of future wealth requires you to maintain your
spending at a lower level today.

12. Budgeting
If your spending exceeds your income, your cash inflows cannot cover
your cash outflows in a particular month, and therefore you will not have
any cash to allocate for savings. Your budget decisions include:
 How much should you work this month (if your employer allows
flexibility)? This decision determines your cash inflows for the month.
 What products or services should you purchase this month? This
decision determines your cash outflows for the month.

13. Manage Your Liquidity
 You should have a plan for how you will cover your daily purchases.
Your expenses can range from your morning cup of coffee to major car
repairs.
 You need to have liquidity, or access to funds to cover any short-term
cash needs.
 You can enhance your liquidity by utilizing money management and
credit management.

14. Money Management
• Involves decisions regarding how much money to retain in a liquid
form and how to allocate the funds among short-term investments.
• If you do not have access to money to cover your cash needs, you
may have insufficient liquidity.
• Finding an effective liquidity level involves deciding how to invest your
money so that you can earn a return, but also have easy access to
cash if needed.
• At times, you may be unable to avoid cash shortages because of
unanticipated expenses.

15. Credit Management
• Involves decisions about how much credit you need to support your
spending and which sources of credit to use.
• Credit is commonly used to cover both large and small expenses when
you are short on cash.
• Credit should be used only when necessary, as you will need to pay
back borrowed funds with interest.

16. Managing Your Liquidity
• When your cash inflows exceed your cash outflows, you use liquidity management to
decide how much of this cash should be allocated to savings at your financial institution.
• Conversely, if your cash inflows are less than your cash outflows, you use liquidity
management to withdraw savings or obtain funds from another source to cover your
spending for the month. Your liquidity management decisions include:
 If you have excess cash this month, how much cash should you add to your checking
or savings account?
 If you have a cash deficiency this month, how much cash should you withdraw from
your checking or savings account?
 If you have a cash deficiency this month, how much credit should you use from
credit cards or other sources?

17. Financing Your Large Purchases
• Loans are typically needed to finance large expenditures, such as the
payment of college tuition or the purchase of a car or a home.
• The amount of financing needed is the difference between the
amount of the purchase and the amount of money you have available.
• Managing loans includes determining how much you can afford to
borrow, deciding on the maturity (length of time) of the loan, and
selecting a loan that charges a competitive interest rate.

18. Personal Financing
Financing is needed to support your large purchases. The purchase of a
new car or a home requires financing. Your financing decisions include:
 Should you lease a car?
 Should you borrow money to purchase a car or home?
 How much cash will you need to borrow?
 How long a period will you need to borrow funds?
 What is the ideal source from which you will borrow funds?

19. Protecting Your Assets and Income
• To protect your assets, you can conduct insurance planning, which
determines the types and amount of insurance that you need.
Automobile insurance and homeowner’s insurance protect your
assets.
Health insurance limits your potential medical expenses.
Disability insurance and life insurance protect your income.

20. Protecting Your Wealth
Explains how to use insurance to protect your assets and your income.
Your insurance decisions
 What types of insurance do you need?
 How much insurance should you purchase to protect your assets?
 How much insurance should you purchase to protect your income?

21. Investing Your Money
• Any funds that you have beyond what you need to maintain liquidity should
be invested. Because these funds normally are not used to satisfy your
liquidity needs, they can be invested with the primary objective of earning a
high return.
• Potential investments include stocks, bonds, mutual funds, and real estate.
• You must determine how much of your funds you wish to allocate toward
investments and what types of investments you wish to consider.
• Most investments are subject to risk however, so you need to manage them
so that your risk is limited to a tolerable level.

22. Personal Investing
Common investing decisions include:
• How much cash should be used to make investments?
• What types of investments should you make?
• How much risk should you tolerate when making investments?
• These decisions will determine how much money you allocate for
investments, and how much cash these investments generate for you
over time.

23. Your Retirement and Estate
• Retirement planning involves determining how much money you should set
aside each year for retirement and how you should invest those funds.
• Retirement planning must begin well before you retire, so that you can
accumulate sufficient money to invest and support yourself after you retire.
• Estate planning is the act of planning how your wealth will be distributed before
or upon your death.
• Effective estate planning protects your wealth against unnecessary taxes and
ensures that your wealth is distributed in the manner that you desire.

24. Retirement and Estate Planning
Common retirement and estate planning decisions include:
• How much cash should you invest toward your retirement each month?
• What types of investments should you make for your retirement
accounts?
• These decisions will determine your cash outflows that you will
contribute to your retirement account while working.

25. Retirement and Estate Planning
• These decisions also will affect the degree to which the value of your retirement
account grows over time, and therefore will determine how much cash inflows you
will receive during your retirement.
• Normally, the more you contribute over the time in which you are employed, the
larger are the cash inflows you will receive during your retirement.
•
• In addition, the higher the performance of the investments you select for your
retirement account, the larger the cash inflows you will receive during your
retirement.
• Also, your estate planning decisions will determine how your remaining cash and
other assets are distributed to your heirs.
.

26. Steps Involved In Developing Your
Financial Plan
• Step 1: Establish Your Financial Goals
• Step 2: Consider Your Current Financial Position
• Step 3: Identify and Evaluate Alternativ Plans That Could Achieve
Your Goals
• Step 4: Select and Implement the Best Plan for Achieving Your Goals
• Step 5: Evaluate Your Financial Plan
• Step 6: Revise Your Financial Plan

27. Step 1: Establish Your Financial Goals
First, identify your general goals in life. These goals do not have to be
put in financial terms.
Types of Financial Goals Your general goals in life influence your
financial goals.
• If you want a vacation to a foreign country every year, one of your
financial goals may be to earn enough income and save enough
money to financially support your travel. If you want a large home,
one of your financial goals should be that you earn enough income
and save enough money over time to make a substantial real estate
purchase.

28.  Set Realistic Goals You need to be realistic about your goals so that
you can have a strong likelihood of achieving them. A financial plan
that requires you to save almost all your income is useless if you are
unable or unwilling to follow that plan.
 Timing of Goals Financial goals can be characterized as;
 Short-term (within the next year)- accumulate enough money to
purchase a car within six months.
 Intermediate-term (typically between one and five years)- pay off a
school loan in the next three years.
 Long-term (beyond five years)-save enough money so that you can
maintain your lifestyle and retire in 20 years.

29. Consider Your Current Financial Position
Your decisions about how much money to spend next month, how much
money to place in your savings account, how often to use your credit card, and
how to invest your money depend on your financial position.
• A person with little debt and many assets / person with mounting debt and
few assets.
• A single individual without dependents/Couple with dependants
• Age and wealth. If you are 20 years old with zero funds in your bank
account, your financial plan will be different than if you are 65 years old and
have saved much of your income over the last 40 years.

30. Identify and Evaluate Alternative
Given your financial goals you need a financial plan that could
help move you from your existing financial position toward
achieving your financial goals. Your financial plan will require
various types of decisions that will influence your career, income
level, and savings over the next several years.

31. Select and Implement the Best Plan for
Achieving
You need to analyze and select the plan that will be most effective in achieving
your goals.
Many alternative plans that could possibly achieve your goals involve trade-offs.
For example, you may have a long-term financial goal of accumulating a large
amount of money by the time you are 50 years old, so that you can retire at
that time. One plan to achieve this goal may be to pursue a career that
generates a higher income level, but this type of career might first require you
to pursue additional education to have the credentials you need.

32. • Consequently, you may have to spend money and time in education
over the next few years to achieve this long-term goal. Alternatively,
you may decide not to pursue additional education, but plan to save a
very high proportion of your income from your existing career to
achieve your goal.
• However, this strategy may require that you forgo some spending over
the next several years to achieve your long-term financial goal of early
retirement.

33. Evaluate Your Financial Plan
After you develop and implement each component of your
financial plan, you must monitor your progress to ensure that
the plan is working as you intended. Keep your financial plan
easily accessible so that you can evaluate it over time.

34. Revise Your Financial Plan
• If you find that you are unable or unwilling to follow the financial plan
that you developed, you need to revise the plan to make it more
realistic.
• Of course, your financial goals may have to be modified as well if you
are unable to maintain the plan for achieving a particular level of
wealth.
• As time passes, your financial position will change, especially with
specific events such as graduating from college, marriage, a career
change, or the birth of a child. As your financial position changes, your
financial goals may change as well. You need to revise your financial
plan to reflect such changes in your means and priorities.