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CHAPTER 2: YOUR FINANCIAL STATEMENTS AND PLANS Mapping Out Your Financial Future Financial planning facilitates: Greater wealth Financial security Attainment of financial goals Financial plans, budgets and statements facilitate financial planning!

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mapping out your financial future
Mapping Out Your Financial Future

Financial planning facilitates:

  • Greater wealth
  • Financial security
  • Attainment of financial goals
financial plans budgets and statements facilitate financial planning
Financial plans, budgets and statements facilitate financial planning!
  • Link future goals and plans with actual results
  • Provide direction, control and feedback
slide4

* 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

The Interlocking Network of Financial Plans & Statements

slide5

* evaluate and plan major outlays

* reduce taxes

* establish savings and investment

programs

* manage credit

* secure adequate insurance

* implement retirement program

* facilitate estate distribution

feedback

FINANCIAL

PLANS

feedback

* monitor and control income, living

expenses, purchases, and savings

on a monthly basis

BUDGETS

FINANCIAL

STATE-

MENTS

Actual financial results

* balance sheet

* income & expenditures statement

special planning concerns
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
types of financial planners
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
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
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

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 and earn interest.

types of tvm calculations
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
Ways to Calculate TVM:
  • Formulas
  • Tables (see Appendices A-D)
  • Financial calculators
  • Spreadsheets (ex: Excel)
  • Internet calculators (search on “calculators”)
future value
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.”
calculating the future value of a single sum
Calculating theFuture 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
Calculating theFuture 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

present value
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.
calculating the present value of a single sum
Calculating thePresent 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?

slide18
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 an annuity
Calculating thePresent 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?

slide20
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

balance sheet
Balance Sheet

A statement of

your financial position

at one point in time.

balance sheet equation
Balance Sheet Equation:

Liabilities Assets = + Net Worth

balance sheet23
Balance Sheet

ASSETS

LIABILITIES

(Payoff Amount of

Loans and Debts)

NET WORTH

(Your Equity Portion)

(Fair Market Value

of Assets)

balance sheet24
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.)
the concept of solvency
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
The Income and Expense Statement

A measure of your

financial performance

over a given time period.

income and expense statement
Income and Expense Statement:

Total Income – Total Expenses =

CASH SURPLUSOR

(CASH DEFICIT)

income cash in
Income: Cash IN  
  • Wages and salaries
  • Bonuses
  • Interest and dividends
  • Child support
  • Tax refunds
  • Gifts
expenses cash out
Expenses: Cash OUT   
  • FIXED

Rent or mortgage payment

Cable TV

Insurance

  • VARIABLE

Dry cleaning

Recreation

Eating out

cash surplus deficit
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
Using Your Personal Financial Statements
  • Maintain a good recordkeeping system
  • Prepare financial statements periodically
  • Track financial progress
ratio analysis
Ratio Analysis

Financial ratios allow you to:

  • Track progress toward your financial goals
  • Evaluate your financial performance over a period of time
balance sheet ratios
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

slide35

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.

slide36
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

slide37

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.

slide38

Income & Expense Statement Ratios

Savings Ratio

  • Shows the percentage of after-tax income being saved during a given period.

Cash surplus

Income after taxes

slide39

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%.

slide40
Debt Service Ratio
  • Indicates ability to repay loan obligations promptly with before-tax income.

Total monthly loan payments

Monthly gross income

slide41

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.

preparing using budgets
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.
budgets help you
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
The Budgeting Process
  • Estimate income
  • Estimate expenses
  • Finalize the cash budget
  • Deal with deficits
what should you do if you have monthly 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
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
deficit spending decreases your net worth

Deficit spending causes you to

Deficit spendingDECREASESyour Net Worth!

Deplete an existing asset,

Incur more debt –

Or both!

things to remember about a budget
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.