Garman/Forgue Personal Finance Ninth Edition Chapter 3 Financial Statements, Tools, and Budgets

3 | 2  Identify your financial values and goals.  Use balance sheets and income statements to measure your financial health.  Evaluate your financial strength using ratios.  Work toward achieving your financial goals through budgeting. Chapter 3: Learning Objectives

3 | 3 Financial Values, Goals, and Strategies SCARY, BUT TRUE: To maintain their “preferred lifestyle”, many people spend every dollar they earn Three in ten people live beyond their means If people are spending so much, what are they saving??

3 | 4 LIVING PAYCHECK to PAYCHECK “I get paid every Friday but I run out of money by Wednesday!” To maintain their preferred lifestyle, many people spend every dollar they earn. Why do so many people live beyond their means?

3 | 5 Start with Goals! Values: –Your beliefs about what is important, valuable, worthwhile –The way we spend, save, invest, donate our money is a reflection of our values –We all differ in the way we value education, health, family life, spiritual life, etc. Goals: –Specific objectives that are consistent with our values –SMART goals: Specific, Measurable, Achievable, Realistic, and Time-Related

3 | 6 GET ORGANIZED! 3 Components of Money Management IMPLEMENT a plan (a budget for spending & saving) CREATE financial statements (balance sheets and income statements) ORGANIZE financial records

3 | 7 II.Why Financial Statements? They Measure Your Financial Health & Progress Balance Sheet (Statement of Net Worth) –Describes your financial condition on a specific date –Shows assets, liabilities, net worth –Compares what you own vs. what you owe

3 | 8 Assets: What Do You Own? –Monetary (liquid) Assets Low-risk, near-cash Checking & savings accts –Tangible (use) Assets Personal property Valued at fair market value –Investment (capital) Assets Acquired for the financial benefits they will provide Stocks & bonds, retirement accts SEE EXAMPLE PGS 70-73

3 | 9 Liabilities: What Do You Owe? – Short-term (current) Liabilities Due within one year – Long-term Liabilities Debts due more than one year from now Net Worth: What is Left? – Net Worth Formula: ASSETS – LIABILITIES = NET WORTH – Where do you stand financially? – Are there any trouble spots? – Negative net worth = insolvent

3 | 10 Net Worth by Age

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3 | 12 Strategies to Increase Your Net Worth Increase Assets Decrease Liabilities Both!

3 | Income Statement –Shows income and spending patterns, which is necessary when preparing a budget –Can be for a month or years time period –Income from all sources –Expenses, fixed and variable –Surplus –Deficit

3 | 14 Sample Income Statement for a College Student SEE EXAMPLE PGS 74-76

3 | 15 Basic liquidity ratio  Can I pay for emergencies?  How many months can I continue to meet my expenses if my income stops? Liquidity Ratio = Liquid Assets Monthly Expenses Experts recommendation: Financial Ratios Assess Your Financial Strength

3 | 16 Asset-to-Debt Ratio  Do you have enough assets compared to debt (liabilities)?  Measures solvency and ability to pay debts  What if you owe more than you own? Asset-to-Debt Ratio = Total Assets Total Liabilities Experts recommendation: If your net worth is positive, this ratio will be greater than 1.0

3 | 17 Debt Service-to-Income Ratio  Indicates your total debt burden  Do I have too much debt compared to my gross income?  Includes all installment loans (mortgage, auto, student) Debt Service-to-Income Ratio = Annual Debt Payments Gross Income Experts recommendation: 36% or

3 | 18 Debt Payment-to-Disposable Income Ratio  Indicates if your NONMORTGAGE debt is too high Debt Payment-to-Disposable = Monthly nonmortgage debt payments Income Ratio Monthly net income Experts recommendation: 16% or

3 | 19 Investment Assets-to-Total Assets Ratio  Am I advancing toward my financial goals (retirement)?  Are enough of my assets made up of investment assets? Investment Assets-to-Total Assets Ratio = Investment Assets Total Assets Experts recommendation: Higher = Better! 20-something’s: 10% 30-something’s: 11-30% 40 and above: 30% or more (50% is desirable)

3 | 20 Budget: A monthly plan for spending and saving Ask yourself:  Do you like to be in control?  Do you like to feel empowered? Income Statement WHERE AM I? Budget WHERE DO I WANT TO GO? Reaching Goals Through Budgeting “Your financial success is largely a matter of CHOICE, not CHANCE!”

3 | 21 Rules for successful budgeting: 1. Keep it simple. 2. Prioritize. 3. Keep it flexible. 4. Be positive. “A budget is designed not to prevent you from enjoying life, but to help you achieve what you want most in life”

3 | 22 Create a monthly budget using 3 columns: 1.Estimated amounts (based on past expenditures) –Do not use unrealistically low numbers! –Your initial math may be alarming: expenses > income –Reconcile needs & wants by identifying priorities (BTW, you may have to make some sacrifices!) 2.Actual amounts (at month end) 3.Budget variance (difference between budgeted & actual amounts) –Evaluate: why did variances occur? –Excessive variances may require budget revisions –Time will help with accuracy –Use surpluses wisely (revolving savings fund / credit card debt)

3 | 23 Make sure “SAVING” is in your budget… What’s your technique? 1.Piggy Bank OR envelope 2.Use automatic deposit to deposit a certain amount in savings 3.Payroll deduction How you save is not as important as getting into the HABIT … small amounts can grow faster than you think!

3 | 24 For years, co-workers were amused by a woman who carried a brown bag lunch each day. That woman later retired COMFORTABLY and lived her later years in beachfront property. A daily coffee and muffin can add up to over $1,300 a year. Assuming an 8% return, how much would would this amount saved each year be in 40 years? What if you could earn an average of 10% on your savings? Go to Did You Know?

3 | 25 Top 3 Financial Missteps in Financial Statements, Tools and Budgets 1.Failing to plan for occasional, non-monthly expenditures. 2.Underestimating how much you spend each month. 3.Using credit cards to “balance” your budget.