2-1 CHAPTER 2: YOUR FINANCIAL STATEMENTS AND PLANS

2-2 Mapping Out Your Financial Future Financial planning facilitates:  Greater wealth  Financial security  Attainment of financial goals

2-3 Financial plans, budgets and statements facilitate financial planning!  Link future goals and plans with actual results  Provide direction, control and feedback

2-4 * 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

2-5 * 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

2-6 * 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

2-7 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

2-8 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.

2-9 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.

2-10 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.

2-11 Ways to Calculate TVM:  Formulas  Tables (see Appendices A-D)  Financial calculators  Spreadsheets (ex: Excel)  Internet calculators (search on “calculators”)

2-12 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.”

2-13 Calculating the Future Value of a Single Sum: Example: What will $5000 grow to become if invested at 10% for 6 years?

2-14 Tables (Find Future Value Factor for 6 years and 10% in Appendix A) FV = PV x Factor $5000 x = $8,860 Calculator (Set on 1 P/YR and END mode.) /- PV 6N6N 10I/YR FV $8,857.81

2-15 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%?

2-16 Tables (Find Future Value Annuity Factor for 6 years and 10% in Appendix B) FV = PMT x Factor $5000 x = $38,580 Calculator (Set on 1 P/YR and END mode.) /-PMT 6N 10I/YR FV $38,578.05

2-17 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.

2-18 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?

2-19 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.) /-FV 25N 7I/YR PV $55,274.75

2-20 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?

2-21 Tables (Find Present Value Annuity Factor for 4 years and 7% in Appendix D.) PV = PMT x Factor $10,000 x = $33,870 Calculator (Set on 1 P/YR and END mode.) /-PMT 4N 7I/YR PV $33,872.11

2-22 Balance Sheet A statement of your financial position at one point in time.

2-23 Balance Sheet Equation: Liabilities Assets=+ Net Worth

2-24 ASSETSLIABILITIES (Fair Market Value of Assets) (Payoff Amount of Loans and Debts) NET WORTH (Your Equity Portion) Balance Sheet

2-25 ASSETS What you own : checking acct. car investments jewelry furniture Balance Sheet

2-26 ASSETSLIABILITIES What you own : checking acct. car investments jewelry furniture What you owe : car loan credit card balances education loans unpaid monthly bills Balance Sheet

2-27 ASSETSLIABILITIES 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

2-28 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.

2-29 The Income and Expense Statement A measure of your financial performance over a given time period.

2-30 Income and Expense Statement: Total Income – Total Expenses = CASH SURPLUS OR (CASH DEFICIT)

2-31 Income: Cash IN     Wages and salaries  Bonuses  Interest and dividends  Child support  Tax refunds  Gifts

2-32 Expenses: Cash OUT     FIXED Rent or mortgage payment Cable TV Insurance  VARIABLE Dry cleaning Recreation Eating out

2-33 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).

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2-35 Using Your Personal Financial Statements  Maintain a good recordkeeping system  Prepare financial statements periodically  Track financial progress

2-36 Ratio Analysis Financial ratios allow you to:  Track progress toward your financial goals  Evaluate your financial performance over a period of time

2-37 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

2-38 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.

2-39 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

2-40 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.

2-41 Savings Ratio  Shows the percentage of after- tax income being saved during a given period. Income & Expense Statement Ratios Cash surplus Income after taxes

2-42 Example: $11,336  ($73,040 – $15,430) = 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%.

2-43 Debt Service Ratio  Indicates ability to repay loan obligations promptly with before-tax income. Total monthly loan payments Monthly gross income

2-44 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.

2-45 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.

2-46 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.

2-47 The Budgeting Process  Estimate income  Estimate expenses  Finalize the cash budget  Deal with deficits

2-48 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.

2-49 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

2-50 Deficit spending DECREASES your Net Worth! Deficit spending causes you to Deplete an existing asset, Incur more debt – Or both!

2-51 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.

2-52 THE END!