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 To maintain their “preferred lifestyle”, many people spend every dollar they earn 40% of Americans live beyond their means Living paycheck to paycheck => living off of credit cards SCARY, BUT TRUE:

3 | 4 Values Goals Plan Values: –What is important, valuable, worthwhile? –Your values determine how you spend, save, invest your money –We all differ! 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 | 5 Turning Your Goals into Reality  WRITE IT DOWN  USE PICTURES AS A CONSTANT REMINDER Page 60

3 | 6 Financial Powerpoint Pg. 68 Page 68

3 | 7 Financial Statements Balance Sheet Cash-Flow Statement

3 | 8 Why Financial Statements? They Measure Your Financial Health & Progress Balance Sheet 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 | 9 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 PG 73

3 | 10 Liabilities: What Do You Owe? - Short-term (current) Liabilities (Due within one year) - Long-term Liabilities (Due 1+ years) Net Worth: Do I own more than I owe? Negative net worth = insolvent Negative net worth = insolvent ASSETS – LIABILITIES = NET WORTH

3 | 11 Average Net Worth by Age

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3 | 13 (Income Statement) –Shows money coming IN and money going OUT –Fixed vs. Variable expenses (SURPLUS) –Do you live within your income? (SURPLUS) (DEFICIT) –Or are you spending more than you earn? (DEFICIT) SEE EXAMPLE PG 76 –Can be a monthly or yearly statement Cash-Flow Statement

3 | 14 Average American Expenses by Percentage Where our money goes!

3 | 15 Liquidity ratioLiquidity 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 RatioAsset-to-Debt Ratio  Do you have enough assets to meet your debt obligations?  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:

3 | 17 Debt Service-to-Income RatioDebt 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 RatioDebt Payment-to-Disposable Income Ratio  Indicates if your NONMORTGAGE debt is too high nonmortgage Debt Payment-to-Disposable = Monthly nonmortgage debt payments Income Ratio Monthly net income Experts recommendation: 16% or

3 | 19 Investment Assets-to-Total Assets RatioInvestment 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!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

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 –Do not use unrealistically low numbers! –Reconcile needs & wants by identifying priorities (Make sacrifices if necessary!) 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 $1,300 a year. 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 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.