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© 2008 Thomson South-Western
YOURFINANCIAL
STATEMENTS AND PLANS
CHAPTER 2
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
Link future goals and plans with actual results
Provide direction, control and feedback
2-4
The Interlocking Network of Financial Plans & Statements
2-5
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
2-6
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.
2-7
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.
2-8
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.
2-9
Ways to Calculate TVM
Formulas
Tables (see Appendices A-D)
Financial calculators
Spreadsheets (ex: Excel)
Internet calculators (search on “calculators”)
2-10
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.”
2-11
Calculating the Future Value of a Single Sum
Example:
What will $5000 grow to become
if invested at 10% for 6 years?
2-12
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 a Single Sum
2-13
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%?
2-14
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
Calculating the Future Value of an Annuity
2-15
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.
2-16
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?
2-17
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
7I/YR
PV $55,274.75
Calculating the Present Value of a Single Sum
2-18
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?
2-19
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
Calculating the Present Value of an Annuity
2-20
Balance Sheet
A statement of
your financial position
at one point in time.
2-21
Balance Sheet Equation
LiabilitiesAssets = +
Net Worth
2-22
ASSETS LIABILITIES
(Fair Market Value of Assets)
(Payoff Amount of Loans and Debts)
NET WORTH
(Your Equity Portion)
Balance Sheet
2-23
ASSETS
What you own:•checking acct.•car•investments•jewelry•furniture
Balance Sheet
2-24
ASSETS LIABILITIES
What you own:•checking acct.•car•investments•jewelry•furniture
What you owe:•car loan•credit card balances•education loans•unpaid monthly bills
Balance Sheet
2-25
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 todetermine net worth.)
Balance Sheet
2-26
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.
2-27
The Income and Expense Statement
A measure of your
financial performance
over a given time period.
2-28
Income and Expense Statement
Total Income – Total Expenses =
CASH SURPLUS OR
(CASH DEFICIT)
2-29
Income: Cash IN
Wages and salaries Bonuses Interest and dividends Child support Tax refunds Gifts
2-30
Expenses: Cash OUT
FIXEDRent or mortgage payment
Cable TV
Insurance
VARIABLEDry cleaning
Recreation
Eating out
2-31
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).
2-32
How We Spend Our Income
2-33
Using Your Personal Financial Statements
Maintain a good recordkeeping system
Prepare financial statements periodically
Track financial progress
2-34
Ratio Analysis
Financial ratios allow you to:
Track progress toward your financial goals
Evaluate your financial performance over a period of time
2-35
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
2-36
Measures your ability to pay current debts with existing liquid assets.
Current is defined as needing payment within one year.
Liquid assetsTotal current debts
Liquidity Ratios
2-37
Savings Ratio
Shows the percentage of after-tax income being saved during a given period.
Income & Expense Statement Ratios
Cash surplusIncome after taxes
2-38
Indicates ability to repay loan obligations promptly with before-tax income.
Total monthly loan paymentsMonthly gross income
Debt Service Ratio
2-39
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.
2-40
Using Budgets
Monitor and control finances.
Allocate income to reach goals.
Implement system of disciplined spending.
Reduce needless spending.
Achieve long-term financial goals.
2-41
The Budgeting Process
Estimate income
Estimate expenses
Finalize the cash budget
Deal with deficits
2-42
If You Have Monthly Deficits
Shift expenses from months with deficits to months with surpluses.
Use savings, investments, or borrowing to cover temporary deficits.
2-43
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
2-44
Depletion of an existing asset,
More debt –
Or both DECREASES net worth
Deficit Spending Results In
2-45
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.