Personal Financial
Statements and Budgets
Chapter 3
Planning Your Financial Future, 4e
by: Boone, Kurtz & Hearth
American’s Spending/Saving
Habits
 Net worth of
typical American household grew
faster than income
 A large percentage of households own common
stock today
 Share of family income devoted to debt repayment
fell
 Spending on health care, entertainment, and
insurance rose at a faster rate than food, housing,
or transportation
 Typical household spent more than $13,000 on
housing and slightly less than $5,500 on food
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Financial Statements and
Budgets
 Can help you determine your current
financial status and control your spending
 Can help you track progress toward your
financial goals
 Can help you identify new goals to establish
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Personal Financial Statements
 Two primary statements exist
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Income statement
 Traces the flow of income and expenses
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Balance sheet (statement of net worth)
 Lists the current value of assets and liabilities
 Your net worth is the difference between your assets
and your liabilities
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Personal Financial Statements
 Financial statements will
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Provide a current evaluation of your financial status
Allow evaluation of your current and future goals
Provide information for loan applications such as a
mortgage
Offer a starting point for estate planning
Serve as the basis for future investments
Help detect current and potential financial problems
Provide necessary data for divorce and prenuptial
agreements
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Personal Financial Statements
 Americans are not good at financial record
keeping
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Fewer than 50 percent of all people regularly
balance their checkbook
 Difficult to gather all information necessary
to develop a complete set of financial
statements
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The Income Statement
 Traces person’s or family’s annual income expenses
and savings
 Income
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Includes are items such as wages, salary, interest, and
dividends
 Taxes
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Includes taxes such as property taxes, federal and state
income taxes, and Social Security and Medicare taxes
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The Income Statement
 Housing expenses
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Includes items such as mortgage payments, furniture,
utilities, and other main expenses
 Some housing expenses are tax deductible
 Transportation
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Includes items such as car payments, maintenance,
gasoline, insurance, and registration fees
 Food
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Includes items such as household, groceries, eating out
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The Income Statement
Child care and medical expenses
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Includes day care and medical insurance,
as well as medical bills not covered by
insurance
Clothing and personal care
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Includes a variety of the items such as
shoes, haircuts, clothing, etc.
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The Income Statement
 Entertainment, gifts, and recreation
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Includes items such as an annual vacation, inexpensive
hobby, sports and weekend entertainment
 Student loan payments
 Life insurance premiums
 Charitable contributions
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Most are tax deductible so keep good records
 Cash allowances
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AKA spending money, represents incidental day-to-day
expenses
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The Income Statement
Available for saving and investment
Income less expenses = the amount left
over for savings and investment
 If expenses exceed income, you’ll have to
withdraw money from savings or
investments or borrow
 Investments could include saving for
retirement or college fund
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The Balance Sheet
 Outlines the household’s assets (what it
owns) and its liabilities (what it owes)
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The difference represents net worth or equity
Represents a snapshot of assets and liabilities at
a single point in time
Assets are generally listed in terms of how
easily they can be converted to cash
Liabilities are generally listed in the order in
which they are due
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The Balance Sheet
 Cash and near-cash financial assets
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Includes items such as a checking account,
savings accounts, money market funds
 Nonretirement financial assets
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Includes items such as stocks, bonds, and mutual
funds not held in retirement accounts
 Retirement and other financial assets
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The Balance Sheet
 Real assets
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Includes items such as a house, household furnishings,
vehicles
Current liabilities
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Debts due in a short period of time
 Long-term liabilities
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Debts due over a longer period of time, such as a
mortgage, student loans, car loan
 Net worth
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Value remaining after subtracting liabilities from assets
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Figure 3.3: Median Household
Net Worth in the United States
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Figure 3.3: Median Household
Net Worth in the United States
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Interpreting Personal Financial
Statements
 Comparing the current year to prior years
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It may help to convert dollar figures into
percentages
 Financial ratios
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Provide benchmarks of your current financial
position
Can then be used to spot trouble areas
Helpful to compare over time
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Relevant Financial Ratios
 Liquidity ratio
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Current financial assets ÷ monthly living expenses
Gives you an idea of how many months you could
continue to meet your expenses should your income
cease
Experts suggest a minimum liquidity ratio between
three and six months
 Debt to total assets ratio
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Total liabilities ÷ total assets
Measures ability to pay your debt, or solvency
Measures what percentage of your assets were acquired
using borrowed funds
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Relevant Financial Ratios
 Debt service ratio
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Calculated by dividing periodic debt payments
by a periodic after-tax income
Measures what percentage of your income is
going to repay the loans and other debts
Lenders like to see a ratio of 40 percent or less
 A ratio above this may make lenders reluctant to lend
you additional money
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Relevant Financial Ratios
 Financial-assets-to-net-worth ratio
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Tells you what percentage of your net worth is
made up of financial assets (vs. real assets)
The higher the ratio, the better
Over time, it indicates how well you’re doing
toward your goal of wealth accumulation
The typical household’s ratio is around 30
percent
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Preliminary Budgeting
Concerns
 Setting up an emergency fund
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Helps cover unexpected expenses
Should be kept in readily available assets for
easy access, such as a savings account or money
market mutual fund
Experts suggest an emergency fund should
equal three to six months of income
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Preliminary Budgeting
Concerns
 Insuring against financial disaster
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Insurance protects your property and income
should something unexpected happen
Insurance types include life, health, disability,
and property and liability
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Budgeting
 The budget is normally prepared on a monthly
basis
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Many bills are paid only once a month
 The budget is designed to monitor and control
expenses
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Permits you to track past and current expenses and plan
future ones
 A budget should never deprive you of
need
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what you
It should support your short- and long-term goals
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Budget Components
 Income (cash inflows)
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It includes all cash expected to flow into the household
 Take-home pay, bonuses, dividends, etc.
 Expenses (cash outflows)
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Fixed expenses
 Includes mortgage payment (rent), insurance, payments to
regular savings deposits
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Variable expenses
 Food, clothing, utility bills
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Budget Format
 Budget should be kept as simple as possible
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Don’t overdo the number of categories
 The basic information includes
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Estimated income
Actual income
Estimated expenses and actual expenses
The difference between estimates and actual
values
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Consumer Spending Patterns
 The average household in the U.S. spends about
$49,400 a year
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The largest single expense is housing
 Consumer spending patterns vary with the age of
the household
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Younger households spend more on housing,
entertainment, and transportation
Older households spend more on health care
 Other factors affecting the budget include
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Income, marital status, children, geographic location
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Figure 3.7: Distribution of
Consumer Spending
Source: Based on data from the Statistical Abstract of the United States.
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Record Keeping
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Adequate financial records are necessary to prepare meaningful financial
statements and budgets
Records need to be kept pertaining to your
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Checking and savings accounts
Brokerage accounts
Mutual fund accounts
Retirement accounts
Wills and trusts
Real estate deeds
Safe-deposit boxes
Life insurance policies
Credit cards
Tax records
Appraisals of certain assets such as art or antiques
Employee benefits
Financial statements
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Record Keeping
 Where should records be kept?
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Home filing cabinet
Safe-deposit box at a local bank
 Protected from fire or theft
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Fire resistant home safe
Personal computer
 Store copies of the electronic files in different
locations
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Record Keeping
 How long should records be kept?
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Review records periodically to determine which
are still essential and which are not
Some records can be discarded after a few
months, while others should be kept for several
years
When destroying records, you should shred
them as they may contain very personal
information
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