Financial Planning
Financial Planning
The process of developing and
implementing a coordinated series of
financial plans to achieve financial
success.
Common Financial Behaviors
BEWARE!
• No clear goals
• Disorganized records
• Lack of economic understanding
• Flawed decision making
Components of Successful Financial Planning
• Specified values
• Explicitly stated goals
• Informed economic projections
• Logical and consistent financial
strategies
Economic Data
Living
Expenses
Earnings
Earnings
Values
Attitudes
Lifestyle
Wants
Needs
Relationships
Money
Wealth
Earnings
Managerial Effort
Planning
Decision Making
Implementing
Controlling
Evaluating
Coping and Adapting
Feedback
Communication
Financial Plans
For Spending/Saving
Financial Plans
For Risk Management
Input
Throughput
Achievement
Of Financial
Objectives
Financial Plans
For Capital Accumulation
Output
Financial Statements
FUNCTIONS PERFORMED:
• Compilation of financial data
• Communicate information
• Indicate financial condition
• Prepares user to read corporate financial
statements
The Balance Sheet
VALUE OF EVERYTHING OWNED MINUS
EVERYTHING OWED:
• Assets – Items owned
• Liabilities- Items owed
• Net worth– Difference between what
one owns and owes.
Assets- Liabilities = Net Worth
Assets
• Monetary or Liquid assets
• Tangible or Household assets
• Investment assets
Liabilities
• Short-term liabilities – anything that will be
paid off in 12 months or less.
• Long-term liabilities—anything that will still
have a balance after 12 months.
Income - Expense Statement
SUMMARY OF CASH-FLOW
TRANSACTIONS OVER TIME:
•Income – How much you made.
•Expenses – How much you spent.
•Net gain or loss—How much you have
left.
•Income – Expenses = Net gain or loss
Incomes
• Salaries or wages
• Bonuses and commissions
• Child support and alimony
• Public assistance
• Social Security and pensions
Incomes
• Scholarships and grants
• Interest and dividends
• Income from the sale of assets
• Other income (gifts, tax refunds, rent,
royalties)
Expenses
• Fixed expenses—items that are the same
every month (you don’t have control over
these).
• e.g. house payment, car payment,
insurance premium
• Variable expenses—expense changes
based on the way you live (you have
control over these).
• e.g. meals, utilities, entertainment
Income Statement
INCOME STATEMENT
INCOME
Gross Wages
Loan from parents
EXPENSES
Taxes
Room rent
Utilities
Laundry
Food
Car Insurance
Car loan
Medical Insurance
Telephone
Clothing
Entertainment
Other
SURPLUS/(DEFICIT)
$
$
1,000
500
$
1,500
$
1,445
$
55
250
500
25
15
120
125
150
150
40
25
45
-
Balance Sheet
Assets
Monetary (Liquid) Assets
Cash
Checking account
Liabilities
$ 1,200
250
Savings account
350
Total monetary (liquid) assets
Tangible (Household) Assets
Home
Car
Furniture
Total investment assets
Total Assets
$
120
1,500
Total short-term (current) liabilities
1,620
$ 1,800
$
Long-term Liabilities
Mortgage
Car loan
2,500
400
Total tangible (household) assets
Investment Assets
Stocks
Short-term (Current) Liabilities
Dentist bill
Credit card balance
Total long-term liabilities
2,900
Total Liabilities
Net Worth
$ 1,500
$ 1,500
$ 6,200
$
2,000
$ 2,000
3,620
$ 2,580
Financial Ratios
OBJECTIVE ASSESSMENTS OF
FINANCIAL STATUS:
•
•
•
•
Basic liquidity ratio
Debt-to-asset ratio
Debt-service-to-income ratio
Investment-assets-to-net-worth ratio
Basic Liquidity Ratio
Using the information from the Balance Sheet earlier in this presentation
Basic Liquidity Ratio =
Monetary (Liquid) Assets
Monthly Expenses
= $1,800
$1,445
= 1.25
This ratio shows that this person could pay their monthly expenses for 1.25
months using monetary assets.
Liquidity Ratio
Using the information from the Balance Sheet earlier in this presentation
Liquidity Ratio =
Liquid Assets
Current Liabilities
= $1,800
$1,620
= 1.11
This ratio shows that this person has $1.11 liquid assets for every $1 of current
liabilities.
Debt Ratio
Total Liabilities
Net Worth
$3,620
2,580
1.403
Debt-to-Asset Ratio
Debt-to-Asset Ratio =
Total Debt
Total Assets
= $3,620
$6,200
= .58
If your debt is greater than your assets you are technically
insolvent.
Debt Service-to-Income Ratio
Debt Service-to-Income Ratio =
AnnualDebt
Repayment
1
Gross Income
= $1,800
$12,000
2
= .15 or 15%
1
The Annual Debt Payment for this calculation includes mortgage
2
Annual debt payment in this example is the car loan monthly payment x 12 months ($150 x 12 = $1,800).
A ratio of 36% or less indicates that gross income is adequate to make debt repayments.
Debt Payment-to-Disposable Income Ratio
Debt Payment-to- Disposable
Income Ratio =
Monthly nonmortgage
debt payments
Disposable income
Disposable income is the amount of take-home pay remaining after all
deductions are withheld for taxes.
A ratio greater than 20% is considered problematic.
Savings Rate
Savings
Rate
Savings Rate =
Savings during the
period
Disposable income
during the period
= $55
$1,250*
= .044 or 4.4%
Describes what percent of disposable income you are saving.
*$1,500 - $250 = $1,250
Good Debt vs. Bad Debt
Debt incurred for consumption is bad debt.
Bad Debt
= Debt Danger Ratio
Annual Income
Debt Danger Ratio beyond 25% can spell trouble.
Assessing Financial Progress
• Balance sheet
• Income - expense statement
• Financial ratios
• Am I spending, saving, and investing
money where I really want to?
Financial Recordkeeping
DETERMINE:
• Where you are
• Where you have been
• Where you are going
Recordkeeping Issues
• Original source records
• Safeguarding/storage of records
• Use of computer software
Key Words and Concepts
Assets include everything you own that has monetary value.
Balance Sheet (or net worth statement) describes an individual’s or family’s financial
condition on a specified date.
Diversification of investments means the investor puts money in a variety of investments.
Fair Market Value is the amount a buyer would pay a willing seller.
Financial Goals are the specific long- and short-term objectives to be attained through
financial planning and management efforts.
Financial Planning is the process of developing and implementing a coordinated series of
financial plans to achieve financial success.
Financial Ratios are objective numerical calculations designed to simplify making
judgmental assessments of financial strength over time.
Financial Statements are compilations of personal financial data designed to communicate
information on money matters
Financial Strategies are preestablished plans of action to be implemented in specific
situations.
Fixed Expenses are usually paid in the same amount during each time period.
Income and Expense (or cash flow) Statement lists and summarizes income and expense
transactions that have taken place over a specific period of time.
Key Words and Concepts (Cont.)
Insolvent means net worth is negative.
Investment assets (also known as capital assets) include tangible and intangible items acquired
for the monetary benefits they provide.
Liquidity is the speed and ease with which an asset can be converted into cash.
Liabilities are your debt (what you owe).
Long-term Liability is an obligation that will be paid off in more than one year.
Monetary Assets (or liquid assets) include cash and near-cash items that can be readily
converted to cash.
Net Gain/Loss shows the amount of money left after you subtract expenses from income.
Net Worth is the dollar amount left when what is owed is subtracted from the dollar value of
what is owned. Everything should be calculated at fair market value.
Short-term (or current) Liability is an obligation that will be paid off within one year.
Tangible (or use) Assets are physical assets that have fairly long lifespans and could be sold to
raise cash but whose primary purpose is to provide maintenance of one’s lifestyle.
Values are fundamental beliefs about what is important, desirable, and worthwhile.
Variable Expenses are expenditures over which and individual has considerable control.
Key Words and Concepts (Concl.)
Financial Ratios:
Basic Liquidity Ratio: monetary (liquid) assets
monetary expenses
Reveals the number of months a family could continue to meets its expenses from monetary
assets after a total loss of income. Families should have a basic liquidity ratio of 3.
Debt-to-Asset Ratio:
total debt
total assets
Measures the solvency and ability to pay debt
Debt Service-to-Income Ratio: annual debt repayments
gross income
Provides an incisive view of the total debt burden of an individual. A ratio of .36 or less
indicates that gross income is adequate to make debt repayments.
Investment Assets-to-Net Worth Ratio: investment assets
net worth
Expresses how well an individual is advancing toward their financial goals for capital
accumulation. Experts recommend 50% or higher.
Savings Rate: savings during the period
disposable income during the period
Calculates the percent of disposable income an individual is saving.