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
The Interlocking Network of
Financial Plans & Statements
* 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
feedback
feedback
* evaluate and plan major outlays
* reduce taxes
* establish savings and investment
programs
* manage credit
* secure adequate insurance
* implement retirement program
* facilitate estate distribution
2-5
FINANCIAL
PLANS
* monitor and control income, living
expenses, purchases, and savings
on a monthly basis
BUDGETS
Actual financial results
* balance sheet
* income & expenditures statement
FINANCIAL
STATEMENTS
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
2-8
Financial Planning Designations
 Certified Financial Planner (CFP): Requires a
comprehensive education in financial planning
 Chartered Financial Consultant (ChFC): Financial
planning designation for insurance agents
 Certified Trust & Financial Advisor (CTFA): Estate
planning and trusts expertise, found mostly in the
banking industry
 Personal Financial Specialist (PFS):
Comprehensive planning credential only for CPAs
 Chartered Life Underwriter (CLU): Insurance
agent designation, often accompanied by the ChFC
credential
2-9
Choosing A Financial Planner
 Largely unregulated industry (be careful with
the self-claimed financial planners)
 Tips on choosing a financial planner:
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Know what you want
Talk to others (get referrals)
Interview several planners
Check the planner’s background
Get it in writing
Receive regular statements
Reassess the relationship regularly
2-10
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.
2-11
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.
2-12
Ways to Calculate TVM:
 Formulas
 Tables (see Appendices A-D)
 Financial calculators
 Spreadsheets (ex: Excel)
 Internet calculators (search on
“calculators”)
2-13
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.”
2-14
Calculating the
Future Value of a Single Sum:
Example: What will $5000 grow to
become if invested at 10% for 6 years?
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
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%?
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
2-16
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.
2-17
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?
2-18
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
7
I/YR
PV $55,274.75
2-19
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?
2-20
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
2-21
Balance Sheet
A statement of
your financial position
at one point in time.
2-22
Balance Sheet Equation:
Assets
=
Liabilities
+
Net Worth
2-23
Balance Sheet
ASSETS
(Fair Market Value
of Assets)
LIABILITIES
(Payoff Amount of
Loans and Debts)
NET WORTH
(Your Equity Portion)
2-24
Balance Sheet
ASSETS
What you own:
•checking acct.
•car
•investments
•jewelry
•furniture
LIABILITIES
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.)
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.
2-25
2-26
The Income and Expense
Statement
A measure of your
financial performance
over a given time period.
2-27
Income and Expense Statement:
Total Income – Total Expenses =
CASH SURPLUS OR
(CASH DEFICIT)
2-28
Income: Cash IN   
Wages and salaries
Bonuses
Interest and dividends
Child support
Tax refunds
Gifts
Expenses: Cash OUT   
FIXED
Rent or mortgage payment
Cable TV
Insurance
VARIABLE
Dry cleaning
Recreation
Eating out
2-29
2-30
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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How We Spend Our Income
Food 13.4%
66%
Housing 32.9%
Transportation 19.3%
Apparel & services 4.4%
Health care 5.5%
Entertainment 4.9%
Personal insurance 1.0%
Pensions/Social Security 8.4%
Other 10.2%
2-32
Using Your Personal
Financial Statements
Maintain a good recordkeeping
system
Prepare financial statements
periodically
Track financial progress
2-33
Ratio Analysis
Financial ratios allow you to:
Track progress toward your
financial goals
Evaluate your financial
performance over a period of
time
2-34
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
2-35
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.
2-36
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
2-37
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.
2-38
Income & Expense Statement Ratios
Savings Ratio
Shows the percentage of aftertax income being saved during a
given period.
Cash surplus
Income after taxes
2-39
Example:
$11,336  ($73,040 – $15,430) =
0.197 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%.
2-40
Debt Service Ratio
Indicates ability to repay loan
obligations promptly with
before-tax income.
Total monthly loan payments
Monthly gross income
2-41
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.
2-42
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.
2-43
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.
2-44
The Budgeting Process
Estimate income
Estimate expenses
Finalize the cash budget
Deal with deficits
2-45
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.
2-46
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
2-47
Deficit spending causes you to
Deplete an existing asset,
Incur more debt –
Or both!
Deficit spending
DECREASES
your Net Worth!
2-48
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.