Chapter 3 Developing Financial Statements, Plans and Budgets Financial statements are assessments of the current status of one’s personal financial position.

Chapter 3 Developing Financial Statements, Plans and Budgets TWO types of statements 1. Income statement Traces flow of income and expenses 2. Balance sheet Lists assets and liabilities Also known as statement of net worth

Chapter 3 Developing Financial Statements, Plans and Budgets Financial statements provide: an evaluation of financial well-being information for loan applications a starting point for estate planning a basis for building future investments a key to potential financial problems information for divorce, prenuptial agreements

Chapter 3 Developing Financial Statements, Plans and Budgets Mark and Susan’s Income Statement  Mark and Susan earned $39,000 and $45,000 in salary respectively.  Mark received a bonus of $2,500 and they collected $1,500 in interest and dividends.  They also received a federal tax refund of $500.  Total income before taxes: $88,500.00

Chapter 3 Developing Financial Statements, Plans and Budgets Consider Taxes. Susan and Mark paid $17,000 in income and Social Security taxes during the year. After deducting for taxes, they found they had a net income of $71,500. Gross income$88, Less taxes 17, Net income 71,500.00

Chapter 3 Developing Financial Statements, Plans and Budgets Housing Expenses –Mortgage payments totaled $12,000 –Utilities $3,600 –Property taxes of $1,800 –Maintenance expenses of $2,500 –Home-owners insurance cost $600 –Miscellaneous expenses $2,500

Chapter 3 Developing Financial Statements, Plans and Budgets Housing: Mortgage*$12, Utilities3, Property Taxes*1, Maintenance2, Insurance Other2, * Tax deductible

Chapter 3 Developing Financial Statements, Plans and Budgets Transportation and Food Expenses  Car payments, gas and repairs, insurance, and registration were estimated to be $5,500.  Bus passes and bike maintenance cost another $500.  Food cost were estimated to be $5,000.

Chapter 3 Developing Financial Statements, Plans and Budgets Transportation: Car payments$3, Gasoline & repairs1, Insurance Registration Other Food: Total Food$5,000.00

Chapter 3 Developing Financial Statements, Plans and Budgets Other Expenses Clothing $2, Child care:$6, Health insur. premiums 1, Health care expenses 1, Vacation, entertainment2, Gifts 2, Life insurance Student loan payments2, Cash allowances3, Miscellaneous2, Total Other Expenses $23,200.00

Chapter 3 Developing Financial Statements, Plans and Budgets Total Expenses –Housing $23, –Food 5, –Transportation 6, –Other23, TOTAL EXPENSES $57,200.00

Chapter 3 Developing Financial Statements, Plans and Budgets Savings & Investment Mark and Susan earned a net income of $71,500 and had total expenses of $57,200. Therefore, they had $14,300 left for savings and investment. Total net income$71, (less) Total expenses57, *Available for savings, investment$14, * * If this figure is negative, net worth declines

Chapter 3 Developing Financial Statements, Plans and Budgets An income statement only shows how much money has been received and spent during a certain time period. A balance sheet is also needed to assess a person’s current financial position.

Chapter 3 Developing Financial Statements, Plans and Budgets The Balance Sheet –Outlines what a person ownsAssets –Outlines what a person owes Liabilities –Difference between the two =Net worth A balance sheet provides a snapshot of a person’s assets and liabilities at any given point in time.

Chapter 3 Developing Financial Statements, Plans and Budgets Current Financial Assets: Checking Account$1, Savings account 0.00 Money market 8, CD’s0.00 Total Current Financial Assets $9,500.00

Chapter 3 Developing Financial Statements, Plans and Budgets Financial Assets: Non-retirement, Retirement and Other Accounts Susan and Mark valued their stocks and bonds not held in retirement accounts or special accounts. Their retirement accounts and college fund total $24,000.

Chapter 3 Developing Financial Statements, Plans and Budgets Financial Assets, cont.: –Non-retirement accts. $7, –Retirement accts. 22, –College fund 2, Subtotal $31, Total Financial Assets $41,000.00

Chapter 3 Developing Financial Statements, Plans and Budgets Real Assets We include houses, cars, furniture, and personal property in valuing fixed assets.

Chapter 3 Developing Financial Statements, Plans and Budgets Real Assets: Home$145, Auto 1 14, Auto Home Furnishings 20, Personal property 15, Total Real Assets $194,000.00

Chapter 3 Developing Financial Statements, Plans and Budgets Total Assets Total financial assets:$41, Total real assets:194, Total assets$235,000.00

Chapter 3 Developing Financial Statements, Plans and Budgets Liabilities--What You Owe –Current liabilities debts due within a short period of time (a month) –Long-term liabilities debts to be paid off over a longer period of time (one year)

Chapter 3 Developing Financial Statements, Plans and Budgets Current Liabilities: Current bills Credit card payments Current loan payments0.00 Total Current Liabilities $500.00

Chapter 3 Developing Financial Statements, Plans and Budgets Long-term Liabilities Generally consider auto loans, student loans, and mortgages when totaling long-term liabilities of more than a year

Chapter 3 Developing Financial Statements, Plans and Budgets Long-term Liabilities: Auto loan $12, Student loan 8, Mortgage 115, Other 0.00 Total Long-term Liabilities $135,000.00

Chapter 3 Developing Financial Statements, Plans and Budgets Total Liabilities Total current liabilities: $ Total long-term liabilities:135, Total liabilities$135,500.00

Chapter 3 Developing Financial Statements, Plans and Budgets Net Worth Total assets: $235, (Less) Total liabilities: 135, *Net Worth $99, * Their net worth is more than twice their annual income, a good ratio.

Chapter 3 Developing Financial Statements, Plans and Budgets Financial Ratios –Financial ratios are benchmarks of a person’s current financial status. –They can also be used to spot worrisome trends in someone’s financial well-being.

Chapter 3 Developing Financial Statements, Plans and Budgets Four Common Ratios –Liquidity ratio –Debt/Total assets ratio –Debt service ratio –Financial assets/ Net worth

Chapter 3 Developing Financial Statements, Plans and Budgets Liquidity Ratio Purpose: Measures how many months someone can meet his or her expenses with no additional income. Formula: Cash and near-cash financial assets /monthly living expenses (annual expenses divided by 12)

Chapter 3 Developing Financial Statements, Plans and Budgets Liquidity Ratio Cash & near-cash assets / Monthly living expenses ($1,500 + $8,000) / ($57,200 / 12) $9,500 / $4, months Their liquidity ratio covers only 1.99 months. Most financial advisors suggest having months coverage. They need to increase their resources in this area.

Chapter 3 Developing Financial Statements, Plans and Budgets Debt/Total Assets Ratio Purpose: Measures ability to pay debts (solvency). Also shows what percentage of assets were acquired using borrowed funds. Total Liabilities / Total assets $135,500 / $235, or 58% They have almost twice as many assets as liabilities, an excellent ratio.

Chapter 3 Developing Financial Statements, Plans and Budgets Financial Planning –A financial plan is a guide to reaching a targeted goal in the future.

Chapter 3 Developing Financial Statements, Plans and Budgets Budget Components A budget is a short-term monthly financial plan –Income or Cash Inflows Includes all money to come in during the month (pay, dividends, bonuses) –Expenses or Cash Outflows  Fixed expenses  Remains constant each month (mortgage payment  Variable expenses  Fluctuate from month to month (clothing)

Chapter 3 Developing Financial Statements, Plans and Budgets Cash Inflows for July

Chapter 3 Developing Financial Statements, Plans and Budgets Fixed Outflows for July

Chapter 3 Developing Financial Statements, Plans and Budgets Selected Variable Outflows for July

Chapter 3 Developing Financial Statements, Plans and Budgets Record Keeping –Crucial to sound financial management –Should be kept on all financial assets –Where to keep records? File cards Safe-deposit boxes Home computers –How long to keep records? IRS cannot audit after three years except for fraud If discarded, is it available elsewhere?