1. Chapter 2: Financial Planning

2. Objectives
Explain the concept of financial planning, its components, and its benefits.
Describe financial statements, particularly the balance sheet and the income and expense statement.
Use financial ratios to evaluate your financial strength and progress.

3. Objectives
Identify the purposes and methods of financial recordkeeping.
Describe the use of computer software in personal financial planning.
Explain how to choose a professional financial planner.

4. Financial Planning
The process of developing and implementing a coordinated series of financial plans to achieve financial success.

5. Common Financial Behaviors
BEWARE!
No clear goals
Disorganized records
Lack of economic understanding
Flawed decision making

6. Components of Successful Financial Planning
Specified values
Explicitly stated goals
Informed economic projections
Logical and consistent financial strategies

7. For Capital Accumulation
Economic Data
Living
Expenses
Earnings
Managerial Effort
Planning
Decision Making
Implementing
Controlling
Evaluating
Coping and Adapting
Feedback
Communication
Values
Attitudes
Lifestyle
Wants
Needs
Relationships
Money
Wealth
Achievement
Of Financial
Objectives
Financial Plans
For Spending/Saving
For Risk Management
For Capital Accumulation
Input
Throughput
Output

8. Financial Statements FUNCTIONS PERFORMED:
Compilation of financial data
Communicate information
Indicate financial condition
Prepares user to read corporate financial statements

9. Assets- Liabilities = Net Worth
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

10. Assets
Monetary assets
Tangible or use assets
Investment assets

11. 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.

12. 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

13. Incomes Salaries or wages Bonuses and commissions
Child support and alimony
Public assistance
Social Security and pensions

14. Incomes Scholarships and grants Interest and dividends
Income from the sale of assets
Other income (gifts, tax refunds, rent, royalties)

15. 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

16. 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

17. Basic Liquidity Ratio
This ratio tell you how many months of expenses you could pay with the your monetary assets. This would be significant if you lost your job and had to make your monthly payments. In this example the person has 1.08 expense months of monetary assets.

18. Debt-to-Asset Ratio

19. Debt Service-to-Income Ratio

20. Investment Assets-to-Net Worth Ratio

21. Good Debt vs. Bad Debt Debt incurred for consumption is bad debt.
= Debt Danger Ratio
Annual Income
Debt Danger Ratio beyond 25% can spell trouble.

22. Assessing Financial Progress
Balance sheet
Income - expense statement
Financial ratios
Am I spending, saving, and investing money where I really want to?

23. Financial Recordkeeping
DETERMINE:
Where you are
Where you have been
Where you are going

24. Recordkeeping Issues Original source records
Safeguarding/storage of records
Use of computer software

25. Professional Financial Planning
Commission-only
Fee-only
Fee-based
Designations and credentials

26. Key Words and Concepts
Financial Planning is the process of developing and implementing a coordinated series of financial plans to achieve financial success.
Values are fundamental beliefs about what is important, desirable, and worthwhile.
Financial Goals are the specific long- and short-term objectives to be attained through financial planning and management efforts.
Financial Strategies are preestablished plans of action to be implemented in specific situations.
Financial Statements are compilations of personal financial data designed to communicate information on money matters.
Balance Sheet (or net worth statement) describes an individual’s or family’s financial condition on a specified date.
Income and Expense (or cash flow) Statement lists and summarizes income and expense transactions that have taken place over a specific period of time.
Assets include everything you own that has monetary value.
Liabilities are your debt.
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.

27. Key Words and Concepts (Cont.)
Fair Market Value is the amount a buyer would pay a willing seller.
Monetary Assets (or liquid assets) include cash and near-cash items that can be readily converted to cash.
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.
Investment assets (also known as capital assets) include tangible and intangible items acquired for the monetary benefits they provide.
Diversification of investments means the investor puts money in a variety of investments.
Short-term (or current) Liability is an obligation that will be paid off within one year.
Long-term Liability is an obligation that will be paid off in more than one year.
Insolvent means net worth is negative.
Fixed Expenses are usually paid in the same amount during each time period.
Variable Expenses are expenditures over which and individual has considerable control.
Net Gain/Loss shows the amount of money left after you subtract expenses from income.
Financial Ratios are objective numerical calculations designed to simplify making judgmental assessments of financial strength over time.

28. Key Words and Concepts (Concl.)
Liquidity is the speed and ease with which an asset can be converted into cash.
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.