2-1 Copyright 2002 by Harcourt, Inc. All rights reserved. CHAPTER 2: YOUR FINANCIAL STATEMENTS AND...

2-1

Copyright 2002 by Harcourt, Inc. All rights reserved.

CHAPTER 2:

YOURFINANCIAL STATEMENTS

AND PLANS

Clip Art 2001 Microsoft Corporation. All rights reserved.

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Mapping Out Your Financial Future

Financial planning facilitates greater wealth and financial security.

Financial plans, budgets, and financial statements provide direction in attaining personal financial goals.

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* Evaluate and plan major outlays* Reduce taxes* Establish savings and investment programs* Manage credit* Secure adequate insurance* Implement retirement program* Facilitate estate distribution

FINANCIALPLANS

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FINANCIALPLANS

* Monitor and control income, living expenses, purchases, and savings on a monthly basis

BUDGETS

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FINANCIALPLANS

* Monitor and control income, living expenses, purchases, and savings on a monthly basis

BUDGETS

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Actual financial results* Balance sheet* Income & expense statement

FINANCIALSTATE-MENTS

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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

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Types of Financial Planners: Commissioned salespeople who

work for financial institutions

Computerized financial plans prepared by financial institutions

Fee-only financial planners who work for the individual client

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Time Value of Money:

Putting a Dollar Valueon Financial Goals


A dollar today is worth more than a dollar received in the future because it can be invested and earn interest.

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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.

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Ways to Calculate TVM:

Formulas

Tables (see Appendices A-D)

Financial calculators

Spreadsheets (ex: Excel)

Internet calculators (search on “calculators”)

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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.”

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Calculating theFuture Value of a Single Sum:

Example:

What will $5000 grow to become if invested at 10% for 6 years?

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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

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Calculating theFuture Value of an Annuity

Example:

What would you accumulate if you could invest $5000 every year for

the next 6 years at 10%?

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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


5000 +/- PMT

6 N

10 I/YR

FV 38,578.05

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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.

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Calculating thePresent 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?

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Tables(Find Present Value

Factor for 25 years and 7% in Appendix C)

PV = FV x Factor

$300,000 x .184 =

$55,200

Calculator


300000 +/- FV

25 N

7I/YR

PV $55,274.75

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Calculating thePresent 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?

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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


10000 +/- PMT

4 N

7I/YR

PV $33,872.11

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Use Financial Statements to:

Define current financial position.

Track changes in financial position over time.

Monitor progress in achieving goals.

Reformulate plans as situations change.

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Balance Sheet

A statement of

your financial position

at one point in time.

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Balance Sheet Equation:

LiabilitiesAssets = +

Net Worth


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ASSETS LIABILITIES

(Fair Market Value of Assets)

(Payoff Amount of Loans and Debts)

NET WORTH

(Your Equity Portion)

Balance Sheet

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ASSETS

What you own:•checking acct.•car•investments•jewelry•furniture

Balance Sheet

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ASSETS LIABILITIES

What you own:•checking acct.•car•investments•jewelry•furniture

What you owe:•mortgage•car loan•credit card balances•education loans•unpaid monthly bills

Balance Sheet

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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.

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The Income and Expense Statement

A measure of your

financial performance

over a given time period.

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Income and Expense Statement:

Total Income – Total Expenses =

CASH SURPLUS OR

(CASH DEFICIT)

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Income: Cash IN

Wages and salaries Bonuses Interest and dividends Child support Tax refunds Gifts

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Expenses: Cash OUT

FIXEDRent or mortgage payment

Cable TV

Insurance

VARIABLEDry cleaning

Recreation

Eating out

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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 13.5%

Housing 33%

Transportation 18.6%

Apparel & services 4.7%

Health care 5.4%

Entertainment 4.9%

Personal insurance 1.1%

Pensions/Social Security 8.4%

Other 10.4%

65%

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How does a Deficit on your Income Statement affect your

Net Worth on your Balance Sheet?

As an example, assume that all your income for the month has been spent.

You decide you just have to take a trip to Jamaica to get away from it all.

The trip will cost $1500.

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Scenario 1: Deplete an Asset

Take money from your savings account to pay

for the trip.

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Before the purchase:

Assets $30,000Liab. $22,000Net worth $ 8,000

After the purchase:


Because you took the money from your savings account, your total assets have declined.

Your liabilities remain the same, so your Net Worth must decrease.

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Scenario 2: Increase a Liability

Charge the trip on your charge card.

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Before the purchase:


After the purchase:


Your assets remain the same, so your Net Worth must decrease.

Because you borrowed money, your total liabilities have increased.

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Deficit spending

DECREASES

your Net Worth!


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Setting Up a Cash Budget

Short-term financial planning report to help you achieve short-term financial goals.

Facilitates achievement of long-term financial goals.

Provides a system for disciplined spending.

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Preparing a Cash Budget:

Estimate income

Estimate expenses

Reformulate as necessary to balance your yearly budget

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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.


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What should you do if you end the year with a deficit?

Liquidate savings/investments.

Borrow to cover the deficit.

Cut low priority expenses; alter spending habits.

Increase income.

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Things to remember about a budget:

Compare your budgeted figures to your actual figures.

Continually update, based upon the actual figures.

Always try to keep your budget balanced or, even better, at a surplus.

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THE END!

2-1 Copyright 2002 by Harcourt, Inc. All rights reserved. CHAPTER 2: YOUR FINANCIAL STATEMENTS AND...

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Transcript of 2-1 Copyright 2002 by Harcourt, Inc. All rights reserved. CHAPTER 2: YOUR FINANCIAL STATEMENTS AND...