Chapter 3

Chapter 3

Financial Statements, Tools, and Budgets

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Learning Objectives

1. Identify your financial values, goals, and strategies.

2. Use balance sheets and cash-flow statements to measure your financial health and progress.

3. Evaluate your financial strength and progress using financial ratios.

4. Collect and organize the financial records necessary for managing your personal finances.

5. Achieve your financial goals through budgeting.


Financial Values,Goals, and Strategies

• Financial Planning: Managing income and wealth continuously through life to meet financial goals.


Financial Values,Goals, and Strategies

• Values are fundamental beliefs that define your financial success.

• Financial goals follow from values.

• Financial Goals: Specific objectives to be attained through financial planning and management efforts.

• Financial strategies are pre-established action plans that guide your financial success.


How to Achieve Financial Goals


Class Discussion Question #1

What are some of your own financial values, goals, and strategies? Why are they important?


Financial Statements• Financial Statements describe an individual’s

or family’s current financial condition. They measure your financial health and progress.

• Balance Sheet (or Net Worth Statement)• Components of the balance sheet:

– Assets

minus– Liabilities

equals– Net Worth


Net Worth by Age


Financial Statements

• Assets: What Is owned:

– Monetary Assets (or liquid assets orcash equivalents)

– Tangible (or use) assets such as property, vehicles, land or a home

– Investment (or capital) assets such as stocks, bonds, CD’s, mutual funds.


Financial Statements

• Liabilities: What Is owed:

– Short-term (or current) liability – credit cards, student loans, etc.

– Long-term liability – mortgage, bank notes

• Net Worth: What is left over

• Strategies toIncrease Your Net Worth include:– Increase Assets, Decrease Liabilities or

both!


Balance Sheet Example


Cash-Flow Statement

• The Cash-Flow Statement tracks where your money came from and went.

– Income

– Expenses

– Surplus (or Net Gain or Net Income)

– Deficit (or Net Loss)


Personal Financeover the Life Cycle


Cash-Flow Statement• Expenses

– Fixed Expenses: Stay the same month to month

• Rent, Mortgage,

• Auto Loan

– Variable Expenses: Change from month to month

• Utilities

• Gasoline

• Tuition


Cash Flow Statement Example


Financial Ratios

• Basic liquidity ratio• Liquidity: The speed and ease with which an

asset can be converted to cash.

= Monetary (liquid) assets = $4,420 = 0.82

Monthly Expenses $5,398

The higher the ratio the better and needs to be at least 1


Financial Ratios• Asset-to-debt ratio

• Do you have enough assets compared to liabilities?

= Total Assets = $300,000 = 3

Total Debt $100,000

• Debt service-to-income ratio

• Can you meet your total debt obligations?

= Annual Debt Repayment = $20,000 = 25%

Gross Income $80,000

• A ratio of 36% or less is desirable !


Financial Ratios• Debt payments-to-disposable income ratio

• Can you pay your debts?

= Monthly Non-Mortgage Debt Payments

Disposable Income

= $500/$5,000 = 10%, where 15% or less is ideal

• Investment assets-to-total assets ratio

• Do you need to invest more?

= Investment Assets/Total Assets = $100K/$300K = 33.3% and may vary by age category


Financial Record Keeping

• Financial record keeping saves time and makes you money.

• Financial Records: Documents that evidence financial transactions.


Budgeting

• Budget: A paper or electronic document usedto record both planned and actual income and expenditures over a period of time.


Budgeting

Rules for successful budgeting:

1. Keep it simple.

2. Make it personal.

3. Keep it flexible.

4. Be positive.


Budgeting – Action Before

• Set financial goals.

– Long-term goals

– Intermediate goals

– Short-term goals

• Make and reconcile budget estimates.

• Take-home pay (or disposable income)


Budgeting – Action Before

• Revise budget estimates.

• Earn more income.

• Cut back on expenses.

• Try a combination of more income and fewer expenses.


About Financial Statements and Budgets


Budgeting – Action During

• Control spending.

• Monitor unexpended balances to control overspending.

• Use a subordinate budget.

• Pay by check to record the purpose of expenditures.

• Keep track of credit transactions.

• Justify exceptions.

• Use the envelope system.


Budgeting – Action After

• Evaluate budgeting progress.

• Budget Variance: Difference between amount budgeted and actual amount spent or received.


What to Do with Budgeted MoneyLeft Over at the End of the Month

• Put into a revolving savings fund.

• Build a cash reserve in a savings account.

• Pay down credit card debt.

• Put toward a mortgage or other loan.

• Invest in a retirement account.


Top 3 Financial Missteps in Financial Statements, Tools and Budgets

People experience challenges in building and maintaining good credit when they do the following:

1. Fail to plan for occasional, non-monthly expenditures.

2. Underestimate how much you spend each month.

3. Using credit cards to “balance” your budget.


Good Money Habits in Financial Statements, Tools, and Budgets

• Identify your financial values, goals, and strategies so you can always keep a balance between spending and saving and stay committed to your financial plans.

• Develop your own balance sheet and update it annually.

• Develop your own cash-flow statement and set up a spending plan for the next month that provides for savings for at least one of your goals.

• Calculate your financial ratios annually to assess your financial progress.


Good Money Habits in Financial Statements, Tools, and Budgets

• Develop a list of financial goals. Start with short-term goals and then expand your list to longer-range goals. Update and revise your goals annually.

• Start an uncomplicated personal financial record-keeping system that meets your needs.


Questions ?