Chapter 3 Developing Financial Statements, Plans and Budgets

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Financial statements are assessments of the
  current status of ones personal financial
  position.

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Chapter 3Developing 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

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Chapter 3Developing 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

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Mark and Susans 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

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Chapter 3Developing 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 88,500.00
• Less taxes 17,000.00
• Net income 71,500.00

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Chapter 3Developing 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

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Housing
• Mortgage 12,000.00
• Utilities 3,600.00
• Property Taxes 1,800.00
• Maintenance 2,500.00
• Insurance 600.00
• Other 2,500.00
• Tax deductible

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Chapter 3Developing 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.

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Transportation
• Car payments 3,600.00
• Gasoline repairs 1,000.00
• Insurance 700.00
• Registration 200.00
• Other 500.00
• Food
• Total Food 5,000.00

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Other Expenses
• Clothing 2,500.00
• Child care 6,000.00
• Health insur. premiums 1,200.00
• Health care expenses 1,000.00
• Vacation, entertainment 2,000.00
• Gifts 2,000.00
• Life insurance 500.00
• Student loan payments 2,500.00
• Cash allowances 3,000.00
• Miscellaneous 2,500.00
• Total Other Expenses 23,200.00

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Total Expenses
• Housing 23,000.00
• Food 5,000.00
• Transportation 6,000.00
• Other 23,200.00
• TOTAL EXPENSES 57,200.00

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Chapter 3Developing 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 71,500.00
• (less) Total expenses 57,200.00
• Available for savings,
• investment 14,300.00
• If this figure is negative, net worth declines

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Chapter 3Developing 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
  persons current financial position.

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Chapter 3Developing Financial Statements, Plans
and Budgets

• The Balance Sheet
• Outlines what a person owns Assets
• Outlines what a person owes Liabilities
• Difference between the two Net worth
• A balance sheet provides a snapshot of
• a persons assets and liabilities at
• any given point in time.

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Current Financial Assets
• Checking Account 1,500.00
• Savings account 0.00
• Money market 8,000.00
• CDs 0.00
• Total Current Financial Assets 9,500.00

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Chapter 3Developing 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.

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Financial Assets, cont.
• Non-retirement accts. 7,500.00
• Retirement accts. 22,000.00
• College fund 2,000.00
• Subtotal
  31,500.00
• Total Financial Assets 41,000.00

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Real Assets
• We include houses, cars, furniture, and personal
  property in valuing fixed assets.

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Real Assets
• Home 145,000.00
• Auto 1 14,000.00
• Auto 2 0.00
• Home Furnishings 20,000.00
• Personal property 15,000.00
• Total Real Assets 194,000.00

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Total Assets
• Total financial assets 41,000.00
• Total real assets 194,000.00
• Total assets 235,000.00

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Chapter 3Developing 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)

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Current Liabilities
• Current bills 100.00
• Credit card payments 400.00
• Current loan payments 0.00
• Total Current Liabilities 500.00

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Chapter 3Developing 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

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Long-term Liabilities
• Auto loan 12,000.00
• Student loan 8,000.00
• Mortgage 115,000.00
• Other 0.00
• Total Long-term Liabilities 135,000.00

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Total Liabilities
• Total current liabilities 500.00
• Total long-term liabilities 135,000.00
• Total liabilities 135,500.00

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Net Worth
• Total assets 235,000.00
• (Less) Total liabilities 135,500.00
• Net Worth
  99,500.00
• Their net worth is more than twice their annual
  income, a good ratio.

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Financial Ratios
• Financial ratios are benchmarks of a persons
  current financial status.
• They can also be used to spot worrisome trends in
  someones financial well-being.

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Four Common Ratios
• Liquidity ratio
• Debt/Total assets ratio
• Debt service ratio
• Financial assets/ Net worth

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Chapter 3Developing 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)

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Liquidity Ratio
• Cash near-cash assets / Monthly living expenses
• (1,500 8,000) / (57,200 / 12)
• 9,500 / 4,767
• 1.99 months
• Their liquidity ratio covers only 1.99 months.
  Most financial advisors suggest having 3 - 6
  months coverage. They need to increase their
  resources in this area.

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Chapter 3Developing 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 / 235,000
• .58 or 58
• They have almost twice as many assets as
  liabilities, an excellent ratio.

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Financial Planning
• A financial plan is a guide to reaching a
  targeted goal in the future.

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Chapter 3Developing 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)

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Cash Inflows for July

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Fixed Outflows for July

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Chapter 3Developing Financial Statements, Plans
and Budgets

• Selected Variable Outflows for July

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Chapter 3Developing 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?