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Chapter 3 Developing Financial Statements, Plans and Budgets

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

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Title: Chapter 3 Developing Financial Statements, Plans and Budgets


1
Chapter 3 Developing Financial Statements, Plans
and Budgets
  • Financial statements are assessments of the
    current status of ones personal financial
    position.

2
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

3
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

4
Chapter 3 Developing 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

5
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 88,500.00
  • Less taxes 17,000.00
  • Net income 71,500.00

6
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

7
Chapter 3 Developing 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

8
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.

9
Chapter 3 Developing 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

10
Chapter 3 Developing 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

11
Chapter 3 Developing 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

12
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 71,500.00
  • (less) Total expenses 57,200.00
  • Available for savings,
  • investment 14,300.00
  • If this figure is negative, net worth declines

13
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
    persons current financial position.

14
Chapter 3 Developing 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.

15
Chapter 3 Developing 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

16
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.

17
Chapter 3 Developing 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

18
Chapter 3 Developing Financial Statements, Plans
and Budgets
  • Real Assets
  • We include houses, cars, furniture, and personal
    property in valuing fixed assets.

19
Chapter 3 Developing 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

20
Chapter 3 Developing Financial Statements, Plans
and Budgets
  • Total Assets
  • Total financial assets 41,000.00
  • Total real assets 194,000.00
  • Total assets 235,000.00

21
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)

22
Chapter 3 Developing 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

23
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

24
Chapter 3 Developing 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

25
Chapter 3 Developing Financial Statements, Plans
and Budgets
  • Total Liabilities
  • Total current liabilities 500.00
  • Total long-term liabilities 135,000.00
  • Total liabilities 135,500.00

26
Chapter 3 Developing 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.

27
Chapter 3 Developing 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.

28
Chapter 3 Developing Financial Statements, Plans
and Budgets
  • Four Common Ratios
  • Liquidity ratio
  • Debt/Total assets ratio
  • Debt service ratio
  • Financial assets/ Net worth

29
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)

30
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 / 4,767
  • 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.

31
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 / 235,000
  • .58 or 58
  • They have almost twice as many assets as
    liabilities, an excellent ratio.

32
Chapter 3 Developing Financial Statements, Plans
and Budgets
  • Financial Planning
  • A financial plan is a guide to reaching a
    targeted goal in the future.

33
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)

34
Chapter 3 Developing Financial Statements, Plans
and Budgets
  • Cash Inflows for July

35
Chapter 3 Developing Financial Statements, Plans
and Budgets
  • Fixed Outflows for July

36
Chapter 3 Developing Financial Statements, Plans
and Budgets
  • Selected Variable Outflows for July

37
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?
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