Financial Planning

Learning Objectives
1. Explain elements of successful financial
planning.
2. Describe the balance sheet and the cash-flow
statement.
3. Use financial ratios to evaluate your financial
strength and progress.
4. Know which financial records to maintain and
where to keep them.
5. Understand which factors to consider when
choosing a professional financial planner.
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 Setting the Stage for Successful
Personal Financial Planning
Financial Planning:
– developing and implementing financial
plans in order to achieve financial success.
– is unique to each individual or family.

Question: What are some components of

financial planning?

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Figure 2.1: Overview of Effective
Personal Financial Management

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Values Provide the Base for Financial
Planning
Values: Fundamental beliefs about what
is important, desirable, and worthwhile.

Activity 1:
“10 Things I Like to Do”
Activity 2:
“Needs versus Wants”

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 Financial Goals Follow from Values

• Financial Goals: objectives to be attained

through financial planning and management
• Financial goals should be specific in terms
of both dollar amounts and the projected
dates by which they are to be achieved.
• SMART goals: Specific, Measurable,
Achievable, Realistic, and Time-Related
• Examples of SMART goals?
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Developing Financial Statements

What are Financial Statements?

Compilations of personal financial data
used to analyze financial situation

– Net worth statement (a.k.a., balance sheet)

– Cash-flow (a.k.a., income and expense)
statement

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 Balance Sheet = Net Worth

• Balance Sheet (Net Worth Statement):

– Describes an individual’s or family’s
financial condition on a specified date.
– A “snapshot” of your finances
• Components of a Balance Sheet
– Assets
– Liabilities
– Net Worth
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 Assets and Debts
• What is Owned- Assets
– Monetary Assets/Liquid Assets

– Tangible (or Use) Assets

– Investment Assets/Capital Assets

• What Is Owed–Liabilities
– Short-term (or Current) Liabilities

– Long-term Liabilities
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 Net Worth–What Is Left

• Net Worth Formula:

Net worth = assets - liabilities

or
Net worth = what is owned - what is owed

Questions: What is YOUR net worth?

Is it a positive number?
How do you increase net worth?

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Table 2.2: Balance Sheet for a College
Student

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The Cash-Flow Statement Tracks
Income and Expenses
Cash-Flow (Income and Expense)
Statement:
– Lists and summarizes income and expense
transactions that have taken place over a
specific period of time (e.g., a month).
– Many people don’t have a clue about small
expenses that add up.
– Suggestion: Track your income and
expenses for the coming week!

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 Income

• Income is not limited to what is earned

from salaries and wages.
• It also includes...
– Gifts
– Interest
– Stock dividends
– Scholarships
– Other sources?

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 Expenses
• Fixed Expenses:
– Usually paid in the same amount during
each time period
– They are often contractual
• Variable Expenses:
– Expenditures you can control.
– Items/amounts differ from month to month.
• Occasional Expenses
– Pay infrequently (e.g., quarterly)
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 Surplus (Loss)

• The surplus (loss)

– shows the amount remaining after
subtracting expenditures from income.

• Surplus/deficit formula:
Surplus(deficit) = total income - total
expenses
– Surplus = Positive cash flow
– Deficit = Negative cash flow
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Table 2.4: Cash-Flow Statement for a College Student

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Financial Ratios Assess Your Financial
Strength and Progress
Financial Ratios:
– Calculations based on information
contained in financial statements.
– Simplify judgments regarding financial
strength and condition.
• Adequacy of emergency savings
• Amount of household debt

– Often used by lenders, financial advisors

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 Basic Liquidity Ratio

Liquidity: The speed and ease with

which an asset can be converted to cash.

Question:
What types of assets are liquid and what assets are not?

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 Basic Liquidity Ratio (Continued)
monetary (liquid) assets
Basic liquidity ratio 
monthly expenses

• Tells how long you could meet monthly

expenses with monetary assets after a loss
of income.
• A higher number is better…Why?
• Three months is a good cushion
(emergency fund).
• More may be needed if income varies
significantly from month to month.
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 Asset-to-Debt Ratio

total assets
Asset - to - debt Ratio 
total debt

• Compares total assets with total liabilities.

• A higher number is better…Why?
• Is 1.0 or larger if net worth is positive
• Should grow as you get older

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 Debt Service-to-Income Ratio

annual debt repayments

Debt service - to - income ratio 
gross income
• Provides a view of total debt burden
• Should be a ratio of .36 or lower
• A lower number is better…Why?
• Indicates ability to make payments for debts and housing payments
– Rent or mortgage payments

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Debt Payments-to-Disposable Income
Ratio
Disposable Personal Income: Take-
home pay remaining after all deductions
are withheld (a.k.a., “net income”)

Question: What are some common payroll deductions?

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 Debt Payments-to-Disposable Income
Ratio (Continued)

monthly nonmortgage debt repayments

Debt payments - to - disposable income ratio 
disposable income

• Indicates ability to handle monthly debt payments other than a

mortgage.
• 20 percent or more is very high.
• Over 15% can cause problems
– (Even 10% for some families!)
• A lower number is better…Why?

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 Investment Assets-to-Total Assets
Ratio

monthly non - mortgage debt repayments

Investment assets - to - assets ratio 
disposable income

• Compares the value of investment assets to total assets.

• A higher number is better…Why?
• Should increase as you get older.
– Less than 20% in 20s
– 50% or more in later life

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 Savings Ratio

annual savings
Savings ratio 
after - tax income
• Compares dollars saved to after-tax income.
• A higher number is better…Why?

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Financial Recordkeeping Saves Time
and Money
• Some records will be original, legal
documents such as receipts, insurance
policies,canceled checks, retirement
account statements.

• Other records will be ones you develop

in the course of financial planning such
as balance sheets and budgets.

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Financial Recordkeeping Saves Time
and Money (Continued)
• Some records can be stored safely at
home in a fire-resistant cabinet or safe.
– Examples?
• Others records should be safeguarded
more securely such as in a safe-deposit
box at bank.
– Examples?
• Keep a list of s.d. box items

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Where to Seek Professional Financial
Planning Advice
• A true financial planner should be able
to analyze a family’s total needs in...
– Investments
– Taxes
– Insurance
– Education goals
– Retirement planning
– Estate planning
• Develop a cohesive plan
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 How are Financial Planners
Compensated?
• Commission-Only Financial Planners
– Paid solely by commissions on products sold
• Fee-Only Financial Planners
– Charge a fee for services; no product sales
• Fee-Based Financial Planners
– Charge a fee and commissions on products
• Fee-Offset Financial Planners
– Fee reduced by commissions earned on products
sold to client
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 Golden Rules of Financial Planning
1. Develop a balance sheet; update annually
2. Develop cash-flow statements monthly or
quarterly and compile into annual statement
3. Calculate financial ratios periodically and
use them to assess financial progress
4. Develop a list of financial goals. Update
and revise your goals annually
5. Start an uncomplicated personal financial
record-keeping system to meet your needs
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