Chapter 2 of Finance 8, Gitman !0th Edition

1. © 2008 Thomson South-Western
YOUR
FINANCIAL
STATEMENTS AND
PLANS
CHAPTER 2

2. 2-2
Mapping Out Your
Financial Future
Financial planning facilitates:
 Greater wealth
 Financial security
 Attainment of financial goals

3. 2-3
Financial Plans, Budgets
And Statements
 Link future goals and plans with
actual results
 Provide direction, control and
feedback

4. 2-4
The Interlocking Network
of Financial Plans &
Statements

5. 2-5
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

6. 2-6
Types of Financial Planners
 Commissioned salespeople who work
for financial institutions.
 Fee-only financial planners who work
for the individual client.
 Planners who charge both fees and
commissions, depending on the
products and services offered.
 Computerized financial plans prepared
by financial institutions.

7. 2-7
Time Value of Money
 Putting a Dollar Value on Financial
Goals
 A dollar today is worth more than a
dollar received in the future because
it can be invested and earn interest.

8. 2-8
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.

9. 2-9
Ways to Calculate TVM
 Formulas
 Tables (see Appendices A-D)
 Financial calculators
 Spreadsheets (ex: Excel)
 Internet calculators (search on
“calculators”)

10. 2-10
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.”

11. 2-11
Calculating the Future
Value of a Single Sum
Example:
What will $5000 grow to become
if invested at 10% for 6 years?

12. 2-12
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
Calculating the Future Value
of a Single Sum

13. 2-13
Calculating the Future Value
of an Annuity
Example:
What would you accumulate if you
could invest $5000 every year for
the next 6 years at 10%?

14. 2-14
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
(Set on 1 P/YR and
END mode.)
5000 +/- PMT
6 N
10 I/YR
FV $38,578.05
Calculating the Future Value
of an Annuity

15. 2-15
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.

16. 2-16
Calculating the Present
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?

17. 2-17
Tables
(Find Present Value
Factor for 25 years and
7% in Appendix C)
PV = FV x Factor
$300,000 x .184 =
$55,200
Calculator
(Set on 1 P/YR and
END mode.)
300000 +/- FV
25 N
7 I/YR
PV $55,274.75
Calculating the Present
Value of a Single Sum

18. 2-18
Calculating the Present 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?

19. 2-19
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
(Set on 1 P/YR and
END mode.)
10000 +/- PMT
4 N
7 I/YR
PV $33,872.11
Calculating the Present
Value of an Annuity

20. 2-20
Balance Sheet
A statement of
your financial position
at one point in time.

21. 2-21
Balance Sheet Equation
Liabilities
Assets = +
Net Worth

22. 2-22
ASSETS LIABILITIES
(Fair Market Value
of Assets)
(Payoff Amount of
Loans and Debts)
NET WORTH
(Your Equity Portion)
Balance Sheet

23. 2-23
ASSETS
What you own:
•checking acct.
•car
•investments
•jewelry
•furniture
Balance Sheet

24. 2-24
ASSETS LIABILITIES
What you own:
•checking acct.
•car
•investments
•jewelry
•furniture
What you owe:
•car loan
•credit card balances
•education loans
•unpaid monthly bills
Balance Sheet

25. 2-25
ASSETS LIABILITIES
What you own:
•checking acct.
•car
•investments
•jewelry
•furniture
What you owe:
•car loan
•credit card balances
•education loans
•unpaid monthly bills
NET WORTH
(Subtract total liabilities
from total assets to
determine net worth.)
Balance Sheet

26. 2-26
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.

27. 2-27
The Income and Expense
Statement
A measure of your
financial performance
over a given time period.

28. 2-28
Income and Expense
Statement
Total Income – Total Expenses =
CASH SURPLUS OR
(CASH DEFICIT)

29. 2-29
Income: Cash IN
 Wages and salaries
 Bonuses
 Interest and dividends
 Child support
 Tax refunds
 Gifts

30. 2-30
Expenses: Cash OUT
 FIXED
Rent or mortgage payment
Cable TV
Insurance
 VARIABLE
Dry cleaning
Recreation
Eating out

31. 2-31
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).

32. 2-32
How We Spend Our Income

33. 2-33
Using Your Personal
Financial Statements
 Maintain a good recordkeeping
system
 Prepare financial statements
periodically
 Track financial progress

34. 2-34
Ratio Analysis
Financial ratios allow you to:
 Track progress toward your
financial goals
 Evaluate your financial
performance over a period of
time

35. 2-35
Balance Sheet Ratios
Solvency Ratio
 Shows the state of your net worth at
a given point in time.
 Indicates your potential to withstand
financial problems.
Total net worth
Total assets

36. 2-36
 Measures your ability to pay current
debts with existing liquid assets.
 Current is defined as needing payment
within one year.
Liquid assets
Total current debts
Liquidity Ratios

37. 2-37
Savings Ratio
 Shows the percentage of after-
tax income being saved during
a given period.
Income & Expense
Statement Ratios
Cash surplus
Income after taxes

38. 2-38
 Indicates ability to repay loan
obligations promptly with
before-tax income.
Total monthly loan payments
Monthly gross income
Debt Service Ratio

39. 2-39
Preparing & Using
Budgets
Budget
 A short-term financial planning
report that helps you achieve
your short-term financial goals.
 Achieving your short-term goals
then helps you achieve your
longer-term goals.

40. 2-40
Using Budgets
 Monitor and control finances.
 Allocate income to reach goals.
 Implement system of disciplined
spending.
 Reduce needless spending.
 Achieve long-term financial goals.

41. 2-41
The Budgeting Process
 Estimate income
 Estimate expenses
 Finalize the cash budget
 Deal with deficits

42. 2-42
If You Have Monthly Deficits
 Shift expenses from months
with deficits to months with
surpluses.
 Use savings, investments,
or borrowing to cover
temporary deficits.

43. 2-43
If You End The Year In
A Deficit
 Liquidate savings/investments
 Borrow to cover the deficit
 Cut low priority expenses; alter
spending habits
 Increase income

44. 2-44
 Depletion of an existing asset,
 More debt –
 Or both
 DECREASES net worth
Deficit Spending
Results In

45. 2-45
Things to remember
about a budget
 Use a Budget Control Schedule to
compare your budgeted figures to
your actual figures and determine the
variances.
 Continually update your budget based
upon the actual figures.
 Always try to keep your budget
balanced or, even better, at a surplus.