Garman/Forgue

Personal FinanceNinth Edition

Chapter 3Financial Statements, Tools, and Budgets

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Identify your financial values and goals.

Use balance sheets and income statements

to measure your financial health.

Evaluate your financial strength using ratios.

Work toward achieving your financial goals

through budgeting.

Chapter 3:Learning Objectives

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Financial Values, Goals, and Strategies

• To maintain their “preferred lifestyle”, many people spend every dollar they earn

• 40% of Americans live beyond their means

• Living paycheck to paycheck => living off of credit cards

SCARY, BUT TRUE:SCARY, BUT TRUE:

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Values Goals Plan

• Values:– What is important, valuable,

worthwhile?

– Your values determine how you spend, save, invest your money

– We all differ! Education, health, family life, spiritual life, etc.

• Goals:– Specific objectives that are consistent with our values

– SMART goals: Specific, Measurable, Achievable, Realistic, and Time-Related

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Turning Your Goals into RealityTurning Your Goals into Reality

WRITE IT DOWNWRITE IT DOWN

USE PICTURES AS A USE PICTURES AS A CONSTANT REMINDERCONSTANT REMINDER

Page 60

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Financial Powerpoint

Pg. 68

Page 68

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Why Financial Statements? They Measure Your Financial Health & Progress

Balance Sheet Balance Sheet (Statement of Net Worth)

– Describes your financial condition on a specific date

– Shows assets, liabilities, net worth

– Compares what you own vs. what you owe

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Assets: What Do You Assets: What Do You OwnOwn??– Monetary (liquid) Assets

• Low-risk, near-cash

• Checking & savings accts

– Tangible (use) Assets

• Personal property

• Valued at fair market value

– Investment (capital) Assets

• Acquired for the financial benefits they will provide

• Stocks & bonds, retirement accts

SEE EXAMPLE PG 73

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Liabilities: What Do You Owe?Liabilities: What Do You Owe?- Short-term (current) Liabilities

(Due within one year)

- Long-term Liabilities

(Due 1+ years)

Net Worth: Do I own more than I owe?

Negative net worth = insolventNegative net worth = insolvent

ASSETS – LIABILITIES = NET WORTHASSETS – LIABILITIES = NET WORTH

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Average Net Worth by AgeAverage Net Worth by Age

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(Income Statement)

– Shows money coming IN and money going OUT

– Fixed vs. Variable expenses

– Do you live within your income? (SURPLUS)(SURPLUS)

– Or are you spending more than you earn? (DEFICIT)(DEFICIT)

SEE EXAMPLE PG 76

– Can be a monthly or yearly statement

Cash-Flow Statement Cash-Flow Statement

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Average American Expenses by Percentage 

 Where our money goes!Where our money goes!

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• Liquidity ratioLiquidity ratio Can I pay for emergencies?

How many months can I continue to meet my expenses if my income stops?

Liquidity Ratio = Liquid Assets

Monthly Expenses

• Experts recommendation:

Financial Ratios Assess Your Financial Strength

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• Asset-to-Debt RatioAsset-to-Debt Ratio

Do you have enough assets to meet your debt obligations?

Measures solvency and ability to pay debts

What if you owe more than you own?

Asset-to-Debt Ratio = Total Assets

Total Liabilities

Experts recommendation:

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• Debt Service-to-Income RatioDebt Service-to-Income RatioIndicates your total debt burden

Do I have too much debt compared to my gross income?

Includes all installment loans (mortgage, auto, student)

Debt Service-to-Income Ratio = Annual Debt Payments

Gross Income

• Experts recommendation: 36% or

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• Debt Payment-to-Disposable Debt Payment-to-Disposable Income RatioIncome RatioIndicates if your NONMORTGAGE debt is too high

Debt Payment-to-Disposable = Monthly nonmortgagenonmortgage debt payments

Income Ratio Monthly net income

• Experts recommendation: 16% or

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• Investment Assets-to-Total Assets Investment Assets-to-Total Assets RatioRatio

Am I advancing toward my financial goals (retirement)?

Are enough of my assets made up of investment assets?

Investment Assets-to-Total Assets Ratio = Investment Assets

Total Assets

• Experts recommendation: Higher = Better!Experts recommendation: Higher = Better!

20-something’s: 10%

30-something’s: 11-30%

40 and above: 30% or more (50% is desirable)

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• Budget: A monthly plan for spending and saving

• Ask yourself:Do you like to be in control?

Do you like to feel empowered?

• Income Statement WHERE AM I?

• Budget WHERE DO I WANT TO GO?

Reaching Goals Through Budgeting

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Rules for successful budgeting:

1.1. Keep it simple.Keep it simple.

2.2. Prioritize.Prioritize.

3.3. Keep it flexible.Keep it flexible.

4.4. Be positive.Be positive.

“A budget is designed not to prevent you from

enjoying life, but to help you achieve what

you want most in life”

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Create a monthly budget using 3 columns:Create a monthly budget using 3 columns:1. Estimated amounts (based on past expenditures)

– Do not Do not use unrealistically low numbers!

– Reconcile needs & wants by identifying priorities (Make sacrifices if necessary!)

2. Actual amounts (at month end)

3. Budget variance (difference between budgeted & actual amounts)

– Evaluate: why did variances occur?

– Excessive variances may require budget revisions

– Time will help with accuracy

– Use surpluses wisely (revolving savings fund / credit card debt)

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Make sure “SAVING” is in your budget…

What’s your technique?

1. Piggy Bank OR envelope

2. Use automatic deposit to deposit a certain amount in savings

3. Payroll deduction

How you save is not as important as getting into the HABIT … small amounts can grow faster

than you think!

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For years, co-workers were amused by a woman who carried a brown bag lunch each day. That woman later retired

COMFORTABLY and lived her later years in beachfront property. A daily coffee and muffin can add up to over

$1,300 a year.$1,300 a year.Assuming an 8% return, how much would this amount saved each year be

in 40 years?

What if you could earn an average of 10% on What if you could earn an average of 10% on your savings?your savings?

Go to http://www.drcalculator.com/calc/savings.html

Did You Know?Did You Know?

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Top 3 Financial Missteps in Financial Statements, Tools and Budgets

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

2. Underestimating how much you spend each month.

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