Chapter 2 Personal Financial Statements PDF

40 % final ( CHAPTER 3 Personal Financial Statements Prepared by: Nur Liyana Mohamed Yousop Learning Objectives Understand the relationship between financial plans and statements. Prepare a personal balance sheet. Generate a personal income and expense statement. Develop a good record-keeping...

40 % final ( CHAPTER 3 Personal Financial Statements Prepared by: Nur Liyana Mohamed Yousop Learning Objectives Understand the relationship between financial plans and statements. Prepare a personal balance sheet. Generate a personal income and expense statement. Develop a good record-keeping system and use ratios to evaluate personal financial statements. Construct a cash budget and use it to monitor and control spending Mapping Out Your Financial Future Financial plans • Its all about math and money • As a road maps, it shows you the way to spend and to save your money Personal financial statements • Let you know where you stand financially Financial Statements Balance sheets and income and expense statements Budget Serve as planning tools that are essential to develop and monitor personal financial plans Detailed financial report that looks forward based on expected income and expenses Using Your Personal Financial Statements Maintain a good recordkeeping system Track financial progress Prepare financial statements periodically The Interlocking Network of Financial Plans & Statements Cash Flow Planning & Record Keeping The best way to get a complete picture of your financial condition is to prepare: Personal Balance Sheet (what you own & owe) Personal Cash Flow Statement @ Personal Income Statement (shows where your money goes) Personal Balance Sheet Introduction Definition: balance sheet is a statement of financial position at a point in time. It lists your assets, liabilities and net worth. A personal financial statement will help you in planning: • • • • your reserve fund how much insurance you need your asset planning needs your retirement funds. Balance Sheet Format and Preparation List your assets at their fair market value as of the date you are preparing the balance sheet List all current and long-term liabilities Calculate net worth Components of balance sheet • There are 3 components summarize your financial picture in balance sheet: Liabilities (what you owe) Net Worth (difference between the two) Assets (what you own) Assets component Assets Liquid assets Investments Lifestyle Cash or other assets that can be readily converted to cash with little or no loss in value. Assets being purchased for getting extra or side income. Assets that help achieve desired quality of life. E.g: cash on hand, current account, savings account and checking account. E.g: preferred stocks, common stock, bonds, mutual finds and ASB. E.g: residence, automobiles, jewelry, clothing, hand phone. Liabilities component Liabilities (as known as debt or leverage; money you owes somebody or an organization) Current liabilities Non-current liabilities/Long term liabilities debt due within 1 year. debt due in 1 year or more. E.g: utilities bills, payments for loans installments balance that are due within one year such as payments for personal loan or computer loan. 1) non-current portion of loans with specific repayment schedules. 2) non-current portion of liabilities without specific repayment schedules. E.g: installment loans on cars (balance) , equipment, house or other property. E.g: mortgage loans. Net Worth Net worth is the amount by which assets > l iabilities. Net worth is a concept applicable to individuals a key measure of how much he/she worth. A consistent increase in net worth indicates good financial health. Net Worth • Consider a couple with the following assets - primary residence valued at RM250,000, an investment portfolio with a market value of RM100,000 and automobiles and other assets valued at RM25,000. Liabilities are primarily an outstanding mortgage balance of RM100,000 and a car loan of RM10,000. • The couple's net worth would be therefore be : • Asset = RM250,000 + RM100,000 + RM25,000 = RM375,000 • Liabilities = RM100,000 + RM10,000 = RM110,000 • Net Worth = RM375,000 –RM110,000 = RM265,000 Median Net Worth by Age Source: Adapted from United States Census Bureau, “Net Worth and Asset Ownership of Households: 2011,” Table 1, http://www.census.gov/people/wealth/. The Concept of Solvency Solvent Insolvent • net worth is positive • sufficient assets to cover financial obligations • net worth is negative • insufficient assets to cover financial obligations Personal Balance Sheet Format Nur Liyana Mohamed Yousop Personal Balance Sheet as at 13 October 2016 Stated as the ENDING VALUE ASSETS LIABILITIES AND NET WORTH Liquid Assets Amount available Current Liabilities Amount due Investment Assets Current/market value of assets (NOT purchase price) Non-Current Liabilities Loan balance (NOT original loan amount) Lifestyle Assets Current/market value of assets (NOT purchase price) Net Worth Total Assets – Total Liabilities TOTAL ASSETS TOTAL LIABILITIES AND NET WORTH The Income Statement @ Cash Flow Statements Introduction Income statement is a detail breakdown of cash income and expenses for a particular period of time. Importance of income statement • it will indicate a person’s financial position. • it helps in doing the person’s budget 20 Personal Income Statement Nur Liyana Mohamed Yousop Personal Income Statement for the year ended 31 December 2016 INCOME List down ALL sources of income for the whole financial cycle Example: Salary, Bonus, Part-time allowance etc EXPENSES List down ALL expenses for the whole financial cycle Example: Loan payments, Food expenses, Transportation cost etc SAVINGS/DISSAVINGS Stated as the TOTAL AMOUNT Income @ Cash Inflows Major source of income : salary or wages. Bonuses Interest and dividends List of personal’s income (Cash inflow or sources of income) Proceeds from sale of assets Child support Tax refunds Gifts Expenses @ Cash Outflows Cash outflows Needed to sustain a person’s life. Types (Used in Cash Budgets) • Fixed @ Inflexible Expenses • Usually contractual, predetermined and involving equal payments each period (typically each month) • E.g: mortgage and installment loan payments, insurance premiums, professional or union dues etc. • Variables @ Flexible Expenses • Change from one time period to the next. • E.g: food, clothes, utilities, entertainment and medical expenses. Cash Surplus or Deficit Cash Surplus • Income > Expenses Cash Deficit • Expenses > Income Financial Ratios Introduction Liquidity ratio : current ratio etc Extra From personal financial statements, we can evaluate a person’s position by calculating his/her financial ratios. usually yearly . info for comparison ↑ Ratios  will know one’s financial strength and weaknessess Ratio Analysis Financial ratios allow you to Track progress toward financial goals Evaluate financial performance over a period of time Asset Liquidity Current Ratio Measures ability to pay current debts Current debt requires payment within one year It should be more than ONE (1) in order to maintain liquid. Liquid assets Current debts 28 A person must maintain adequate liquidity so that he or she will be able to make short-term payments. Asset Liquidity Liquid Asset to Take Home Pay • Take home pay is the pay received by an employee after the deduction of taxes and other obligations. • A person must have liquid assets equal to 3-6 months to take-home pay or 25%-50% range in order to be safe side. boleh straight away Liquid Assets Take-Home Pay > - gaji bersih Take home pay = total wages and salaries – income tax - epf tolak or letak all 3 & Dt Side Level of Debt Debt Ratio Must avoid having a lot of debt. Total Liabilities Total Assets The lower the ratio the better. It shows the family/individual has the ability to pay its debts. E.g: 35% = means that the debt ratio is quite alright because it is not that high. The family/individual has the ability to pay its debts. Must be less than 40%. If it is more than 40%, it is not safe. Inability to pay its debts. Level of Debt Debt Service Coverage Ratio Take-Home Pay Debt Service Charges** ** Debt service charges = house mortgage payment + car loan payment + life insurance loan payment ** Total monthly loan installment The higher the ratio the better. It shows the family/individual has the ability to make payments. E.g: 3.50 = means that the individual/family earned RM3.50 in take-home pay for each RM1 of required debt repayment and interest. Solvency Ratio Solvency ratio indicates the ability of an individual to repay all his/her existing debts using existing assets in case of unforeseen events. A higher ratio is indicative of greater solvency because the higher the ratio becomes, the more funds are available to meet current obligations. Normally ratio ≥ 50 is better / good Total net worth Total assets Savings Ratio • Indicates relative amount of cash surplus achieved during the given period. • A higher saving ratio translates to better money management skills. • Higher is better (> 20%) Cash Surplus Income After Taxes Annual Inflation Rate • We have to compare financial performance with annual inflation rate or current inflation rate • If inflation is high, this can cause standard living of a person to decrease and also will affect net worth. • E.g. Text book page 29-30 Annual Inflation Rate You must take inflation into account when planning for future expenses, particularly for retirement. Maintaining the financial lifestyle you desire in your retirement years is dependent on how much you have accumulated by the time you retire and how fast you spend those funds during retirement. Inflation rates have been low recently, but there are no assurances the low rates will continue. Annual Inflation Rate Inflation can also affect your investments. Generally, higher inflation or the expectation of higher inflation leads to higher interest rates (lower bond values) and weaker stock prices. When consumers expect things to cost more in the future, they often put less value on their financial assets, and the prices of those financial assets fall. Cash Budgets Personal Budgeting • Personal budget is a plan which indicates a person’s financial goals and how one uses his or her resources. • A personal budget should posse’s realistic and achievable budget goals. • A personal budget is divided into 2 parts: • Master budget • Monthly Income and Expense Plan Preparing & Using Budgets Budget Financial planning report that helps achieve shortterm financial goals and how one uses his/her resources. Master budget Monthly income and expenses plan Detail planned income, expenses and contribution of savings. After doing the master budget, then preparing the monthly budget. Time Frame • Should be prepared for a period of one year. To determine how income and expenses will take place. Fixed Expenses Fixed expenses is “any expense that does not change from period to period," such as mortgage or rent payments, utility bills, and loan payments. The amounts may vary slightly, which may be the case with utilities, but you know they are due on a regular basis. Here is a list of categories to include in your fixed expenses: Mortgage(s) Rent Cable TV fees Professional / Club / Union fee Monthly saving programs Monthly investment programs Property taxes (if paying monthly) Strata fee / condo fee House / tenant insurance EPF Lease / car loan payment Vehicle insurance (if paying monthly) Life / Disability / Extended health (or other) insurance Bank fees Debt payments for your debt repayment plan Variable Expenses The definition of variable costs can differ, but it can be simply define as anything you can buy in a store (for example groceries, gas, or coffee) or expenses that are within your control. You can decide how much and if you will spend on these items. Here is a list of what you can include in your variable expenses category: Groceries Personal care items (drugstore) / Medical expenses Fuel / public transportation costs Parking Clothing & shoes Daycare Work lunches & snacks Eating out Entertainment Tobacco / alcohol Lottery Babysitting Sports & recreation, other hobbies Utility bills (cable, cell, electricity, water, etc.) Hair care / salon services Magazines / newspapers / books Children’s lessons and activities Importance of Cash Budget Maintain information to monitor and control finances Implement disciplined spending Allocate income to reach goals 42 Achieve longterm financial goals Reduce needless spending Continually update budget based upon actual figures Use a Budget Control Schedule to compare budgeted figures to actual figures and determine the variances The Budgeting Process Estimate income 43 Estimate expenses Finalize the cash budget Deal with deficits Dealing with Deficits Shift expenses from months with deficits to months with surpluses 44 Use savings, investments, or borrowing to cover temporary deficits If You End the Year in a Deficit Liquidate savings / investments Borrow to cover the deficit Deficit Cut low priority expenses; alter spending habits Increase income Remember !! “Don’t be discouraged if your net worth is negative. This should be an accurate depiction of your financial situation” Past Examination Question June 2016 (Q1) Jan 2013 (Q1) Dec 2013 (Q1) 47 June 2014 (Q1) Dec 2015 (Q1) June 2015 (Q1) Dec 2014 (Q1)