FM-1-NOTES.pdf

FM 1 NOTES Figure 1 presents the Interlocking Network of Financial Plans and Statements. This shows how CHAPTER 2.5 - BASIC IDEAS OF FINANCE various financial...

FM 1 NOTES Figure 1 presents the Interlocking Network of Financial Plans and Statements. This shows how CHAPTER 2.5 - BASIC IDEAS OF FINANCE various financial documents, like balance sheets, income statements, and budgets, work together to The general concept of financial management is the create a cohesive view of an individual’s or quote, “It’s hard to get where you need to go if you don’t organization’s financial health. know where you are.” As such, monitoring your financial status is a must and is essential if you have a personal Financial Plans - Evaluate and plan or business goal, this is because financial statements major outlays tell where you are or what your current financial Financial plans guide the Manage Credit performance or situation is. controlling and monitoring Secure adequate process by providing a insurance The Balance Sheet reports your assets, liabilities, and framework for budgets coverage new net worth as of a specified date. received and expended. Establish savings/investmen t programs Assets These represent Manage everything you own that employee benefits has value, such as cash, Reduce Taxes investments, and Implement property. (and siya, chrz) retirement program; and Liabilities The debts or obligations Minimize estate you owe, such as loans, taxes. mortgages, or accounts payable. Budgets - Monitor and Control income, Net Worth This is the difference Results from the budget living expenses, between your assets and help update the financial purchases, and liabilities, representing plans. The budget savings on a your overall financial influences the data in the monthly basis. health. financial statements. Financial Statements - Actual Financial The Income and Expense Statement reports how you Results: did over a period of time, month, or year. Also referred The outcomes and data to as a profit and loss statement (P&L) or an income reported in the financial Balance Sheet statement in business contexts. This statement helps statements inform and Income and assess financial performance, identify patterns in influence the budgets. Expense insights and adjustments Statement. spending and earnings, and evaluate overall financial in the Financial health. Statements are used to revise and enhance the financial plans. Finance is the management of money matters. Keep track of your income and expenses, save money, invest in assets, manage debt, and assess risk to achieve financial goals. FIGURE 1 Income is the amount of money, property, and other transfers of value received over a set period of time in exchange for services or products.  RISK VERSUS UNCERTAINTY The ideal formula for Income and Savings: Risk refers to the degree of uncertainty and/or potential INCOME - SAVINGS = EXPENSE financial loss inherent in an investment decision. Expense is the cost that businesses incur in running Uncertainty refers to situations where the outcome is their operations. Expenses include wages, salaries, unknown or unpredictable making it difficult to foresee maintenance, rent, and depreciation. Expenses are what might happen in the future. deducted from revenue to arrive at profits. MANAGING RISK INCOME VERSUS EXPENSE Understanding and managing risk is essential to Income is the money an entity or an individual receives successful financial planning. Make a risk assessment while Expense is the cost and spending an entity or an chart to identify potential threats to your finances. individual incurs. Create a budget by tracking your income and expenses. Use the money jar method to allocate funds to different THE FINANCIAL STATEMENTS categories and prioritize your spending. A. BALANCE SHEET WHAT ARE ASSETS? “Tells you where you are.” Assets are things of value that you own. There are two Balance Sheet reports an individual or a company’s types: Tangible (cash, property, vehicles) and financial position at a specific point of time. Intangible (patents, trademarks, investments). Example of a Balance Sheet: UNDERSTANDING DEBT Debt is the amount owed by the borrower to the lender. A debt is the sum of money that is borrowed for a certain period of time and is to be returned along with an interest. The amount as well as the approval of the debt depends upon the creditworthiness of the borrower. The debt snowball method involves paying off your smallest debts first and then using that momentum to tackle larger debts. It is a great way to stay motivated and achieve financial freedom. WHAT IS EQUITY? Equity refers to the ownership value of an asset or business after all debts and liabilities have been paid off. EXAMPLE: If someone owns a house worth Php 400,000 and owes Php 300,000 on the mortgage, that means the owner has Php 100,000 in equity.  You are SOLVENT when your Net Worth is BALANCE SHEET - MAJOR HEADINGS Positive Assets: Liabilities and Net Worth: You are INSOLVENT when your Net Worth is Total Liquid Total Current Negative Assets Liabilities Total Investments Total Long-term B. INCOME STATMENT Total Real Liabilities “Detailing a company’s income and expenses Property Total Liabilities over a reporting period” Total Personal Net Worth Property Total Liabilities and Total Assets Net Worth Income statement also known as a profit and loss statement, is a financial report that summarizes a company's revenues, expenses, and profits over a NET WORTH specific period, such as a quarter or a year. It shows how much money the company earned and spent, and Net worth is a measure of the total value of an ultimately how much profit or loss it generated. individual’s or organization's assets minus their liabilities. It represents what you own compared to what Example of an Income Statement: you owe. For Assets - It is the fair market value of what you own. For Liabilities - Current - The amount you owe that is due within one year Long term - The amount you owe that is due more than one year from date. Net Worth Formula: ASSETS - LIABILITIES = NET WORTH Notice that it is similar to the accounting equation but instead of Assets = Liabilities + Equity. Equity is instead changed to Net Worth and the equal sign is placed after the Liabilities. WHAT IS FAIR MARKET VALUE? What you can sell an asset for, (refers to the market value of an asset) that is the Net Realizable Value. To understand more. FMV is about the asset’s market value, while NRV is about the practical amount you can actually realize from it after costs are deducted. SOLVENCY Solvency is the ability of a company to meet its INCOME STATEMENT - MAJOR HEADINGS long-term debts and financial obligations. Income: Expenses: Wages and Housing and Utilities  Salaries Food Self-employed Transportation income Medical Bonuses and Clothing and Commissions Personal Care Investment Insurance and Taxes Income Appliances, furniture Pensions Recreation Other income Other Total Total Income Expenses IMPORTANCE OF RECORDS The financial statements are built using an individual's records. If an Individual does not have records, the financial statements will not provide useful information. You will be flying blind. From Yogi Berra, “You’ve got to be very careful if you don’t know where you are going, because you might not get there.” Records allow you to prepare financial statements which allow you to know where you are at the moment. BALANCE SHEET RATIOS “Detailing a company's income and expenses over a reporting period” SOLVENCY RATIO LIQUIDITY RATIO FIGURE 2 Formula: Formula: Figure 2 presents a more comprehensive comparison between Liquidity and Solvency Ratio. TOTAL NET WORTH TOTAL LIQUID ASSETS DIVIDED BY TOTAL DIVIDED BY TOTAL ASSETS CURRENT DEBT (Liabilities) Measures how much Liquid assets include Cash, cushion you have before Savings Accounts, Money insolvency Market accounts, and Certificates of deposit. Liquid ratio shows how long you could continue to pay current debts with existing liquid assets