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Week 2 Assignment

In this week assignment, we are going to expand our financial plan (attached) that we created in Week 1 assignment by answering the following questions.

Please make use of the instructions available in Building your own financial plan sections at the end of Chapter 2, 3 and 4 to make the necessary calculations and then summarize your decisions in a word document by responding to these questions. (attached power points)

1. Describe the actions you will take to increase your net cash flows in the near future.

2. Detail your plans to increase your net cash flows in the distant future.

3. Report on how much you must save per year and the return you must earn to meet your goals.

1. Financial Goals

· As I am 21 right now and still studying, my short-term goal is to secure a permanent job in some stable company with a steady income. With this I can finance my expenses and keep my family happy and satisfied.

· Intermediate term goals would be to grow in the company and be at a very responsible position with income enough for me and my family. I may be married to someone, so I need to satisfy every need. So, for that need to earn that much.

· Long Term Financial Goals would be to earn as much that my family and my kids should be more than happy. I have my retirement plans intact. I should have enough to travel the world around many times and with my kids and family.

2. Current Financial Position

· In savings, I have around 700K.

· My investments are around 200K.

· My net worth will be around 900K.

3. Plans

· I need to have steady job and growing income. I should grow each day with raise in my salaries.

· I need not stop spending but need to spend smartly. Only spend to what is necessary.

· Investments should me made keeping in mind the risk involved. The returns should obviously be there, but risk is more important.

4. Implementing the plan

· Start with first phase to get a job. Try applying in companies with relevant profile I am looking for and prepare for the interviews and get a job.

· Once I get the job learn and earn as much as I can and make investment rather than spending a lot.

· Try to excel in my work and learn more which will stimulate me to achieve my goal to reach in a reputed position where I can have more income and make my family and myself happier beyond what I expected to be.

5. Evaluating the plan

· I need to check whether I am earning enough to achieve my goal and savings are sufficient to back up the post retirement life.

· In this phase I need to evaluate whether the actual results coming out of ongoing actions are in line with my stated goals and evaluate the result with planned result.

6. Revising the plan

· Once I evaluate the plan, I will know if I am on the right path to getting my goal. If I am not, then I need to bridge the gap by making alterations in my plan.

· If I do not get a promotion at my work, then I must do necessary things which contribute to perform well and upskill myself thereby get recognition and promotion.

· If my savings are not reaching my target, then I need to manage my expenses to the minimum and cut down unnecessary expenses. Get a good investment plan from professionals.

· Be realistic to the plan and do the things to bridge the gap between desired result and actual result.

Personal Finance

SIXTH EDITION

Chapter 4

Using Tax Concepts for Planning*

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Chapter Objective (1 of 2)
4.1 Provide a background on taxes
4.2 Explain how to determine your tax filing status
4.3 Demonstrate how to calculate your gross income
4.4 Show how deductions and exemptions can be used

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Chapter Objective (2 of 2)
4.5 Explain how to determine your taxable income, tax liability, and refund or additional taxes owed
4.6 Explain how tax planning fits within your financial plan

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Background on Taxes (1 of 10)
Taxes are an integral part of our economy
They are paid on earned income, consumer purchases, wealth transfers and capital assets
Special taxes are levied on things like alcohol, cigarettes and gasoline

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Background on Taxes (2 of 10)
Corporations pay income tax on profits
Homeowners pay property taxes
Taxes are used to pay for government services and programs
Most individuals pay taxes at federal, state and local levels

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Background on Taxes (3 of 10)
Federal tax system is administered by the Internal Revenue Service (IRS)
Taxes are paid in several ways
At the time of a transaction
Through payroll withholding
By making estimated quarterly payments
Tax year for federal income tax ends on Dec. 31 with taxes filed by April 15

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Background on Taxes (4 of 10)
Tax Law Changes
Economic Growth and Tax Relief Reconciliation Act of 2001: tax cut package designed to provide short-term economic stimulus through tax relief for taxpayers
Provisions scheduled to phased in between 2001 and 2011 when the law was scheduled to expire

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Background on Taxes (5 of 10)
Jobs and Growth Tax Relief Act of 2003: an act that accelerated much of the tax relief resulting from the 2001 Tax Relief Act
Individual rates lowered 2-3%
Child tax credit increased to $1,000
Standard deduction increased for married taxpayers

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Background on Taxes (6 of 10)
Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010: Legislation that extended many of the previous tax law provisions through the year 2012
American Taxpayers Relief Act of 2012: Permanently set in place many provisions from the 2010 legislation

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Background on Taxes (7 of 10)
Affordable Care Act of 2010: Legislation requiring everyone must obtain health insurance and report medical coverage status on their tax return
If proof of health insurance is not provided a penalty will be assessed

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Background on Taxes (8 of 10)
Social Security and Medicare Taxes
Earned Income: Earned income represents salary or wages
FICA (Federal Insurance Contribution Act): Taxes paid to fund the Social Security System and Medicare
Medicare: a government health insurance program that covers people over age 65 and provides payments to health care providers in the case of illness

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Background on Taxes (9 of 10)
Social Security and Medicare Taxes
Your employer matches the amount that is withheld from your wages
Social Security taxes equal 6.2% of your salary up to a maximum level of $118,500 as of 2015
Medicare taxes are 1.45 % of your earned income
Self-employed people must pay both parts of these taxes themselves—15.3%

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Background on Taxes (10 of 10)
Personal income taxes: taxes imposed on income earned
If you earn income you must file a Form 1040, 1040A or 1040EZ to determine your tax liability
Filing deadline is April 15 of each year

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Financial Planning Online
Go to www.irs.gov
/
This Web site provides information about tax rates, guidelines, and deadlines

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Filing Status
Taxpayers must specify a filing status for their tax return because different rates are associated with each status.
Single
Married filing jointly
Married filing separately
Head of household
Qualifying widow(er) with dependent child

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Exhibit 4.1 Form 1040 (page 1)*
*2014 IRS forms are displayed in this chapter because 2015 forms were not available at the time of main text publication. 2015 IRS forms can be obtained online from irs.gov.

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Exhibit 4.1 Form 1040 (page 2)*
*2014 IRS forms are displayed in this chapter because 2015 forms were not available at the time of main text publication. 2015 IRS forms can be obtained online from irs.gov.

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Gross Income (1 of 5)
Gross income: all reportable income from any source, including salary, interest income, dividend income, and capital gains received during the tax year
Wages and Salaries—including bonuses, but excluding contributions to an employee sponsored retirement account
Interest income: interest earned from investments or loans to other individuals

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Gross Income (2 of 5)
Dividend income: income received in the form of dividends paid on stocks or mutual funds
Capital gain: income earned when an asset is sold at a higher price than was paid for it
Short-term capital gain: a gain on assets that were held less than 12 months
Long-term capital gain: a gain on assets that were held for 12 months or longer

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Gross Income (3 of 5)
Capital gains tax: the tax that is paid on a gain earned as a result of selling an asset for more than the purchase price
The tax rate on a long-term capital gain is lower than the tax rate on ordinary income
The tax rate that applies depends on your tax bracket but ranges between 0% and 20%

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Gross Income (4 of 5)
Determining gross income
Gross income: all reportable income from any source, including salary, interest income, dividend income, and capital gains received during the tax year

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Exhibit 4.2 Schedule B of Form 1040*
*2014 IRS forms are displayed in this chapter because 2015 forms were not available at the time of main text publication. 2015 IRS forms can be obtained online from irs.gov.

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Exhibit 4.3 Schedule D of Form 1040 (Page 1)*
*2014 IRS forms are displayed in this chapter because 2015 forms were not available at the time of main text publication. 2015 IRS forms can be obtained online from irs.gov.

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Exhibit 4.3 Schedule D of Form 1040 (Page 2)*
*2014 IRS forms are displayed in this chapter because 2015 forms were not available at the time of main text publication. 2015 IRS forms can be obtained online from irs.gov.

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Gross Income (5 of 5)
Determining gross income
Determined by adding your salary, net business income, interest income, dividend income, and capital gains
Adjusted gross income: adjusts gross income for contributions to IRAs, alimony payments, interest paid on student loans, and other special circumstances

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Deductions and Exemptions (1 of 6)
Standard deduction: a fixed amount that can be deducted from adjusted gross income to determine taxable income
Not affected by income
Affected by filing status and age
Adjusted by the IRS each year to keep pace with inflation

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Deductions and Exemptions (2 of 6)
EXHIBIT 4.4 Standard Deduction Amounts for the 2015 Tax Year
Filing Status Standard Deduction
Married filing jointly and surviving spouses $12,600
Head of household 9,250
Single individuals 6,300
Married, filing separately 6,300

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Deductions and Exemptions (3 of 6)
Itemized deductions: specific expenses that can be deducted to reduce taxable income
Interest expense – interest paid on borrowed money—primarily interest on mortgages
State income tax: an income tax imposed by some states on people who receive income from employers in that state
Local income taxes also deductible when itemizing

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Deductions and Exemptions (4 of 6)
Real estate tax: a tax imposed on a home or other real estate in the county where the property is located
Medical expenses: medical expenses in excess of 10.0% of adjusted gross income may also be itemized
Charitable gifts
Gifts to qualified organizations
Cash or property
Be sure to keep receipts and records of gifts

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Deductions and Exemptions (5 of 6)
Other expenses
Theft losses, job expenses if substantial
Summary of deductible expenses
Total deductible expenses to decide whether to itemize or use the standard deduction

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Exhibit 4.5 Schedule A of Form 1040 (Page 1)*
*2014 IRS forms are displayed in this chapter because 2015 forms were not available at the time of main text publication. 2015 IRS forms can be obtained online from irs.gov.

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Financial Planning Online
Go to www.turbotax.com
Use the tools on this Web site to estimate your tax liability for the year and tax refund if applicable
You will need to input income, filing status, exemptions and deductions to obtain the estimates

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Deductions and Exemptions (6 of 6)
Exemptions
Personal exemption: an amount that can be deducted for each person who is supported by the income reported on a tax return
Usually one exemption each for the filer, the spouse and each dependent child
Deducted from gross income to determine taxable income

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Taxable Income and Taxes (1 of 5)
Taxable income: adjusted gross income less deductions and exemptions
Calculating Taxes
Dependent upon taxable income and filing status
Progressive tax—a tax system where a positive relationship exists between an individual’s income level and tax rate

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Exhibit 4.6 Tax Rate Schedules for 2015 (1 of 4)
EXHIBIT 4.6 Tax Rate Schedules for 2015
Tax Rate–Single Taxpayers – 2015

Taxable income:
Over— But not over— Tax +% On amount over—
$ 0 $ 9,225 $ 0.00 10 $ 0
9,225 37,450 922.50 15 9,225
37,450 90,750 5,156.25 25 37,450
90,750 189,300 18,481.25 28 90,750
189,300 411,500 46,075.25 33 189,300
411,500 413,200 119,401.25 35 411,500
413,200 ———— 119,996.25 39.6 413,200

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Exhibit 4.6 Tax Rate Schedules for 2015 (2 of 4)
EXHIBIT 4.6 Tax Rate Schedules for 2015
Tax Rates–Married Individuals Filing Jointly and Surviving Spouses – 2015

Taxable income:
Over— But not over— Tax +% On amount over—
$ 0 $ 18,450 $ 0.00 10 $ 0
18,450 74,900 1,845.00 15 18,450
74,900 151,200 10,312.50 25 74,900
151,200 230,450 29,387.50 28 151,200
230,450 411,500 51,577.50 33 230,450
411,500 464,850 111,324.00 35 411,500
464,850 ———— 129,996.50 39.6 464,850

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Exhibit 4.6 Tax Rate Schedules for 2015 (3 of 4)
EXHIBIT 4.6 Tax Rate Schedules for 2015
Tax Rates–Married Individuals Filing Separately – 2015

Taxable income:
Over— But not over— Tax +% On amount over—
$ 0 $ 9,225 $ 0.00 10 $ 0
9,225 37,450 922.50 15 9,225
37,450 75,600 5,156.25 25 37,450
75,600 115,225 14,693.75 28 75,600
115,225 205,750 25,788.75 33 115,225
205,750 232,425 55,662.00 35 205,750
232,425 ———— 64,989.25 39.6 232,425

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Exhibit 4.6 Tax Rate Schedules for 2015 (4 of 4)
EXHIBIT 4.6 Tax Rate Schedules for 2015
Tax Rates – Head of household – 2015

Taxable income:
Over— But not over— Tax +% On amount over—
$ 0 $ 13,150 $ 0.00 10 $ 0
13,150 50,200 1,315.00 15 13,150
50,200 129,600 6,872.50 25 50,200
129,600 209,850 26,722.50 28 129,600
209,850 411,500 49,192.50 33 209,850
411,500 439,000 115,737.00 35 411,500
439,000 ———— 125,362.00 39.6 439,000

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Taxable Income and Taxes (2 of 5)
Determining your tax liability
Determine filing status and follow the instructions on the tax schedule
Tax Liability = Tax on Base + [Percentage on Excess over the Base x (Taxable Income – Base)]

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Taxable Income and Taxes (3 of 5)
Tax credits: specific amounts used to directly reduce tax liability
Child tax credit: a tax credit allowed for each child in a household
Currently $1,000
Available as a refund to low-income workers who owe no income tax
In 2017 the credit will not be allowed to exceed the taxpayer’s liability

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Taxable Income and Taxes (4 of 5)
College expense credit: a tax credit allowed to those who contribute toward their dependents’ college expenses
Coverdell Savings Accounts: tax-free accounts that can be used for a variety of school expenses
Section 529 College Savings Plan
Allows tax benefits for parents who set aside money for their children’s future college expenses
Available to all parents, regardless of income

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Taxable Income and Taxes (5 of 5)
Earned income credit: a credit used to reduce tax liability for low-income taxpayers
Other tax credits are also available, for example for child care and adoptions

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Financial Planning Online
Go to turbotax.intuit.com/tax-tools/
This Web site provides an estimate of your tax liability for the year and the tax refund that you may receive, based on your income, filing status, exemptions and deductions.

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How Tax Planning Fits Within Your Financial Plan (1 of 5)
The key tax planning decisions for building your financial plan are:
What tax savings are currently available to you?
How can you increase your tax savings in the future?
Should you increase/decrease the amount of your withholding
What records should you keep?

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How Tax Planning Fits Within Your Financial Plan (2 of 5)
EXHIBIT 4.7 Application of Tax Concepts to Stephanie Spratt’s Financial Plan
GOALS FOR TAX PLANNING
1. Reduce taxable income (thereby reducing taxes paid) to the extent allowable by the IRS.
2. Reduce taxes paid by deferring income.
ANALYSIS
Present Situation:
Gross Income = $38,000
Federal Income Taxes = $3,693.75
Taxes (excluding FICA) as a Percentage of Income = 10%
Reduce Taxes by: Comment
Increasing deductions? The only qualified deduction I had was a charitable contribution of $200, so this is not an option for me this year.
Reducing gross income? I did not contribute any portion of my income to an individual retirement
account or a qualified retirement plan.
Total tax savings? $0 per year

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How Tax Planning Fits Within Your Financial Plan (3 of 5)
EXHIBIT 4.7 Application of Tax Concepts to Stephanie Spratt’s Financial Plan
Long-Term Tax Plan:
Reduce Taxes by: Comment
Increasing deductions? If I purchase a home, the interest expense on my mortgage loan, as well as the real estate taxes, will help boost my itemized deductions. These deductions will likely be higher than the standard deduction to which I would be entitled. In addition, my sales taxes can be counted toward my itemized deductions.
Reducing gross income? I can also contribute to an IRA or to my employer’s qualified retirement plan. If I can afford to contribute $5,000 of my salary to either the IRA or the qualified plan, I will reduce my gross income and defer taxes on that portion of my income.
Tax savings (computed below) $877.50

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How Tax Planning Fits Within Your Financial Plan (4 of 5)
EXHIBIT 4.7 Application of Tax Concepts to Stephanie Spratt’s Financial Plan
To compute my estimated tax savings, I will compare the taxes paid under my current situation to what I would pay if I bought a home and paid $6,000 in mortgage interest and real estate taxes and contribute $5,000 to my IRA. My estimated tax deduction will be $600 and my charitable contributions will remain at $200.
Category Current Situation Long-Term Plan
Gross Income $38,000 $38,000
– IRA contribution $0 $5,000
= Adjusted gross income $38,000 $33,000
– Deductions $6,300 $6,800
– Exemptions $4,000 $4,000
= Taxable income $27,700 $22,200
Tax liability (based on applying
tax rates to the taxable income) $3,693.75 $2,868.75
Approximate Total Tax Savings = $825.00 per year*
*Actual tax savings will change each year as the mortgage interest declines, as changes occur in other
itemized deductions, and as the standard deduction increases.

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How Tax Planning Fits Within Your Financial Plan (5 of 5)
EXHIBIT 4.7 Application of Tax Concepts to Stephanie Spratt’s Financial Plan
DECISIONS
Decisions Regarding Tax Savings for This Year:
So far I have only taken advantage of one tax reduction strategy.
Decisions Regarding Tax Savings in the Future:
I can improve my cash flows over time by taking advantage of tax deductions. If I buy a home, the interest
that I would pay on the mortgage loan, as well as the real estate taxes I would be assessed, is tax-deductible. The purchase of a home would likely increase my monthly cash outflows, but I would benefit from deducting the interest payments and real estate taxes as itemized deductions, thereby reducing my taxable income.
As my income increases, my tax bracket may increase. I need to maximize my potential tax savings to limit the taxes I will pay. I should contribute the maximum allowable amount to my retirement plan (without compromising my cash budget) so that I can take full advantage of the related tax savings. Also, I hope to buy a home in the future. The interest I will pay on a mortgage loan for this home will be high, but I will enjoy tax savings, while also building equity in my home.

Personal Finance

SIXTH EDITION

Chapter 3

Applying Time Value Concepts

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Chapter Objectives (1 of 2)
3.1 Describe the importance of the time value of money
3.2 Calculate the future value of a dollar amount that you save today
3.3 Calculate the present value of a dollar amount that will be received in the future
3.4 Calculate the future value of an annuity

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Chapter Objectives (2 of 2)
3.5 Calculate the present value of an annuity
3.6 Explain how time value can be used to estimate savings
3.7 Explain how time value fits within your financial plan

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The Importance of the Time Value of Money (1 of 2)
The value of money is influenced by the time it is received
The value of a given amount of money is generally greater the earlier it is received
The earlier you start saving, the more quickly your money can earn interest and grow

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The Importance of the Time Value of Money (2 of 2)
Can be applied to a single dollar amount—also called a lump sum
Can also be applied to an annuity
Annuity: a series of equal cash flow payments that are received or paid at equal intervals in time
An example would be a monthly deposit of $50 into your savings account

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Future Value of a Single Dollar Amount (1 of 9)
Compounding: the process of earning interest on interest
To determine the future value of an amount of money you deposit today, you must know:
The amount of your deposit today
The interest rate to be earned on the deposit
The number of years the money will be invested

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Future Value of a Single Dollar Amount (2 of 9)
Future value interest factor (FVIF):
a factor multiplied by today’s savings to determine how the savings will accumulate over time
Can be calculated using the future value table or a financial calculator
Future value table shows various interest rates (i) and time periods (n)

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Future Value of a Single Dollar Amount (3 of 9)
Suppose you want to know how much money you will have in five years if you invest $5,000 now and earn an annual return of 4 percent
The present value of money (PV) is the amount invested, or $5,000
Find the interest rate of 4 percent and a time period of five years on the table

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Future Value of a Single Dollar Amount (4 of 9)
Using the information in the example and the table, we can determine that, in five years, your money will be worth:
$5,000 x 1.217 = $6,085
The future value can also be determined using a financial calculator with the following inputs; PV = -$5,000; N = 5; I/Y = 4; PMT = 0; CPT FV = $6,083.26*
*Note there is a slight rounding error between the two values.

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Future Value of a Single Dollar Amount (5 of 9)
Impact of a longer period
As the number of years increases, the FVIF increases
What if you invested your $5,000 for 20 years instead of 5 years? Assuming the interest rate is still 4%:
$5,000 x 2.191 = $10,955

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Future Value of a Single Dollar Amount (6 of 9)
Impact of a higher interest rate
The higher the interest rate, the more your money will grow
What if you invested your $5,000 at an interest rate of 9% instead of 4%? Assuming a period of 20 years:
$5,000 x 5.604 = $28,020

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Future Value of a Single Dollar Amount (8 of 9)
The power of compounding
An amount of savings can grow substantially due to compounding
Compounding can also expand your debt
Not only do you pay interest on your debt, you also pay interest on the interest on your debt

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Future Value of a Single Dollar Amount (9 of 9)
Twisted logic about long-term debt
Some people believe that it is to their advantage to postpone payment of debt as long as possible
More enjoyable to spend than to pay!
They fail to recognize how debt can accumulate over a long-term period

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Financial Planning Online (1 of 2)
Go to the banking section of About.com
This Web site provides information on how you can pay your bills online.

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Present Value of a Dollar Amount (1 of 5)
Discounting: the process of obtaining present values
Present values tell you the amount you must invest today to accumulate a certain amount at some future time
This amount is based on some interest rate you could earn over that period

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Present Value of a Dollar Amount (2 of 5)
To determine present values, you need to know:
The amount of money to be received in the future
The interest rate to be earned on the deposit
The number of years the money will be invested

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Present Value of a Dollar Amount (3 of 5)
Using the Present Value Table
Present value interest factor (PVIF):
a factor multiplied by a future value to determine the present value of that amount
Notice that PVIF is lower as the number of years increases and as the interest rate increases
Can also be calculated using a financial calculator

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Present Value of a Dollar Amount (4 of 5)
You would like to accumulate $50,000 in five years by making a single investment today. You believe you can achieve a return from your investment of 7 percent annually. What is the dollar amount that you need to invest today to achieve your goal?

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Present Value of a Dollar Amount (5 of 5)
Using the information in the example and the table we can determine that in order to have $50,000 today:
$50,000 x 0.713 = $35,650
This can also be determined using a financial calculator with these inputs; FV = $50,000; N = 5; I/Y = 7; PMT = 0; CPT PV = $35,649.30*
*Note there is a slight rounding error between the two methods.

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Future Value of an Annuity (1 of 4)
Annuity due: a series of equal cash flow payments that occur at the beginning of each period
Ordinary annuity: a series of equal cash flows that occur at the end of each period
Timelines: diagrams that show payments received or paid over time
These values can also be calculated using a table or a financial calculator

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Future Value of an Annuity (2 of 4)
Future value interest factor for an annuity (FVIFA): a factor multiplied by the periodic savings level (annuity) to determine how the savings will accumulate over time
i is the periodic interest rate
n is the number of payments in the annuity

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Future Value of an Annuity (3 of 4)
Suppose that you have won the lottery and will receive $150,000 at the end of every year for the next 20 years. As soon as you receive the payments, you will invest them at your bank at an interest rate of 7 percent annually. How much will be in your account at the end of 20 years, assuming you do not make any withdrawals?
Note that this is an ordinary annuity

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Future Value of an Annuity (4 of 4)
Using our example and the table, we can determine that, at the end of twenty years, you would have:
$150,000 x 40.995 = $6,149,250
This can also be determined using a financial calculator with these inputs; PMT = -$150,000; N = 20; I/Y = 7; PV = 0; CPT FV = $6,149,323.85*
*Note there is a slight rounding error between these two methods.

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Financial Planning Online (2 of 2)
Go to the calculators in the personal finance section of Yahoo.com
This Web site provides several tools that, among other things, will help you estimate of the future value of your savings

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Present Value of an Annuity (1 of 4)
The present value of an annuity is determined by discounting the individual cash flows of the annuity and adding them up
This value also can be obtained by either using a present value of an annuity table or a financial calculator

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Present Value of an Annuity (2 of 4)
Present value interest factor for an annuity (PVIFA): a factor multiplied by a periodic savings level (annuity) to determine the present value of the annuity

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Present Value of an Annuity (3 of 4)
Suppose you have just won the lottery. As a result of your luck, you will receive $82,000 at the end of every year for the next 25 years. Now, a financial firm offers you a lump sum of $700,000 in return for these payments. If you can invest your money at an annual interest rate of 9 percent, should you accept the offer?

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Present Value of an Annuity (4 of 4)
Using our example and the previous table we can determine that the present value of the stream of $82,000 payments is:
$82,000 x 9.823 = $805,486
Since this amount is more than the $700,000 offered, you would reject the offer

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Using Time Value to Estimate Savings (1 of 2)
Estimating the future value from savings
Provides motivation for regular saving
Estimating the annual savings that will achieve a future amount
Helps set specific goals when saving for a large purchase

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Using Time Value to Estimate Savings (2 of 2)
How time value can motivate saving
Money can grow substantially over time when you invest periodically and earn interest
May be more motivated to save because you can see the reward of your effort

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How a Savings Plan Fits Within Your Financial Plan
Key savings decisions for building your financial plan are:
How much should I attempt to accumulate in savings for a future point in time?
How much should I attempt to save every month or every year?

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How a Savings Plan Fits Within Stephanie’s Financial Plan
In the next two slides you can see how Stephanie Spratt can use the time value concepts to help her devise a savings plan that fits her budget

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Using Time Value to Estimate Stephanie’s Savings (1 of 4)
EXHIBIT 3.2 How Time Value of Money Decisions Fit Within Stephanie Spratt’s Financial Plan
GOALS FOR A SAVINGS PLAN
1. Calculate how much savings I will accumulate by various future points in time.
2. Determine how much I need to save each year to ensure a comfortable living upon retirement.
ANALYSIS
Present Situation:
Expected Savings per Year = $5,000
Expected Annual Rate of Return = 6% or 7%

Estimated Amount of Savings to Be Accumulated:
Savings Accumulated over: Assume Annual
Return = 6% Assume Annual
Return = 7%
5 years $28,185 $28,753
10 years 65,905 69,080
15 years 116,380 125,645
20 years 183,930 204,975
25 years 274,325 316,245
30 years 395,290 472,305

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Using Time Value to Estimate Stephanie’s Savings (2 of 4)
EXHIBIT 3.2 How Time Value of Money Decisions Fit Within Stephanie Spratt’s Financial Plan
Annual Savings Needed to Achieve a Specific Savings Goal:
Savings Goal = $80,000 in 10 years, $200,000 in 20 years, $600,000 in 30 years
Expected Annual Rate of Return = 6% or 7%
Savings Goal Assume Annual Return = 6% Assume Annual Return = 7%
$80,000 in 10 years $6,069 $5,790
$200,000 in 20 years 5,437 4,879
$600,000 in 30 years 7,589 6,352
To achieve a savings goal of $80,000 in 10 years, I would need to save $6,069 per year (assuming an annual return of 6% on my money). To achieve a goal of $200,000 in 20 years, I would need to save $5,437 per year (assuming a 6% annual return).

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Using Time Value to Estimate Stephanie’s Savings (3 of 4)
EXHIBIT 3.2 How Time Value of Money Decisions Fit Within Stephanie Spratt’s Financial Plan

DECISIONS
Decision on My Savings Goal in the Future:
If I can save $5,000 a year, I should accumulate $28,185 in 5 years and $65,905 in 10 years. These estimates are based on an assumed annual return of 6%. If my annual return is higher, I should accumulate even more than that. The estimated savings for longer time periods are much higher.
A comparison of the third column with the second column in the table shows how much more savings I could accumulate if I can earn an annual return of 7% instead of 6%.

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Using Time Value to Estimate Stephanie’s Savings (4 of 4)
EXHIBIT 3.2 How Time Value of Money Decisions Fit Within Stephanie Spratt’s Financial Plan

Decision on My Savings Goal per Year:
Although my initial plan was to develop a budget for saving about $5,000 a year, I will try to save more so that I can achieve my savings goals. I will use a minimum savings goal of $5,000, but will try to save about $6,000 per year.

Personal Finance

SIXTH EDITION

Chapter 2

Planning with Personal Financial Statements

Chapter Objectives
2.1 Explain how to create your personal cash flow statement
2.2 Identify the factors that affect your cash flows
2.3 Forecast your cash flows
2.4 Explain how to create your personal balance sheet
2.5 Explain how your personal financial statements fit within your financial plan

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Personal Cash Flow Statement (1 of 3)
Personal cash flow statement: a financial statement that measures a person’s cash inflows and outflows
Cash inflows include salaries, interest, dividends
Cash outflows include all expenses, both large and small

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Personal Cash Flow Statement (2 of 3)
Create a statement by recording your revenues and expenses over a period of time
Net cash flows: cash inflows minus cash outflows

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Personal Cash Flow Statement (3 of 3)
EXHIBIT 2.1 Personal Cash Flow Statement for Stephanie Spratt
Cash Inflows Last Month
Disposable (after-tax) income $2,500
Interest on deposits 0
Dividend payments 0
Total Cash Inflows $2,500
Cash Outflows Last Month
Rent $600
Internet 50
Electricity and water 60
Cellular 60
Groceries 300
Health care insurance and expenses 130
Clothing 100
Car expenses (insurance, maintenance, and gas) 200
Recreation 600
Total Cash Outflows $2,100
Net Cash Flows +$400

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Factors That Affect Cash Flows (1 of 3)
Factors affecting cash inflows:
Stage in your career path
Closely related to your stage in the life cycle—college, career, retirement
Type of job
Based on skill level and demand for those skills
Number of income earners in your household

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Factors That Affect Cash Flows (2 of 3)
Factors affecting cash outflows:
Size of family
Age
Personal consumption behavior
Some people spend all of their income and more while others spend mainly on necessities and concentrate on saving for the future

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Creating a Budget (1 of 8)
Budget: a cash flow statement that is based on forecasted cash flows for a future time period
Budgets are useful for anticipating either cash surpluses or cash deficiencies

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Creating a Budget (2 of 8)
EXHIBIT 2.3 Stephanie Spratt’s Revised Personal Cash Flow Statement
Cash Inflows Actual Amounts Last Month Expected Amounts This Month
Disposable (after-tax) income $2,500 $2,500
Interest on deposits 0 0
Dividend payments 0 0
Total Cash Inflows $2,500 $2,500
Cash Outflows Actual Amounts Last Month Expected Amounts This Month
Rent $600 $600
Internet 50 50
Electricity and water 60 60
Cellular 60 60
Groceries 300 300
Health care insurance and expenses 130 [430]
Clothing 100 100
Car expenses (insurance, maintenance, and gas) 200 [500]
Recreation 600 600
Total Cash Outflows $2,100 $2,700
Net Cash Flows +$400 -$200

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Creating a Budget (3 of 8)
EXHIBIT 2.4 Summary of Stephanie Spratt’s Revised Cash Flows
Last Month’s
Cash Flow Situation
Unusual Cash Flows Expected This Month This Month’s Cash Flow Situation
Cash inflows $2,500 $0 $2,500
Cash outflows $2,100 $600 $2,700
Net cash flows $400 -$600 –$200

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Creating a Budget (4 of 8)
Anticipating cash shortages
Small shortages can usually be made up from your checking account
Budgets provide warning of shortages so that you can prepare for them
Assessing the accuracy of the budget
Compare predicted cash flows to actual cash flows
Adjustment may be necessary

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Creating a Budget (5 of 8)
Forecast net cash flows over several months
Use the information for a typical month and adjust it for unusual expenses such as seasonal shopping
Allow for some unexpected expenses like medical care, car and home maintenance
Create an annual budget by extending your budget out for longer periods
Go to the website https://money.strands.com/ for an App that will help with this task

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Creating a Budget (6 of 8)
EXHIBIT 2.5 Stephanie Spratt’s Revised Personal Cash Flow Statement
Cash Inflows Expected Amounts (forecasted at the beginning of the month) Actual Amounts (determined at the end of the month) Forecasting Error
Disposable (after-tax) income $2,500 $2,500 $0
Interest on deposits 0 0 0
Dividend payments 0 0 0
Total Cash Inflows $2,500 $2,500 $0
Cash Outflows Expected Amounts Actual Amounts Forecasting Error
Rent $600 $600 $0
Internet 50 50 0
Electricity and water 60 60 0
Cellular 60 60 0
Groceries 300 280 +20
Health care insurance and expenses 430 430 0
Clothing 100 170 -70
Car expenses (insurance, maintenance, and gas) 500 500 0
Recreation 600 650 -50
Total Cash Outflows $2,700 $2,800 –$100
Net Cash Flows -$200 -$300 -$300

Creating a Budget (7 of 8)
Improving the budget
Periodically review the budget to see if you are progressing toward your goals
Look for areas that can be changed to improve the budget over time
Focus on ethics
Don’t become overly dependent on others
Create a budget and stay within it

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Creating a Budget (8 of 8)
EXHIBIT 2.6 Annual Budget for Stephanie Spratt
Cash Inflows Typical Month This Year’s Cash Flows (equal to the typical monthly cash flows × 12)
Disposable (after-tax) income $2,500 $30,000
Interest on deposits 0 0
Dividend payments 0 0
Total Cash Inflows $2,500 $30,000
Cash Outflows Typical Month This Year’s Cash Flows
Rent $600 $7,200
Internet 50 600
Electricity and water 60 720
Cellular 60 720
Groceries 300 3,600
Health care insurance and expenses 130 1,560
Clothing 100 1,200
Car expenses (insurance, maintenance, and gas) 200 2,400
Recreation 600 7,200
Total Cash Outflows $2,100 $25,200
Net Cash Flows +$400 $4,800 (difference between cash inflows and outflows)

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Financial Planning Online (1 of 2)
Go to www.moneycrashers.com/five-steps-to-effective-budgeting
This Web site provides tips on effective budgeting based on your goals.
The Web site https://www.mint.com/ also contains a lot of budgeting information and other financial tools.

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Personal Balance Sheet (1 of 15)
Personal balance sheet: a summary of your assets (what you own), your liabilities (what you owe), and your net worth (assets minus liabilities)
A balance sheet reflects your financial position at a specific point in time

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Financial Planning Online (2 of 2)
Go to http://www.dailyfinance.com
/
Search for Calculators
This Web site provides an estimate of the savings you can accumulate over time if you can reduce your spending on one or more of your monthly expenses.

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Personal Balance Sheet (2 of 15)
Assets
Liquid assets are financial assets that can be easily sold without a loss in value
Household assets are items normally owned by a household, such as a home, a car, and furniture
You need to establish market values for these assets—the amount you would receive if you sold the asset today

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Personal Balance Sheet (3 of 15)
Investment (financial assets)
Bonds: certificates issued by borrower, usually firms and government agencies, to raise funds
Stocks: certificates representing partial ownership in a firm

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Personal Balance Sheet (4 of 15)
Mutual funds: investment companies that sell shares and invest the proceeds in investment instruments
Real estate: holdings in rental property and land
Rental property: housing or commercial property that is rented out to others

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Personal Balance Sheet (5 of 15)
Liabilities
Current liabilities: debts that will be paid within a year
Long-term liabilities: debts that will be paid over a period longer than one year
Net worth is the difference between what you own and what you owe.

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Personal Balance Sheet (6 of 15)
Creating a personal balance sheet
Allows you to determine your net worth
Update it periodically to monitor changes in your net worth over time

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Personal Balance Sheet (7 of 15)
EXHIBIT 2.7 Stephanie Spratt’s Personal Balance Sheet
Assets
Liquid Assets
Cash $500
Checking account 3,500
Savings account 0
Total liquid assets $4,000
Household Assets
Home $0
Car 1,000
Furniture 1,000
Total household assets $2,000
Investment Assets
Stocks $3,000
Total investment assets $3,000
Total Assets $9,000

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Personal Balance Sheet (8 of 15)
EXHIBIT 2.7 Stephanie Spratt’s Personal Balance Sheet
Liabilities and Net Worth
Current Liabilities
Credit card balance $2,000
Total current liabilities $2,000
Long-Term Liabilities
Mortgage $0
Car loan 0
Total long-term liabilities $0
Total Liabilities $2,000
Net Worth $7,000

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Personal Balance Sheet (9 of 15)
Changes in the personal balance sheet
Some changes will affect both your personal balance sheet and your net worth
Other changes will affect you personal balance sheet and leave your net worth unchanged
Consider the previous personal balance sheet with the purchase of a new car…
Note that her assets increase but her liabilities increase by the same amount

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Personal Balance Sheet (10 of 15)
EXHIBIT 2.8 Stephanie Spratt’s Personal Balance Sheet if She Purchases a New Car
Assets
Liquid Assets Present Situation If She Purchases a New Car
Cash $500 $500
Checking account 3,500 500
Savings account 0 0
Total liquid assets $4,000 $1,000
Household Assets
Home $0 $0
Car 1,000 20,000
Furniture 1,000 1,000
Total household assets $2,000 $21,000
Investment Assets
Stocks $3,000 $3,000
Total investment assets $3,000 $3,000
Total Assets $9,000 $25,000

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Personal Balance Sheet (11 of 15)
EXHIBIT 2.8 Stephanie Spratt’s Personal Balance Sheet if She Purchases a New Car
Liabilities and Net Worth
Current Liabilities
Credit card balance $2,000 $2,000
Total current liabilities $2,000 $2,000
Long-Term Liabilities
Mortgage $0 $0
Car loan 0 16,000
Total long-term liabilities $0 $16,000
Total Liabilities $2,000 $18,000
Net Worth $7,000 $7,000

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Personal Balance Sheet (12 of 15)
Impact of the economy on the personal balance sheet
Favorable economic conditions can increase job opportunities and income
Unfavorable economic conditions result in lost jobs and income
Net worth can decline to the point of becoming negative

How Cash Flows Affect the Personal Balance Sheet
Wealth is built by using net cash flows to invest in assets without increasing liabilities
Net cash flows can be used to decrease liabilities which will increase net worth
Net worth can change even if net cash flows are zero; for example, the value of an asset or investment increases or decreases

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Personal Balance Sheet (13 of 15)
Analysis of the personal balance sheet
Allows monitoring of liquidity, debt, and ability to save
Liquidity is measured by the liquidity ratio
Liquidity ratio = Liquid assets/Current liabilities
From personal balance sheet on previous slides
4,000/2,000 = 2
Higher liquidity ratio = greater liquidity

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Personal Balance Sheet (14 of 15)
Debt level is measured by debt-to-asset ratio
Debt-to-Asset Ratio = Total liabilities/total assets
From personal balance sheet on previous slides
2,000/9,000 = 22.22%
Higher ratio = higher debt relative to assets

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Personal Balance Sheet (15 of 15)
Savings rate measures savings over the period in comparison to disposable income over the period

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How Budgeting Fits Within Your Financial Plan (1 of 5)
The key budgeting decisions for building your financial plan are:
How can I improve my net cash flows in the near future?
How can I improve my net cash flows in the distant future?

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How Budgeting Fits Within Your Financial Plan (2 of 5)
EXHIBIT 2.11 Application of Budgeting Concepts to Stephanie Spratt’s Financial Plan
GOALS FOR A BUDGETING PLAN
1. Determine how I can increase my net cash flows in the near future.
2. Determine how I can increase my net cash flows in the distant future.
ANALYSIS
Present Situation:
Cash Inflows = $2,500 per month
Cash Outflows = $2,100 per month
Net Cash Flows = $400 per month
Estimated Savings per Year = $4,800 ($400 per month×12 months)

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How Budgeting Fits Within Your Financial Plan (3 of 5)
EXHIBIT 2.11 Application of Budgeting Concepts to Stephanie Spratt’s Financial Plan
Increase Net Cash Flows by:
Increasing my salary? (New job?) No. I like my job and have no plans to search for another job right now, even if it would pay a higher salary.
Increasing my income provided by
my investments? No. My investments are small at this point. I cannot rely on them to provide much income.
Other? (If yes, explain.) No.

Reduce Cash Outflows by:
Reducing my household expenses? No.
Reducing my recreation expenses? Yes (by $100 per month).
Reducing my other expenses? No.
Overall, I identified only one adjustment to my budget, which will increase monthly net cash flows by $100.

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How Budgeting Fits Within Your Financial Plan (4 of 5)
DECISIONS
Decision to Increase Net Cash Flows in the Near Future:
I initially established a budget to save $4,800 per year. During the next year, I can attempt to save an additional $100 per month by reducing the amount I spend on recreation. I can increase my savings if I reduce cash outflows. By reducing cash outflows by $100 per month, my savings will increase from $400 to $500 per month. The only way that I can reduce cash outflows at this point is to reduce the amount I spend for recreation purposes.
EXHIBIT 2.11 Application of Budgeting Concepts to Stephanie Spratt’s Financial Plan

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How Budgeting Fits Within Your Financial Plan (5 of 5)
Decision to Increase Net Cash Flows in the Distant Future:
My cash inflows will rise over time if my salary increases. If I can keep my cash outflows stable, my net cash flows (and therefore my savings) will increase. When I buy a new car or a home, my monthly cash outflows will increase as a result of the monthly loan payments. If I buy a new car or a home, I need to make sure that I limit my spending (and therefore limit the loan amount) so that I have sufficient cash inflows to cover the monthly loan payments along with my other typical monthly expenses.
If I get married someday, my husband would contribute to the cash inflows, which would increase net cash flows. We would be able to save more money and may consider buying a home. If I marry, my goal will be to save even more money per month than I save now, to prepare for the possibility of raising a family in the future.
EXHIBIT 2.11 Application of Budgeting Concepts to Stephanie Spratt’s Financial Plan

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