Pesonal finance 6th madura chapter 01 overview of a financial plan

Personal Finance

SIXTH EDITION

Chapter 1
Overview of a Financial
Plan

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Chapter Objective
1.1 Explain how you benefit from personal finance
1.2 Identify the key components of a financial plan
1.3 Explain how financial planning affects your cash flows
1.4 Outline the steps involved in developing your financial plan

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Definitions

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Personal finance: the process of planning your spending, financing, and investing to
optimize your financial situation

•

Personal financial plan: a plan that specifies your financial goals and describes the
spending, financing, and investing plans that are intended to achieve those goals

•

Opportunity cost: what you give up as a result of a decision

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How You Benefit from an Understanding of Personal Finance

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Make your own financial decisions

– Every spending decision has an opportunity cost
•

Judge the advice of financial advisors

– Make informed decisions
•

Become a financial advisor

– Many career opportunities available

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Components of a Financial Plan

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Budgeting and tax planning

•

Managing your liquidity

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Financing your large purchases

•

Protecting your assets and income (insurance)

•

Investing your money

•

Planning your retirement and estate

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A Plan for Your Budgeting and Tax Planning

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Budget planning: The process of forecasting future expenses and savings

–

Evaluate your current financial position



Assets: what you own



Liabilities: what you owe



Net worth: the value of what you own minus the value of what you owe

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Budget and Tax Planning

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A Plan to Manage Your Liquidity (1 of 2)

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Liquidity: access to funds to cover any short-term cash deficiencies

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Money management: decisions regarding how much money to retain in a liquid form
and how to allocate the funds among short-term investment instruments

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A Plan to Manage Your Liquidity (2 of 2)

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Credit management: decisions regarding how much credit to obtain to support your
spending and which sources of credit to use

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Managing Your Liquidity

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A Plan for Your Financing

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Loans often needed for large expenditures

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College tuition, car, house

–

Managing loans



How much can you afford to borrow?



Determining maturity of the loan



Selecting a loan with a competitive interest rate

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Financing Your Large Purchases

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A Plan for Protecting Your Assets and Income

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Insurance planning: Determining the types and amount of insurance needed to protect
your assets

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Automobile and homeowner’s insurance protect assets

–

Health insurance limits potential medical expenses

–

Disability and life insurance protect your income

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A Plan for Your Investing

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Any funds beyond what you need to maintain liquidity should be invested

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Primary objective to earn a high return

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Potential investments include stocks, bonds, mutual funds and real estate

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Risk: uncertainty surrounding the potential return on an investment

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Manage investments to keep risk at a tolerable level

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A Plan for Your Retirement and Estate

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This includes insurance planning, retirement planning, and estate planning

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Retirement planning: determining how much money should be set aside each year for
retirement and how you should invest those funds

–

Estate planning: determining how your wealth will be distributed before or upon your death

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Building Your Own Financial Plan

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Enhances your net worth

•

Builds your wealth

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All components of your financial plan affect your cash inflows and outflows and how
much cash you have available

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How Financial Plan Decisions Affect Your Cash Flows (1 of 13)

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How the components relate to your cash flows

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Cash inflows are cash that you receive

–

Cash outflows are cash that you spend

–

Budgeting balances income and spending

–

Liquidity deals with cash excesses or shortages

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How Financial Plan Decisions Affect Your Cash Flows (2 of 13)

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Part 1 – Tools for Financial Planning College tuition, car, house

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Budgeting allows you to plan how you will use the cash you receive in a given period



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How much should you work this month (if your employer allows flexibility)?

Budget decisions determine how much you spend and the amount of your cash outflows each
month



What products or services should you purchase this month?

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How Financial Plan Decisions Affect Your Cash Flows (3 of 13)

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How Financial Plan Decisions Affect Your Cash Flows (4 of 13)

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Part 2 – Managing Your Liquidity

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If you have excess cash this month, how much cash should you add to your checking or saving
account?

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If you have a cash deficiency this month, how much cash should you withdraw from your
checking or savings account?

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If you have a cash deficiency this month, how much credit should you use from credit cards or
other sources?

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How Financial Plan Decisions Affect Your Cash Flows (5 of 13)

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How Financial Plan Decisions Affect Your Cash Flows (6 of 13)

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Part 3 – Personal Financing

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Should you lease a car?

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Should you borrow money to purchase a car?

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Should you borrow money to purchase a home?
How much cash will you need to borrow?
How long a period will you need to borrow funds?
What is the ideal source from which you will borrow funds?

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How Financial Plan Decisions Affect Your Cash Flows (7 of 13)

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How Financial Plan Decisions Affect Your Cash Flows (8 of 13)

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Part 4 – Protecting Your Wealth

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What types of insurance do you need?
How much insurance should you purchase to protect your assets?
How much insurance should you purchase to protect your income?

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How Financial Plan Decisions Affect Your Cash Flows (9 of 13)

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