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Chapter 2
The Financial Plan
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Learning Objectives
• Describe the purpose of a financial plan
• Identify the key components of a financial
plan
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What is a Financial Plan?
• A personal financial plan involves
specifying financial goals including the
spending, financing, and investing plans
needed to reach the goal
• A good financial plan is like a blueprint for a
builder.
• The plan should spell out every aspect of
how to accumulate and grow wealth and
provide for emergencies
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What is a Financial Plan?
• A good financial plan includes 7 key
components (see figure 2.1):
–
–
–
–
–
–
Budget and taxes
Managing liquidity, or ready access to cash
Financing large purchases
Managing your risk
Investing your money
Planning for retirement and the transfer of your
wealth
– Communication and record keeping
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Figure 2.1
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Check Your Financial IQ
• What is the purpose and function of a
financial plan?
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Check Your Financial IQ
• It is like a blueprint to a builder. It spells out
every aspect of your financial life and helps
you accumulate wealth and plan for
emergencies
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The Components of Your Financial
Plan
• The first step in building a financial plan is
understanding the different parts of it
• The following slides explore the seven
components and how they can help you
achieve financial security
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Component One: A Plan for Your
Budgeting and Taxes
• Budgeting is the
process of
forecasting
future expenses
and income
• A budget helps you plan your
spending and saving, so you can
meet your needs and wants.
• Creating a budget involves several
steps:
– Establishing your net worth
– Establishing your income
– Identifying your expenses
– Considering the impact of taxes
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Step One: Establishing Your Net Worth
• The first step is to determine where you are
financially.
• Do you have money in the bank?
• Do you owe people money?
• Do you have a job?
• Knowing the answers to these questions will help
you determine your current financial positions.
• This will help you recognize how far you are from
your goals and help you set budget priorities
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Step 1: Establishing Your Net Worth
• Assets are anything
we own, such as cars
or baseball cards.
• Liabilities are what
we owe, or our debt
• Net Worth = Assets
– Liabilities
• Equity means
ownership
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• For example:
• Asset = Car worth = $5000
• Liability = Amount owed on
the car = -$2000
• Net worth = Car value minus
amount owed = $3,000
• The equity would also be
$3000
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Step 1: Establishing Your Net
Worth
• As you save money, you will accumulate
more assets (including cash)
• You will also have the chance to reduce your
liabilities
• Both of these will lead to increasing your net
worth
• Check out Figure 2.2 to see an example of
calculating net worth
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Figure 2.2
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Step 2: Establishing Your Income
• Income is the
money coming in
through wages
earned, allowance,
or other sources
• A key factor in shaping a budget is
understanding your income.
• Having an income is the major means by
which a person saves money, builds
wealth, acquires assets, and fulfills wants
and needs.
• A person’s income often depends on
decisions he or she makes about education
and career choices.
• In general, more education or specialized
training translates into more income.
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Math for Personal Finance
• Jamaal makes $9 an hour and works about
15 hours a week. He also gets a $25 per
week allowance.
• What is his total annual income?
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Math for Personal Finance
• Solution: $9 an hour x 15 hours per week =
$135 per week x 52 weeks per year = $7,020
per year income from his job. He also gets
$25 per week x 52 weeks per year = $1,300
per year income from his allowance. His
total annual income is equal to $7,020 +
$1,300 = $8,320
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Step 3: Identifying Your Expenses
• Expenses are also an important part of a
budget
• When creating a budget, estimate how much
money you have going out every month
• Typical expenses include clothing or
entertainment
• Refer to the chart in Figure 2.3 for typical
household expenditures
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Figure 2.3
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Step 4: Considering the Impact of Taxes
• Income taxes (money owed to the
government on earned income) may also
impact your budget
• The more money you make, the higher the
share of your income you will pay in income
taxes
• Include tax planning in your financial plan as
your income level increases
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Component 2: A Plan to Manage Your
Liquidity
• Liquidity refers to
how much readily
available cash you
have on hand for
meeting immediate
wants and needs.
• Liquidity assets include cash
and assets that can be quickly
and easily turned into cash
• Note that your liquidity is
different than your net worth.
• You may have a number of
valuable assets, but if they are
not liquid, they will be of little
use to you when facing a shortterm financial need.
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Component 2: A Plan to Manage Your
Liquidity
• Money Management and Credit management decisions are
both involved in liquidity management.
• Money management involves making decisions about how
much cash or liquid assets to keep in reserve and how much to
invest in less liquid assets, such as real estate (buildings and
land).
• Money Management helps determine how much money to keep
liquid to avoid cash shortfalls.
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Component 2: A Plan to Manage Your
Liquidity
• Interest is like
rent on money
• Credit Management involves
making decisions about getting credit
and using credit.
• Credit is commonly used to cover
immediate cash shortfalls, so it
increases liquidity.
• Credit can be very costly.
• When you use credit (borrow money)
the lender charges interest on the
money you borrow.
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Component 2: A Plan to Manage Your
Liquidity
• Some lenders charge higher interest (rent) on
money than others.
• It is not wise to rely on credit cards if you are not
able to pay back the borrowed money quickly.
• A financial plan should contain a credit
management plan.
• Take a look at figure 2.4 for an illustration of
liquidity management.
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Figure 2.4
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Component 3: A Plan for Your
Financing
• Major purchases can require borrowing
money for long periods of time.
• It is common to pay for a portion of the cost
of these purchases and to take a loan for – or
finance – the remaining amount.
• Figure 2.5 illustrates this process
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Figure 2.5
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Component 3: A Plan for Your
Financing
• This type of borrowing (financing) differs
from the borrowing credit cards are often
used for.
• Longer-term financing is usually available at
a lower cost to the borrower than can be
found with credit cards
• Use of long-term financing requires great
caution
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Component 3: A Plan for Your
Financing
• A number of factors determine how much you can
borrow and the payment terms.
• Payment terms include information about the
interest rate and the time period for paying back the
loan
• You might be lent more money than you should
borrow.
• When you borrow money, you have a payment
schedule that requires you to make timely
payments.
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Math for Personal Finance
• Ruston plans on buying a car that is priced at
$3,500. He has saved $1,000 for a down
payment and his grandparents have agreed to
contribute another $500 toward the purchase.
• How much of the vehicle will Ruston need to
finance?
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Math for Personal Finance
• Solution: Ruston can put a total of $1,500
down on the car and finance the remainder
which is $3,50 - $1,500 = $2,000.
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Component Four: A Plan to Manage
Your Risk
• Come up with a plan to protect assets as you
accumulate them.
• For example, if you buy a car, what happens if that
car is stolen or hit?
• Unless you have insurance on the car, you will
suffer the loss of that asset yourself.
• If there is a greater chance of you suffering a
financial loss, then the risk is higher.
• Many people purchase insurance
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Component Four: A Plan to Manage
Your Risk
• Insurance planning is a component of your
financial plan
• It determines the types and amounts of insurance
you need.
• People typically insure houses, boats, cars, and
other major assets.
• You also need insurance to cover you for
unexpected events, such as an illness or injury.
• Many adults have life insurance that will provide a
cash amount in the event of their death.
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Component 5: A Plan for Your Investing
• Any funds you do not spend should be
invested with the expectation of earning even
more money.
• Common types of investments include:
–
–
–
–
Stocks
Bonds
Mutual Funds
Real Estate
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Component 5: A Plan for Your Investing
• People invest money so they can make more
money
• Remember that different types of
investments have different levels of risk
• Riskier investments can produce great
returns—but also may experience significant
losses
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Component 6: A Plan for Your
Retirement
• People who plan for retirement while they are
young often retire early
• Retirement planning involves determining how
much to save for retirement and how to invest that
money.
• The government provides several ways to save for
retirement that allow you to accumulate wealth
without paying taxes until you retire
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Component 7: A Plan for
Communication and Record-Keeping
• Communicate your financial plan to your
family.
• Keeping good records of your finances is
equally important.
• These records will help you when you file
your taxes and calculate your net worth.
• Your heirs may also need these records at
some point as well.
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Check Your Financial IQ
• What are the components of your financial plan?
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Check Your Financial IQ
1. Budgeting and taxes
2. Managing liquidity, or ready access to cash
3. Financing large purchases
4. Managing your risk
5. Investing your money
6. Planning for retirement and the transfer of your
wealth
7. Communication and record keeping
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Summary
• Financial planning involves specifying
financial goals
• It involves describing the spending,
financing, and investing plans needed to
reach those goals.
• Your plan is like a blueprint for your
financial future
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Summary
• A good financial plan contains seven key components:
– 1. Budgeting and taxes
– 2. Managing liquidity, or ready access to cash
– 3. Financing large purchases
– 4. Managing your risk
– 5. Investing your money
– 6. Planning for retirement and the transfer of your
wealth
– 7. Communication and record keeping
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Key Terms and Vocabulary
•
•
•
•
•
•
•
•
Asset
Budgeting
Credit management
Equity
Finance
Income
Interest
Liability
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•
•
•
•
•
•
•
Liquidity
Money management
Net worth
Payment terms
Personal financial plan
Real estate
Risk
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Websites
• www.bls.gov/news.release/cesan.nr0.htm
• Moneycentral.msn.com/home.asp
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