Overview FIN 6253

Week 1
Islamic Financial Planning
and Wealth Managment

Total Financial Planning

There 4 components to total financial planning
1. Financial Independence
2. Accumulation
3. Protection
4. Distribution

Six steps in Islamic Financial Planning

1. Establish and defining client-planner relationship
2. Gathering information and setting financial goals
4. Analyze and evaluate the information
5. Execute the action plan
6. Monitor plan implementation and revise plan.

Financial Planning and Its Benefits (adopted from Kapoor)

Personal financial planning - Process of managing
money to achieve personal economic satisfaction.
Advantages of personal financial planning:

1) Increased effectiveness in obtaining, using, and

protecting your financial resources.
2) Increased control of your financial affairs.
3) Improved personal relationships.
4) A sense of freedom from financial worries
obtained by looking to the future.
1-2

The Financial Planning Process

Determine your current financial situation.
Develop your financial goals.
Identify alternative courses of action.
Evaluate your alternatives.
Create and implement your financial action
plan.
Review and revise your plan.
1-3

Consequences of Choices:
Opportunity Cost
Opportunity cost - What you give up when you
make a choice

The cost, or trade-off of a decision, cannot

always be measured in dollars. Sometimes
the cost is your time.
What opportunity costs do you have
from being a college student?
1-4

Every Financial Decision

Evaluating Types of Risk
InflationInvolves
risk.
Rising prices cause lost buying power.

Interest-rate risk.
Effect costs of borrowing and rate of return.

Income risk.
The loss of a job.

Personal risk.
Health, safety, or costs.

Liquidity risk.
Higher return may mean less liquidity.

1-5

Financial Planning Information Sources

Printed materials.
Financial institutions.
School courses and educational
seminars.
The internet, online sources, computer
software.
Financial specialists.

Financial planners, bankers, accountants

insurance agents, lawyers and tax payers
1-6

Developing Personal Financial Goals

Types of financial goals include those...

Influenced by the time frame in which you want to
achieve your goals.
Influenced by the financial need that drives your
goals.
Timing of goals.
Short-term, intermediate and long-term goals.
Goals for different financial needs
Consumer product goals, etc.
1-7

Goal-Setting Guidelines
(SMART principle)

Goals should be realistic

Goals should be stated in specific terms
Goals should have a time frame
Goals should indicate the action to be taken
Discuss some of your goals

1-8

Influences on Personal Financial Planning

Life cycle and personal values
Adult life cycle stage.
Marital status, household
size, and employment.
Major events.
Graduation, marriage, children, retirement, etc.
Values.
What values are important to you?
Global influences
Economic conditions
1-9

Changing Economic Conditions

Consumer
prices

The value of the dollar

changes in inflation.

Consumer
spending

The demand for goods and

services by individuals and
households.

Interest rates

The cost of money; cost of

credit when you borrow; return
on your money when you save
or invest.
1-10

Changing Economic Conditions

(continued)

Money Supply

The dollars available for

spending in our economy.

Unemployment

The number of individuals

without employment who are
willing and able to work.

Housing starts

Number of new homes being

built.
1-11

Changing Economic Conditions

GDP: Gross
Domestic Product

(continued)
Total value

of goods and
services produced in a
country.

Trade balance

Difference between a
countrys exports and
imports.

Market indexes

The relative value of

stocks as represented by
the index, such as the
Dow Jones Average or the
S&P 500.

1-12

Opportunity Costs and Financial Results

Evaluated When Making Decisions

Personal
Opportunity Costs
(time, effort, health)
Financial
Opportunity Costs
(Interest, liquidity,
safety )

Financial
Acquisitions
(automobile,
home, college
education,
investments,
insurance,
retirement fund)

1-13

Time Value of Money

Increases in an amount of money
as a result of interest earned.
Saving today means more money
tomorrow. Spending means lost interest.
Saving and spending decisions involve
considering the trade-offs. Current needs
can make spending worthwhile.
1-14

How Simple Interest is Computed

Simple Interest.
Amount in savings x annual interest rate x time
period equals the interest.

$100 x 5% x 1 (1 year)
100 x .05 x 1 = $5.00
In one year you have $100 in principle plus
$5.00 in interest for a total of $105 at the end of
the year.

1-15

Future Value
Future value is the amount to which current
savings will increase based on a certain interest
rate and a certain time period.
Future value is also call compounding - earning
interest on previously earned interest.
Future value can be computed for a single
amount or for a series of deposits.

1-16

Present Value
The current value for a future amount based on a
certain interest rate and a certain time period.
Present value calculations are also called discounting.
The present value of the amount you want in the future
will always be less than the future value. (See Exhibit
1-8C)
Present value can be computed for a single amount or
for a series of deposits.

1-17

Developing a Flexible Financial Plan

A financial plan is a formalized report that...

Summarizes your current financial situation.

Analyzes your financial needs.
Recommends future financial activities.
Your financial plan can be created by you, with
assistance from a financial planner, or made using a
money management software package.

1-19

Implementing Your Financial Plan

Develop good financial habits.

Use a well conceived spending plan to help

you stay within your income, while allowing
you to save and invest for the future.
Have appropriate insurance protection to
prevent financial disasters.
Become informed about tax and investment
alternatives.
Study personal finance.
1-20

Implementing Your Financial Plan

(continued)
Achieving your financial
objectives requires
two things.

A willingness to learn.
Appropriate information sources (see Appendix A).
Current periodicals.
Financial institutions.
Courses and seminars.
Personal financial software.
The World Wide Web.
Financial specialists.

1-21

How to you decide ?

Suppose you just won a $100 million
lottery and you are given the choice
of taking a lump sum or payments
over 20 years. Which would you do? Why?

1-22

Components of Financial Planning (Kapoor)

Obtaining (chapter 2)
Planning (chapters 3, 4)
Savings (chapter 5) - Accumulation
Borrowing (chapters 6, 7) - Financing
Spending (chapters 8, 9)
Managing risk (chapters 10,11,12) - Protection
Investing (chapters 13-17)

Retirement & estate planning (chap 18, 19)- Distribution

1-18

Review BHLB C.D

25

Shariah principles on Islamic financial planning

There are many verses from the Quran and Hadith that relates to
financial planning :(i)

Al Asr 103, 1-3 informed us on the importance of time and

thus implies that we need to set our goals in life:-

The time! Verily, Man is in loss, except those who believe (in
Islam) and do the righteous good deed and recommend one
another to the truth and recommend one another to
patience.
(ii) According to Al Bukhari and Muslim our Prophet Muhammad
S.A.W (pbuh) mentioned .. Remember five things before
comes five things, healthy before sick, young before old,
rich before poor, spacious before tight, life before death
26

What is Financial Planning ?

Simply put, financial planning answers the what if questions
in our life. It is based on our potential earnings, projected
investment (retirement plan), expected rate on return on
investment (children education plan), predicted expenditure
(monthly installment), accumulation of asset
and setting up of our personal financial goals

27

Differences in financial planning approaches

Conventional

Islamic

Wealth
resources

Scarcity of resources

Bounties of God, no
scarcity

Ownership of
asset

Individual freedom- profit maximization

A trust
profit sharing

Life style goals

Personal satisfaction

Prosperity (Falaah)

28

Means in achieving financial goals

Conventional
Life style
creation
Means of
achieving
profit
Profit
determination

Luxurious. (no limit)

Debt driven
Risk avoidance

Ex ante (predetermined)
up front

Islamic
Posses a limit .Not to be
extravagant. Live by
means
Risk sharing

Ex post (unknown)
until the end of
investment

29

Addressing human needs within the

Maqasid As-Syariah?
It outlines the objectives and wisdom (hikmah)
as prescribed by Syariah (Allah & His Prophet
s.a.w.) in all its rulings to protect and preserve
the benefits and interests (maslahah) of society.
What is Maslahah?
is the benefits or interests which are deemed
necessary from Syariah perspectives to protect and
preserve the five darurah. (Al-Mansul, Fakhruddin
Ar-Razi, p.24)

And We have sent you (O Muhammad) not

but a mercy to the whole universe

Alleviate Hardship

(Al-Ambiya:107)

Eliminate Prejudice

Justice

Maqasid as-Shariah
(The Objectives of Shariah)

Religion
Wealth

Intellect
Life

Posterity

Preservation and Promotion

Methodology in Determining Maqasid

as-Syariah
Based on the Quran and Hadith of the Prophet s.a.w.
Istiqra Tasarrufat As-Sharii (A Comprehensive deduction of
every characteristics of hukum (legal rulings)
E.g. Salam Original ruling is not allowed based on Bay Makdum
(sale of something which is inexistence)

Learn from the way the Companions and the Tabien derive their
Syariah rulings and how they understand Nusus (the sources i.e.
Quran and Hadith)
The role of Aqal or using Rational Faculty

Maqasid as-Syariah in Financial Transactions

The origin of Muamalat matters is by understanding its
underlying wisdom (Imam As-Syatibi, Al-Muwafaqat, 2/300)
To facilitate the needs of
human being (AlJumuah:10)
Ar-Rawaj or to ensure wealth
is circulated among as many
as possible in a fair way (AlHasyr:7)

To avoid dispute and

ensure stability
To promote maslahah
and avoid harm

To promote transparency and

accountability (Al-Baqarah:282)

To uphold and promote justice in acquiring

wealth
It is prohibited for a Muslim when he sells
something which has defects to his brother
unless he informs his brother about it (AlHakim)

Free from Riba

Free from Gharar

Fahish

Free from Qimar or

Maysir (Gambling)

Free from Ikrah

(coercion)

Free from element of

exploitation of needs
(bay al-mudtarr)

Free from jahl mufdi ila

al-niza` (lack of
information leading to
dispute)

Free from Ihtikar

(hoarding)

Characteristics
of Islamic
Financial
System

A system grounded on
moral and ethical
framework of Shariah
Community oriented and entrepreneurfriendly emphasizing on productivity
and physical expansion of economic
production and services

Free from Najsh

(Raising prices by
making false bids)
- bay muzayadah is
allowed
Constructed upon the
principle of brotherhood
and cooperation

Conceptual Balance Sheet of an IFI

Commercial
Bank

Assets

Liabilities

Trade Finance
(Mudarabah/ BBA)

Custodial Services
(Amanah/Wadiah)

Asset-backed
Securities
(Ijarah/Salam/Istisna)

Investment
Bank

Fund Management
(Mudarabah/ Special
Mudarabah/Musyarakah)
Fee-based Services/
Advisory
(Wakalah/Jualah/
Kafalah)

Commercial
Bank

Deposits/Investments
(Mudarabah/ Wakalah)
Fund Management/
Private Equity Venture
Capital
(Special Mudarabah/
Musyarakah)
Capital Owners Equity
(Musyarakah)

Investment
Bank

Pyramid of Maslahah
(in the context of Social Responsibility)

Assumptions:
The fulfiment
of organizational
objectives is based
(The
Embellishment)
upon the principles of continuous improvement and
sharpening of the edge

(The Complementary)

(The Necessity)

The Necessity Level

1st
The Necessity

Protect the welfare or basic needs of their employees such as

providing adequate prayer rooms and protecting the employees
safety and health in the workplace, thus reflecting the
safeguarding of the faith and values of life respectively.
Must confine their business operations to those that safeguard
the values of religion, life, intellect, posterity and property.
Accordingly, corporations have a moral and social responsibility to
avoid any business activities, albeit higher profits, which may
cause disruption and chaos to the societys lives. The examples
include business activities which can endanger the lives and
disruption of peoples intellect as a result of environmental
degradation, and the manufacturing of illicit drugs for public
consumption

Interests of lives which people essentially depend upon comprising the five maslahah
(faith, life, intellect, posterity and wealth). These are absolutely necessary for the proper
functioning of religious and mundane affairs of individuals, such that their absence will
precipitate chaos and collapse of normal order in society. Within the scope of the
essentials, managers are expected to strive for the preservation and protection of the
essential needs (religion, life, intellect, posterity and property) of their stakeholders and
public interests in general.

The Complementary
Level

2nd

Complementary

Eg. managers who have fulfilled their essentials level may

want to further extend their social responsibility commitment.
In this instance, the essential needs of employees such as
fair pay and a safe workplace can be further extended to
include continuous training and enhancing human quality
programmes. The latter is not really essential in the sense
that if managers neglect this kind of commitment, it will not
pose a severe destruction to the employees. However, if the
managers assume such a responsibility it is a fulfillment of
the complementary interest that will advance the intellectual
well-being (knowledge and skills) of the workers

As soon as the scope within the essentials has been fulfilled, the
corporations may strive for the second level, the complementary (hjiyyat)
which is deemed beneficial to remove difficulties, even though it may not
pose a threat to the very survival of normal order

The Embellishment
Level
3rd
Embellishment

Involving in charity or giving donations to the poor

and needy; providing scholarships to the less
fortunate students and providing sufficient, correct
and clear information or advertisement regarding
products offered to customers are some of the
examples of Corporate Social Responsibility (CSR)
commitment with respect to achieving the
embellishments for society

Embellishment refer to interests whose realization leads to perfection and

beautification of human affairs and conduct of life. Within the ambit of the
embellishments, the corporations are expected to discharge their social
responsibilities by engaging in activities or programmes that may lead to
improvements and attainments of perfections of public life conditions.

To repel a public harm a

private damage is preferred

Severe damage is avoided by

a lighter damage

Harm is put to an end

Islamic Legal Maxim

as a Framework to
Manage CSR

Harm must not be

sustained

Harm is repelled as far as

possible

Do not Inflict Harm nor reciprocate harm

Harm cannot put to an

end to by its like

The repealing of harm is

preferred to the
attainments of benefits

Shariah principles on Islamic financial planning

1.

4.

Prohibition of riba (usury)

2.

Avoidance of gharar (ambiguity)

3.

Prohibition of maisir (gambling)

Forbidding of non permissible transactions

41

Retirement fund need

En Johari, age 30 years is currently earning RM 20,000 per
month (RM 240,000 p.yr) .He plans to retire at 55 years. He estimated
that his retirement income needed for the first year is 90% of his
last drawn salary.
Assuming that his salary increment grows at 5% p.a.
Compute the amount needed upon retirement ?

42

Retirement fund need

En Johari, age 30 years is currently earning RM 20,000 per
month (RM 240,000 p.yr) .He plans to retire at 55 years. He estimated
that his retirement income needed for the first year is 90% of his
last drawn salary.
Assuming that his salary increment grows at 5% p.a.
Compute the amount needed upon retirement ?
Present value (PV) = - RM 240,000
Profit rate (i) = 5%
Tenure (n) = 25 years (55 years-30years)
Future value (FV) = RM 812,725.18 x 90% = RM 731,452.66
43

Children education plan

Mr. Kelvin has a daughter whose education plan requires
RM 500,000 to finance her tertiary education 10 years from
today.

He has set as set aside RM 200,000 for this purpose. He wants to

know the rate of return on investment (ROI) that is required over
10 years that will enable him to meet his financial goal.
Compute the ROI ?

44

Children education plan

Mr. Kelvin has a daughter whose education plan requires
RM 500,000 to finance her tertiary education 10 years from
today.

He has set as set aside RM 200,000 for this purpose. He wants to

know the rate of return on investment (ROI) that is required over
10 years that will enable him to meet his financial goal.
Compute the ROI ?
Present value (PV) = - RM 200,000
Tenure (n) = 10 years
Future value (FV) = RM 500,000
Profit rate (i) = 9.6 % p.a

45

Purchase of property (fixed rate)

Puan Sharifah wish to purchase a completed house costing
RM 200,000
She paid 10% down payment and signed the Sale and Purchase
Agreement with the vendor
Compute her monthly installment if the bank charge her 10% p.a
profit rate for 20 years tenure under BBA financing ?
What is the banks selling price ?
What is its profit margin ?
Is there an alternative financing ?

46

BBA Financing Model

(No Iwad /Bai Inah-hilah/No transfer of pty. as no possesn.)

(3) Bank buys the house from the

customer and resells it to him/her
plus banks profit (cost plus margin)
RM180,000 + RM236,889.60
= RM 416,889.60*

Bank
(seller)

(2) Customer
seeks 90%
financing i.e.
RM180,000

* RM

180,000 @ (10% p.a profit rate) for 20 years

= RM 1,737.04 per mth X 240 months

(4) Customer pays to

the bank the selling
price of RM 416,889.60
by monthly installments
of RM 1,737.04

Developer

Customer
(buyer)

(1) Cost of house

RM 200,000.Customer
pays 10% (RM 20,000)
to purchase the house
from developer.

** Profit of RM 236 ,889.60 is capitalized in the selling price of RM 416,889.60

% profit = RM 236,889.60 (Profit) / RM 180,000 (COF) = 132 %

47

The formula for computing monthly installment for BBA Home financing is the same as
conventional home financing i.e. by means of present value of annuities as indicated below
i.e. Example if financing amount is RM 180,000. Profit rate is (10% APR ) Tenure for 20 years,
the detail computation will be as follows:Computed using the standard formula for present value of annuities, i.e.

PV

Pmt
1
1
i
(1 i) n

which gives
Pmt

i (1 i ) n PV
(1 i ) n 1

Hence,

Present value (PV)

Annual Percentage Rate (APR) - i
Tenure (n)
Monthly installments

=
=
=
=

RM 180,000
10 p.a
240 months (20 years)
RM 1,737.04 per month.
48

Customers share
RM 20,000
(10%) (ii)

Customers
equity increases
by RM 389.58

Financiers
share
RM 180,000
(90%) (ii)

(i) Customer and Bank jointly

invest RM 200,000 to purchase
the house

Diminishing Partnership
using variable rental rate
Monthly rental
payment RM 1,289.58
(iii)

Actual rental
RM 1,000
Share purchase
RM 289.58

Banks equity
reduces
by RM 389.58

Customers Profit
RM 100 (10%)
Amt. used to redeem
share
Banks Profit
RM 900 (90%)
based on actual
rental value

Customer buys back share

at par value
value RM 289.58

RM 100 (customers share of rental ) + RM 289.58 (additional

redemption sum) = RM 389.58 will be used to buy banks share.

49

Payment Schedule for Diminishing Partnership Home Financing Model

Month/ Monthly/ Additional /Total Payment/ Customers/ Rental Division/
Rental Contribution
ratio(%). Customer- Bank

0
1
2
3
4
5
6
---240

A
1,000
1,000
1,000
1,000
1,000
1,000
-----1,000

B
C= A+B
289.58
1,289.58
289.58
1,289.58
289.58
1,289.58
289.58
1,289.58
289.58
1,289.58
289.58
1,289.58
---------------289.58
1,289.58
Total RM 309,499.20

D
10.000
10.195
10.391
10.587
10.785
10.984
11.183
-------100.00

Rental Distribution
E-1 (Customers) = RM 20,000 X 1,000 =
200,000
E-2 (Customers)

= RM 20,389.6 X 1,000 =
200,000

Equity Sharing
G-1 = Customers Equity
H-1 = Banks Equity

=
=

100.00* 900.00
101.95** 898.05
103.91
896.09
105.87
894.13
107.85
892.15
109.84
890.16
---------- ----------993.59
6.41

Customer s/
Equity

Banks /
Banks
Equity
Cash Flow

G
H
20,000.0
180,000.0 (180,000)
20,389.6
179,610.4 1,289.58
20,781.1
179,218.9 1,289.58
21,174.9
178,825.1 1,289.58
21,570.0
178,430.0 1,289.58
21,967.5
178,032.5 1,289.58
22,366.9
177,633.1 1,289.58
----------------------- ---------200, 000.0
0
1,289.58
Rental rate = 6%

RM 100.00* -- F-1 (Banks) RM 180,000 X 1,000 = RM 900

200,000
RM 101.95** - F-2 (Banks) RM 179, 610.4 X 1,000 = RM 898.05
200,000

RM 20,000 + RM 100 + RM 289.58 = RM 20,389.60

RM 200,000 RM 20,389.6
= RM 179,610.40

Rental rate - IRR 6 % = RM 1,000 x12 / RM 200,000

RM 289.58 = 0.005 (200,000-(1.005)240 x 20,000

(1.005) 240 - 1

50

Definition Financial Planning ?

Personal financial planning can be defined as

(i)

the development and implementation of a plan of action

to efficiently make the most of available resources to meet your

financial objectives or goals

(ii) the process of determining whether and how an individual

can meet life goals through proper management of financial
resources

51

Total Financial Planning

There 4 components to total financial planning
1. Financial Independence
2. Accumulation
3. Protection
4. Distribution

Financial Independence
It involves a plan for medium - to- long term
investment, with the sole purpose of creating
earnings which will support you/your family to
continue living the current lifestyle or lives the
desired lifestyle, when you decide not to work
anymore

Accumulation
It involves short-to-medium term savings or
investment for a planned expenditure in the
future.

It is about creating funds in advance for

purposes such as vacation, deposits/down
payments for car or house, childrens
education, renovation etc.

Protection
Protection is about risk management or
insurance planning. There are many kinds of
risks that can affect you life and cost you a
fortune e.g. untimely death, disability, terminal
illnesses, fire, flood.
Insurance can be used as a vehicle of
protection to protect your dependents from
financial losses

Distribution
Distribution is about estate planning.
It is a lifelong process of evaluating ones
financial position and plans which involve the
accumulation, preservation and distribution of
assets to ensure that they
reach the beneficiaries according to the
desired proportion.

What are your financial goals ?

Although this question may be personal, it can be predicted
based on the stage of ones life cycle. i.e. how it affect
you and your family members i.e.

Young (20s 30s)

1.
2.
3.

4.

Mid-life ( 40s)

Pre-retirement (50s)

Retirement (6Os)

Can we predict ones financial needs based on the above life

cycle ?

Re: BHLB CD on products

57

We can plan to achieve our personal financial

goals ?
There are five basic steps:1.

Set your priorities and establish your goals

2.
3.

4.
5.

Look at what you have

Protect what you already have

Increase and grow what you have and wants in future

Put it all together and do an annual review whether
you have achieved your set goals

58

Case Study- 1 : Refer to pg 10 of yr. notes

Jason Chee financial goals as at 1.1.03

Age: 38 years Salary: RM 5,000

1.

Increase income by 10 % p.a RM 12,000 annual increment

by 31.12. 2003 (High priority)

2.

Education fund for two children RM 60,000 by 31.12.2017

(High priority)
3.

Freehold terrace house- RM 200,000 by 31.12.2013

(Medium priority)

4. Annual vacation RM 10,000 by 31.12.03 (Low priority)

59

Case Study 2- refer to pg 11 of your notes

Analysis of Personal Financial Statement

Encik Husni Lim (Overview of B/S)

1.
2.

Analysis of personal Balance Sheet (Table 2.1)

Analysis of Income and Expenditure Statement Table 2.3)

Why we need to analyze the above statements ?

(I) Measure his present financial standing
(ii) Compare his current financial position with his desired goals
(iii) Keep track changes in En Husni Lims financial position
overtime
60

Case Study: 2

Analysis of Personal Financial Statement

Encik Husni Lim
In order to understand Encik Husni Lims financial position,
compute the following financial ratios
(i)

Solvency ratio = Net worth/Total assets (B/S)

(ii) Liquidity ratio = Liquid assets/Current Liabilities (B/S)

(iii) Savings ratio = Cash Surplus/Income (I/S)
(iv) Debt service ratio = Loan payments/Income (I/S)

(v) Gearing ratio = Long-term liabilities/Total assets (B/S)

61

Case Study: 2

Analysis of Personal Financial Statement

Encik Husni Lim
Compute the following ratios and give your comments on the
Balance sheet:(i) Solvency ratio = Net worth/Total assets

626,000/1,367,000 = 0.46
SOR is the ratio of your personal net worth to your total assets.
The higher the ratio, the stronger is your financial position. As
you reach your retirement age, the solvency ratio should
ideally converge to 1.0 i.e. you are debt-free
62

Case Study: 2

Analysis of Personal Financial Statement

Encik Husni Lim
Compute the following ratios and give your comments on the
Balance sheet:(ii) Liquidity ratio = Liquid assets/Current Liabilities

5,000/1,000 = 5.0
L.R measure your ability to pay off the short-term liabilities. It
should be above 1.0. It is advisable to maintain 3-6 months
of your salary in a emergency fund to tide over unforeseen
events
63

Case Study: 2

Analysis of Personal Financial Statement

Encik Husni Lim

Compute the following financial ratios and comments on the

Balance sheet
(v) Gearing ratio = Long-term liabilities/Total assets

740,000/1,367,000 = 0.54
G.R measures how much leverage you have undertaken to
acquire your assets. The higher the G.R, the higher the
probability of bankruptcy.

64

Case Study: 2

Analysis of Personal Financial Statement

Encik Husni Lim (Overview of I.S)

Compute on the following ratios and comments on the Income

Statement:(iii) Savings ratio = Cash Surplus/Income

6,500/55,600 = 0.12
SAR measures the proportion of your income saved in a year.
A positive savings ratio indicates that you are saving while a
negative savings ratio indicates that you are overspending.
You may encounter negative ratio due to big-ticket
purchases. However, you have to manage your personal
finance well and remain positive in most years

65

Case Study: 2

Analysis of Personal Financial Statement

Encik Husni Lim

Compute on the following ratios and comments on the Income

Statement:iv) Debt service ratio = Loan Payments/Income

(12,000 + 5,000)/55,600 = 0.31

DSR measures your ability to service loan payments in a prompt
and timely manner. A ratio larger than 0.4 indicates that
your are too highly leveraged and you may encounter
difficulties in servicing your loan obligation in future
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Purpose of Personal
Financial Statements
Report your current financial position in relation to

the value of the items you own and the amounts you
owe.
Measure your progress toward your financial goals.
Maintain information on your financial activities.
Provide data you can use when preparing tax forms
or applying for credit.

3-10

Components of a Balance Sheet

(net worth statement)

Assets - what you own.

Liquid assets.
Real estate.
Personal possessions.
Investment assets.
Liabilities - what you owe
Current liabilities (< 1 year).
Long term liabilities.
Compute your net worth.
Assets minus liabilities.

3-11

Where Did Your Money Go? Components of a Cash Flow

Statement

Shows inflow, outflow for a given time period.

Record inflow.
Net income from employment.
Savings and investment income.
Other sources.
Record cash outflows.
Fixed and variable expenses.
Net cash flow can be a surplus or a deficit.
Use this statement as a basis for creating a
spending, saving and investment plan.
3-12

Ratios for Evaluating Financial

Progress
Debt ratio = total liabilities/net worth; compares debt to
net worth; lower debt ratio is best
Current ratio liquid assets/current liabilities; shows
how well short term assets cover short term debt; higher
ratio is good
Liquidity ratio = liquid assets/monthly expenses; shows
# of months that living expenses can be paid; higher ratio
is good
Debt payments ratio = monthly credit payments/takehome pay; try to keep ratio below 20%
Savings ratio = monthly savings/gross income;
Americans tend to be poor savers; shoot for at least 10%

3-13

Purposes of a Budget
In contrast to cash flow, which was a record of
how you spent money in a past time period, a
budget is a plan for spending in the future, such
as for the next month. A budget helps you

Live within your income.

Spend your money wisely.
Reach your financial goals.
Prepare for financial emergencies.
Develop wise financial management habits.

3-14

Creating and Implementing a Budget

Assessing your current situation.

Measure your current financial position.
Determine your needs, values and life situation.

Steps in the budgeting process.

Set financial goals.
Estimate income from all sources.
Budget amount for an emergency fund, periodic
expenses and financial goals.
4 Budget set amounts that you are obligated to pay.
These are your fixed expenses. BE SURE TO
1
2
3

BUDGET FOR SAVINGS.

3-15

Creating and Implementing a Budget

Steps in the budgeting process (continued).

5 Estimate amounts that are to be spent for household and
living expenses. These are your variable expenses.
6 Record actual amounts for inflows and outflows,
comparing actual amounts with budgeted amounts to
determine variances.
Deficits and surpluses.
7 Review your spending and savings
patterns and evaluate whether
revisions are needed in your
savings and spending plans.
3-16

Characteristics of Successful Budgeting

Well planned.

Realistic.
Flexible.
Clearly communicated.

3-17

Selecting a Budgeting System

1) Mental budget it is all in your head
2) Physical budget-use envelopes for
your expenses such as food, rent.
3) Written budget use spreadsheets
4) Computerized budget use
software such as Quicken
(www.quicken.com)
3-18

Saving to Achieve Financial Goals

Common reasoning for saving include

To set aside money for irregular and unexpected
expenses.
To pay for the replacement of expensive items, such as
cars or a down payment on a house.
To buy special items like recreational equipment or to
pay for a vacation.
To provide for long-term expenses such as retirement or
the education of children.
To earn income from the interest on savings for use in
paying living expenses.

3-19

Savings Techniques-If I dont see it, I

wont spend it
Payroll deductions into saving accounts
Automatic payments from checking into
savings accounts or mutual funds
Saving regularly in 401(k) plans
Also save coins, make periodic deposits
Write a check each payday as a % of
income and deposit into savings
3-20

Money Management & Achieving

Financial Goals
Balance Sheet reports current financial position
Cash Flow Statement shows cash you have
received and spent in the past
Budget helps you to spend and save to achieve
financial goals

3-21

Assignments

Prepare a balance sheet for yourself

Prepare a cash flow statement for last month
Prepare a monthly budget
Monitor the budget and show variances

3-22

Re: CD by Elaine Bedel & Maybak IW Mgt strategy

Case study

80