LECTURE 2

MANAGING PERSONAL FINANCIAL STATEMENTS

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LEARNING OUTCOMES
At the end of this chapter, you should be able to:
• Explain how prudent money management is performed.
• Prepare meaningful budgets, cash flow and net worth statements
• Calculate and analyze personal financial ratios.
• Apply the time value of money concepts in financial planning.
• Discuss other factors that needs to be considered in money management.
 Introduction to Money Management

• Money management comprises daily financial decisions, plans and activities

that are required to manage personal economic resources to achieve long-
term financial goals.

• This process includes maintaining a proper personal record system,

preparation of a personal cash flow and net worth statements and creating a
proper personal budgeting system.
The following are some basic principles and examples that relate to opportunity costs
and trade offs:
• Spending too much money on current living expenses reduces the amount one
can save and invest.
• Saving and investing for the future reduces the amount you can spend now.
• Buying on credit ties up future income.
• Using savings for purchases results in lost interest and depletes savings.
• Comparison shopping can save money but takes up valuable time.

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 Cash Flow Management
• Cash flow management is the process of analyzing, monitoring and organizing your
personal cash flow.

• The personal cash flow statement accounts for cash inflows (income) and outflows
(expenses) to determine whether there would be a cash surplus/(deficit).

• It is important to identify and categorize income and expenses in a personal cash flow
statement to enable better organization, monitoring and control of one’s personal finances.
Thoughts about money

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 Cash Flow Management
Types of Income
• Active
• Income from employment
and/or business activities
• Passive
• Derived from savings,
investments and/or
royalties
Types of Savings
• Emergency savings
• 3 to 6 months of living
expenses
• Planned savings
• Income – Planned Savings
– Expenses = Cash
Surplus/(Deficit)
• Discretionary savings
• Income – Expenses = Cash
Surplus/(Deficit)
• Windfall
• Extraordinary income
Types of Expenses
• Fixed Expenses
• Contractual obligations
• Expenses with constant
amounts every month.
• Variable expenses
• Necessities but amounts are
different every month e.g.
utilities
• Discretionary expenses
• Nice to haves and personal
wants e.g. branded clothing,
entertainment, dining out
 Cash Flow Management
Types of Income
• Active
• Income from employment
and/or business activities
• Passive
• Derived from savings,
investments and/or
royalties
Types of Savings
• Emergency savings
• 3 to 6 months of living
expenses
• Planned savings
• Income – Planned Savings
– Expenses = Cash
Surplus/(Deficit)
• Discretionary savings
• Income – Expenses = Cash
Surplus/(Deficit)
• Windfall
• Extraordinary income
Types of Expenses
• Fixed Expenses
• Contractual obligations
• Expenses with constant
amounts every month.
• Variable expenses
• Necessities but amounts are
different every month e.g.
utilities
• Discretionary expenses
• Nice to haves and personal
wants e.g. branded clothing,
entertainment, dining out
 Cash Flow Management
Types of Income
• Active
• Income from employment
and/or business activities
• Passive
• Derived from savings,
investments and/or
royalties
Types of Savings
• Emergency savings
• 3 to 6 months of living
expenses
• Planned savings
• Income – Planned Savings
– Expenses = Cash
Surplus/(Deficit)
• Discretionary savings
• Income – Expenses = Cash
Surplus/(Deficit)
• Windfall
• Extraordinary income
Types of Expenses
• Fixed Expenses
• Contractual obligations
• Expenses with constant
amounts every month.
• Variable expenses
• Necessities but amounts are
different every month e.g.
utilities
• Discretionary expenses
• Nice to haves and personal
wants e.g. branded clothing,
entertainment, dining out
 The Personal Budget and Cash Flow Statement
• A personal budget is a statement that itemizes the expected income sources
and expected expenses for a period of time, typically a month. However, it
can also be prepared for other time periods e.g. weekly and/or daily
depending on the motivation of the individual. It is prepared before income is
received and expenses are incurred.

• The main objective of a budget is to help the individual plan his/her savings
and spending every step of the way in order to help him/her achieve their
longer term financial goals.

• The cash flow statement is the record of the actual income earned and
expenses incurred for a particular time period. This is commonly prepared
monthly, yearly or both.
 Successful Money Management
Items in Your Home File
o Personal and employment records
o Money management records
o Tax records
o Financial services records
o Credit records
o Consumer purchase & auto records
o Housing records
o Insurance records
o Investment records
o Estate planning and retirement records
Items in the safe deposit box
o Records that would be difficult-to-replace
o Birth, marriage and death certificates, copy of will
o Citizenship and military papers
o Adoption and custody papers
o Serial numbers and photos of valuables
o CDs and credit and banking account numbers
o Mortgage papers and titles
o List of insurance policies
o Annual stock investment statements
o Rare coins and stamps
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 Successful Money Management
Records on your personal computer
o Current and past budgets
o Summary of checks written and other
banking transactions
o Past income tax returns prepared with
tax preparation software
o Account summaries and performance
results of investments
o Computerized versions of wills,
estate plans, and other documents

3-12
Cash Flow Statement for the month ended 31 December 2020 (Updated)
Important concepts of cash flow management:
• Try to reflect on what constitutes one’s real needs and wants. There are some
basic needs such as food, clothing and shelter that everyone requires to live.
However, beyond this, the needs and wants of individuals may differ.

• Conduct research and compare prices before making a purchase especially

for big ticket items and regularly purchased items.

• If the item is not within your budget, consider delaying your purchase until a
later date. Keeping within your budget will help you achieve your financial
masterplan. Do not be distracted by short term spending temptations.
 Examples of needs and wants
Needs – Things we cannot live without Wants – Nice to haves
Basic food Fine dining
Basic Shelter/Home Luxury condominium and/or Resort Bungalow
Basic Clothing Branded fashion clothes and accessories
Transportation – Car/motocycle/public Sports car, Harley Davidson motor-bike,
transport Luxury car
Mobile phone Full featured SMART phone
Computer Advanced full featured specifications
computer that exceeds our daily use
Quality family time Overseas vacation

Source : Adapted from AKPK POWER Programme.

 The Net Worth Statement
• Net Worth = Total Assets – Total Liabilities
• The net worth statement is a snap shot of the difference between the assets and
liabilities at a particular date. In other words, the net worth statement resembles a
personal balance sheet.
Net Worth Statement as at 31 December 2020
 Some important notes when analyzing the net worth statement
• A positive net worth alone does not mean that a person has sufficient financial liquidity.
• There could be high levels of illiquid assets (e.g. Real Property, EPF Balances etc)
• A negative cash flow does not necessarily mean a person is financially doomed –
• Need to consider age and earnings potential of individual
• It is important to distinguish between productive and unproductive assets and liabilities. This Photo by Unknown Author
is licensed under CC BY-SA
• Productive assets are assets that would generate income (active and/or passive) for the holder.
• Properties rented out (where the rental income is more than the mortgage payments) and Investments in
shares in profitable companies and/or unit trusts that generate good dividend income.
• Unproductive assets are those used to support lifestyle wants that do not generate any active or passive
income.
• For example, owning a luxury car for leisure purposes, a holiday bungalow that generates no income or
owning land that is left idle.
• Productive liabilities are loans taken to finance productive asset or activity.
• For example, loans taken to support the working capital or fixed asset of a sustainable business
venture, study loans taken to finance acquisition of skills and knowledge, etc.
• Unproductive liabilities are loans taken to support lifestyle expenses
• For instance credit card debt outstanding incurred to pay for holidays, keep up with fashion/trends and
regular personal entertainment (e.g. clubbing, partying etc).
• There are a lot of people who seem to be prosperous (e.g. drive luxury cars, wear expensive clothes)
but may be living on borrowed funds and possibly negative net worth!
 A person’s net worth can be improved as follows:
• Strive to improve your savings and investments over time.
• A person can do this by having a proper budget and developing the habit of setting aside
regular saving and investments. Indirectly, this helps to convert active income to passive
income and increases personal assets (cash and/or investments) over the long term.

• Cutting down spending on unnecessary items to increase cash surplus.

• Cash surpluses will add to the cash on the net worth statement whereas cash deficits will
reduce the cash holdings.
• One can also increase income streams and cash surpluses by having profitable hobbies
(e.g. writing music, books or art) or productive activities such as having a part-time job
such has being an e-hailing driver or building up passive income through investments.

• Implement proper debt management to reducing your debts. [More in Lecture 3]

This Photo by Unknown Author is licensed
under CC BY-SA-NC
• Selling some of the non-essential and or unproductive assets. Besides this decluttering
exercise may also help us organize our life better and reduce stress.
 Personal Financial Ratios
𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴
• Liquidity Ratio =
𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿

(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠+𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 𝑜𝑜𝑜𝑜 𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚 𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 )

• Savings Ratio = X 100%
𝑁𝑁𝑁𝑁𝑁𝑁 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 ℎ𝑜𝑜𝑜𝑜𝑜𝑜 𝑝𝑝𝑝𝑝𝑝𝑝∗∗

𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 𝑎𝑎𝑎𝑎𝑎𝑎 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐

• Net debt to income ratio =
𝑁𝑁𝑁𝑁𝑁𝑁 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 ℎ𝑜𝑜𝑜𝑜𝑜𝑜 𝑝𝑝𝑝𝑝𝑝𝑝

𝑁𝑁𝑁𝑁𝑁𝑁 𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊
• Solvency Ratio =
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴

𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷

• Gearing Ratio =
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴
 Cash Flow Statement for the month ended 31 December 2020
Net Worth Statement as at 31 December 2020 (Updated)
Actual Budget Difference
Monthly Income
Salary (net EPF, SOCSO and Tax) 4,350 4,500 (150)
Other sources 600 400 200
Total Monthly Income 4,950 4,900
Less :
Savings (10% of monthly income) - (490) 490
Emergency Funds
Income (Net of savings) 4,950 4,410
Less : Fixed Expenses
Car Loan Instalments 650 650 -
Credit Card Oustanding 500 500
Personal Loans
Housing Loan Instalments
Rental 700 700 -
Car Insurance & Road Tax 100 100 -
Total Fixed Expenses 1,950 1,450
Less: Variable Expenses
Food 750 600 150
Telephone Bill 200 150 50
House Utilities (Electricity and Water) 150 100 50
Petrol, parking and toll 500 400 100
Clothing 250 200 50
Household items 600 100 500
Car repairs 300 200 100
Total Variable Expenses 2,750 1,750
Less : Discretionary Expenses
Astro
Internet
Entertainment 150 200 (50)
Wedding gifts 200 - 200
Birthday present for mother 200 - 200
Total Discretionary Expenses 550 200 350
Total Expenses 5,250 3,400
Excess/(Deficit) (300) 1,010
• https://www.akpk.org.my/akpk_faq/?lang=en&loc=faq_list&category=corporate
&topic=fe&sub_topic=borrowing_basics
 Examples of Calculation
- Assume the fixed deposits are renewed on a
monthly basis
(10,357 + 5,532 + 30,444) 46,333
• Liquidity Ratio = = = 4.11 ( Greater than 1) - Assume the Study Loan and Car Loan are
Medium Term Loans due in more than a year
(11,278) 11,278

0−300
• Savings Ratio = X 100 = - 6% ( Not healthy – Should be at least 10%)
4,950

650
• Net debt to income ratio (excluding credit card) = = 0.1313 or 13.13 % (< 40%)
4,950
Note : If the person was only making partial payments on
• Net debt to incomes ratio (including credit card outstanding paid) the credit card, this is not a healthy trend.
(650+500) Note : The is still a large credit card balance outstanding
= = 0.2323 or 23.22% (< 40%) which is already due on the net worth statement.
4,950

𝑁𝑁𝑁𝑁𝑁𝑁 𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊 77,526

• Solvency Ratio = = = 0.5889 = 58.89%
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 131,644

𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 (36,572+ 6,256)

• Gearing Ratio = = = 0.3253 = 32.53%
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 131,644
 Time Value of Money
The time value of money concept is important in personal financial planning as it
can be used to :
• Determine the amount an individual needs to save for his/her retirement nest-
egg.
• Estimate the future value of shares and bonds given a certain yield.
• Calculate the loan instalment payments

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 Concept Formula
Future value of a single amount FV = PV (1+i)n

Future value of an Ordinary Annuity 1+𝑖𝑖 𝑛𝑛 −1

Future Value of an Ordinary Annuity = PMT
[Cash flow at end of period] 𝑖𝑖

Future value of an Annuity Due 1+𝑖𝑖 𝑛𝑛 −1

Future Value of an Annuity Due = PMT x (1+i)
[Cash flow at beginning of period] 𝑖𝑖

Present value of a single amount PV = FV/(1+i)n

Present value of an ordinary annuity 1− 1+𝑖𝑖 −𝑛𝑛

Present Value of an Ordinary Annuity = PMT
𝑖𝑖

Present value of an annuity due Present Value of an Annuity Due

1− 1+𝑖𝑖 −(𝑛𝑛−1)
= PMT + PMT
𝑖𝑖
 Common applications of Time Value of Money
• Retirement Planning
• Estimated life insurance coverage needs
• Determining Housing Loan Instalments
• Bond Calculations
Example : Time Value of Money for retirement
Summary of information
• Current age = 35 Desired retirement age = 55
• Current net take-home pay = RM80,000 per annum
• Target replacement income = 70%
• Salary growth rate = 5%
• Estimated post-retirement inflation rate = 4%
• Average post-retirement rate of return on investment = 6%
• Number of remaining working years = 55-35 = 20 years
• Estimated last drawn salary at 55 years = 80,000 (1+0.05)20 = RM 212,264
• Yearly retirement income needs (PMT) = 212,264 X 70% = RM148,585
• Inflation adjusted rate of return (i) = (6-4)/(1 + 4/100) = 1.9231%
• Retirement period (n) = 80- 55 = 25 years
• Residual value (FV) = 0
• Let’s say : Return = r and Inflation rate = I
• Inflation adjusted return = (1+r)/(1+i) - 1
= [(1+r) –(1+i)]/(1+i)
= (1+r – 1-i)/(1+i)
= (r – i)/(1+i)
 Use the Present Value of Annuity Due formula
−(𝑛𝑛−1)
1 − 1 + 𝑖𝑖
Present Value of an Annuity Due = PMT + PMT
𝑖𝑖

Substitute :
Annual replacement income after retirement (PMT) = 148,585
Number of years in retirement (n) = 80 -55 = 25 years
Inflation adjusted rate of return post-retirement (i) = ((1+0.06)/(1+0.04)) -1 = 1.9231%

Estimation of required retirement savings required at age 55

= (148,585 + (1 – (1+0.019231)- (25-1))/0.019231 = RM2,983,550
 Capital Preservation Method
(Version with stated Legacy Sum)
Same facts except the individual requires a legacy sum upon his/her death .
Let’s say, he/she wants to leave RM300,000 to his next of kin at the age of 80.
 Use the Present Value of Annuity Due formula
−(𝑛𝑛−1)
1 − 1 + 𝑖𝑖
Present Value of an Annuity Due = PMT + PMT + PV of legacy sum
𝑖𝑖

Substitute :
Annual replacement income after retirement (PMT) = 148,585
Number of years in retirement (n) = 80 -55 = 25 years
Inflation adjusted rate of return post-retirement (i) = ((1+0.06)/(1+0.04)) -1 = 1.9231%
FV of legacy sum at age 80 = RM300,000

Estimation of required retirement savings required at age 55

= 148,585 +148,585 (1 – (1+0.019231)- (25-1))/0.019231 + 300,000/(1.09231)25
= RM3,169,891
 Other factors
• Personal Factors – personal backgrounds, preferences and events
• Stage of the life cycle
Early Years Middle Years Nearing Retirement Retirement
(20s to mid-30s) (Mid 30s to late 40s) (Late 40s to mid 50s) (Mid 50s and above)
Financial Goals Getting started Build and invest Consolidation Income and Security
(Financial freedom)
Financial concerns • Building • Family • Retirement planning • Retirement funding
emergency funds commitments • Maximizing investment adequacy
• Savings • Mortgage returns
• Short term • Car loans
obligations • Children’s
Education
• Managing
Investments
• Increasing income
streams
Relative importance of o Cash flow o Insurance o Investment planning
financial plans management planning o Estate planning
o Savings plan o Investment
o Debt management planning
o Investment plan o Tax planning
Other factors
• Financial literacy and individual lifestyle
• Financial awareness versus financial discipline
• Individual lifestyle is influenced by personal values and socialization.

• Macroeconomic and Microeconomic conditions

• Macroeconomic conditions are measured by indicators such as GDP,
unemployment rates, inflation, interest rates, international trade etc. It
measures the overall strength of a nation’s economy.
• Microeconomics is a discipline that explains the behavior of individuals and
firms within an economy. It involves the demand and supply of goods and
services in the economy and taxes which determine the relevant prices.
 Thought for the Day
Spending versus Saving

“Don't save what is left after spending; spend what is left after saving.”

Source : https://ringgitplus.com/en/blog/Household-Budgeting/6-Useful-Tips-For-Better-Budgeting.html
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