Mapping Out Your Financial Future
by
Charles Lamson
Operating without a budget is like traveling through an unfamiliar state without a road map. On your journey to financial security, you need navigational tools to guide you to your destination: the fulfillment of your financial goals. Financial plans, financial statements, and budgets provide direction by helping you work toward specific financial goals. Financial plans are the road maps that show you the way, whereas personal financial statements let you know where you stand financially. Budgets, detailed short-term financial forecasts that compare estimated income with estimated expenses, allow you to monitor and control expenses and purchases consistent with your financial plans. All these are essential to sound personal financial management and the achievement of goals. They provide control by bringing the various dimensions of your personal financial affairs into focus.
The Role of Financial Statements in Financial Planning
Before you can set realistic goals, develop your financial plans, and effectively manage your money, you must take stock of your current financial situation. You also need tools to monitor your progress. Personal financial statements are planning tools that provide an up-to-date evaluation of your financial well-being, help you identify potential financial problems, and, in general, help you make better informed financial decisions. They measure your financial condition so you can establish realistic financial goals and evaluate your progress toward those goals. Knowing how to prepare and interpret personal financial statements is therefore a cornerstone of personal financial planning.
Two types of personal financial statements---the balance sheet and income and expense statement---are essential to developing and monitoring personal financial plans. They show your financial position as it actually exists and report on financial transactions that have really occurred.
The balance sheet describes your financial position---the assets you hold, less the debts you owe, equal your net worth (general level of wealth)---at a given point in time. It helps you track the progress you are making in building up your assets and reducing your debt.
In contrast, the income and expense statement measures financial performance over time. It tracks income earned, as well as expenses made, during a given period (usually a month or a year). You use it to compare your actual expenses and purchases with the amounts budgeted and then make the necessary changes to correct discrepancies between the actual and budgeted amounts. The information helps you control your future expenses and purchases so you will have the funds needed to carry out your financial plans.
Budgets, another type of financial report, are forward looking. Because they are based on expected income and expenses, budgets allow you to monitor and control spending.
Exhibit 1 summarizes the various financial statements and reports and their relationship to each other in the personal financial planning process. Note that financial plans provide direction to annual budgets. Budgets directly affect your balance sheet and income and expense statement. As you move from plans to budgets to actual statements, you can compare your actual results with your plans. This will show you how well you are meeting your financial goals and staying within your budget. Subsequent posts take a detailed look at preparing and evaluating basic personal financial statements.
*SOURCE: PERSONAL FINANCIAL PLANNING, 10TH ED., 2005, LAWRENCE J. GITMAN, MICHAEL D. JOEHNK, PGS. 42-43*
END
|
No comments:
Post a Comment