Friday, October 14, 2011

What is Personal Financial Planning?

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The Financial Planning Process

1. What is Personal Financial Planning?

Personal Financial Planning is the process that enables us to achieve our life goals and protect our future welfare, through the effective management of finances, and implementation of risk protection policies.

Setting goals crystallises our thinking. It gives tangibility and reality to our dreams (e.g. owning a home, comfortable retirement, children’s education, travel or personal goals), and our vision of how our lives will be (e.g. standard of living, welfare and lifestyle). A plan significantly enhances our chances of achieving our goals. The planning process ensures that our goals are prioritised, are in line with our values, and achievable within appropriate time frames. It also helps us anticipate and provide for life events that may put our goals at risk (e.g. unemployment, ill heath, trauma or death).

Progress with the plan should be reviewed regularly, and also when there are significant changes to either our personal circumstances (e.g. marriage, birth, separation, or employment) or the financial environment (e.g. taxation, inflation, financial market performance, or government funding and regulation).

A plan should address the areas of day-to day cash management (e.g. bank facilities), debt reduction, risk protection (insurances), savings and investment, retirement, asset protection and estate planning (wills and trusts).

Once we have decided to establish a financial plan we should seek advice from a professional financial adviser, such as a qualified Financial Planner. A good planner will help us ensure that the process is conducted thoroughly, and using broad experience and knowledge set a workable plan and advise us in detail on how to meet our financial goals. The Financial Planners and Investment Advisors Association recommend that a six-step process be followed establish present position, identify objectives (personal and financial), analyse the information gathered and recommend solutions (plan), communicate those solutions (the plan), implement the plan, and monitor and review the plan. We should add to this the need to revise and replace goals as personal circumstances change.

By implementing a Personal Financial Plan, we increase the chances of achieving our life goals, and of enhancing and protecting our welfare, and our quality of life.

2. Explain the personal financial statements which must be prepared to provide a set of information about a person’s financial circumstances.

In the personal financial planning process, personal financial statements help us to know where we stand now, develop our plan and monitor our progress.

The two types of financial statements which have which are essential to the process are

· the balance sheet and

· the income and expenditure statement.

Our balance sheet summarises our current financial position on the day it is drawn up. It is sometimes known as our statement of financial position.

On the balance sheet, we list the values of our assets and liabilities. Our assets are the items we own, whilst our liabilities are what we owe other people.

Note that assets should recorded at their current fair market value and should be included regardless of whether the purchase has been financed and there is still an amount due.

It is useful to group assets in four broad categories, reflecting their underlying characteristics, for example

Liquid assets (can be converted quickly with little or no loss in value)

Cash on hand and in bank

Savings account

Bank term deposits 1 month

Financial investments ( owned to provide a return)

Bank deposits 1 month

Government bonds, corporate debt and capital notes

Finance company debentures and deposits

Shares and managed funds

Value of any business owned

Rental property

Life insurance surrender values

Value of retirement schemes

Collectables (stamps, coins, antiques, etc)



Holiday home



Household contents and jewelry

Liabilities can similarly be grouped as follows

Current liabilities



Utilities, insurances, medical providers and other suppliers

Trades people

Family members

Credit cards

Bank overdraft

Other bank facilities due 1 month

Non-current liabilities

Home loan

Other property loans

Hire purchase

Other bank and credit facilities due 1 month

The difference between the sum total of our assets and our liabilities is Net Worth, which is summarises our current wealth, and is a good tool for monitoring progress with financial plan.

Our income and expenditure statements record all our sources of income and the ways in which we spend our money, usually over a 1-month period.

Income sources include:

Salaries and wages

Commissions and bonuses

Self-employment income

Private superannuation

Employer superannuation

Government superannuation

Interest and dividends

Sales of securities

Social welfare payments and other government support

Ex-partner maintenance




Insurance claims

Expenditure can include


Mortgage payments

Other loan payments


Household repairs and maintenance

Cleaner, lawncare and gardener

Groceries, alcohol etc

Dining out

Medical bills (doctor, dentist, specialist, pharmacist)

and medical insurance

Petrol and oil

Car maintenance, repairs and tyres

Power, gas, water


Insurances (car, home, contents, etc)

Appliance or furniture repairs and purchases

Tuition fees




As with liabilities, it is useful to group expenditures into categories, such as housing, health, food, clothing, utilities, insurance, recreation, repairs and maintenance, vehicles, etc. This then enables us to compare our expenditure under these categories against other households, and against changes we wish to make. It can help us identify areas which require attention.

The net difference between our total income and expenditure is our net cashflow.

The income and expenditure statement can form the basis of preparing a personal budget, which is another very useful financial planning tool.

3. Give four ratios which in their various ways provide useful information for evaluating a person’s individual set of financial circumstances.

Ratios analysis is a way of tracking our financial progress over time.

Balance sheet ratios

1. Solvency ratio = Total net worth/Total assets

When we evaluate our balance sheet we should be most concerned with our net worth at any time. We use the solvency ratio to measure our risk of insolvency (=negative net worth), and how much of a cushion we have against this.

If we have a solvency ratio of 0.50 or 50% we know that our assets would have to decline in value by 50% for to become insolvent.

2. Liquidity ratio = Liquid assets/Total current debts

Current debts include current bills, and loan, credit card and HP repayments due within 1 months.

A liquidity ratio of 0.0 or 0 % tells us that we can cover just over two months of amounts due within twelve months.

Income and expenditure statement ratios

Our focus here is on our cash surplus (or deficit).

3. Savings ratio = Cash surplus/Income after taxes

We can compare this ratios with national averages and against a target ratio set in our plan.

4. Debt service ration = Total monthly loan payments/Monthly gross(pre-tax income)

This ratio enables us to ensure that we can comfortably service our loan commitments. We can monitor this against expedient limits and against targets we set in our plan.


Gitman, L.J. & Joehnk, M.D. Personal Financial Planning. (8th ed). Fort Worth USA. Dryden Press. pp. 56-10.

Anon. Fundamentals of Investment Planning. Chapter One, Florida State University online course FP101. Retrieved March 16, 2000 from the World Wide Web http//

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