Building Strong Personal Financial Statements By John Robert Maniego, RFP

In Benjamin Graham’s book entitled “The Intelligent Investor”, he summed up by saying that investors should use a “businesslike” approach to investing. Investing in shares is just like owning a business; and that investments must be approached as if one were buying a business. I believe that the author of one of the most famous finance and investment books was right and I believe the same applies to personal finance.

Managing your personal and financial affairs to some extent should be managed like a business simply because it attempts to look for ways to increase the value of your personal life like sending your children to school, purchasing a home, and having food to eat. It involves money. It needs the existence of long term partnerships between married couples, siblings, parents and their children in order to manage emotions and expectations fostering a mutually beneficial living household environment for all. Therefore like all businesses, it is also imperative that households and individuals manage and make household or personal financial statements.

Building personal financial statements is not yet a popular practice in the Philippines. Perhaps individuals forego creating financial statements because they simply think that their current lifestyle does not merit one or probably they are afraid to face the harsh reality of their financial situation. In a personal finance perspective, I think that people put themselves at a financial disadvantage by not creating a personal financial statement. They neglect to see the true financial health situation of their household, families or their lives. They can be deceived by thinking that, financially, everything is all right. They are deceived by thinking their income or savings can cover their current or future lifestyle only to wake up to a shocking reality of piling debt and hungry mouths to feed.

The benefits of creating one’s personal financial statements can be used by people as a progressive, proactive and forward looking decision making tool for the household. Financial statements will be able to show people a clear photographic snap shot of their current financial state realize their weak points and further enhance their strong points. Like in business, it can help people realize that they aren’t saving enough cash to pay for their child’s tuition fee due next month or a retirement happening in a few years. They realize that taking out a loan for an automobile upgrade or swiping a credit card to buy the latest Apple gadget may not be beneficial at this time because interest costs will just eat up future expected earnings to credit card payments.

Financial statements can help you realize other sources of passive income from prospective suitable investments like dividend from stocks; coupon payments from bond investments; capital gains from an increase in property or other fixed assets; indirect tax management benefit from interest payments; or the money earnings you would have lost to inflation if you have just left your savings in a savings account. All these you might never realized if you have never taken the time to make your own financial statements.

Personal financial statements are not very different from business financial statements except that personal financial statements are simple. Here are the steps that you can follow in creating your own personal financial statements.

1.Cash Flow / Income and Expense Statements

In personal finance, this is the most important financial statement that you need. This shows you the sources of monthly income vs. the amount of monthly expenditures that you have. Income sources can be categorized as variable and fixed or passive and salary paid income. Sources of inflows like bonuses, expected salary increases, expected earnings from financial assets should also be included.

On the expense side, monthly expenditures should include tax payments, mortgage payments, groceries, utility bills, savings for contingency funding, credit card payments, tuition fee expenses, etc. As a rue of thumb, be as thorough as possible when listing down your income and expense.

The difference should more or less be a positive value which is savings. Savings should be invested in a suitable financial investment to yield the highest possible yield for its proper risk/use. Usually financial planners project a personal cash flow statement for the next twelve months to be able to see an annual figure of what you need taking into account seasonal/monthly variability of income and expenses.

2.Balance Sheet

Like a business accounting balance sheet, the personal balance sheet should also be made by applying the universal accounting equation of Assets = Liabilities + Equity and categorizing items according to the duration of assets. For married couples, a combined balance sheet will suffice. Assets must be divided into cash items like a contingency fund (equivalent to at least six months living expenses). Next are the financial assets which are composed of mutual fund shares, time deposits, bond investments, receivable income from sole proprietorship business and shares of stocks in a family held corporation, and other shares of stock investment. Financial assets must be recorded using market values. Lastly are the long term assets like home appliances, designer furniture, and precious jewelry, luxury items like paintings & sculptures, family home and other real estate properties.

On the liabilities side, all types of outstanding debt should be included like credit cards, home and automobile mortgages, personal loans, tax payables, advances etc. The difference between personal assets vs. outstanding personal liabilities is your personal net worth. The net worth is basically an indicator of your financial stability. This is where people get deceived. By focusing on assets alone, people get the misconception that they are financially well off, but in reality they are sitting on a pile of debt which will eventually catch up on their income. If most of your assets are funded by debt then I suggest hiring a personal financial planner or start paying off debt to free up cash from interest payments. All ways remember that each person should not be a slave to money. As the popular adage goes, every person must maximize his full potential by letting your money work for you.

Creating one’s personal financial statements is a relatively easy task. For individuals with no accounting background, a financial planner can help do this for you. You just need to be open and supply him or her with all the right financial information. Updating and monitoring at least annually is also a must because personal circumstances change.

On a more personal note, making a personal financial statement will change the very core of your existence for the better. For myself, it showed me the value of how to properly handle my personal finances. I desired less of material possessions; it showed me that happiness is not all about what I can buy but what I have and making the most of it. I learned that true wealth is not in the amount of money that you have, but is in the amount of love, understanding, humility and support that you give people. Creating financial statements will basically give you empowerment; the empowerment to know yourself and have the right attitude. The right attitude that will not only point you toward the right kind of financial freedom, but the right attitude in the way you live your life.

Understanding Financial Statements 101 by John Robert Maniego, RFP

(This article was published in the the October 5, 2010 issue in the Banking and Finance section of Business Mirror Newspaper. )

Everyday the hues of our investment landscape change and this requires financial analysts and market watchers to constantly update themselves on news and data information about companies, trends and sentiments of markets. Sometimes an analyst needs to use a “camera”; take several snap shots of various points in the past and present to make certain assumptions about the future operations and formulate an investment or business decision. These snap shots are basically what you call financial statements.

Financial statements or popularly known as “FS” are official documents used by firms to present the results of business and financial activities for/over a period of time. Individuals can also prepare financial statements for private banker and wealth management use. There are several users of financial statements namely investors, firm managers, stakeholders, journalists, private and wealth managers, consultants etc. Users of financial statements use these as a reportorial and feedback mechanism to make decisions based on fundamental aspects of firms and individuals. Equity investors use financial statements of publicly listed firms to identify market and industry driving firms for long term stock investing. Entrepreneurs and “angel capitalists” look at financial projections and capital budgeting data to see if viable business prospects meet their required return on investments (ROI). Creditors and debt holders use FS to measure repayment capacity. Lastly, individuals use financial statements to find out sources of income and expenditures for proper household and personal wealth management.

Today, the understanding of financial statement has evolved from its old passive accounting purpose towards a more progressive, proactive and forward looking decision making apparatus. To understand financial statements, users must have basic understanding of accounting. Basic accounting principles are definitely cornerstones of financial statements. By knowing basic accounting, financial statement analysis will enable users to putting together a story from the pieces of photographs taken and make assumptions about a firm’s future health and performance.

International Accounting Standards or IAS requires the presentation of four basic financial statements. These are income statement, balance sheet, cash flow and changes to owner’s equity. All these financial statements follow a theoretical framework which is the universal accounting equation: Assets = Liabilities + Equity. This balanced equation tells users that all resources properly mirror your funding sources which are debt and capital. Let’s discuss each financial statement below.

1. Income Statement

The income statement tells us the operational performance of a firm over a period of time. It shows the revenues/profits and expenses/losses of a firm or individual. Revenues are classified as operating and non-operating. This follows for expenditures as well. Tax and interest payments are deducted from the latter to arrive at earnings or net income. Earnings are what concerns analysts, because prolonged earnings growth can signify value to investors and shareholders. The basic equation for the income statement is shown in the illustration below.

2. Balance Sheet

The balance sheet tells you about the “financial health” situation of the firm or individual. It is dictated by accounting standards that a classified balance sheet is prepared. A classified balance sheet subdivides items into categories pertaining to current and long term items (liquidity vs. solvency). An illustration of the balance sheet is shown below.

The illustration shows that the balance sheet classifies liquid items above solvent items. It strictly enforces the universal accounting equation Assets = Liabilities + Equity. Equity includes net income.

Users must know that assets are resources that generate future benefit while liabilities and equities are “money” sources used to fund the acquisition of these assets. The statement of equity is also included in the balance sheet but in some cases a separate statement is also prepared for this.

1. Cash Flow Statements

This statement tells us the sources and uses of cash. Like the balance sheet, the cash flow statement is also classified. It is subdivided according to operating, investing and financing of cash. Take note that this statement operates on the basis of cash as compared to the two previous statements which is based on accruals. To better understand the cash flow statement, I will show you how to derive it through a simple illustration like the previous two statements.

The cash flow statement tells us that net income (including non-cash transactions like depreciation, amortization, and non-operating gains / loss) added to changes in current assets and liabilities arrive at operating cash. Theoretically, the main source of cash for firms should come from internally generated cash. Changes in long term assets results in investing cash, while changes in long term liabilities and equity should give financing cash. Adding these three cash flow categories, we arrive at total cash flows which tell us the total cash generated by the business from its three major areas of undertakings. Cash from operations is used by firms as a tool towards attaining financial leverage and is also the main indicator of cash flow health for firms. Banks look at cash from operations as a deciding factor for lending and repayment capacity. With leverage, firms are able to acquire more earning assets and free up much need cash from internal sources for working capital and dividends payments.

The financial statements are the responsibility of several groups within the firm. It is management’s responsibility that the financial statements are reported based on proper accounting standards and regulations. An external auditor, appointed by the Board of Directors certifies that the firm’s management has exercised its fair judgment and that the financial statements reported are free of any material errors. Lastly, it is the Board of Directors that approves the financial statements for public dissemination.

In conclusion, understanding financial statements is not an easy thing to do. Users, like analysts, must read through an on-going study of official documents to fully understand a firm or individual. Users must also go through processes like data gathering, processing, analyzing and validation of information to create a very clear picture or story of the firm. They must also compare firms vs. industry thru cross-section and trending analysis; and use different kinds of ratios to identify promising firms and isolate industry lagers. Overall, the point of understanding financial statements is to make calculated risky decisions on an investment or business proposition.

How and What of Cash in Business and Personal Finance by JR Maniego, RFP

(This article was published in the July 27, 2010 of the Banking & Finance Section of the Business Mirror Newspaper.)

In troubled financial times, you often hear financial gurus, CEOs of firms, investors and market watchers utter the phrase “Cash is king”. Around the world the 2008 global credit crunch sent small and even huge, too big to fail businesses to their knees begging for their respective sovereigns to lend them tax payer and bail out money to survive. Why is such a simple phrase so important and easy to recall for everyone even for the biggest of companies and most respectable individuals? Basically, this phrase talks about one thing alone, cash flows.

In today’s financial world, cash flows have joined revenue in the hierarchy of financial importance. In business and personal finance, it is now considered one of the more important drivers for growth and value. According to popular economics, cash or money is used in several ways; as a medium of exchange, a unit of account and a store of value. Money has been around for some time and it has evolved through the years in different forms like coins, bills, debit cards, smart cards or gift certificates which all possess the ability to transfer and/or represent value. Despite the increase in financial innovative practices like the use of credit cards, online and electronic payments; money still remains an important building block of our economy. Money still possesses the ability to move markets, control behavior and tilt sentiments. Today, Bangko Sentral ng Pilipinas reported about over a trillion pesos worth of liquidity/cash circulating in the Philippine financial system which has shielded our economy and our financial markets from volatile asset price movements abroad. Countries around the world, for the past several months, has lost almost 11% of value (MSCI All Country Index) yet because of high cash prevalent in our domestic activities, our markets have found a stable floor preventing erratic movements in prices and depressed asset valuations.

Looking at the profile of companies across industries doing better this year are the companies that exhibit high cash items in their balance sheets. Holding and subsidiary firms of the Sys, Ayalas, Pangilinans, Gokongweis and recently even the Lopezes have shown tremendous cash balances and favorable net cash from operations. Even for retail and individual investors, a proper balance of cash relative to other personal assets bring flexibility to the decision making purposes for  personal investing and expenditure management.

Basically, the abundance of cash is an indication of the financial health of a person and a business. And in troubled times, investors and decision makers look to cash as one of the main deciding factors. On a financial perspective, generated cash from operations gives you a peek into the core fundamentals of any entity. It is an eye opener to the “true” financial health. It can help you easily spot conditions of other important financial aspects like profitability, efficiency and financial leverage.

1. Cash can lead to asset and liability efficiency.

It is a source of present and future financial health. It can be used as fuel to meet current and long term needs. Efficiently managed firms can easily payoff costly short term expenditures and direct excess cash flows into earning resources that will give future benefit and value to shareholders. For individuals, a carefully executed household cash management plan can give the family a much needed vacation or a long overdue house renovation.

2. Cash can provide financial leverage.

It is also a financial leverage tool for businesses and individual. Banks, basically, look at cash flows as an indicator of repayment capacity. By having favorable cash results from operations or several sources of personal income, businesses and individuals can borrow money for acquisition purposes and leave internally generated cash to pay off working capital needs, pay dividends and other investment opportunities.

3. Cash, a tax management tool.

It is also an indirect tool for tax management. By being leveraged, interest payments will directly lower your annual taxable income; therefore exhibiting a corruption-free and legal way of paying your right taxes. Kidding aside, may be President Noynoy Aquino should craft favorable banking lending policies for small businesses and in effect help increase tax revenue possibilities to manage the looming budget deficit.

4. Cash is true profits.

Basically, earnings are intangible. It is something a firm or an individual cannot touch.   You cannot go to your vendor or to a mall saying I have millions of profits, please supply me with raw materials or please feed my family 3 times a day. A firm can never realize profitability and stock prices can never soar for long periods if sales are not converted into cash.  Huge firms like of Enron and Sunbeam are among the many firms that turned belly up due to improper revenue manipulation/ practices for the very purpose of hiding low cash flow balances. For individuals, the use of credit cards and spending money you do not have gives an individual a perception of having more money; leaving you with debt.

Cash provides a lot of advantages but hording excessive amounts for periods of time are also a disadvantage. For one, you are subjected to opportunity cost on an alternative investment. Second, you lose to inflation. Rule of thumb is that you hold cash to meet obligations for less than two years; the rest should be properly invested. By holding excessive amounts of cash for more than 2 years, you lose Php 116,400 with a million cash holding.

The pros of holding cash out weight the cons. Firms and individuals need to constantly practice a balancing act of “spending and saving” to realize its full benefit. Always remember that the value that saving provides stops where savings is not spent. So manage your cash wisely, put the right amount in short term deposits, placements, treasury bills and financial products suitable for its intended us; but in excess it is best you invest it somewhere else to realize its full potential.