Imagine on your next vacation, you are planning to drive to a location where you have never been. Your destination is on the other side of the country. After packing the car, you simply get in and drive off into the unknown, expecting to arrive at your vacation destination in two days. Eventually, you realize that something seems to be wrong. You've been driving for two days, but you haven't arrived yet. You think to yourself, "Surely it must be just ahead," and continue driving. A full day later, you're getting quite concerned. Not only have you not arrived at your destination, but now you have absolutely no idea where you are. Finally, you stop and ask at a gas station and find out that you've actually been driving in a large circle and are only 100 miles from where you started out on your journey.

Sounds crazy, doesn't it? Of course, if you were going to travel to a place where you had never been, you would most likely begin by determining how to get there. You would consult some maps—perhaps MapQuest or Google Maps— and maybe ask questions of others who had been there. You might even use a GPS, or possibly even check with a travel agent prior to setting out on your vacation. In taking these steps before you left home, you would not only have a good idea how to begin your journey, but you would have the means to doublecheck yourself. Using the maps and the GPS, you would be able to gauge your progress and make any course corrections necessary along the way. If you had to detour because of roadwork or other hazards, you could use these tools to help you get back on track. Even if travel emergencies caused a delay, you could confidently continue your trip because you had planned well, planned in advance, and had the necessary tools to guide you on your way. In the first scenario, you likely would have returned home extremely frustrated after wasting your vacation. However, in the second, you would have accomplished your goal and had a wonderful trip.

People need to have personal financial statements for the same reason that a traveler needs to formulate plans and use maps. Without some way to monitor progress, a person has no way of knowing whether he or she is making real progress toward achieving financial goals. When the (almost) inevitable setbacks come, there must be a way to reevaluate and get back on track. In terms of financial goals, the "maps" are financial statements. The three basic financial statements used in financial planning are the statement of financial position (balance sheet), the cash flow statement, and the budget (pro forma cash flow statement). "Pro forma" refers to a presentation of data where certain amounts are projected. For example, a pro forma statement of financial position might show a debt payment that is assumed, but has not yet been incurred.

Cash flow management, too, is a concern for everyone. It seems that many people have "too much month left at the end of the money." The way to avoid this situation—and there are no exceptions—is to spend less than you earn. This solution probably sounds a bit simplistic, and to some extent, it is. However, the truth is that most people will have situations arise to cause them, at least temporarily, to spend more than they earn.

How do people get the money they need when it is not available (or not advisable) to take it from existing personal resources? They borrow the money. Throughout history, people have used debt in various forms to achieve their financial objectives. While the abuse of debt can get a person into serious financial trouble, prudent use of debt—or leveraging—can be a significant aid in accomplishing financial objectives.

This module examines the construction and uses of personal financial statements, the elements of two of the financial statements, and the use of the statements to help analyze a client's financial situation. The module continues with the topic of cash flow management, with an emphasis on sensible and practical debt usage. Specifically, it covers the appropriate uses of debt, some of the problems associated with using debt, and the various types of debt. Students will also investigate what, under a range of conditions, constitutes acceptable levels of debt, what remedies there are to relieve misuses of debt, as well as some of the legislation relating to consumer credit. The module also addresses the question and a comparison of buying versus leasing as a means of acquiring assets. Finally, it covers the both the uses and the creation of a budget.

About the Author

Michael Angell, CFP®, EA is an associate professor at the College for Financial Planning. He obtained his bachelor's degree in mathematics at Creighton University. His 20+ years of work experience includes banking, insurance, investments, retirement, and estate planning. In addition to his responsibilities at the College, Michael also serves as a private client services advisor with an independent investment firm and is also a federally licensed tax practitioner with a nationally recognized company. You can contact him at michael.angell@cffp.edu.

Complexity Level: Overview