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Lesson 5
Read Chapter 3 and then answer in the appropriate place below the following question:
How do you use financial statements to figure out where you are at present and set strategies to reach financial goals?
See here which group you were randomly assigned to and only place your group response in there.
Group 1: Financial statements are crucial elements which represent the current financial situation. All the different kinds like income statements, balance sheets, and cash flow statements allow us to understand if the transactions we make are necessary. In other words, we have to use them accordingly by distinguishing the "perspectives" each of them provides. The financial statements make us more aware of the financial state we are in as well as help show us how we might plan for the future. Displaying the financial situation someone is in through the statements can allow one to understand the demands and resources one has in order to live a comfortable life. Income statements show where the income came from and went; Cashflow statements help us understand the liquidity of our finances and how much residue is remaining after the necessary transactions; Balance sheets can help us understand long and short term financial situations as a whole. Similarly, accounting equation is one principle that we need to keep in mind. It tells us how assets, liabilities, and net worth interact with each other at a glance. As mentioned earlier, all the financial statements are beneficial to analyze current and potentially future situations, making them essential for strategizing and attaining financial goals. For instance, after breaking down finances, it can be understood where most of the money is going or is stored. For example, common sized statements, things like a pie graph showing the percentages of where your expenses are going. Maybe 40% is being taken rent, 20% is being taken by other necessities, now leaving you with only 40% to use freely. It's cleaner to look at and provides some perspective of where it's all going, but also makes it easier to break things into smaller percentages and partition them for future goals, like 15% towards a new car, or 5% for a new laptop. This visualization can give us warnings if our expenses are too much, or if we have room to spend more liberally. It's like a calendar but for money! There are cases like above, when the expenses become to much to sustain and one must take action to balance it back out. If the area where money is being taken can be reduced, that should be the focus to reduce expenses. If not, other avenues and assets should be explored to increase secondary income. Financial statements help us to visualize our spending habits as well as the potential of how our current assets can increase. Using financial statements, expenses can be monitored and controlled, allowing the residual income to increase. Financial statements can also help recognize if there is enough money to begin/maintain alternate income pathways like potential investment opportunities. Hence, financial statements help us figure out where we are by visualizing our cash flow while anticipating the potential future plan, and thus lead to creating practical strategies.
Group 2:
-Understanding current financial situation: Financial statements can help us understand our current situation before making a financial goal. The income statement can show where our income comes from and where we spend it out, so we can see whether we have surplus or a deficit. The cash flow statement can help us understand our liquidity and whether we actually have enough cash after paying living expenses and debts. Moreover, the balance sheet shows our assets, liabilities, and net worth at a specific period of time. We can also use common-size statements and ratio analysis. Common-size statements are useful to compare our financial statements (income statement, cash flow statement, and balance sheet) and analyze whether the strategy is truly effective, because they show each figure as a percentage which makes it easier to see, which expenses, assets or liabilities take a large proportion of our finances. Ratio analysis can also help us understand certain areas such as liquidity and debt. For example, the debt-to-assets ratio shows how much of our debt could be covered by our assets, and the interest coverage ratio shows whether our income is enough to afford the interest we owe.
-Setting strategies to reach financial goals:
If the income statement shows that one expense takes a large percentage of income, people should focus on reducing that expense first. For example, if rent takes a large part of my income, I may consider finding cheaper housing instead of only cutting small expenses. This strategy can help me increase my monthly surplus, so I can save more money toward my financial goals.
If the cash flow statement shows that debt repayment uses a large share of cash, reducing debt should be the top priority. Paying down debt can increase future free cash flow which gives people more money to save or invest. This can help them reach goals such as building an emergency fund, increasing savings or accumulating more assets over time. The balance sheet can confirm whether this debt is really the priority. If it shows that debt is much larger than assets, or that the net worth is low or negative, that debt is more likely to be the main obstacle holding back financial progress.
If the financial statement shows that income or assets depend too much on one source, diversification can be another strategy. For example, people can create another source of income through investment instead of depending only on their salary. They also hold different types of assets instead of putting most of their wealth into one asset. This strategy can reduce financial risk and make it easier to build wealth more steadily toward long-term financial goals. When choosing a strategy, we also need to consider the big picture and the possible consequences of the decision, instead of focusing on only one financial figure.
This can be seen more concretely in a real situation. Using the example of a person earning an income of 1,200 euros a month. After paying rent, utilities, phone bills, the car payment, food, etc., the income statement shows how the person is left with very little to no surplus for savings at the end of the month.
Looking at the cash flow statement, the car payment is probably the biggest expense outside of basic and necessary living costs. And on a simple balance sheet, comparing what's owned (the car, some savings) to what's owed (the rest of the car loan), this person could easily be at zero net worth or even negative, since the car is losing value while they're still paying it off at full price.
The better strategy here is dealing with the car payment rather than cutting small things like food or daily expenses, because it's the biggest cash outflow. This expense is a problem across all three statements at once. It drags down the income statement's surplus, then it dominates the cash flow statement, and it's also the main reason why the net worth is low or negative on the balance sheet. Because a car is usually a depreciating asset, fixing that, whether by paying it off or switching to a cheaper car, would make a bigger difference than cutting smaller costs.
Group 3:
Financial statements can help us check if we are actually making progress towards our financial goals. For example, I can compare my financial statements by months or by years to see if my savings are increasing or my debt is increasing. It can also help me notice if I am spending too much in certain areas or if I am not saving as much as I planned, by doing this I can understand whether my current decisions are helping me reach my long term goals. Moreover If I want to buy something expensive or contribute money for my education, I can look at my income, expenses, savings instead of setting a goal that is difficult to achieve
I agree with what you are writing. Accounting is the process of recording where money comes from and where it goes. It is important for college student today, especially those who earn salary and live on their own. There is three statements in Financial statements, which are income statement, cash flow statement and balance sheet. Cash flow statement is able to see how much liquidity money do you have. That is because this statement shows that operating cash flow, investing cash flow and financing cash flow. If you know about own cash flow statement, you can recognize that how much money you can spent and you are able to manage yourself. This is definitely necessary for people who live by yourself or a breadwinner.
I also think Balance sheet is useful to understand my own current final situation. By recognizing my assets, debts, and net worth, it allows to compare how much I have or owe. For example, if I have a large amount of debts compared to assets, I may focus on repaying my debts before making other economic plan. On the other hand, if my net worth is increasing, I can use some of it for my future goals or save more money. I think this is important because my whole final situation is not always good while I have enough money for using. By looking at net worth can give me a more realistic understanding of where I am financially.By understanding my current financial situation, I can set realistic financial goals and determine what priority should be for archiving the goals. As a university student, I think this can be especially useful because I need to think about future financial situation, even if I do not have a large income. Instead of only thinking how much I can spend now, I can think about what i want my financial situation to look like with financial statements in the future. Therefore, financial statements are not just recording what happened in the past, instead they can provide me skills which change my spending habits when necessary, make better financial situation, and set realistic strategies.
Group 4:
In order to begin the real work of financial management, you have to find and organize all your financial information in as clear and concise a way as possible. The easiest way to do this is to use the industry-standard financial statements to organize your information. However, raw data is meaningless to most people, so you have to explain the relationships of the data on each form to the user's goals or to something that the user will understand or utilize. This is where the Common-Size statements add more value since they show any specific thing you want to look at compared to your income or assets and shows your progress that way.
I also think it is important to look at the three financial statements together rather than relying on only one of them. Each statement shows a different part of our financial situation. The income statement can show whether we have a surplus or deficit and which expenses have the biggest effect on our income. The cash flow statement can show whether we actually have enough cash available after money comes in and goes out. On the other hand, the balance sheet gives us a snapshot of our assets, debts, and net worth at a specific point in time. Looking at all three together can give us a much more accurate picture of where we are financially. For example, I might think that I am doing well financially because I have a surplus and am not spending more than I earn. However, if I look at my cash flow statement and see that a large amount of my cash is going toward debt repayments, I may realize that I do not actually have as much money available for saving or investing as I thought. This shows why looking at only one statement can sometimes give us an incomplete picture. The relationships between the statements can help us understand how one financial decision affects other parts of our financial situation.
However, these tools are much more useful when they are connected to specific financial goals. Therefore, before you can use the comparative statements like Common-Size, you must find what your goals are and how you plan to achieve them so you have data to input into the comparative statements. Then, after you have those statements completed, you can move on to checking to see if their plan works and if their goal, as they currently have it, is possible, or if they need to reconsider how much they put in different places. Once they have finished this analysis of their plans, they can revise the plans as necessary. However, even though you feel like you've finished your plan, planning must be continuous because you should always, periodically, be reevaluating and adjusting your plans and analyzing if you need to adjust. If you don't readjust your plans, when macro or micro factors change, you will be confused why your plans aren't working now when they were when you started.
I 100% agree with the statement that financial statements make so much more sense when they are tied to specific financial goals. As I was reading the chapter, I realized that these statements are not only useful for understanding our current financial situation, but also for making better financial decisions. From my perspective, I would personally use these statements to identify where I can make realistic changes rather than simply deciding where I should spend less or not. The common-size statements from the chapter would really come in handy for me because they allow me to see which expenses take up the largest percentage of my income. In addition to that, I also wanna harp on the point that financial planning needs to be an ongoing process. As my income, expenses, and goals are very likely to change in the future, I would need to make it a habit to review my financial statements regularly and adjust my strategies. This would make things much easier, as I keep making progress toward goals such as saving more money, reducing debt, or increasing my net worth.
Group 5: We can use financial statement to know our current financial situation through income statement, cash flow statement and balance sheet. Income statement helps us see the balance of income and expenses, to figure out if our situation is sustainable. On the other hand, cash flow statement focuses on the movement of cash, where we can understand the liquidity we have. Balance sheet lists our assets, debt and net worth, which is useful to visually understand the current situation.
For example, if our goal is to save for a down payment on a house, having more income than expenses alone does not tell us how much we can set aside. We also need to consider loan repayments and other cash outflows. If the remaining cash is insufficient, we can identify expenses to reduce and see how these changes would increase the amount available for our goal. Comparing our statements over time helps us evaluate whether these decisions bring us closer to our financial goals and adjust our strategies when needed.
Note: Each group will need to have a volunteer to share with everyone early in class which of the five group responses was the best and why.
Note: This lesson is the theme for Mid-Term, due in just a few weeks.