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FIN2602NOTES
,UNIT 1 Personal financial planning process
Even though individual needs differ, the same steps in the personal financial planning process
applies to all i.e.
Analysing your current/present financial situation
Setting future financial objectives
Preparing a budget/plan for the achievement of such objectives
Steps in Financial planning process
Step 1: Gathering information
Information must be gathered in order to determine your current financial position. Typical
information that will be gathered during this step will include details of family, matrimonial status,
health, income statement and balance sheet, property details, etc. Beside this information listed
before, a person's liquidity preferences, attitude towards risk, political views and views about the
country's economic prospects must also be explored.
Step 2: Identification of objectives and needs
Before a person can decide what they want to achieve, they must consider what is important to
them. The formulation of objectives is a statement by a person of their prospects for their financial
future. Planning therefore centres on objectives and how to achieve them. Objectives should be
linked to specific time periods, the reason being that different objectives can be achieved through
employing different methods:
Immediate or short term objectives: Short term objectives are aspired to in the early stage
of the life cycle and should be very specific. Funds for such objectives are generated from
current income and or savings.
Medium term objectives: These objectives are usually present during the working years and
stretch over the largest part of the life cycle. The achievement of these objectives is a
prerequisite for the achievement of objectives over the long term. Spending patterns could
be adjusted to provide for needs over the medium term.
Long term objectives: These objectives provide the greatest flexibility during planning.
Retirement planning is usually the most important planning component of the last stage of
the life cycle.
It is advisable to list objective in order of importance in order to make a distinction between urgent
and important. Higher priority must be given to important needs because of the negative financial
implications of not being able to meet such objectives.
Step 3: Identification of constraints
We must also be aware of the fact that there will always be external influences or constraints that
have to be taken into account in personal financial planning. These are factors that may restrict or
even be entirely in conflict with the objectives and needs that have been identified.
Step 4: Comparison of current situation with identified needs
Information regarding a person's current situation shows what planning has been done. A
comparison between the current situation and the identified future objectives indicates which needs
have already been provided for and which not i.e. it identifies the "gaps".
,Step 5: Analysis of investment opportunities
Before any decisions are made to meet certain needs, an analysis of existing investment
opportunities is necessary. It is essential to examine the purpose of each alternative as well as the
advantages and disadvantages involved in each.
Step 6: Development of the plan
During this phase, a person must decide which investment will provide for which needs. Needs are
expressed in terms of the risk involved in the occurrence of certain events. Insurance options to
counteract these events or provide for such risks are listed opposite each risk. In order to develop a
plan, a person must choose e.g. an insurance company and decide on the specific amount required
for life cover and the monthly premium they can afford.
Step 7: Balancing the budget
It is of cardinal importance that the budget should balance i.e. the income should be equal to
expenditure plus savings. A surplus or a shortfall indicates that the plan needs further attention.
Step 8: Implementation of the plan
During this phase e.g. the specific insurance policy can be taken out. It is important to note that no
plan can be implemented in the absence of sufficient funds.
Step 9: Review the plan
As with any other plan, personal financial plan cannot be expected to remain the perfect plan and as
such periodic reviews are necessary to ensure that the plan keeps up with changing times and
circumstances. It is recommended that the plan be revised at least once a year.
UNIT 2 Measuring and assessing of personal financial performance
Budget
In its simplest form a budget can be defined as the quantification of a plan in monetary terms. At the
same time, it sets certain standards that have to be met in order to achieve certain objectives. In
other words, it is a mechanism used to exercise financial control. This plan and control mechanism
can benefit any household.
Purpose of a budget
As stated above, a budget is a financial plan for the household over a given period. Budgeting is the
most important step in the personal financial planning process and thus your first step towards
financial success.
Firstly your income and expenditure must be estimated over the given period. This forecasting is
based on the expectations of the compiler regarding his/her future financial situation. The purpose
of a budget, as stated earlier, is to enable individuals to achieve their objectives. A budget forces you
to assess your current and future financial situations and to keep track of your income and expenses.
, Principles involved in drawing up a budget
The following principles serve as a guide in the development of a budget which will increase the
possibility that the predetermined objectives will be achieved.
i. Involvement
All the people for whom the budget is going to serve as a plan and a control mechanism over a
specified period should be involved in its preparation. The household budget should have the
support of all the members of the family. This will inspire confidence in the budget and everybody
will have a better understanding of the nature and purpose of the planning process.
ii. Efficient organization
The authority within a family to incur certain expenses must be clearly stated. A framework should
be created so that objectives can be achieved in a co-ordinated way. Each member of the family
should know what is expected of him or her in the achievement of those objectives.
iii. Proper Administrative system
An administration system that is directly linked to specific responsibilities concerning the budgeting
process and its implementation is essential. A particular person should be responsible for
administration of the budget. By administration it is meant that all documents reflecting income and
expenditure should be filed in an orderly manner.
iv. Good communication
Communication is a process of informing or reporting in order to achieve mutual understanding
between two or more people. To achieve household’s objectives, such objectives must be
communicated to all stakeholders. Members of the family should know why their spending is
restricted. To a large extent, effective decision making depends on effective communication. It
should not be simply assumed that the family knows why certain discrepancies have occurred in the
budget or why certain items can no longer be purchased.
v. A Realistic Budget
A prerequisite for a budget is realism. To a large extent, the care with which budget figures are
calculated determines the budget's future success. For a budget to be realistic, each variable that
may occur should be anticipated in respect of:
a) Their specific time horizon
b) An acceptable internal and external environment that will reign during that period
The budget should also be flexible. Changing circumstances could result in certain expenses
changing their patterns completely e.g. children may become sicker in winter time which can see
medical costs increasing significantly over this period. In such case, the family's objectives could also
change for that period.
Budgeted figures are based on pre-estimates or forecasts which means that certain assumptions are
made about the future, and certain factors which could lead to alteration of the budget are taken
into account. The forecast process serves as a basis for the budget and is therefore a pre-requisite
for its preparation. No budget can be reliable if forecasts are not made. There is an important
difference between forecasting and budgeting. Forecasting indicates whether or not a future plan is
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