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Financial Planning 3A
Personal Financial Management

16/03/21

What do these people have in common?

 Mike Tyson
 MC Hammer
 Abe Lincoln
 Henry Ford
 Diego Maradona
 Elton John
 Walt Disney
 Donald Trump
 Paul Gascoigne

Footnote 2

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Personal financial planning

Client Analyse Advise
information

• Assets and • Cash flow • Debt management

liabilities statement: inform strategies and
• Income and you of extra funds techniques
expenditure available for risk
• Education protection, savings
provisions and future
• Emergency fund investments .
provisions • Budget: help with
developing
financial discipline
when managing
expenses.

Footnote 3

The importance of personal financial planning

 Trends can be identified by gathering and recording the same information every
year.
 It enables the financial planner and the client to identify areas of excessive
spending and to put a plan in place to rectify the situation.
 It identifies available cash for investment in the most productive and appropriate
manner.
 It enables the effective management of debt.
 The client is in a better position to monitor whether they are on track to meet their
financial goals.

Step 2 in the 6 step financial planning process

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Assets Liabilities Cash flow

Fundamental assets Short term  Income
 (Generally cannot be used to Long term  Expenditure
earn an income for investment
purposes, but are important for Interest to be factored in  Importance
other areas of financial  Ascertain available funds for
planning) investment.
Investment  Facilitates the financial
planning process.
 Identify areas of
overspending.
 Facilitates the budgeting
process.

Footnote 5

Phases of an individual’s Life Cycle

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Budgeting
Benefits
 Facilitates accurate and effective financial planning.
 Encourage involvement from all family members and identifies each individual’s personal
objectives.
 Plan for current needs and make provision for future.
 Client more conscious of what is spent, how it is spent and how it can be controlled.
 Identifies problems at early stage.
 Identifies available financial resources.
 Assists in identifying priorities and ranking expenses according to level of importance.
 Develops a sense of financial responsibility.
 Plays a role in educating children from a young age on how to handle money and financial
responsibility.

Footnote 7 7

Additional Notes on Budgeting

Involvement
Authority and responsibility
Communication
Realistic expectations
Planning and time frames
Flexibility
Human Behaviour
Following through
Record Keeping and Admin

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Drawing up a budget

Calculate
estimated Compare Bi-annual
Prepare the Calculate
income from income and review
budget expenses
both expenses process
partners

Footnote 9

Emergency fund planning

Even with the best planning, an event may still take the client by surprise:
 Car accident
 Theft
 Unforeseen medical expenses
 Legal costs

If the client does not have access to an emergency fund, they may be forced to either borrow
money or raise finance

The benefits of having an emergency fund include having quick access to funds, saving interest
and fees on loans and eliminating the need for certain short-term insurance by substituting it with
an emergency fund.

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Emergency fund planning

What every individual needs is an emergency fund.

 3 – 6 times monthly expenses

 Funds MUST be liquid
 Invested in low risk investments
 Capital available in access bond can serve the purpose of emergency fund

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Basic financial ratios

Solvency Ratio

Relative to individuals stage in a life cycle, for a young person or a newly married
couple, the solvency ratio will be small as they would likely to have more debt. A
couple nearing retirement will have a higher solvency ratio as they are aiming to
reduce debt completely or eliminate it.

[Net Worth(assets – liabilities) / Total Assets] x 100

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Basic financial ratios

Liquidity ratio

Compares the amount of liquid assets with current debt. Liquid assets are cash or
assets that can be converted into cash within 12 months. Current debt represents
the amount of debt that is to be repaid within 12 months.

[Liquid Assets / Current Debt] x 100

Amount of months of debt that can be funded if income ceased and liquid assets
were required to meet current debt obligations (multiply ratio by 12 months)

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Basic financial ratios

Savings Ratio

Level of savings as a percentage of total income. Savings can be expressed as

investments and amount left over after deducting expenditure from income.

[Savings / Total Income] x 100

Savings Ratio will depend on the unique circumstances of the individual.

 A couple with small children will most likely have a small savings ratio.
 An elderly couple at retirement will most likely have a small savings ratio.
 A couple who has no children and ten years to retirement will have a high savings
ratio.
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Basic financial ratios

Debt Service Ratio
Monthly debt commitments expressed as a percentage of gross monthly income.

[(Annual debt commitments/12) / (Annual gross income/12)] x 100

 This ratio can be used to indicate the effect of any debt management actions.
Such as taking on more debt or deciding that one partner should leave work or
work part time.
 Debt commitments include rates and taxes and one needs to take into account
debt that will be paid off during the year and potential increases in debt.
 Gross income will include other income besides salary, for example a bonus or
remuneration for extra work done.
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The National Credit Act 34 of 2005

 The NCA became fully operational on 1 June 2007.
 The main aim of the Act is to protect consumers taking credit or entering into
consumer credit transactions.
 The Act also makes provision for the control and regulation of all credit
transactions
 Further provision is made for the registration of debt counsellors and debt
restructuring for over-indebted consumers.
 The Act also regulates credit bureaux and consumer credit information
 Regulated by National Credit Regulator (NCR) & National Credit Tribunal (NCT)

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Debt management
Credit
 The National Credit Act of 34 of 2005 defines credit as the “deferral of payment
owed to a person”.
 Credit is the power to buy or borrow on trust.

Debt
 “Something that is owed” or a “state of obligation to pay something owed.”

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Debt management strategies

 Determine the interest rates that are being charged on the credit, pay off the debt
with the highest interest rate first and pay off while still continuing to pay off the
lower interest debt with the minimum amount payable.
 If possible transfer most expensive debt to debt with a lower interest rate.
 Consolidate smaller loans into one larger loan.
 In certain cases liquidate investments.
 Sell non-essential assets and use the proceeds to pay off debts.
 If possible pay any additional amounts of money received into a mortgage bond.
 Communicate with creditors and keep them informed of the situation.
 Decrease unnecessary monthly expenses and if possible, increase the amount of
income coming in.
 If all fails then client must declare insolvency.

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Types of credit
An important aspect of debt management is to have a good understanding of the
different types of credit available and the implications of the credit for the client. In
terms of the NCA, a credit agreement is one of the following:
(a) A credit facility, for example, a credit card or in-store credit;
(b) A credit transaction, for example, an instalment agreement for a motor vehicle, a
mortgage agreement, a lease of movable property;
(c) A credit guarantee; or
(d) Any combination of the above.

A credit agreement may be a short term credit transaction if the amount does not
exceed R8 000 and is repayable within a maximum period of 6 months.

Footnote 19

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Maximum interest rates

Type of credit Maximum interest rate

Mortgage agreement
Credit facilities
Unsecured credit transaction
Developmental credit agreements
Short-term credit transactions
Other credit agreements
Incidental credit agreements
Repo rate + 12% per year
Repo rate + 14% per year
Repo rate + 21% per year
Repo rate + 27% per year
5% per month on the first loan
3% per month on subsequent loans within the calendar year
Repo rate + 17% per year
2% per month

• Repo rate currently at 3.5%

• The exact rate charged is influenced by credit history, measured by their credit
score

Footnote 20

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Debt consolidation
Simply put it is paying all your short-term/medium term debt by increasing your bond
amount.

 Debt consolidation is used as a debt management strategy.

 If the client has taken on too much debt and is battling with his monthly cash flow
then debt consolidation can improve the cash flow situation. The downside is that
the interest cost is generally higher because you are paying it over a longer
period of time.
 The interest rate on the bond may be at a lower rate than the interest on other
debt.
When advising a client if debt consolidation is effective you need to compare the monthly
payments before and after and compare interest paid before and after.

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Debt consolidation - example

Jason wants to consolidate his debt. He currently has a R2 000 000 bond for 20
years on his property .The bond has a balance of R1 646 817.54 and another 12
years left and is subject to an interest rate of 11%.

 He has a student loan of R350 000 over 6 years @ 13%, he has a balance of
R261 893.13 and four years left
 He also has one H/P outstanding on his vehicle, R280 000 over 5 years @12%
he has a balance of R236 518.73 and four years left.

This is the only debt that he has.

Footnote 22

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Debt consolidation- example

Question one
 What is Jason’s new bond payment if he were to consolidate the debt?

Question two
 What does Jason save in the short term?

Question three
 What does Jason pay in the long term?

Footnote 23

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Question one Solution

Jason wants to consolidate his debt. He currently has a R2 000 000 bond for 20 years on his property .The
bond has a balance of R1 646 817.54 another 12 years left and is subject to an interest rate of 11%.

He has a student loan of R350 000 over 6 years @ 13%, he has a balance of R261 893.13 and four years left
He also has one H/P outstanding on his vehicle, R280 000 over 5 years @12,%, he has a balance of
R236 518.73 and four years left.

He can combine the total debt in his home loan and pay one payment. The payment will be:

P/YR=12; C/YR=12; END

N = 144(12*12)
I/YR = 11
PV = 2 145 229.40 (1 646 817.54 + 261 893.13 + 236 518.73)
PMT = ?
FV =0
 PMT = - 26 891.63

Footnote 24

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Question two Solution

 Question two : What does Jason save in the short term?
 Compare the total debt payments before consolidation to total debt payment after consolidation.
 He has a student loan of R350 000 over 6 years @ 13%, he has a balance of R261 893.03 and four years left.

P/YR=12; C/YR=12; END

I/YR = 13
N = 72
PV = 350 000
PMT =?
FV =0
PMT = - 7025.94

 He also has one H/P outstanding on his vehicle, R280 000 over 5 years @12%, he has a balance of R236 518.67 and four years left.

P/YR=12; C/YR=12; END

N = 60
I/YR = 12
PV = 280 000
PMT =?
FV =0
PMT = - 6228.45

Footnote 25 25

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Question two Solution

 He currently has a R2 000 000 bond for 20 years on his property .The bond has a balance of
R1 646 817.18 another 12 years left and is subject to an interest rate of 11%.
P/YR=12; C/YR=12; END
N = 240
I/YR = 11
PV =2 000 000
PMT =?
FV =0
 PMT = - 20 643.77

 Compare the total debt payments before consolidation to total debt payment after consolidation.
Total debt payment before consolidation per month
= 20 643.77 + 7025.94 + 6228.45 = R33 898.16

Total debt payment after consolidation per month = R26 891.63

Saving = R33 898.16 – R26 891.63 = R7 006.53 per month

Footnote 26 26

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Question three Solution

 Question three :What does Jason pay in the long term?
 Compare the total interest he would pay before consolidation and after consolidation.
1. Student loan: R350 000 over 6 years @ 13%; ran for 2 years, 4 years left:
P/YR=12; C/YR=12; END
N = 72
I/YR = 13
PV = 350 000
PMT = ?
FV =0
PMT = - 7025.94
25 INPUT 72
AMORT [f FV]
=; = INT = - R75 351.71
2. H/P on his vehicle: R280 000 over 5 years @12%; ran for year, 4 years left:
P/YR=12; C/YR=12; END
N = 60
I/YR = 12
PV =280 000
PMT = ?
FV =0
PMT = - 6 228.45
13 INPUT 60
AMORT [f FV]
=; =; INT = - R62 446.55

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Question three Solution

3. Bond/P on his property: R2 000 000 over 20 years @11%; ran for 8 years and 12 years left:
P/YR=12; C/YR=12; END
N = 240
I/YR = 11
PV =2 000 000
PMT = ?
FV = 0
PMT = - 20 643.77
97 INPUT 240
AMORT [f FV]
=; =; INT = - R1 325 883.60
4. Total interest payable before consolidation = R5 351.71 + 62 446.55 + 1 325 883.60 = R1 463
681.86
5. Total interest after consolidation: New balance = 2 145 228.88
New payment = 26 891.63 (over 12 years)
Total Interest = (26 891.63 x 12 x 12) - 2 145 228.88 = R1 727
165.67
6. Difference is therefore R 263 483.81 additional interest payable, the cost of the consolidation.

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Question three Solution

Summary: Monthly saving after consolidation = R7006.53
Additional interest after consolidation = R263 483.81
However, a PV analysis gives a more realistic result (picture):
 Calculate PV’s: assume inflation = 7.5% (using the difference between current prime & inflation & home loan rate)
 PV’s of cash flows before consolidation:
Home loan: P/YR=12; C/YR=12; END Hire purchase: P/YR=12; C/YR=12; END
N = 144 N = 48
I/YR = 7.5 I/YR = 7.5
PV =? PV =?
PMT = -20 643.77 PMT = -6 228.45
FV =0 FV =0
 PV = 1 956 336  PV = 257 599
Student loan: P/YR=12; C/YR=12; END Restructured Home loan: P/YR=12; C/YR=12; END
N = 48 N = 144
I/YR = 7.5 I/YR = 7.5
PV =? PV =?
PMT = -7 025.94 PMT = -26 891.63
FV =0 FV =0
 PV = 290 581  PV = 2 548 423
 Sum of PV’s = 1 956 336 + 257 599 + 290 581 = 2 504 516
Minus: PV of restructured loan - 2 548 423
- 43 907 (total cost of restructuring in today’s money)

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