Chapter 3 Money Management Strategy: Financial Statements and Budgeting

1. Chapter 3 Money Management Strategy: Financial Statements and Budgeting

2. Chapter 3Learning Objectives • Recognize relationships among financial documents and money management activities • Design a system for maintaining personal financial records • Develop a personal balance sheet and cash flow statement • Create and implement a budget • Relate money management and savings activities to achieve financial goals

3. Planning for Successful Money Management Objective 1: Recognize relationships among financial documents and money management activities • Daily spending and saving decisions are the heart of financial planning • Decisions must be coordinated with needs, goals, and personal situations • Money management is the day-to-day financial activities needed to manage personal economic resources, while working toward long-term financial security

4. Planning for Successful Money Management(continued) OPPORTUNITY COST AND MONEY-MANAGEMENT • Spending money on current living expenses reduces the amount you can save and invest • Saving and investing for the future reduces the amount you can spend now • Buying on credit ties up future income • Using savings for purchases results in lost interest and depletes savings • Comparison shopping can save money but takes valuable time

5. COMPONENTS OF MONEY MANAGEMENT Storingandmaintainingpersonalfinancialrecordsanddocuments Creatingpersonalfinancialstatements(balancesheets andcash flowstatements of income and outflow) Creating and implementing a plan for spending, and saving (budgeting)

6. A System for Personal Financial Records Objective 2: Design a system for maintaining personal financial records Benefits of an Organized System of Financial Records • Handling daily business affairs, including payment of bills on time • Planning and measuring financial progress • Completing required tax reports • Making effective investment decisions • Determining available resources for current and future buying

7. A System for Personal Financial Records(continued) ITEMS IN YOUR HOME FILE • Personal and employment records • Money management records • Tax records • Financial services records • Consumer purchase, auto and credit records • Housing records • Insurance records • Investment records • Estate planning and retirement records

8. A System for Personal Financial Records(continued) ITEMS IN THE SAFE DEPOSIT BOX • Records that would be hard to replace • Birth, marriage and death certificates, copy of will • Citizenship and military papers • Adoption and custody papers • Serial numbers and photos of valuables • CDs and credit and banking account numbers • Mortgage papers and titles • List of insurance policy numbers • Stock and bond certificates • Coins and other collectibles

9. A System for Personal Financial Records (continued) RECORDS ON YOUR PERSONAL COMPUTER • Current and past budgets • Summary of checks written and other banking transactions • Past income tax returns prepared with tax preparation software • Account summaries and performanceresults of investments • Computerized versions of wills, estate plans, and other documents

10. A System for Personal Financial Records(continued) HOW LONG SHOULD RECORDS BE KEPT? • Birth certificates, wills, and Social Security information should be kept indefinitely • Keep records on personal property and investments as long as you own them • Keep documents related to the purchase and sale of real estate indefinitely • Copies of tax returns and supporting data should be kept six years

11. Personal Financial Statements Measure Financial Progress Objective 3: Develop a personal balance sheet and cash flow statement Purpose of Personal Financial Statements • Report your current financial position in relation to the value of the items you own and the amounts you owe • Measure your progress toward your financial goals • Maintain information on your financial activities • Provide data you can use when preparing tax forms or applying for credit

12. Personal Financial Statements Measure Financial Progress (continued) BALANCE SHEET: WHERE ARE YOU NOW? Also called the Net Worth Statement or Statement of Financial Planning Preparation of Balance Sheet requires using the following Steps STEP 1: LISTING ITEMS OF VALUE • Assets - what you own • Liquid assets • Real estate • Personal possessions • Investment assets

13. Personal Financial Statements Measure Financial Progress(continued) STEP 2: DETERMINING THE AMOUNTS OWED • Liabilities - what you owe • Current liabilities (< 1 year) • Long term liabilities STEP 3: COMPUTING NET WORTH • Assets – Liabilities = Net Worth • Assets = Net Worth + Liabilities • Insolvency is the inability to pay debts when they are due

15. Personal Financial Statements Measure Financial Progress(continued) Net Worth is an indication of the financial position at any given date Ways to increase Net Worth • Increasing your savings • Reducing spending • Increasing the value of investments and other possessions • Reducing the amounts you owe

16. Financial Ratio • Debt ratio = liabilities / net worth $25,000 / 50,000 = 0.5 High or low is better? • Current ratio = liquid asset / current liabilities $4,000 / 2,000 = 2 What does it mean? High ratio means you have enough cash to pay bill

17. Financial Ratio • Liquidity ratio = liquid assets / monthly expenses $10,000 / 4,000 = 2.5 What does it mean? Low or high is better? • Debt-payments ratio = monthly credit payment / take-home pay $540 / 3,600 = 0.15 What does it mean?

18. Financial Ratio • Savings ratio = amount saved each month / gross income $648 / 5,400 = 0.12 What is the a proper ratio?

19. Personal Financial Statements Measure Financial Progress (continued) THE CASH FLOW STATEMENT • Cash Flow is the actual inflow, outflow for a given time period • The Cash Flow statement is also called personal income and expenditure statement

20. Personal Financial Statements Measure Financial Progress (continued) THE CASH FLOW STATEMENT The process of preparing cash flows statement follows these steps STEP 1: RECORD INCOME • Wages, salaries, and commissions • Self-employment business income • Savings and investment income • Gifts, grants, scholarships and educational loans • Government payments, such as Social Security, public assistance, and unemployment benefits • Amounts received from pension and retirement programs • Alimony and child support payments

21. Personal Financial Statements Measure Financial Progress (continued) STEP 2: RECORD CASH OUTFLOWS • Fixed Expenses • Variable expenses STEP 3: DETERMINE NET CASH FLOWS • The difference between income and outflows can either be positive or negative • Cash flow statement provides the foundation for preparing and implementing a spending, saving, and investment plan

23. Budgeting for Skilled Money Management Objective 4: Create and implement a budget • A budget is a spending plan • The main purposes of a budget are to help you • Live within your income • Spend your money wisely • Reach your financial goals • Prepare for financial emergencies • Develop wise financial management habits

24. Budgeting for Skilled Money Management (continued) STARTING THE BUDGETING PROCESS ***Steps in the budgeting process • Set financial goals • Estimate income from all sources • Budget amount for an emergency fund, periodic expenses and financial goals • Budget Fixed Expenses that you are obligated to pay

25. Budgeting for Skilled Money Management (continued) ***Steps in the budgeting process(con’t) • Budget Variable Expenses—the amounts that are to be spent for household and living expenses • Record Spending Amounts—the actual amounts for inflows and outflows, comparing actual amounts with budgeted amounts to determine variances • Review Spending and Saving Patterns • Evaluate whether revisions are needed in your savings and spending plans

27. Budgeting for Skilled Money Management (continued) CHARACTERISTICS OF SUCCESSFUL BUDGETING • Well-planned • Realistic • Flexible • Clearly communicated

28. Selecting a Budgeting System • Mental budget – it is all in your head • Physical budget-use envelopes for your expenses such as food, rent, etc. • Written budget – use spreadsheets • Computerized budget – use software such as Quicken (www.quicken.com)

29. Money Management and Achieving Financial Goals Objective 5: Relate money management and savings activities to achieve financial goals IDENTIFYING SAVING GOALS… • To set aside money for irregular and unexpected expenses • To pay for the replacement of expensive items, such as cars or a down payment on a house • To buy special items like recreational equipment or to pay for a vacation • To provide for long-term expenses such as retirement or the education of children • To earn income from the interest on savings for use in paying living expenses

30. Money Management and Achieving Financial Goals (continued) SELECTING A SAVINGS TECHNIQUE • Payroll deductions into savings accounts • Automatic payments from checking into savings accounts or mutual funds • Saving regularly in 401(k) plans • Also save coins, make periodic deposits • Write a check each payday as a % of income and deposit into savings

32. Money Management and Achieving Financial Goals (continued) • Balance Sheet reports current financial position • Cash Flow Statement shows cash you have received and spent in the past • Budgets help you to spend and save to achieve financial goals

33. Assignments • Prepare a balance sheet for yourself • Prepare a cash flow statement for last month • Prepare a monthly budget • Monitor the budget and show variances

34. Online Research • Do an online search to see if you can find the savings rate in the United States …How does your savings ratio compare to the average?