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Chapter 3
Money Management
Strategy: Financial
Statements and Budgeting
Chapter 3
Money Management
Strategy: Financial
Statements and Budgeting
Chapter 3Learning Objectives1. Recognize relationships among financial
documents and money management activities
2. Design a system for maintaining personal financial records
3. Develop a personal balance sheet and cash flow statement
4. Create and implement a budget 5. Relate money management and savings
activities to achieve financial goals2
Planning for Successful Money ManagementObjective 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
3
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 incomeUsing savings for purchases results in lost
interest and depletes savingsComparison shopping can save money but
takes valuable time4
5
COMPONENTS OF MONEY MANAGEMENT
Creating and implementing
a plan forspending, and saving (budgeting)
Creatingpersonalfinancial
statements(balance
sheets andcash flow
statements of income
and outflow)
Storingand
maintainingpersonalfinancialrecords
anddocuments
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
6
A System for Personal Financial Records (continued)
ITEMS IN YOUR HOME FILEPersonal and employment recordsMoney management recordsTax recordsFinancial services recordsConsumer purchase, auto and credit
recordsHousing recordsInsurance recordsInvestment recordsEstate planning and retirement records
7
A System for Personal Financial Records (continued)
ITEMS IN THE SAFE DEPOSIT BOXRecords that would be hard to replace
Birth, marriage and death certificates, copy of will
Citizenship and military papersAdoption and custody papersSerial numbers and photos of valuablesCDs and credit and banking account numbersMortgage papers and titlesList of insurance policy numbersStock and bond certificatesCoins and other collectibles
8
A System for Personal Financial Records (continued)
RECORDS ON YOUR PERSONAL COMPUTER
Current and past budgetsSummary of checks written and other
banking transactions Past income tax returns prepared with tax
preparation softwareAccount summaries and performance
results of investmentsComputerized versions of wills,
estate plans, and other documents
9
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
10
Personal Financial Statements Measure Financial ProgressObjective 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
11
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 VALUEAssets - what you ownLiquid assets
Real estatePersonal possessionsInvestment assets
12
Personal Financial Statements Measure Financial Progress (continued)
STEP 2: DETERMINING THE AMOUNTS OWED
Liabilities - what you oweCurrent liabilities (< 1 year) Long term liabilities
STEP 3: COMPUTING NET WORTHAssets – Liabilities = Net WorthAssets = Net Worth + LiabilitiesInsolvency is the inability to pay debts when
they are due13
14
Personal Financial Statements Measure Financial Progress (continued)
Net Worth is an indication of the financial position at any given date
Ways to increase Net WorthIncreasing your savingsReducing spendingIncreasing the value of investments and other
possessionsReducing the amounts you owe
15
Financial RatioDebt ratio = liabilities / net worth$25,000 / 50,000 = 0.5High or low is better?
Current ratio = liquid asset / current liabilities
$4,000 / 2,000 = 2What does it mean? High ratio means you have enough cash to pay
bill
16
Financial RatioLiquidity ratio = liquid assets / monthly
expenses$10,000 / 4,000 = 2.5What does it mean? Low or high is better?
Debt-payments ratio = monthly credit payment / take-home pay
$540 / 3,600 = 0.15What does it mean?
17
Financial RatioSavings ratio = amount saved each month /
gross income$648 / 5,400 = 0.12What is the a proper ratio?
18
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
19
Personal Financial Statements Measure Financial Progress (continued)
THE CASH FLOW STATEMENTThe process of preparing cash flows statement
follows these steps
STEP 1: RECORD INCOMEWages, salaries, and commissionsSelf-employment business incomeSavings and investment incomeGifts, grants, scholarships and educational
loansGovernment payments, such as Social Security,
public assistance, and unemployment benefitsAmounts received from pension and retirement
programsAlimony and child support payments 20
Personal Financial Statements Measure Financial Progress (continued)
STEP 2: RECORD CASH OUTFLOWSFixed ExpensesVariable expenses
STEP 3: DETERMINE NET CASH FLOWSThe difference between income and
outflows can either be positive or negativeCash flow statement provides the
foundation for preparing and implementing a spending, saving, and investment plan
21
22
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
23
Budgeting for Skilled Money Management (continued)
STARTING THE BUDGETING PROCESS
***Steps in the budgeting process
1. Set financial goals
2. Estimate income from all sources
3. Budget amount for an emergency fund, periodic expenses and financial goals
4. Budget Fixed Expenses that you are obligated to pay
24
Budgeting for Skilled Money Management (continued)
***Steps in the budgeting process (con’t)
5. Budget Variable Expenses—the amounts that are to be spent for household and living expenses
6. Record Spending Amounts—the actual amounts for inflows and outflows, comparing actual amounts with budgeted amounts to determine variances
7. Review Spending and Saving Patterns
8. Evaluate whether revisions are needed in your savings and spending plans
25
26
Budgeting for Skilled Money Management (continued)
CHARACTERISTICS OF SUCCESSFUL BUDGETING
Well-planned Realistic Flexible Clearly communicated
27
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)
28
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 29
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
30
31
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
32
AssignmentsPrepare a balance sheet for yourself
Prepare a cash flow statement for last month
Prepare a monthly budget
Monitor the budget and show variances
33
Online ResearchDo 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?
34