Money Management Strategy: Financial Statements and Budgeting

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• Chapter 3
• Money Management Strategy Financial Statements
  and Budgeting

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Chapter 3Learning Objectives

1. 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 goals

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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

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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

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COMPONENTS OF MONEY MANAGEMENT
Creating and implementing a plan for spending,
and saving (budgeting)
Creatingpersonalfinancialstatements(balancesh
eets andcash flowstatements of income and
outflow)
Storingandmaintainingpersonalfinancialrecords
anddocuments
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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

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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

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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

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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

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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

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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

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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

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Personal Financial Statements Measure Financial
Progress (continued)

• STEP 2 DETERMINING THE AMOUNTS OWED
• Liabilities - what you owe
• Current liabilities (lt 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

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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

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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

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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?

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Financial Ratio

• Savings ratio amount saved each month / gross
  income
• 648 / 5,400 0.12
• What is the a proper ratio?

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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

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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

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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

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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

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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

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Budgeting for Skilled Money Management (continued)

• Steps in the budgeting process (cont)
• Budget Variable Expensesthe amounts that are to
  be spent for household and living expenses
• Record Spending Amountsthe 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

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Budgeting for Skilled Money Management (continued)

• CHARACTERISTICS OF SUCCESSFUL BUDGETING
• Well-planned
• Realistic
• Flexible
• Clearly communicated

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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)

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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

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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

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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

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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

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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?