Chapter 3

Money Management Strategy: Financial Statements and Budgeting

Money Management Strategy: Financial Statements and Budgeting

McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

Planning for Successful Money Management

• 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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Opportunity Cost andMoney 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.3-3

Major Money Management Activities

Creating and implementing

a plan forspending, and saving (budgeting).

Creatingpersonalfinancial

statements(balance

sheets andcash flow

statements of income

and outflow).

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Storingand

maintainingpersonalfinancialrecords

anddocuments.

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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What to Keep in Your Home File

• Items you refer to often. 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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What to Keep in a Safe Deposit Box

• Safe deposit box is for 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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Records on Personal Computer

• Home 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 performance

results of investments. Computerized versions of wills,

estate plans, and other documents.

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How Long to Keep Records

• 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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Purpose of PersonalFinancial 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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Components of a Balance Sheet(net worth statement)

• Assets - what you own. Liquid assets. Real estate. Personal possessions. Investment assets.

• Liabilities - what you owe Current liabilities (< 1 year). Long term liabilities.

• Compute your net worth. Assets minus liabilities.

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Where Did Your Money Go? Components of a Cash Flow Statement

• Shows inflow, outflow for a given time period. Record inflow.

• Net income from employment.• Savings and investment income.• Other sources.

Record cash outflows.• Fixed and variable expenses.• Net cash flow can be a surplus or a deficit.

• Use this statement as a basis for creating a spending, saving and investment plan.

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Ratios for Evaluating Financial Progress

• Debt ratio = total liabilities/net worth; compares debt to net worth; lower debt ratio is best

• Current ratio – liquid assets/current liabilities; shows how well short term assets cover short term debt; higher ratio is good

• Liquidity ratio = liquid assets/monthly expenses; shows # of months that living expenses can be paid; higher ratio is good

• Debt payments ratio = monthly credit payments/take-home pay; try to keep ratio below 20%

• Savings ratio = monthly savings/gross income; Americans tend to be poor savers; shoot for at least 10%

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Purposes of a Budget

• In contrast to cash flow, which was a record of how you spent money in a past time period, a budget is a plan for spending in the future, such as for the next month. A budget helps 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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Creating and Implementing a Budget

• Assessing your current situation. Measure your current financial position. Determine your needs, values and life

situation.• 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 set amounts that you are obligated to pay. These are your fixed expenses. BE SURE TO BUDGET FOR SAVINGS. 3-15

Creating and Implementing a Budget

• Steps in the budgeting process (continued).5 Estimate amounts that are to be spent for

household and living expenses. These are your variable expenses.

6 Record actual amounts for inflows and outflows, comparing actual amounts with budgeted amounts to determine variances.

Deficits and surpluses.7 Review your spending and savings

patterns and evaluate whether revisions are needed in your savings and spending plans. 3-16

Characteristics of Successful Budgeting

• Well planned.• Realistic.• Flexible.• Clearly communicated.

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Selecting a Budgeting System

1) Mental budget – it is all in your head

2) Physical budget-use envelopes for

your expenses such as food, rent.

3) Written budget – use spreadsheets

4) Computerized budget – use software such as Quicken (www.quicken.com)

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Saving to Achieve Financial Goals

• Common reasoning for saving include… 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.3-19

Savings Techniques-If I don’t see it, I won’t spend it

• Payroll deductions into saving 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 & Achieving Financial Goals

• Balance Sheet reports current financial position

• Cash Flow Statement shows cash you have received and spent in the past

• Budget helps 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?

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