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

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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 incomeUsing savings for purchases results in lost

interest and depletes savingsComparison shopping can save money but

takes valuable time4

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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

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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

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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

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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

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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 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

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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 VALUEAssets - what you ownLiquid assets

Real estatePersonal possessionsInvestment assets

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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

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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 WorthIncreasing your savingsReducing spendingIncreasing the value of investments and other

possessionsReducing the amounts you owe

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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

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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?

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Financial RatioSavings ratio = amount saved each month /

gross income$648 / 5,400 = 0.12What 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 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

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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

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

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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

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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 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

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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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AssignmentsPrepare 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 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?

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