3 CHAPTER LECTURE notes
I. PLANNING FOR SUCCESSFUL MONEY MANAGEMENT (p. 78)
Money management refers to the day-to-day financial activities necessary to handle
current personal economic resources while working toward long-term financial security.
Opportunity Cost and Money Management (p. 78)
Trade-offs are associated with every spending, saving, borrowing, and investing decision.
Components of Money Management (p. 78)
Personal financial records, financial statements, and spending plans (budget) are the
foundation for planning and implementing money management activities.
II. A SYSTEM FOR PERSONAL FINANCIAL RECORDS (p. 79)
Organized money management requires a system of financial records including the
following categories:
1.
money management records
2.
personal and employment records
3.
tax records
4.
financial services records
5.
credit records
6.
consumer purchase records
7.
housing and automobile records
8.
insurance records
9.
investment records
10.
estate planning and retirement records
III. PERSONAL FINANCIAL STATEMENTS FOR MEASURING FINANCIAL PROGRESS
(p. 81)
A personal balance sheet and cash flow statement provide information about a persons or
households current financial position and a summary of current income and spending.
The Personal Balance Sheet: Where Are You Now?
(p. 81)
A balance sheet, also known as a net worth statement, specifies what you own and what
you owe.
Items of value minus amounts owed equals net worth.
Assets, the first item on the balance sheet, are cash and other property that has a monetary
value.
Liquid assets are cash and items of value that can easily be converted into cash.
Real estate includes a home, condominium, vacation property, or other land that a person
or family owns.
Personal possessions are the major portion of assets for most families.
Investment assets consist of money set aside for long-term financial needs.
Liabilities are amounts owed to others but do not include items not yet due, such as next
months rent.
Current liabilities are debts that must be paid within a short time, usually less than a year.
Long-term liabilities are debts that are not required to be paid in full until more than a
year from now.
Your net worth is the difference between your total assets and your total liabilities: Assets
- Liabilities = Net worth
The balance sheet of a business is usually expressed as: Assets = Liabilities + Net worth
Insolvency is the inability to pay debts when they are due; it occurs when a persons
liabilities far exceed his or her available assets.
Evaluating Your Financial Position (p. 84)
A person or household experiences financial improvement if net worth increases over
time.
Debt ratioliabilities divided by net worthmay be used to indicate a persons financial
situation; a low debt ratio is desired.
Current ratioliquid assets divided by current liabilitieshow well a person will be able
to pay upcoming debts.
Liquidity ratioliquid assets divided by monthly expensesindicates the number of
months that expenses can be paid if an emergency arises.
Debt-payment ratiomonthly credit payments divided by take-home payprovides an
indication of how much of a persons earnings goes for debt payments (excluding a home
mortgage).
Savings ratioamount saved each month divided by gross incomefinancial experts
recommend a savings rate of about 10 percent.
The Cash Flow Statement: Where Did Your Money Go? (p. 84)
Cash flow is the actual inflow and outflow of cash during a given time period.
A cash flow statement is a summary of cash receipts and payments for a given period,
such as a month or a year.
Income is the inflows of cash to an individual or a household. For most people, the main
source of income is money received from a job.
Cash payments for living expenses and other items make up the second component of a
cash flow statement.
Fixed expenses are payments that do not vary from month to month.
Variable expenses are flexible payments that change from month to month.
The difference between your income and your cash outflows can be either a positive
(surplus) or negative (deficit) cash flow. A deficit exists if more cash goes out than comes in
during a month. This amount must be made up by withdrawals from savings or borrowing.
IV. BUDGETING FOR SKILLED MONEY MANAGEMENT (p. 88)
A budget, or spending plan, is necessary for successful financial planning. The main
purposes of a budget are to help you
1.
live within your income
2.
spend your money wisely
3.
reach your financial goals
4.
prepare for financial emergencies
5.
develop wise financial habits
Starting management the Budgeting Process (p. 88)
A personal balance sheet is an effective scorecard for assessing personal economic
progress.
Your lifestyle is how you spend your time and money and is strongly influenced by your
career, family, and personal values.
Step 1. Setting Financial Goals (p. 89)
Financial goals are plans for future activities that require you to plan spending, savings,
and investing.
How much you budget for various items will depend on current needs and plans for the
future. Sources that can assist with planning your spending include:
your cash flow statement
sample budgets from government reports
articles in personal financial planning magazines
estimates of future income and expected inflation
Step 2. Estimating Income (p. 89)
Available money should be estimated for a given time periodsuch as a month.
Income variations (due to seasonal work or sales commissions) should be based on the
recent past and realistic expectations.
Step 3. Budgeting an Emergency Fund and Savings
(p. 91)
An emergency fund and savings for irregular payments should be first set aside to avoid
not having anything left for savings.
Step 4. Budgeting Fixed Expenses (p. 91)
Definite obligations (rent, mortgage, and credit payments) should be allocated first.
Assigning amounts to spending categories can be based on your cash flow statement,
government data, current magazine articles, and estimates of future income and expenses.
A spending diary of past expenses can also assist with this task.
Step 5. Budgeting Variable Expenses (p. 92)
Planning for variable expenses is more difficult than fixed expenses.
These expenses will fluctuate based on household situation, time of the year, health,
economic conditions, and other factors.
Step 6. Recording Spending Amounts (p. 92)
A budget variance is the difference between amount budgeted and the actual amount
received or spent. A deficit exists when actual spending exceeds planned spending. A surplus is
when actual spending is less than planned spending.
Step 7. Reviewing Spending and Saving Patterns
(p. 93)
The results of your budget may be obvioushaving extra cash, falling behind in
payments. Or the results may need to be reviewed in detail to determine areas of needed changes.
The most common overspending areas are entertainment and food, especially away-from-home
meals.
At this point of the budgeting process, you should also evaluate, reassess, and revise your
financial goals.
Characteristics of Successful Budgeting (p. 93)
A successful budget should be:
well-planned
realistic
flexible
clearly communicated
V. MONEY MANAGEMENT AND ACHIEVING FINANCIAL GOALS (p. 95)
1.
2.
3.
The personal financial statements and budget can be used to achieve financial goals with
the balance sheet reporting your current financial positionwhere you are now.
the cash flow statement: telling you what you received and spent over the past month.
the budget: planning spending and saving to achieve financial goals.
People commonly prepare a balance sheet on a periodic basis, such as every three or six
months. Between those points in time, the budget and cash flow statement help you plan and
measure spending and saving activities.
The budget would serve to plan your spending and saving between these points in time,
and your cash flow statement of income and outflows would document your actual spending and
saving.
Changes in net worth result from cash inflows and outflows. In periods when outflows
exceed your inflows, you must draw on savings or borrow (buy on credit). When this happens,
lower assets (savings) or higher liabilities (due to the use of credit) result in a lower net worth.
When inflows exceed outflows, putting money into savings or paying off debts will result in a
higher net worth.
Identifying Saving Goals (p. 96)
Common reasons for saving include:
to set aside money for irregular or unexpected expenses
to replace expensive items
to buy special items
to provide for long-term expenses
to earn interest for additional income
Selecting a Savings Technique (p. 97)
Since most people find saving difficult, financial advisers suggest several methods:
write a check each payday and deposit it in a distant financial institution
use payroll deduction
save coins
spend less on certain items
Calculating Savings Amounts (p. 97)
To achieve financial objectives, you should convert your savings goals into specific
amounts.
Your use of an interest-earning savings plan is vital to the growth of your money and the
achievement of your financial goals.