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Budgets and Balance Sheets: Your Personal Financial Statements © 2010 Pearson Education, Inc. All rights reserved Chapter 4.

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Presentation on theme: "Budgets and Balance Sheets: Your Personal Financial Statements © 2010 Pearson Education, Inc. All rights reserved Chapter 4."— Presentation transcript:

1 Budgets and Balance Sheets: Your Personal Financial Statements © 2010 Pearson Education, Inc. All rights reserved Chapter 4

2 Learning Objectives Explain the steps involved in creating a budget Explain the steps involved in creating a personal balance sheet Analyze the importance of budgeting in your financial plan © 2010 Pearson Education, Inc. All rights reserved 0-2

3 Creating a Budget A budget is a forecast of future cash inflows and outflows Creating a budget is a key part of your financial plan A budget provides guidance for reaching your personal goals It gives you a detailed roadmap to your financial future © 2010 Pearson Education, Inc. All rights reserved 0-3

4 Step 1: Create a Personal Cash Flow Statement Identify your current cash inflows and cash outflows Many cash inflows include salary, hourly wages, or allowance Cash outflows include car payment, rent, or phone bill See Figure 4.1 for an example of a Personal Cash Flow Statement © 2010 Pearson Education, Inc. All rights reserved 0-4

5 Figure 4.1 © 2010 Pearson Education, Inc. All rights reserved 0-5

6 Step 2: Turning Your Cash Flow Statement into a Budget Forecast your net cash flows for a period a time into the future Think of how the cash flows might change from month to month Be sure to include expected, yet irregular expenses, such as school activity fees or vacation © 2010 Pearson Education, Inc. All rights reserved 0-6

7 Step 2: Turning Your Cash Flow Statement into a Budget A good budget should include unexpected expenses Adjust the budget as necessary as you get more information An annual budget helps identify times where you can save money and times when you will be spending more money See Figure 4.2 for an example of an annual budget © 2010 Pearson Education, Inc. All rights reserved 0-7

8 Figure 4.2 © 2010 Pearson Education, Inc. All rights reserved 0-8

9 Working with and Improving Your Budget A budget will help you save money for: – major purchases –unexpected expenses –unexpected opportunities A budget will help you anticipate future cash shortfalls A budget is a great planning tool © 2010 Pearson Education, Inc. All rights reserved 0-9

10 Assessing the Accuracy of the Budget A forecast error is the difference between what you forecast to happen and what actually happened Evaluate your forecasts and compare those with the actual cash flows Keep an expense journal to track your spending After looking at your forecast error, you may need to adjust your spending Look at Figure 4.3 for an example forecast errors © 2010 Pearson Education, Inc. All rights reserved 0-10

11 Figure 4.3 © 2010 Pearson Education, Inc. All rights reserved 0-11

12 Check Your Financial IQ What are the steps involved in creating a budget? © 2010 Pearson Education, Inc. All rights reserved 0-12

13 Check Your Financial IQ Step 1: Creating a personal cash flow statement Step 2: Turning a cash flow statement into a budget Step 3: Working with and improving your budget © 2010 Pearson Education, Inc. All rights reserved 0-13

14 Personal Balance Sheet Personal balance sheet tells you what your financial position is at a point in time. A personal balance sheet helps you make decisions on how to use extra money Knowing where you are financially will help guide in deciding how to manage: – your liquidity –your use of credit and borrowing, –your investments –and more © 2010 Pearson Education, Inc. All rights reserved 0-14

15 Assets Assets on a balance sheet can be classified in several ways: –Liquid assets –Household assets –investments © 2010 Pearson Education, Inc. All rights reserved 0-15

16 Liquid Assets Liquid assets are financial assets that are either cash or can be easily converted to cash without significant loss of value Liquid assets include money in checking and savings accounts They are necessary for covering unexpected emergency expenses It is important that they have quick availability, It is also important for them to be making money © 2010 Pearson Education, Inc. All rights reserved 0-16

17 Math for Personal Finance Jeff has $1,000 in a savings account, $340 in his checking account, and $2,100 in stock that his grandmother gave him. He also owns his car, which is worth about 43,200 How much does Jeff have in liquid assets? © 2010 Pearson Education, Inc. All rights reserved 0-17

18 Math for Personal Finance Solution: Jeff’s liquid assets consist of the money in his savings and checking accounts, which is $1,000 + $340 = $1,340. © 2010 Pearson Education, Inc. All rights reserved 0-18

19 Household Assets Household assets include those assets owned by a household – cars, houses, furniture The market value of something is what it would be worth if you sold it today Another type of asset is household assets While creating your personal balance sheet, evaluate the true market value of these assets Kelley Blue Book (for cars), EBay, and other internet sites are good resources for determining the value of these assets © 2010 Pearson Education, Inc. All rights reserved 0-19

20 Investments An investment is something you acquire with the ultimate goal of making money Investments are the third major category of assets Investments are something you buy that you believe will increase in value over time Some common investment assets are: –Stocks –Bonds –Real estate © 2010 Pearson Education, Inc. All rights reserved 0-20

21 Investments Bonds are basically certificates that function like IOUs— promises to repay a certain amount of money at some future time When you buy a bond, you are essentially loaning the issuer money The issuer pays you interest until the maturity date People buy bonds expecting to receive interest income while they hold the bond and getting their money back when the bond matures Investing in bonds involves some risks © 2010 Pearson Education, Inc. All rights reserved 0-21

22 Investments Stocks are certificates that represent fractional ownership of a firm People buy stocks expecting that the company will do well and the value will increase Each share of ownership represents a percentage of the business and is called a share of stock Stocks can be risky It is possible that the value will decline or disappear altogether © 2010 Pearson Education, Inc. All rights reserved 0-22

23 Math for Personal Finance Emily owns 50 shares of Company Y’s stock that is currently selling for $170 a share. She also owns 65 shares of Company Z’s stock worth about $47 a share. What is the total value of her stock holdings? © 2010 Pearson Education, Inc. All rights reserved 0-23

24 Math for Personal Finance Solution: Company Y 50 x $170 = $8,500 Company Z 65 x $47 = $3,055 Total = $11,555 © 2010 Pearson Education, Inc. All rights reserved 0-24

25 Investments Mutual funds are created so investors can pool their money in order to invest in a larger variety of financial assets, such as stocks and bonds from many different companies Mutual funds are managed by professionals who decide which stocks/bonds to purchase Individual investors who buy shares in the fund do not have to be experts in stock or bond selection The risk of loss is usually spread across many different investments © 2010 Pearson Education, Inc. All rights reserved 0-25

26 Investments Real estate includes homes, rental property, farms, and other land Real estate is another type of investment People invest in this hoping it will generate revenue over time and increase in value © 2010 Pearson Education, Inc. All rights reserved 0-26

27 Liabilities Liabilities represent the amount of debt a person owes These debts can be put into 2 categories: –Current liabilities –Long-term liabilities © 2010 Pearson Education, Inc. All rights reserved 0-27

28 Liabilities Current liabilities are debts that must be paid off within 1 year Credit card balances are the most common form of current liabilities for people A credit card acts like a short term loan that “should” be paid of every month When you pay the credit card bill, you are eliminating the current liability © 2010 Pearson Education, Inc. All rights reserved 0-28

29 Liabilities Long-term liabilities are debt that will take longer than 1 year to pay off Examples of long-term liabilities include student loans, car loans, and home mortgages Each payment includes an interest component and some amount that will reduce the initial liability (principal) Note that many people use credit cards this way This leads to paying more money than originally intended © 2010 Pearson Education, Inc. All rights reserved 0-29

30 Net Worth Net worth is the difference between your assets and your liabilities Figuring your net worth is an easy way to measure your wealth You can figure your net worth with a personal balance sheet Refer to Figure 4.4 for an example of figuring out your net worth © 2010 Pearson Education, Inc. All rights reserved 0-30

31 Figure 4.4 © 2010 Pearson Education, Inc. All rights reserved 0-31

32 Math for Personal Finance Lakisha’s car is worth about $6,000 and she still owes $1,200 on it. She has an outstanding credit card balance of $450. What is her net worth? © 2010 Pearson Education, Inc. All rights reserved 0-32

33 Math for Personal Finance Solution: Lakisha’s net worth is $6,000 - $1,200 - $450 = $4,350 © 2010 Pearson Education, Inc. All rights reserved 0-33

34 Changes in the Personal Balance Sheet Your Personal Balance Sheet changes as you acquire new assets or liabilities This will affect your net worth There are 2 ways to increase your net worth 1.The value of your assets needs to increase by more than your liabilities 2.To pay down debt on your liabilities © 2010 Pearson Education, Inc. All rights reserved 0-34

35 Analysis of Your Personal Balance Sheet Lenders look at your personal balance sheet to determine if you can pay the loan Loan officers use a debt-to-asset ratio to determine if you have borrowed too much money Keep your personal balance sheet in good shape It can influence the options you have for making financial decisions and having a good financial plan © 2010 Pearson Education, Inc. All rights reserved 0-35

36 Check Your Financial IQ What are the steps in creating a personal balance sheet? © 2010 Pearson Education, Inc. All rights reserved 0-36

37 Check Your Financial IQ To see your net worth, you need to identify all your assets, identify all your liabilities, and then subtract your liabilities from you assets. © 2010 Pearson Education, Inc. All rights reserved 0-37

38 Budgeting and Your Financial Plan Your cash flows feed into your balance sheet If cash flows exceeds cash outflows, you will either increase assets or reduce liability Take a look at figure 4.5 to see how this will show up on your balance sheet in the form of increased net worth © 2010 Pearson Education, Inc. All rights reserved 0-38

39 Figure 4.5 © 2010 Pearson Education, Inc. All rights reserved 0-39

40 Budgeting and Your Financial Plan Budgeting helps in financial planning because it makes you answer the following questions: –How can I improve my net cash flows in the near term? –How can I improve my net cash flows in the long term? –What decisions should I make about using credit, borrowing, and investing? © 2010 Pearson Education, Inc. All rights reserved 0-40

41 Check Your Financial IQ What is the importance of budgeting to your financial plan? © 2010 Pearson Education, Inc. All rights reserved 0-41

42 Check Your Financial IQ Budgeting helps you evaluate your current financial condition and determine how to improve net cash flows and make wise credit, borrowing, and investment decisions. © 2010 Pearson Education, Inc. All rights reserved 0-42

43 Summary The budgeting process allows you to monitor and control cash inflows and outflows Examine the difference between your forecast and actual cash inflows and outflows You can anticipate future problems and make necessary adjustments © 2010 Pearson Education, Inc. All rights reserved 0-43

44 Summary Your personal balance sheet tells you your financial position at a point in time It is a summary of your assets, your liabilities, and your net worth Assets can be listed as liquid assets, household assets, and investments Liabilities represent the amount of debt you owe Liabilities can be split into two categories: –Current liabilities –Long-term liabilities © 2010 Pearson Education, Inc. All rights reserved 0-44

45 Summary Budgeting can help you manage your cash flows to increase your net worth You can use this in building a financial plan © 2010 Pearson Education, Inc. All rights reserved 0-45

46 Vocabulary Bond Budget Current liability Forecast error Household asset Investment Liability Liquid asset Long-term liability Market value Mutual fund Net worth Personal balance sheet Real estate Stock © 2010 Pearson Education, Inc. All rights reserved 0-46

47 Websites (Kelley Blue Book)www.kbb.com © 2010 Pearson Education, Inc. All rights reserved 0-47


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