Chapter 2 Money Management Skills McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

Money Management Skills Chapter Objectives Identify the main components of wise money management Create a personal balance sheet and cash flow statement Develop and implement a personal budget Connect money management activities with saving for personal financial goals 2-2

Objective 1 Identify the Main Components of Wise Money Management Money management = day-to-day financial activities necessary to manage current personal economic resources, while working toward long-term financial security Daily spending and saving decisions = central to financial planning Must be coordinated with needs, goals, and personal situations 2-3

Components of Money Management 2-4

Money Management Troubles & Debt Getting out of debt: Evaluate your credit situation Track your spending Plan to make payments on time Consider other income sources If appropriate, seek assistance 2-5

An Organized Personal Financial Records System Provides a basis for: Handling daily business affairs, such as bill paying Planning and measuring financial progress Completing required tax reports Making effective investment decisions Determining available resources for current and future buying 2-6

Records in Your Home File Items you refer to often Personal and employment records Money management records Tax records Financial services records Credit records Consumer purchase and auto records Housing records Insurance records Investment records Estate planning and retirement records 2-7

What to Keep in a Safe Deposit Box Records and items that would be hard to replace: Birth, marriage and death certificates List of checking, savings and financial institution account numbers 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 Copy of will 2-8

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 investment performance results Computerized versions of wills, estate plans, and other documents * Keep a backup! 2-9

How Long to Keep Records Retention Period Birth certificates, wills and social security information Indefinitely Personal property and investments As long as you own them Documents re: purchase and sale of real estate Copies of tax returns and supporting data 7 years minimum 10 years better 2-10

Objective 2 Create a Personal Balance Sheet and Cash Flow Statement Benefits Recap your current financial position in relation to the value of items you own and amounts you owe Measure progress toward financial goals Maintain information on financial activities Provide information for preparing tax forms or applying for credit 2-11

Balance Sheet A financial statement that reports what an individual or family owns and owes as of a specific date: Also called: Net worth statement Statement of financial position Items of Value (what you own) - Amounts owed (what you owe) Net Worth (your wealth) = 2-12

Components of a Balance Sheet Step 1 – List items of value Liquid assets Real estate Personal possessions Investment assets Step 2 – Determine amounts owed Current liabilities (< 1 year) Long term liabilities Step 3 - Compute your net worth. 2-13

Net Worth Assets - Liabilities = Net Worth Measurement of current financial position Net worth ≠ cash available Insolvency: Inability to pay debts when due Liabilities far exceed assets 2-14

Sample Balance Sheet 2-15

Ways to Increase Net Worth Increase your savings Reduce spending Increase the value of investments and other possessions Reduce amounts owed 2-16

Evaluating Financial Progress Ratios 2-17

The Cash Flow Statement Inflows and Outflows Cash flow statement = personal income and expenditure statement Summary of cash receipts and payments for a given period Total cash received during the time period Cash outlays during the time period Cash surplus or deficit - = 2-18

The Cash Flow Statement Inflows and Outflows Step 1 - Record Income Net income from employment (Net Pay) Savings and investment income Other sources Step 2 - Record cash outflows Fixed and variable expenses Step 3 - Determine Net Cash Flow Use this statement as a basis for creating a spending, saving and investment plan 2-19

Sample Cash Flow Statement 2-20

Objective 3 Develop and Implement a Personal Budget Budget = spending plan Helps you: Live within your income Spend money wisely Reach financial goals Prepare for financial emergencies Develop wise financial management habits 2-21

The 7 Steps in Budgeting Process Set financial goals Estimate income from all sources Budget an Emergency Fund and Savings Budget Fixed Expenses Budget Variable Expenses Record Spending Amounts Review Spending and Saving Patterns Review financial progress Revise goals and budget allocations 2-22

2-23

Typical Budget Allocations 2-24

Characteristics of a Successful Budget Well planned Realistic Flexible Clearly communicated 2-25

Budgeting Systems Mental budget Physical Budget Written Budget Appropriate if financial resources and responsibilities are limited Physical Budget Envelopes, folders or containers Written Budget On notebook paper Computerized Budget Spreadsheet or specialized software 2-26

Objective 4 Connect Money Management Activities with Savings for Personal Financial Goals Your Balance Sheet: Snapshot of where you are now Your Cash Flow Statement: What you received and spent over a specific period Your Budget: Planning spending and saving to achieve financial goals 2-27

Changes in Net Worth Changes in Net Worth result from cash inflows and outflows. Outflows > Inflows Draw from savings or borrow Problem/Result: Lower assets or higher liabilities Inflows > Outflows Put money into savings or pay off debts Result: Higher net worth 2-28

Selecting a Saving Technique Write a check each payday and deposit in a savings account Use payroll deduction to deposit a certain amount in savings (direct deposit) Save coins or spend less on certain items 2-29

Calculating Savings Amounts Convert savings goals into specific amounts Use savings and investments plans to grow your money Use time value of money to calculate progress toward financial goals 2-30

Using Savings to Achieve Financial Goals 2-31