Money Management Strategy Chapter 3

Section 3.1 Objectives Discuss the relationship between opportunity costs and money management Explain the benefits of keeping financial records and documents Describe a system to maintain personal financial documents

Money Management and Trade-Offs Plan to get most of your money Keep track of where your money goes Consider your values, goals, and state of your bank account to make better spending decisions

Benefits of Organizing Your Financial Documents Find what you need in a hurry Plan and measure your financial progress Handle routine money matters, such as paying bills on time Determine how much money you will have now and in the future Make effective decisions about how to save money

Where to Keep Your Financial Documents Home Files Safe-Deposit Boxes Home Computers

Home Files Types of files Employment records Money management records Checkbook Checks Tax records Receipts Insurance records Do not keep hard to replace documents here because no protection against fire, water, or theft

Safe-Deposit Boxes Types of files $100 or less per year Birth certificates Mortgage papers Copy of will CDs Car titles Account and policy numbers $100 or less per year Bank loss from fire or disasters is rare Insurance protection Could also use a fire-proof box

Home Computers Budgets Summary of banking transactions Tax records Resume

Section 3.2 Objectives Describe a personal balance sheet and cash flow statement Develop a personal balance sheet and cash flow statement

Personal Financial Statements Help you: Determine what you own and what you owe Measure your progress toward your financial goals Track your financial activities Organize information that you can use when you file your tax return or apply for credit

Personal Balance Sheet Step One: Determine Your Assets Step Two: Determine Your Liabilities Step Three: Calculate Your Net Worth Step Four: Evaluate Your Financial Situation

Step One: Determine Your Assets Assets – Any items of value that you own Liquid Assets – items quickly converted to cash Real Estate – land and any structures, should list market value on balance sheet Personal Possessions – Car and other things not real estate Should list current value, not purchase value Investment Assets – retirement accounts, stocks, bonds

Step Two: Determine Your Liabilities Liabilities – debts you owe for longer than a month – so utility bills would not be a liability Current Liabilities – debts that are paid within a year such as medical bills, cash loans, taxes Long-term Liabilities – debts that do not have to be fully paid within a year such as car loans, student loans, mortgage loans

Step Three: Calculate Your Net Worth Assets-Liabilities = Net Worth Net worth is not what you can spend, just an indication of your general financial situation With high net worth, a person could still have trouble paying the bills May be insolvent – liabilities greater than assets

Step Four: Evaluate Your Financial Situation Update every few months to track changes over time Increase net worth by: Increasing savings Increasing your investments Reducing your expenses Reducing debt

Cash Flow Statement Two parts – cash inflow/cash outflow Step One: Record Your Income Step Two: Record Your Expenses

Step One: Record Your Income All sources of income within a given month Net income Interest on investments/savings Discretionary Income – amount of money left after paying for essentials – some financial experts say this good indication of the strength of your income

Step Two: Record Your Expenses Can be either fixed or variable Fixed – Cable TV, rent, loan payments, trash pick up Variable – Food, clothes, electricity, medical costs, recreation

Step Three: Determine Your Net Cash Flow Income – Expenses = Cash Flow Surplus – Extra money Deficit – More money spent than earned Accurate cash flow statement can help you prepare and implement a spending, savings, and investment plan

Cash Flow Statement for Month Ending July 31, 2012 Income (Cash Inflow) Take home pay Allowance Savings account interest Total Income $450 100 12 $562 Expenses (Cash Outflow) Fixed Expenses (cable tv, rent, commuter expenses) Variable Expenses (recreation, clothing, take-out food) Total Expenses $ 80 320 $400 Net Cash Flow $162

Evaluating Your Financial Progress Ratio Calculation Example Meaning Debt Ratio Liabilities divided by net worth $25,000/$50,000 = 0.5 Compare your liabilities to your net worth. A low debt ratio is desirable Liquidity Ratio Liquid assets divided by monthly expenses $10,000/$4,000 = 2.5 Indicates number of months you would be able to pay your living expenses in case of an emergency. The higher the better. Debt-payments Ratio Monthly credit payments divided by take-home pay $540/$3,600 = 15% Indicates how much of a person’s earnings goes to pay debts (excluding mortgage). Most experts recommend a ration of less than 20% Savings Ratio Amount saved each month divided by gross monthly income $600/$5,000 = 12% Most financial experts recommend a saving ratio of at least 10%

Section 3.3 Objectives Identify the steps of creating a personal budget Discuss the advantage of increasing your savings

Budgeting for Financial Goals Step One: Set Your Financial Goals Step Two: Estimate Your Income Step Three: Budget for Unexpected Expenses Step Four: Budget for Fixed Expenses Step Five: Budget for Variable Expenses Step Six: Record What You Spend Step Seven: Review Spending and Saving Patterns

Step 1: Set Your Financial Goals Take into consideration: Career Lifestyle Values Hopes for the future Be specific Use time frame (short, intermediate, long-term)

Step 2: Estimate Your Income Include all sources; paycheck, investments Estimate income best you can if it varies from week to week

Step 3: Budget for Unexpected Expenses Have emergency fund 3 to 6 months worth of living expenses

Step 4: Budget for Fixed Expenses Mortgage Car payments Student loans Insurance

Step 5: Budget for Variable Expenses Medical costs Heating and cooling Other basic utilities

Step 6: Record What You Spend Keep track of actual expenses and money paid out Budget variance – difference between what was budgeted and what was spent – could be deficit or surplus

Step 7: Review Spending and Saving Patterns Review financial progress Revise goals if needed If deficits, ask where you can cut Use your financial goals to help decide what to cut

Budget Sucessfully A good budget is: Carefully planned Practical Flexible Written and easily accessible

Ways to Increase Your Savings Pay yourself first Payroll savings Spending less to save