1. Budgets and Balance Sheets: Your Personal Financial Statements
Chapter 4
Budgets and Balance Sheets: Your Personal Financial Statements
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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
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3. Creating a Budget
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
A budget is a forecast of future cash inflows and outflows
Discuss the importance of creating an accurate budget.
A budget is the foundation of a financial plan.
Explain how a budget is not a negative thing. It empowers you to have the things you want.
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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
Discuss the importance of monitoring and recording your cash flows.
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5. Figure 4.1
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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
Ask students what cash flows they currently have. Will any change in the near future?
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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
Explain how it is important to forecast for everything – ATM fees, coffee, etc – this helps in creating an accurate budget
Give examples of unexpected expenses such as car breakdowns or medical emergencies
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8. Figure 4.2
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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
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10. Assessing the Accuracy of the Budget
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
A forecast error is the difference between what you forecast to happen and what actually happened
Explain how it is important to monitor your budget because errors can occur and need to be fixed.
Explain how you might need to increase your income or decrease your outflow to fix these errors.
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11. Figure 4.3
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12. Check Your Financial IQ
What are the steps involved in creating a budget?
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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
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14. Personal Balance Sheet
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
Personal balance sheet tells you what your financial position is at a point in time.
Discuss the importance of a balance sheet in regard to your financial plan.
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15. Assets Assets on a balance sheet can be classified in several ways:
Liquid assets
Household assets
investments
Explain why it is important to list your assets on a balance sheet. It helps you figure out where you are financially.
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16. Liquid Assets
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
Liquid assets are financial assets that are either cash or can be easily converted to cash without significant loss of value
Explain how you want to increase your liquid assets.
Explain that most savings accounts include an interest rate that will increase your savings.
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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?
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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.
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19. Household Assets 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
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
Explain how to estimate market value and how it’s important to understand that what you pay for something isn’t necessarily what it’s worth.
Remind students that it is important for a financial plan to be accurate and realistic
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20. Investments Investments are the third major category of assets
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
Explain that an investment is something you put your money into with the hopes of making more money.
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21. Investments
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
Bonds are basically certificates that function like IOUs—promises to repay a certain amount of money at some future time
Explain what risks may be involved with bonds (issuer not returning money)
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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
Explain how stocks work. You buy a stock at a certain price. The value can increase or decrease. If it increases and you sell, you make money. If it decreases, you lose money.
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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?
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24. Math for Personal Finance
Solution:
Company Y
50 x $170 = $8,500
Company Z
65 x $47 = $3,055
Total = $11,555
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25. Investments
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
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
Explain how mutual funds work.
Explain how the risk of loss isn’t as risky since it is spread across a few investments.
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26. Investments Real estate is another type of investment
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
Explain why people invest in real estate. People buy real estate and sell it hoping the value has increased and they will make a profit.
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27. Liabilities Liabilities represent the amount of debt a person owes
These debts can be put into 2 categories:
Current liabilities
Long-term liabilities
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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
Explain that current liabilities are a short term “loan” that should be paid off fairly soon.
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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
Explain that for most long term liabilities, there is the initial amount (principal) and these will have an interest on them, costing you more money than the initial amount.
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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
Explain that net worth can be negative if there are more liabilities than assets.
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31. Figure 4.4
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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?
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33. Math for Personal Finance
Solution: Lakisha’s net worth is $6,000 - $1,200 - $450 = $4,350
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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
The value of your assets needs to increase by more than your liabilities
To pay down debt on your liabilities
Tell students to make updates to their budget as their personal balance sheet changes.
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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
Explain that if you have more debt (liabilities) than assets, you might not get a loan.
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36. Check Your Financial IQ
What are the steps in creating a personal balance sheet?
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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.
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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
Remind students that cash inflows is money that is coming “in”. Cash outflows is money that is going “out” – spending.
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39. Figure 4.5
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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?
Explain that net cash flows means money coming in/money that you have.
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41. Check Your Financial IQ
What is the importance of budgeting to your financial plan?
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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.
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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
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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
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45. Summary
Budgeting can help you manage your cash flows to increase your net worth
You can use this in building a financial plan
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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
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47. Websites www.forbes.com www.kbb.com (Kelley Blue Book)
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