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Chapter 3


                             Money Management
                              Strategy: Financial
                               Statements and
                                  Budgeting




McGraw-Hill/Irwin   Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Planning for Successful
        Money Management
• Daily spending and saving decisions are
   the heart of financial planning.
• Decisions must be coordinated with
  needs, goals, and personal situations.
• Money management is the day-to-day
  financial activities needed to manage
  personal economic resources, while
  working toward long-term financial
  security.

                                            3-2
Opportunity Cost and
           Money Management
• Spending money on current living
    expenses reduces the amount you can
    save and invest.
•   Saving and investing for the future reduces
    the amount you can spend now.
•   Buying on credit ties up future income.
•   Using savings for purchases results in lost
    interest and depletes savings.
•   Comparison shopping can save money but
    takes valuable time.
                                                  3-3
Major Money Management Activities

  Storing       Creating     Creating and
    and         personal    implementing
maintaining     financial      a plan for
 personal     statements      spending,
 financial      (balance     and saving
                             (budgeting).
  records     sheets and
    and        cash flow
documents.    statements
               of income
                   and
                outflow).
                                        3-4
Benefits of an Organized System of
             Financial Records
• Handling daily business affairs,
    including payment of bills on time.
•   Planning and measuring financial
    progress.
•   Completing required tax reports.
•   Making effective investment decisions.
•   Determining available resources for
    current and future buying.

                                             3-5
What to Keep in Your Home File
• Items you refer to often.
     Personal and employment records.
     Money management records.
     Tax records.
     Financial services records.
     Consumer purchase, auto and credit records.
     Housing records.
     Insurance records.
     Investment records.
     Estate planning and retirement records.
                                                    3-6
What to Keep in a Safe Deposit Box

• Safe deposit box is for records that would
  be hard to replace.
     Birth, marriage and death certificates, copy of will
     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.

                                                             3-7
Records on Personal Computer
• Home 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 performance
      results of investments.
     Computerized versions of wills,
      estate plans, and other documents.
                                                  3-8
How Long to Keep Records
• Birth certificates, wills, and Social
  Security information should be kept
  indefinitely.
• Keep records on personal property and
  investments as long as you own them.
• Keep documents related to the purchase
  and sale of real estate indefinitely.
• Copies of tax returns and supporting
  data should be kept six years.
                                           3-9
Purpose of Personal
          Financial Statements
• Report your current financial position in
  relation to the value of the items you own
  and the amounts you owe.
• Measure your progress toward your
  financial goals.
• Maintain information on your financial
  activities.
• Provide data you can use when preparing
  tax forms or applying for credit.

                                               3-10
Components of a Balance Sheet
             (net worth statement)

• Assets - what you own.
    Liquid assets.
    Real estate.
    Personal possessions.
    Investment assets.
• Liabilities - what you owe
    Current liabilities (< 1 year).
    Long term liabilities.
• Compute your net worth.
    Assets minus liabilities.
                                       3-11
Where Did Your Money Go? Components
      of a Cash Flow Statement
• Shows inflow, outflow for a given time
  period.
     Record inflow.
       • Net income from employment.
       • Savings and investment income.
       • Other sources.
     Record cash outflows.
       • Fixed and variable expenses.
       • Net cash flow can be a surplus or a deficit.
• Use this statement as a basis for creating
  a spending, saving and investment plan.
                                                        3-12
Ratios for Evaluating Financial
                Progress
• Debt ratio = total liabilities/net worth; compares
  debt to net worth; lower debt ratio is best
• Current ratio – liquid assets/current liabilities;
  shows how well short term assets cover short
  term debt; higher ratio is good
• Liquidity ratio = liquid assets/monthly expenses;
  shows # of months that living expenses can be
  paid; higher ratio is good
• Debt payments ratio = monthly credit
  payments/take-home pay; try to keep ratio below
  20%
• Savings ratio = monthly savings/gross income;
  Americans tend to be poor savers; shoot for at
  least 10%
                                                       3-13
Purposes of a Budget
• In contrast to cash flow, which was a
  record of how you spent money in a past
  time period, a budget is a plan for
  spending in the future, such as for the
  next month. A budget helps you…
     Live within your income.
     Spend your money wisely.
     Reach your financial goals.
     Prepare for financial emergencies.
     Develop wise financial management habits.
                                                  3-14
Creating and Implementing a Budget

• Assessing your current situation.
   Measure your current financial position.
   Determine your needs, values and life
    situation.
• Steps in the budgeting process.
   1 Set financial goals.
   2 Estimate income from all sources.
   3 Budget amount for an emergency fund,
     periodic expenses and financial goals.
   4 Budget set amounts that you are obligated to
     pay. These are your fixed expenses. BE
       SURE TO BUDGET FOR SAVINGS.                  3-15
Creating and Implementing a Budget

• Steps in the budgeting process
 (continued).
  5 Estimate amounts that are to be spent for
    household and living expenses. These are
    your variable expenses.
  6 Record actual amounts for inflows and
    outflows, comparing actual amounts with
    budgeted amounts to determine variances.
          Deficits and surpluses.
  7   Review your spending and savings
      patterns and evaluate whether
      revisions are needed in your
      savings and spending plans.               3-16
Characteristics of Successful Budgeting

 • Well planned.
 • Realistic.
 • Flexible.
 • Clearly communicated.




                                          3-17
Selecting a Budgeting System
1)    Mental budget – it is all in your head
2)    Physical budget-use envelopes for
      your expenses such as food, rent.
3)    Written budget – use spreadsheets
4)    Computerized budget – use
      software such as Quicken
      (www.quicken.com)



                                               3-18
Saving to Achieve Financial Goals

• Common reasoning for saving include…
   To set aside money for irregular and
    unexpected expenses.
   To pay for the replacement of expensive items,
    such as cars or a down payment on a house.
   To buy special items like recreational
    equipment or to pay for a vacation.
   To provide for long-term expenses such as
    retirement or the education of children.
   To earn income from the interest on savings for
    use in paying living expenses.
                                                      3-19
Savings Techniques-If I don’t see it, I
           won’t spend it
• Payroll deductions into saving accounts
• Automatic payments from checking into
  savings accounts or mutual funds
• Saving regularly in 401(k) plans
• Also save coins, make periodic deposits
• Write a check each payday as a % of
   income and deposit into savings


                                            3-20
Money Management & Achieving
          Financial Goals
• Balance Sheet reports current financial
  position
• Cash Flow Statement shows cash you
  have received and spent in the past
• Budget helps you to spend and save to
  achieve financial goals




                                            3-21

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money management strategy

  • 1. Chapter 3 Money Management Strategy: Financial Statements and Budgeting McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
  • 2. Planning for Successful Money Management • Daily spending and saving decisions are the heart of financial planning. • Decisions must be coordinated with needs, goals, and personal situations. • Money management is the day-to-day financial activities needed to manage personal economic resources, while working toward long-term financial security. 3-2
  • 3. Opportunity Cost and Money Management • Spending money on current living expenses reduces the amount you can save and invest. • Saving and investing for the future reduces the amount you can spend now. • Buying on credit ties up future income. • Using savings for purchases results in lost interest and depletes savings. • Comparison shopping can save money but takes valuable time. 3-3
  • 4. Major Money Management Activities Storing Creating Creating and and personal implementing maintaining financial a plan for personal statements spending, financial (balance and saving (budgeting). records sheets and and cash flow documents. statements of income and outflow). 3-4
  • 5. Benefits of an Organized System of Financial Records • Handling daily business affairs, including payment of bills on time. • Planning and measuring financial progress. • Completing required tax reports. • Making effective investment decisions. • Determining available resources for current and future buying. 3-5
  • 6. What to Keep in Your Home File • Items you refer to often.  Personal and employment records.  Money management records.  Tax records.  Financial services records.  Consumer purchase, auto and credit records.  Housing records.  Insurance records.  Investment records.  Estate planning and retirement records. 3-6
  • 7. What to Keep in a Safe Deposit Box • Safe deposit box is for records that would be hard to replace.  Birth, marriage and death certificates, copy of will  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. 3-7
  • 8. Records on Personal Computer • Home 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 performance results of investments.  Computerized versions of wills, estate plans, and other documents. 3-8
  • 9. How Long to Keep Records • Birth certificates, wills, and Social Security information should be kept indefinitely. • Keep records on personal property and investments as long as you own them. • Keep documents related to the purchase and sale of real estate indefinitely. • Copies of tax returns and supporting data should be kept six years. 3-9
  • 10. Purpose of Personal Financial Statements • Report your current financial position in relation to the value of the items you own and the amounts you owe. • Measure your progress toward your financial goals. • Maintain information on your financial activities. • Provide data you can use when preparing tax forms or applying for credit. 3-10
  • 11. Components of a Balance Sheet (net worth statement) • Assets - what you own.  Liquid assets.  Real estate.  Personal possessions.  Investment assets. • Liabilities - what you owe  Current liabilities (< 1 year).  Long term liabilities. • Compute your net worth.  Assets minus liabilities. 3-11
  • 12. Where Did Your Money Go? Components of a Cash Flow Statement • Shows inflow, outflow for a given time period.  Record inflow. • Net income from employment. • Savings and investment income. • Other sources.  Record cash outflows. • Fixed and variable expenses. • Net cash flow can be a surplus or a deficit. • Use this statement as a basis for creating a spending, saving and investment plan. 3-12
  • 13. Ratios for Evaluating Financial Progress • Debt ratio = total liabilities/net worth; compares debt to net worth; lower debt ratio is best • Current ratio – liquid assets/current liabilities; shows how well short term assets cover short term debt; higher ratio is good • Liquidity ratio = liquid assets/monthly expenses; shows # of months that living expenses can be paid; higher ratio is good • Debt payments ratio = monthly credit payments/take-home pay; try to keep ratio below 20% • Savings ratio = monthly savings/gross income; Americans tend to be poor savers; shoot for at least 10% 3-13
  • 14. Purposes of a Budget • In contrast to cash flow, which was a record of how you spent money in a past time period, a budget is a plan for spending in the future, such as for the next month. A budget helps you…  Live within your income.  Spend your money wisely.  Reach your financial goals.  Prepare for financial emergencies.  Develop wise financial management habits. 3-14
  • 15. Creating and Implementing a Budget • Assessing your current situation.  Measure your current financial position.  Determine your needs, values and life situation. • Steps in the budgeting process. 1 Set financial goals. 2 Estimate income from all sources. 3 Budget amount for an emergency fund, periodic expenses and financial goals. 4 Budget set amounts that you are obligated to pay. These are your fixed expenses. BE SURE TO BUDGET FOR SAVINGS. 3-15
  • 16. Creating and Implementing a Budget • Steps in the budgeting process (continued). 5 Estimate amounts that are to be spent for household and living expenses. These are your variable expenses. 6 Record actual amounts for inflows and outflows, comparing actual amounts with budgeted amounts to determine variances.  Deficits and surpluses. 7 Review your spending and savings patterns and evaluate whether revisions are needed in your savings and spending plans. 3-16
  • 17. Characteristics of Successful Budgeting • Well planned. • Realistic. • Flexible. • Clearly communicated. 3-17
  • 18. Selecting a Budgeting System 1) Mental budget – it is all in your head 2) Physical budget-use envelopes for your expenses such as food, rent. 3) Written budget – use spreadsheets 4) Computerized budget – use software such as Quicken (www.quicken.com) 3-18
  • 19. Saving to Achieve Financial Goals • Common reasoning for saving include…  To set aside money for irregular and unexpected expenses.  To pay for the replacement of expensive items, such as cars or a down payment on a house.  To buy special items like recreational equipment or to pay for a vacation.  To provide for long-term expenses such as retirement or the education of children.  To earn income from the interest on savings for use in paying living expenses. 3-19
  • 20. Savings Techniques-If I don’t see it, I won’t spend it • Payroll deductions into saving accounts • Automatic payments from checking into savings accounts or mutual funds • Saving regularly in 401(k) plans • Also save coins, make periodic deposits • Write a check each payday as a % of income and deposit into savings 3-20
  • 21. Money Management & Achieving Financial Goals • Balance Sheet reports current financial position • Cash Flow Statement shows cash you have received and spent in the past • Budget helps you to spend and save to achieve financial goals 3-21