Chapter 2 – Money Management Strategy (Financial Statements and Budgeting) PDF

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Chapter 2 – Money Management Strategy (Financial Statements and Budgeting) LO 1 – Recognize relationships among financial documents and money management activities Money management: refers to the day-to-day financial activities necessary to manage current personal economic resources while working toward long-term financial security In terms of money management decisions, examples of trade-off situations, or opportunity costs, include the following: 

Spending money on current living expenses reduces the amount you can use for savings and inveting for long-term financial security

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Saving and investing for the future reduces the amount you can spend now

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Buying on credit results in payments later and a reduction in the amount of future income available for spending

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Using savings for purchases results in lost interest earnings and an inability to use savings for other purposes

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Comparison shipping can save you money and improve the quality of your purchases but uses up something of value cannot replace: your time

LO 2 – Create a system for maintaining personal financial records An organized system of financial records provides a basis for: 

Handling daily business affairs, including paying bills on time

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Planning and measuring financial progress

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Completing required tax reports

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Making effective investment decisions

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Determining available resources for current and future buying

Safety deposit box: private storage area at a financial institution with maximum security for valuables and difficult-to-replace documents

LO 3 – Develop a personal balance sheet and cash flow statement Personal financial statements: personal balance sheet and the cash flow statement The main purposes of personal financial statements are to: 

Summarize the value of the items that you own and the amounts that you owe

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Track you cash inflows by source and you outflows by type

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Identify strengths and weaknesses in your current financial situation

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Measure progress toward your financial goals

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Provide data for use in filing your income tax return or applying for credit

Personal balance sheet: reports what you own and what you owe

Assets: cash and tangible property and intangible items with a monetary value

Liquid assets: cash and items of value that can easily be converted to cash

Real estate: a home, a condominium, vacation property or other land that a person or family owns Personal possessions: automobiles and other personal belongings Investment assets: funds set aside for long-term financial needs Liabilities: debt you owe now, not something you may owe in the future Current liabilities: debts you must pay within a short time, usually less than a year Long-term liabilities: debts you do not have to pay in full until more than a year from now Net worth: the difference between your total assets and your total liabilities Insolvency: the inability to pay debts when they are due You can increase your net worth in various ways, including: 

Increasing your savings (increases assets)

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Reducing spending (increases assets and may decrease liabilities)

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Increasing the value of investments and possessions (increases assets)

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Reducing your amount of debt (decreases liabilities)

Cash flow: the actual inflow and outflow of cash during a given time period Cash flow statement: summary of cash receipts and payments for a period of time, such as a month or a year

Income: the inflow of cash to an individual or household Common cashflows include: 

Wages, salaries, and commissions

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Self-employed business income

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Savings and investment income (interest, dividends, rent)

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Gifts, grants, scholarships, and educational loans

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Government payments

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Amounts received from pension and retirement programs

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Alimony and child support payments

Take-home pay: person’s earning after deductions for taxes and other items Discretionary income: money left over after paying for housing, food, and other necessities Fixed expenses: payments that do not vary from month to month Variable expenses: flexible payments that change from month to month The steps to better analysis include: 1. Measure your progress toward financial goals 2. Identify how your assets are distributed among the different categories 3. Calculate your current asset allocation, defined as the percentage allocation of financial assets between cash, fixed income, and equity investments 4. Identify whether your investments are tax efficient 5. Identify assets that may be lost, stolen, damaged, or destroyed 6. Summarize the types and extent of your indebtedness Compiling your latest cash flow statements will: 1. Highlight your sources of income 2. Reveal whether you are overspending 3. Help you assess your spending and saving patterns LO 4 – Create and implement a budget Budget: a specific plan for spending income The main purposes of a budget are to help you:

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Spend less than your income

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Understand your sources and uses of cash

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Prioritize and attain your financial goals

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Prepare an emergency fund

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Develop wise financial management habits

These actions reflect a lifestyle influences by three factors: 

Career. Your job situation influences the amount of your income, the way you spend your leisure time, and even the people with whom you associate

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Family. The size of your household and the ages of its members also affect your lifestyle

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Values. Ideas and beliefs you regard as important strongly influence your interests, activities, and purchasing habits

Creating and implementing a budget can be achieved in seven steps: 1. Setting financial goals a. Your personal financial statements and budgeting allow you to achieve your financial goals with: i. Your cash flow statement: telling you what you received and spent over the past month ii. Your balance sheet: reporting your current financial position – where are you now iii. Your budget: planning spending and saving to achieve financial goals 2. Estimating income 3. Budgeting emergency fund and savings

4. Budgeting fixed expenses a. The following sources can help you plan your spending i. Your cash flow statement ii. Consumer expenditure data iii. Information on web sites iv. Estimates of future income and expenses and anticipated changes in inflation rates

5. Budgeting variable expenses a. Consumer price index is a measure of the general price level of consumer goods and services in Canada 6. Recording spending amounts a. Budget variance: difference between the amount budgeted and the actual amount received or spent b. Budget deficit: spending exceeded his planned spending c. Budget surplus: actual spending had been less than planned 7. Reviewing spending and saving patterns

Money management experts advise that a successful budget should be: 

Well planned. A good budget takes time and effort to prepare

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Realistic. If you have a moderate income, don’t immediately expect to save enough money for an expensive car or a lavish vacation

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Flexible. Unexpected expenses and changes in your cost of living require a budget that you can easily revise

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Clearly communicated. Unless you and others involved are aware of the spending plan, it will not work LO 5 – Calculate savings needed to achieve financial goals

Common reasons for saving include: 

Setting aside money for irregular and unexpected expenses

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Earning income from the interest on savings for use in paying living expenses

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Paying for the replacement for expensive items, such as an automobile or to have money for a down payment on a house

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Buying special items, such as home entertainment or recreational equipment, or paying for a vacation

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Providing for long-terms expenses, such as children’s education or retirement

Here are some suggestions for multi-income households 1. Pooled Income: all incomes are combined, and bills are paid from the pool 2. Sharing the biils: each persons is responsible for paying predetermined bills 3. 50/50: each person contributed an equal amount into the pool to cover shared expenses 4. Proportionate contributions: this method is similar to the 50/50. However, each person contributes a percentage of their income...