Personal Finance Chapter 2 PDF

Chapter 2: Money Management Strategy: Financial Statements and Budgeting Ted Stephenson, MBA, CFA, CFP Professor @ George Brown College © 2024 McGraw Hill Limited  Chapter 2: Learning Outcomes Learning Objectives: LO1 Recognize relationships among financial documents and money...

Chapter 2: Money Management Strategy: Financial Statements and Budgeting Ted Stephenson, MBA, CFA, CFP Professor @ George Brown College © 2024 McGraw Hill Limited  Chapter 2: Learning Outcomes Learning Objectives: LO1 Recognize relationships among financial documents and money management activities. LO2 Create a system for maintaining personal financial records. LO3 Develop a personal balance sheet and cash flow statement. LO4 Create and implement a budget. LO5 Calculate savings needed to achieve financial goals. 2 © 2024 McGraw Hill Limited Planning for Successful Money Management (1) Money Management Will Yield Benefits ▪ Daily spending and saving decisions are at the center of financial planning. ▪ Coordinate these decisions with your needs, goals and personal situation. ▪ Maintaining financial records is essential. 3 © 2024 McGraw Hill Limited Planning for Successful Money Management (2) Opportunity Cost and Money Management ▪ Spending money on current living expenses reduces the amount you can save and invest. ▪ Saving and investing reduces the amount you can spend now. ▪ Buying on credit ties up future income. ▪ Using savings for purchases results in lost interest earning. 4 © 2024 McGraw Hill Limited Planning for Successful Money Management (3) ▪ Major money management activities are: 5 © 2024 McGraw Hill Limited A System for Personal Financial Records (1) ▪ An organized system of financial records provides: ▪ Handling of daily business affairs. ▪ Planning and measuring of financial progress. ▪ Completing required tax reports. ▪ Making effective investment decisions. ▪ Determining available resources. 6 © 2024 McGraw Hill Limited A System for Personal Financial Records (2) ▪ Most financial records are kept in one of the following places: ▪ Home files, home computer, or online ▪ Safe Deposit Box or fireproof home safe ▪ Computer, tablet, phone 7 © 2024 McGraw Hill Limited A System for Personal Financial Records (4) ▪ What Not to Keep… 8 © 2024 McGraw Hill Limited Personal Financial Statements for Measuring Financial Sustainability (1) ▪ Purposes of personal financial statements: ◼ Summarize the value of items you own and the amounts you owe. ◼ Track your cash inflows and outflows. ◼ Identify strengths and weaknesses in your current financial situation. ◼ Measure progress towards your financial goals. ◼ Provide data for use in filing your income tax return or applying for credit. 9 © 2024 McGraw Hill Limited Personal Financial Statements for Measuring Financial Sustainability (2) ◼ A personal balance sheet reports what an individual or family owns or owes; also called a net worth statement or statement of financial position. ◼ For example, if your possessions are worth $14,500 and you owe $8,000 to others, your net worth is $6,500. 10 © 2024 McGraw Hill Limited Personal Financial Statements for Measuring Financial Sustainability (3) ▪ Steps in creating a personal balance sheet include: ▪ Step 1: Listing Items of Value ▪ Assets – Cash and other property with a monetary value 1. Liquid assets 2. Real estate 3. Personal possessions 4. Investment assets 11 © 2024 McGraw Hill Limited Personal Financial Statements for Measuring Financial Sustainability (4) ▪ Step 2: Determining Amount Owed ▪ Liabilities – amounts owed to others ▪ Current liabilities: debts to be paid within short time, usually less than one year ▪ Long term liabilities: do not have to pay in full until more than a year from now 12 © 2024 McGraw Hill Limited Personal Financial Statements for Measuring Financial Sustainability (5) ▪ Step 3: Computing Net Worth ▪ Net Worth – the difference between total assets and total liabilities ▪ Assets – Liabilities = Net Worth ▪ Assets = Liabilities + Net Worth 13 © 2024 McGraw Hill Limited Personal Financial Statements for Measuring Financial Sustainability (6) 14 © 2024 McGraw Hill Limited Personal Financial Statements for Measuring Financial Sustainability (7) 15 © 2024 McGraw Hill Limited Personal Financial Statements for Measuring Financial Sustainability (8) ▪ A person with a high net worth may still have financial difficulties. ▪ You can increase your net worth by: ▪ Increasing your savings. ▪ Reducing your spending. ▪ Increasing the value of your investments and possessions. ▪ Reducing your amount of debt. ▪ Net Worth is an indication of your financial position on a given date 16 © 2024 McGraw Hill Limited Personal Financial Statements for Measuring Financial Sustainability (9) Creating a Cash Flow Statement of Inflows and Outflows ▪ A cash flow statement, also called a personal income and expenditure statement, is a summary of cash receipts and payments for a period of time, such as a month or a year. ▪ This report provides data on your income and spending patterns, which will be helpful when preparing a budget. 17 © 2024 McGraw Hill Limited Personal Financial Statements for Measuring Financial Sustainability (10) Creating a Cash Flow Statement of Inflows and Outflows ▪ Step 1: Record income ▪ Step 2: Record cash outflows ▪ Fixed expenses do not vary from month to month ▪ Variable expenses are flexible payments ▪ Step 3: Determine net cash flow ▪ Net cash flow can be a surplus or a deficit ▪ Used as a basis for creating a spending, saving and investment plan. 18 © 2024 McGraw Hill Limited Personal Financial Statements for Measuring Financial Sustainability (11) 19 © 2024 McGraw Hill Limited Personal Financial Statements for Measuring Financial Sustainability (12) 20 © 2024 McGraw Hill Limited Personal Financial Statements for Measuring Financial Sustainability (13) Analyzing your Current Financial Situation ▪ Your first step to assessing your current financial situation is to complete a personal balance sheet and cash flow statement. ▪ This will serve as a basis of comparison for future personal balance sheets. 21 © 2024 McGraw Hill Limited Personal Financial Statements for Measuring Financial Sustainability (14) Analyzing your Current Financial Situation ▪ The steps to better Balance Sheet analysis include: 1. Measure your progress toward your financial goals. 2. Identify how your assets are distributed among the different categories. 3. Calculate your current asset allocation. 22 © 2024 McGraw Hill Limited Personal Financial Statements for Measuring Financial Sustainability (15) Analyzing Your Current Financial Situation 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. 23 © 2024 McGraw Hill Limited Personal Financial Statements for Measuring Financial Sustainability (16) ▪ Compiling your latest cash flow statements will: 1. Highlight your sources of income. 2. Reveal whether you are overspending. 3. Help assess your spending and saving patterns. 24 © 2024 McGraw Hill Limited Personal Financial Statements for Measuring Financial Sustainability (17) Ratio Interpretation ▪ Debt Ratio: Liabilities Show relationship between debt and net worth Net Worth A high current ratio is desirable ▪ Current Ratio: Liquid Assets to have cash available to pay Current Liabilities bills ▪ Liquidity Ratio: Liquid Assets Indicates the number of months in which living expenses can be Monthly Expenses paid if an emergency arises 25 © 2024 McGraw Hill Limited Personal Financial Statements for Measuring Financial Sustainability (18) Ratio Interpretation ▪ Debt Payments Ratio: ▪ Indicates how much or a persons’ earnings goes for debt payments Monthly Payments Take-Home Pay ▪ Financial experts recommend ▪ Savings Ratio: monthly savings of at least 10 per cent Amount Saved Each Month Gross Income 26 © 2024 McGraw Hill Limited Budgeting: A Money Management Skill (1) ▪ Budget is a specific plan for spending income ▪ Purposes: ▪ Spend less than your income. ▪ Understand your sources and uses of cash. ▪ Prioritize and attain your financial goals. ▪ Prepare an emergency fund. ▪ Develop wise financial management habits. 27 © 2024 McGraw Hill Limited Budgeting: A Money Management Skill (2) ▪ Budget is a specific plan for spending income for a certain lifestyle. Lifestyle is influenced by: ▪ Career ▪ Family ▪ Values 28 © 2024 McGraw Hill Limited Budgeting: A Money Management Skill (3) Creating and implementing a budget can be achieved in seven steps: 1. Setting financial goals 2. Estimating income 3. Budgeting emergency fund and savings 4. Budgeting fixed expenses 5. Budgeting variable expenses 6. Recording spending amounts 7. Reviewing spending and saving patterns 29 © 2024 McGraw Hill Limited Budgeting: A Money Management Skill (4) 30 © 2024 McGraw Hill Limited Budgeting: A Money Management Skill (5) A successful budget should be: ▪ Well planned. ▪ Realistic. ▪ Flexible. ▪ Clearly communicated. 31 © 2024 McGraw Hill Limited Money Management to Achieve Financial Goals (1) ▪ Common reasoning for saving includes: ▪ Setting aside money for unexpected expenses. ▪ Earning income from the interest on savings. ▪ Replacement of expensive items. ▪ Buying special items. ▪ Providing for long-term expenses. 32 © 2024 McGraw Hill Limited Money Management to Achieve Financial Goals (2) Selecting a saving technique: ▪ Should make regular periodic savings deposits ▪ Can be a percentage of income (5−10%) or specific dollar amount ▪ Always “pay yourself first”. 33 © 2024 McGraw Hill Limited Money Management to Achieve Financial Goals (3) 34 © 2024 McGraw Hill Limited Money Management to Achieve Financial Goals (4) Suggestions for dual-income households include: ▪ Pooled Income. ▪ Sharing the Bills. ▪ 50/50. ▪ Proportionate Contributions. 35 © 2024 McGraw Hill Limited Summary LO1 Recognize relationships among financial documents and money management activities Requires effective coordination of personal financial records, personal financial statements and budgeting activities LO 2 Create a system for maintaining personal financial records Foundation of effective money management Should provide easy access as well as security 36 © 2024 McGraw Hill Limited Summary LO3 Develop a personal balance sheet and cash flow statement Net worth statement lists all items of value (assets) and all amounts owed to others (liabilities) Difference is your net worth Person income and expenditures statement is a summary of cash receipts and payments for a given period of time Provides data on your income and spending patterns 37 © 2024 McGraw Hill Limited Summary LO4 Create and implement a budget Seven-step process will help you live within your means and channel your resources toward the attainment of prioritized financial goals LO5 Calculate savings needed to achieve financial goals Future and present value calculations may be used to compute the increased value of savings for achieving financial goals 38 © 2024 McGraw Hill Limited Appendix: Key Formulae 39 © 2024 McGraw Hill Limited