Personal Finance Chapter 2 - Money Management Skills

Budget

-Spending plan -Necessary for successful financial planning -The common financial problems of overusing credit, lacking a regular savings program, and failing to ensure future financial security can be minimized through budgeting

Budget Fixed Expenses

-The amount you budget for various items will depend on your current needs and plans for the future -A budget involves projected or planned income and expenses -A cash flow statement reports the actual income and expenses

Deficit

-Actual spending exceeded their planned spending by an amount

Record Spending Amounts

-After having established a spending plan, you will need to keep track of your actual income and expenses -Similar to preparing a cash flow statement -Variances for income should be viewed as the opposite of variance for expenses

Estimate Income

-After setting goals, you need to estimate available money for a given time period -A common budgeting period is a month, since many payments, such as rent, utilities, and credit cards are due each month -In determining available income, include only money that you are sure you'll receive -Estimate on the low side to help avoid overspending and other financial difficulties

Cash Flow Statement

-Also called a personal income and expenditure statement -A summary of cash receipts and payments for a given period, such as a month or a year -Provides data on your income and spending patterns, which will be helpful when preparing a budget -A checking account can provide info for your cash flow statement -Deposits to the account are your inflows -Checks written, cash withdrawals, and debit card payments are your outflows

Take-Home Pay

-Also called net pay or disposable income -A person's earnings after deductions for taxes and other items

Creating a Personal Balance Sheet - Step 1: Listing Items of Value

-Available cash and money in bank accounts combined with other items of value are the foundation of your current financial position

Current Liabilities

-Debts you must pay within a short time, usually less than a year -Include such things as medical bills, tax payments, insurance premiums, cash loans, and charge accounts

Set Financial Goals

-Financial goals are plans for your spending, saving, and investing -Goals should take a SMART approach

Revise Your Goals and Budget Allocations

-Most common overspending areas are entertainment and food -Purchasing less expensive brand items, buying quality used products, and avoiding credit card purchases are common budget adjustment techniques

Money Management

Day-to-day financial activities necessary to manage current personal economic resources while working toward long-term financial security

Discretionary Income

Money left over after paying for housing, food, and other necessities

Insolvency

The inability to pay debts when they are due; it occurs when a person's liabilities far exceed available assets

Preparing a Cash Flow Statement - Step 3: Determine Net Cash Flow

-The difference between income and outflows can be either a positive (surplus) or negative (deficit) cash flow -A deficit exists if more cash goes out than comes in during a given month -This amount must be made up by withdrawals from savings or by borrowing -When you have a cash surplus, this amount is available for saving, investing, or paying off debts -A cash flow statement provides the foundation for preparing and implementing a spending, saving, and investment plan. It reports the actual spending of a household

Budget Variance

-The difference between the amount budgeted and the actual amount received or spent

Main Purposes of a Budget

-To help you live within your income, spend your money wisely, reach your financial goals, prepare for financial emergencies, and develop wise financial management habits

Balance Sheet

-AKA net worth statement or statement of financial position -Reports what you own and what you owe -(Items of value: what you own) - (Amounts owed: what you owe) = Net worth: your wealth

Surplus

-Actual spending is less than planned

Length of Personal Finance Records

-Birth certificates, wills, and SSN- permanently -Property or investment records- as long as you own them -Tax-related info- federal tax laws -Copies of tax returns- 7 years

Liquid Assets

-Cash and items of value that can easily be converted to cash -Money in checking and savings accounts

Places Financial Records are Kept

1. Home File- should be used to keep records for current needs and documents with limited value 2. Safe Deposit Box - Birth, marriage, death certificates, checking/savings account numbers, etc 3. Computer - budget, bank information

How to Increase Net Worth

1. Increasing their savings 2. Reducing spending 3. Increasing the value of investments and other possessions 4. Reducing amounts owed

3 Steps for Preparing a Cash Flow Statement

1. Record Income -Income is the inflows of cash for an individual or a household 2. Record Cash Outflows 3. Determine Net Cash Flow

Income

Inflows of cash for an individual or a household

Organized System of Financial Records

Provides a basis for: 1. Handling daily business activities, such as bill paying 2. Planning and measuring financial progress 3. Completing required tax reports 4. Making effective investment decisions 5. Determining available resources for current and future spending

Assets

-Cash and other tangible property with a monetary value -4 categories on example: --Liquid assets- money in checking account --Real estate- house --Personal possessions- automobiles and other personal belongings, difficult to convert to cash --Investment assets- funds set aside for long-term financial needs

Preparing a Cash Flow Statement - Step 2: Record Cash Outflows

-Cash payments for living expenses and other items -Fixed expenses and variable expenses -Every individual and household has different cash outflows

Successful Budgeting

-Changes in income, living expenses, and goals will require changes in your spending plan -Well planned -Realistic -Flexible -Clearly communicated

Long-Term Liabilities

-Debts you do not have to pay in full until more than a year from now -Include auto loans, educational loans, and mortgages

Budget an Emergency Fund and Savings

-Financial advisors suggest that an emergency fund representing 3-6 months of living expenses be established for use in periods of unexpected financial difficulty

Variable Expenses

-Flexible payments that change from month to month -Examples include food, clothing, utilities, recreation, medical expenses, gifts, and donations

Creating a Personal Balance Sheet - Step 2: Determining Amounts Owed

-Liabilities is a debt you owe now, not something you may owe in the future -Two categories: current and long-term

Selecting a Budgeting System

-Mental budget; only exists in a person's mind. Useful if you have limited resources and minimal financial responsibilities -Physical budget; involves envelopes, folders, or containers to hold the money or slips of paper -Written budget; can be kept in a notebook or with multicolumn accounting paper -Digital budget; may involve a spreadsheet program, specialized software such as Quicken, or an app

Creating a Personal Balance Sheet - Step 3: Computing Net Worth

-Net worth is the difference between total assets and total liabilities -Assets - Liabilities = Net worth -The amount you would have left if all assets were sold for the listed values and all debts were paid in full -Total assets = Liabilities + Net worth

Review Your Financial Progress

-Occasionally, you will have to review areas where spending has been more or less than expected -Can prepare an annual summary to compare actual spending with budgeted amounts for each month; spreadsheet program can be useful -The summary will help you see areas where changes in your budget may be necessary -Review process is vital to both successful short-term money management and long-term financial security

Fixed Expenses

-Payments that do not vary from month to month -Rent or mortgage payments, installment loan payments, cable/Internet service, and a monthly train ticket are examples -Use of a checkbook or some other recordkeeping system is necessary for an accurate total of cash outflows

Preparing a Cash Flow Statement - Step 1: Record Income

-Start by identifying the funds received -For most, main source of income is money received from a job -Other common income sources include commissions, self-employment income, interest, dividends, gifts, grants, scholarships, government payments, pensions, retirement income, alimony, child support

Cash Flow

-The actual inflow and outflow of cash during a given time period -Income from employment will probably represent your most important cash inflow; however, other income, such as interest earned on a savings account, should also be considered -Payments for items such as rent, food, and loans are cash outflows

Budget Variable Expenses

-Variable expenses fluctuate by household situation, time of year, health, economic conditions, and a variety of other factors

Financial Tools

1. Balance sheet: reports your current financial position - where you are now 2. Cash flow statement: tells you what you received and spent over the past month 3. Budget: Plan spending and saving to achieve financial goals

Purpose of Personal Financial Statements

1. Report your current financial position 2. Measure your progress toward financial goals 3. Maintain information about your financial activities 4. Provide data for preparing tax forms or applying for credit

3 Major Money Management Activities

1. Storing and maintaining personal financial records and documents 2. Creating personal financial statements (balance sheets and cash flow statements of income and outflows) 3. Creating and implementing a plan for spending and saving (budgeting)

Saving Techniques

1. Write a check each payday to deposit in a separate savings account or use an automatic payment or a smartphone app to electronically transfer an amount to savings 2. Payroll deduction is available at many places of employment. Under a direct deposit system, an amount is automatically deducted from your salary and deposited in savings. 3. Saving coins or spending less on certain items can help you save

Safe Deposit Box

A private storage area at a financial institution with maximum security for valuables

Liabilities

Amounts owed to others but do not include items not yet due, such as next month's rent