Finance Test 1

what does an important personal opportunity cost involve?

time that when used for one activity cannot be used for other activities. Time used for studying, working, or shopping will not be available for other uses

what is the basis for planning, implementing, and measuring the progress of your spending, saving, and investing activities?

your financial goals

most financial records are kept in one of what three places

a home file, a safe deposit box, or a computer system or online

when do most people prepare a balance sheet? what is done between those points in time?

on a periodic basis, such as every three or six months. -Between those points in time, your budget and cash flow statement help you plan and measure spending and saving activities

what should you only include when determining income? what should not be?

only money that you are sure you'll receive. Bonuses, gifts, or unexpected income should not be considered until the money is actually received

3 types of goals

short term, intermediate, long term

main purposes 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.

common financial goals for a single person(short,intermediate, and long)

-Short-Term Goals (less than 2 years): Complete college, pay off auto loan -Intermediate Goals (2-5 years): Take a vacation to Europe, Pay off education loan, attend graduate school -Long-Term Goals (over 5 years): Buy a vacation home in the mountains, Provide for retirement income

Why do so many Americans—living in one of the richest countries in the world—have money problems? (2 reasons)

-poor planning and weak money management habits in areas such as spending and the use of credit. -extensive advertising, selling efforts, and product availability that encourage overbuying

why is planning for variable expenses not as easy as budgeting for savings or fixed expenses?

because variable expenses will fluctuate by household situation, time of year, health, economic conditions, and other factors. -ex) A major portion of the Robinsons' planned spending—over 60 percent of their budgeted income—is for variable living costs.

what do typical financial goals include?

buying a new car or a larger home, pursuing advanced career training, contributing to charity, traveling extensively, and gaining self-sufficiency during working and retirement years

how can individuals and families can increase their net worth?

by (1) increasing their savings; (2) reducing spending; (3) increasing the value of investments and other possessions; and (4) reducing amounts owed

The U.S. economy is affected by what?

by both foreign investors and competition from foreign companies. American businesses compete against foreign companies for the spending dollars of American consumers

what is the main focus of financial planning activities?

Daily spending and saving decisions -you must coordinate these decisions with your needs, goals, and personal situation

Five methods that are available for calculating time value of money

Formula calculation Time value of money tables Financial calculator Spreadsheet software Websites and apps.

future value

Future value is the amount to which current savings will grow based on a certain interest rate and a certain time period. For example, $100 deposited in a 6 percent account for one year will grow to $106. This amount is computed as follows: Future value = $100 + ($100× 0.06 ×1 year) = $106

variable expenses

flexible payments that change from month to month. ex) food, clothing, utilities (such as electricity and telephone), recreation, medical expenses, gifts, and donations. The use of a checkbook or some other record-keeping system is necessary for an accurate total of cash outflows

what is is central to financial decision making?

goal setting

intermediate goals

have a time frame of two to five years

In addition to being defined by your family situation, what are you also defined by?

your values

individuals with poor credit ratings typically pay what?

higher interest rates

Advantages of effective personal financial planning include what?

Increased effectiveness in obtaining, using, and protecting your financial resources throughout your life. Increased control of your financial affairs by avoiding excessive debt, bankruptcy, and dependence on others. Improved personal relationships resulting from well-planned and effectively communicated financial decisions. A sense of freedom from financial worries obtained by looking to the future, anticipating expenses, and achieving personal economic goals.

what is essential for successful personal financial management?

Maintaining financial records and planning your spending -The time and effort you devote to these activities will yield benefits

your financial goals should be SMART what is this acronym

S—specific, so you know exactly what your goals are and can create a plan designed to achieve those objectives. M—measurable, by a specific amount. For example, "Accumulate $5,000 in an investment fund within three years" is more measurable than "Put money into an investment fund." A—action-oriented, providing the basis for the personal financial activities you will undertake. For example, "Reduce credit card debt" will usually mean actions to pay off amounts owed. R—realistic, involving goals based on your income and life situation. For example, it is probably not realistic to expect to buy a new car each year if you are a full-time student. T—time-based, indicating a time frame for achieving the goal, such as three years. This allows you to measure your progress toward your financial goals.

3 amounts used to calculate the time value of money for savings in the form of interest earned

The amount of the savings (commonly called the principal). The annual interest rate. The length of time the money is on deposit.

what is a common starting point for financial planning?

The current financial position of an individual or family

is your net worth money available to use but an indication of your financial position on a given date?

no

what do low savings affect?

personal financial situations

what are the two documents you create yourself called? what do they include?

personal financial statements the personal balance sheet and the cash flow statement

two main reasons americans have financial problems

poor planning, weak management of money habits advertising efforts and availability of goods create overspending

money management

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

Like financial resources, your personal resources (time, energy, health, abilities, knowledge) require what?

require planning and wise management

What should you cut first when a budget shortage occurs? what are the most common overspending areas?

This question doesn't have easy answers, and answers will vary for different households. -entertainment and food, especially away-from-home meals. -Purchasing less expensive brand items, buying quality used products, and avoiding credit card purchases are common budget adjustment techniques. When household budgets must be cut, spending is most frequently reduced for vacations, dining out, cleaning and lawn services, cable/internet service, and charitable donations.

Using the following balance sheet items and amounts, calculate the total liquid assets and total current liabilities:Money market account $2,900 Medical bills $310 Mortgage $164,000 Checking account $840 Retirement account $89,800 Credit card balance $549

Total liquid assets----------=Money market account + Checking account=$2,900 + $840=$3,740Total current liabilities----------=Medical bills + Credit card balance=$310 + $549=$859

time value of money tables

Traditionally, before calculators and computers, future value and present value tables were used to provide for easier computations

surplus

When you have a cash surplus, this amount is available for saving, investing, or paying off debts.

at this point in the budgeting process, what may you also revise?

revise your financial goals. -Are you making progress toward achieving your objectives? Have changes in personal or economic conditions affected the desirability of certain goals? Have new goals surfaced that should be given a higher priority?

common financial goals for a parent with kid(short,intermediate, and long)

short: Increase life insurance, Increase savings intermediate: Increase investments, Buy a new car long: Accumulate a college fund for children, Move to a larger home

common financial goals for a married person with no kids(short,intermediate, and long)

short: Take an annual vacation, Buy a new car intermediate: Remodel home, Build a stock portfolio long: Buy a retirement home, Provide for retirement income

home file

should be used to keep records for current needs and documents with limited value. -Your home file may be a series of folders, a cabinet with several drawers, or even a box. -Whatever method you use, your home system should be organized to allow quick access to needed documents and information

how to create a personal balance sheet?

step 1: Available cash and money in bank accounts combined with other items of value are the foundation of your current financial position (assets) step 2: Determine Amounts Owed step 3: compute net worth(assets-liabilities)

Personal financial statements

tell you the starting point of your financial journey

cash flow

the actual inflow and outflow of cash during a given time period When you receive a paycheck or pay living expenses, your total assets and liabilities change. -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. In contrast, payments for items such as rent, food, and loans are cash outflows

In simple terms, interest rates represent what?

the cost of money -Like everything else, money has a price

present value

the current value for a future amount based on a particular interest rate for a certain period of time

adult life cycle

the stages in the family situation and financial needs of an adult—is an important influence on your financial activities and decisions. -Your life situation is also affected by events such as graduation, dependent children leaving home, changes in health, engagement and marriage, divorce, birth or adoption of a child, retirement, a career change or a move to a new area, or the death of a spouse, family member, or other dependent

how many months of living expenses do financial advisors suggest that an emergency fund represent?

three to six months of living expenses be established for use in periods of unexpected financial difficulty.

what do you use a budget for?

to tell your money where to go, rather than having overspending and debt control your life

Based on the following data, determine the amount of total assets, total liabilities, and net worth.Liquid assets $4,570 Investment assets $9,040Current liabilities $2,370 Household assets $94,890Long-term liabilities $83,230

total Assets----------=Liquid assets + Investment assets + Household assets =$4,570 + $9,040 + $94,890=$108,500

opportunity cost

what you give up by making a choice. This cost, commonly referred to as the trade-off of a decision, cannot always be measured in dollars

budget

will help you live within your income, spend your money wisely, reach your financial goals, prepare for financial emergencies, and develop wise financial management habits. -With a budget, you will be in control of your life -Without a budget, others will be in control, such as those to whom you owe money -aka spending plan and is necessary for successful financial planning

financial plan

a formalized report that summarizes your current financial situation, analyzes your financial needs, and recommends future financial activities.

take-home pay (aka net pay)

a person's earnings after deductions for taxes and other items

safe deposit box

a private storage area at a financial institution with maximum security for valuables and difficult-to-replace documents -Important financial records and valuable articles should be kept in a location that provides better security than a home file.

inflation

a rise in the general level of prices

annuity

a series of equal deposits or payments

cash flow statement (aka personal income and expenditure statement)

a summary of cash receipts and payments for a given period, such as a month or a year. -This report provides information on your income and spending patterns, which will be helpful when preparing a budget.

present value computations (aka discounting)

allow you to determine how much to deposit now to obtain a desired total in the future. For example, using the present value table, if you want $1,000 five years from now and you earn 5 percent on your savings, you need to deposit $784 ($1,000 × 0.784).

liabilities

amounts owed to others but do not include items not yet due, such as next month's rent. -a debt you owe now, not something you may owe in the future.

formula calculation

.With this conventional method, math notations are used for computing future value and present value.

seven step process of budgeting activities

(1) Set Financial Goals (2) Estimate Income (3) Budget an Emergency Fund and Savings (4) Budget Fixed Expenses (5) Budget Variable Expenses (6) Record Spending Amounts (7) Review Spending and Savings Patterns

what 5 things does an 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

savings ratio

-Amount saved each month divided by gross income -Financial experts recommend monthly savings of 5-10 percent.

debt ratio

-Liabilities divided by net worth -Shows relationship between debt and net worth; a low debt ratio is best.

current ratio

-Liquid assets divided by current liabilities Liquid assets divided by current liabilities $4,000/$2,000 = 2 -Indicates $2 in liquid assets for every $1 of current liabilities; a high current ratio is desirable to have cash available to pay bills.

liquidity ratio

-Liquid assets divided by monthly expenses -Indicates the number of months in which living expenses can be paid if an emergency arises; a high liquidity ratio is desirable.

debt-payments ratio

-Monthly credit payments divided by take-home pay -Indicates how much of a person's earnings goes for debt payments (excluding a home mortgage); most financial advisors recommend a debt-payments ratio of less than 20 percent.

How long should you keep personal finance records?

-Records such as birth certificates, wills, and Social Security data should be kept permanently. -Records on property and investments should be kept as long as you own these items. -Federal tax laws dictate the length of time you should keep tax-related information. -Copies of tax returns and supporting data should be saved for seven years. -Normally, an audit will go back only three years; however, under certain circumstances, the Internal Revenue Service may request information from farther back. -Financial experts also recommend keeping documents related to the purchase and sale of real estate indefinitely.

what are the three major money management activities are interrelated?

1. storing and maintaining personal financial and personal documents 2. creating personal financial statements (balance sheets and cash flow statements of inflows and outflows) 3. creating and implementing a plan for spending and saving (budgeting)

financial calculator

A variety of calculators are programmed with financial functions. -Both future value and present value calculations are performed using appropriate keystrokes

debt vs equity security

Investing in a bond, which is a debt security, involves borrowing by a company or government. In contrast, investing in stock, called an equity security, represents ownership in a corporation.

financial goals should take a SMART approach with goals that are...

Specific, Measurable, Action-oriented, Realistic, and Time-based

assets

are cash and other tangible property with a monetary value

liquid assets

cash and items of value that can easily be converted to cash. -Money in checking and savings accounts is liquid and is available to the Scott family for current spending. The cash value of their life insurance may be borrowed if needed. While assets other than liquid assets can also be converted into cash, the process is not quite as easy.

two categories of liabilities

current liabilities and long-term liabilities

long-term liabilities

debts you do not have to pay in full until more than a year from now

current liabilities

debts you must pay within a short time, usually less than a year. -ex)medical bills, tax payments, insurance premiums, cash loans, and charge accounts

deflation

decline in prices, can also have damaging economic effects. As prices drop, consumers expect they will go even lower. As a result, consumers cut their spending, which causes damaging economic conditions. While widespread deflation is unlikely, certain items may be affected and their prices will drop.

The difference between income and outflows can be what?

either a positive (surplus) or a negative (deficit) cash flow.

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.

where do most financial documents come from?

financial institutions, businesses, or the government

in most societies, what sets prices for securities, goods, and services?

the forces of supply and demand

personal financial planning

the process of managing your money to achieve personal economic satisfaction. This planning process allows you to control your financial situation. Every person, family, or household has a unique situation; therefore, financial decisions must be planned to meet specific needs and goals.

financial ratios

used to measure changes in your financial situation. These relationships indicate progress toward an improved financial position.

short term goals

will be achieved within the next year or so, such as saving for a vacation or paying off small debts

what are the basis of financial recordkeeping and personal economic choices?

Invoices, credit card statements, insurance policies, and tax forms

global influences

The global economy can influence financial activities

balance sheet

reports what you own and what you owe

For time value of money tables , and for an annuity to exist, the deposits must what?

the deposits must earn a constant interest rate. For example, if you deposit $50 a year at 7 percent for six years, starting at the end of the first year, you will have $357.65 at the end of that time ($50 × 7.153). The nearby Figure It Out! feature presents examples of using future value to achieve financial goals.

budget variance

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

net worth

the difference between total assets and total liabilities

values

the ideas and principles that you consider correct, desirable, and important

economics

the study of how wealth is created and distributed

Most people want to handle their finances so that what?

they get full satisfaction from each available dollar.

To determine the future value of equal yearly savings deposits, what can be used?

time value of money tables

what influences interest rates?

The forces of supply and demand

Use the following items to determine the total assets, total liabilities, net worth, total cash inflows, and total cash outflows.Rent for the month$1,600 // Monthly take-home salary$3,135Spending for food$820 // Cash in checking account$640Savings account balance $2,080Balance of educational loan $3,300Current value of automobile $9,350Telephone bill paid for month$160 // Credit card balance$330Loan payment $270 // Auto insurance$420Household possessions $5,300 // Video equipment$2,825Payment for electricity$185

Total Assets----------=Savings account balance + Current value of automobile + Video equipment + Personal computer + Cash in checking account + Household possessions + Value of stock investment=$2,080 + $9,350 + $2,825 + $2,150 + $640 + $5,300 + $1,335=$23,680Total Liabilities----------=Credit card balance + Educational loan balance=$330 + $3,300=$3,630

what do personal financial statements provide?

information about your current financial position and present a summary of your income and spending

long term goals

involve financial plans that are more than five years off, such as retirement, money for children's college education, or the purchase of a vacation home

time value of money

involves the increases in an amount of money as a result of interest earned

how do you prepare a personal balance sheet to determine your current financial position

items of value (what you own) minus amounts owed (what you owe) =net worth (your wealth)

Traditionally, where does the United States rank among industrial nations in savings rate?

low -Studies reveal that the majority of Americans do not set aside an adequate amount for emergencies.

How you save is far less important than what?

making regular periodic savings deposits that will help you achieve financial goals. -Small amounts of savings can grow faster than most people realize.

discretionary income

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

what is balance sheet also called?

net worth statement or statement of financial position

Why is an improved cash flow important for your financial situation?

A positive monthly cash flow will allow you to set aside funds for future financial security and avoid financial difficulties

what are successful budgets like?

-Well planned: takes time and effort to prepare, and should involve everyone affected by it. -Realistic: If you have a moderate income, don't immediately expect to save enough money for an expensive car. -Flexible: Unexpected expenses and life situation changes will require a budget that can easily be revised. -Clearly communicated: Unless you and others involved are aware of the spending plan, it will not work. The budget should be written and available to all household members.

Since most people find saving difficult, what methods do financial advisors suggest to make it easier?

1) On each payday, deposit an amount in a separate savings account. Or use an automatic payment or a smartphone app to electronically transfer an amount to savings. This deposit can be a percentage of income, such as 5 or 10 percent, or a specific dollar amount. 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. Each day, bring lunch instead of buying it, or avoid expensive coffee and snacks. Then, put the money saved in a container or use a phone app to transfer money to a savings or investment account.

3 Steps to Financial Literacy

1) Plan a system to monitor your cash inflows (income) and outflows (spending). 2) Identify your fixed expenses. 3) Seek actions to take to control and reduce variable expenses.