Personal Finance Chapter 2 Money Management Skills
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 investments decisions. 5. Determining available resources for current and future spending.
Budgeting may be viewed in seven main steps:
1. Set financial goals. 2. Estimate income. 3. Budget an Emergency fund and savings. 4. Budgeting fixed expenses 5. Budget variable expenses. 6. Record spending amounts. 7. Review spending and saving patterns.
Components of Money Management
1. Storing and maintaining personal financial records and documents. 2. Creating personal financial statements (balance sheet and cash flow statements of income and outflows). 3. Creating and implementing a plan for spending and savings (budgeting).
The process for preparing a cash flow statement involves three steps:
1. Total cash received during the time period. 2. MINUS cash outflows during the time period 3. EQUAL cash surplus or deficit
Individuals and families can increase their net worth by:
1. increasing their savings 2. reducing spending 3. increasing the value of investments and others possessions; 4. reducing amounts owed Remember, u net worth is not money available to use, but an indication of u financial position on a given date.
cash flow statement
A financial summary for a specific period that shows the beginning balance on hand, the receipts and disbursements during the period, and the balance on hand at the end of the period.
saving ratio
Amount saved each month divided by gross income. Financial experts recommend monthly savings of 5-10 percent.
payroll deduction
Amount subtracted from a paycheck,either by government requirement (mandatory taxes,Social Security,etc.) or at the employee's request (health insurance,retirement plan,etc.).
Creating a Personal Balance Sheet
Assets: 1. Liquid Assets (checking account balance, savings, money market accounts; cash value of life insurance and total liquid assets) 2. Real Estate (current market value of home) 3. Personal possessions (auto, appliances, furniture, entertainment, computer, jewelry and total household assets). 4. Investments assets (retirement accounts, mutual funds and total investments assets) This items gives u a TOTAL ASSETS. Liabilities: Current liabilities (medical bills, charge account & credit card balances, balance due on auto loan and total current liabilities) Long-term liabilities: mortgage, home improvement loan, student loan and total long-term liabilities. Net Worth = Assets - liabilities
variable expenses
Expenses that change from month to month
Current ratio
Indicates $2 in liquidity assets for every $1 of current liabilities; a high current ratio is desirable to have cash available to pay bills.
Debt-payments ratio
Indicates how much of a person's earnings goes for debt payments (excluding a home mortgage); most financial advisors recommends a debt payment ratio of less than 20 percent.
Liquidity ratio
Indicates the number of months in which living expenses can be paid if an emergency arises; a high liquidity ratio is desirable.
Disposable income
It is also known as a personal disposable income PDI. It is the amount of money households have available for spending and saving after income taxes have been accounted for.
U prepare the balance sheet to determine your current financial position using the following process:
Items of value (what u own) - Amounts owed (what u owe) = Net worth (u wealth)
discretionary income
Money left over after paying for housing, food, and other necessities.
balance sheet
a financial statement that reports what an individual or a family owns and owes; also called a net worth statement or statement of financial position.
safe deposit box
a small, secure storage compartment that you can rent in a bank, usually for $100 a year or less
take home pay
also called net pay, it is the amount of income left after taxes and other deductions are taken out of your gross pay; also, it is called disposable income.
Liabilities
amounts owed to others.
deficit
an excess of liabilities over assets (usually over a certain period)
investment assets
are funds set aside for long term financial needs
personal possesions
car, personal belongings
Liquid assets
cash and items of value that can easily be converted to cash.
assets
cash and other property with a monetary value.
Money management
day to day financial activities necessary to manage current personal economic resources while working toward long-term financial security.
Long-term liabilities
debts that are not required to be paid in full until more than a year from now.
current liabilities 1
debts that must be paid within a short time, usually less than a year.
net worth 1
difference between total assets and total liabilities.
budget
documents that projects income and spending. Specific plan for expending income, also called spending plan.
income
earnings from work or investments. Inflows of cash to an individual or a household.
steps to get out of debt
evaluate credit situation track your spending plan to make payments on time consider other income sources if appropriate, seek assistance
ways to increase net worth
increase savings reduce spending increase value of investments reduce amounts owed
A mortgage
is an amount borrowed to buy a house or other real state that will be repaid over a period of 15, 20, or 30 years.
Solvency
it is the ability to pay u bills as they come due because u assets exceed u liabilities.
debt ratio
liabilities divided by net worth. A low debt ratio is best.
current liabilities
liabilities due within a short time, usually within a year
surplus
more than is needed, desired, or required. this amount is available for saving, investing, or paying off debts.
real estate
property consisting of houses and land
A cash flow statements
provides the foundation for preparing and implementing a spending, saving, and investment plan. The cash flow statement reports the actual spending of a household. In contrast, budget, which has a similar format, documents projected income and spending.
main purpose of personal financial statements (4)
report current financial position measure your progress towards financial goals maintain info about financial activities provide data for preparing tax forms/applying for credit
fixed expenses
set costs that must be paid such as rent, insurance, and car payments
cash flow
the actual inflow and outflow of cash during a given time period.
net cash flow
the difference between income and outflows can be either a positive (surplus) or negative (deficit). A deficit means more money goes out than comes in during a given month.
budget variance
the difference between the budgeted amount and the actual amount that you spend
insolvency
the inability to pay debts when they are due because liabilities far exceed the value of assets.
The cash flow statement is
the inflows and outflows. Also called a personal income and expenditure statement. It is a summary of cash receipts and payments for a given period, such as a month or a year. This report provides data on u income and spending patterns, which will be helpful when preparing a budget.
net worth
total assets minus total liabilities