Chapter 2 Money Management Strategy: Financial Statements and Budgeting

Chapter 2

Money ManagementStrategy: Financial

Statements and Budgeting

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Kapoor Dlabay Hughes Ahmad

Prepared by Cyndi Hornby, Fanshawe College 2004 McGraw-Hill Ryerson Ltd.

2004 McGraw-Hill Ryerson Ltd.

Learning Objectives – Chapter 2

1. Recognize relationships among financial documents and money management activities.

2. Create a system for maintaining personal financial records.

3. Develop a personal balance sheet and cash flow statement.

4. Create and implement a budget.5. Calculate savings needed to achieve

financial goals.2-2

2004 McGraw-Hill Ryerson Ltd.

Learning Objective # 1Recognize relationships

among financial documents and money management activities.

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Opportunity Cost & Money Management

Spending money 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 -savings can’t be used for other purposes.Every decision made means you give up something else.Comparison shopping can save money but takes your valuable time.

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Major Money Management Activities

Createand

implementa plan forspending

(budgeting)and

saving.

Createpersonalfinancial

statementsof income

andoutflow(balance

sheet andcash flow).

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Storeand

maintainpersonalfinancialrecords

anddocuments.

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Learning Objective # 2Create a system for

maintaining personal financial records.

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Why Keep Financial Records?

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Handling daily business affairs, including paying of bills on timePlanning and measuring financial progressCompleting required tax formsMaking effective investing decisionsDetermining available resources for current and future buying

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What to Keep in Your Home FileItems you refer to often.

Personal and employment records.Tax records.Financial services records.Money management records.Credit records.Consumer purchase records.Insurance records.Investment records.Housing and car records.Estate planning and retirement records. 2-8

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What to Keep in a Safe Deposit Box

Safe deposit box is for records and items that would be hard to replace.

Birth, marriage and death certificates.Citizenship and military papers.Adoption and custody papers.Serial numbers and photos of valuables.GIC’s and bank account numbers.Mortgage papers and titles.List of insurance policy numbers.Stock and bond certificates.Coins and collectibles.Copy of will. 2-9

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Other Places to Keep Records

Automobile.Vehicle registration.

Lawyer.Original of your will and living will.

Doctor and hospital.Copy of your living will.

Home computer.Current and past budgets.Chequing account records.Wills, estate plans, investments.Past income tax returns.

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Learning Objective # 3Develop a personal balance

sheet and cash flow statement.

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Purpose of Personal Financial Statements

Report your current financial position in relation to the value of the items you own and the amounts you owe.

Measure your progress toward your financial goals.

Maintain information on your financial activities.

Provide information you can use when preparing tax forms or applying for credit.

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Balance Sheet A financial statement that reports

what an individual or family owns or owes; also called a net worth statement

- =

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Items of value(what you own)

Amounts Owed(what you owe)

Net Worth(your wealth)

2004 McGraw-Hill Ryerson Ltd.

Components of a Balance Sheet(Net Worth Statement)

Assets - what you own.Liquid assets.Real estate.Personal possessions.Investment assets.

Liabilities - what you oweCurrent liabilities.Long term liabilities.

Net Worth.Assets minus liabilities.Insolvent means liabilities far exceed assets. 2-14

2004 McGraw-Hill Ryerson Ltd.

A financial statement that summarizes cash receipts and payments for a given period of time

+ =

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Cash Flow Statement

Total cash received during that time

period

Cash outflows during the time

period

Cash surplus or

deficit

2004 McGraw-Hill Ryerson Ltd.

Components of a Cash Flow Statement

Shows inflow and outflow during a given time period.

Record income.•Income from employment.•Savings and investment income.•Other sources.

Record cash outflows.•Fixed and variable expenses.

Net cash flow can be a surplus or a deficit.

Used as a basis for creating a spending, saving and investment plan. 2-16

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Learning Objective # 4Create and implement a

budget.

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Creating and Implementing a Budget

Budget: A specific plan for spending incomePurpose:

Live within your budgetSpend your money wiselyReach your financial goalsPrepare for financial emergenciesDevelop wise financial management habits

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The Budgeting ProcessStep 1: Setting Financial Goals

plans for future activities that require you to plan your spending and investingShould be realistic; stated in specific, measurable terms; have a definite time frame; imply type of action to be taken

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The Budgeting Process (con’t)

Step 2: Estimating IncomeEstimate available money for given period of time – usually one monthBased on number of times income received each month, spending should be planned accordinglyDifficult if your earnings vary by season or income is irregular

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The Budgeting Process (con’t)Step 3: Budgeting Emergency Fund

and SavingsRecommend 3-6 months of living expenses be established

Step 4: Budgeting Fixed ExpensesWill depend on your current needs and plans for the future

Step 5: Budgeting Variable ExpensesWill fluctuate by household situation, time of year, health, economic conditions, etc.

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The Budgeting Process (con’t)

Step 6: Recording Spending AmountsRecord actual income and expensesBudget Variance – difference between amount budgeted & the actual amount received or spentDeficit – actual spending exceeds planned spendingSurplus – actual spending less than planned spending 2-22

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The Budgeting Process (con’t)

Step 7: Reviewing Spending and Saving PatternsReview your financial progressRevise your goals and budget allocations

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Successful Budgets Are...Well planned.Realistic.Flexible.Clearly communicated.

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Learning Objective # 5Calculate savings needed to

achieve financial goals.

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Saving to Achieve Financial Goals

Common reasoning for saving include…To set aside money for irregular and unexpected expenses.To pay for the replacement of expensive items, such as appliances, cars or a down payment on a house.Save to buy special items or pay for a vacation.Put aside money to long-term expenses such as retirement or children's education.To earn income from the interest on savings for use in paying living expenses.2-26

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Selecting a Saving Technique

Should make regular periodic savings deposits Can be a percentage of income (5-10%) or specific dollar amount

Write a cheque each payday and deposit into a special savings account at another financial institutionPayroll deductionDirect depositSaving coins at end of each day 2-27

2004 McGraw-Hill Ryerson Ltd.

Suggestions for Dual-Income Households

Pooled Income – incomes combined and bills paid from poolSharing the Bills – each responsible for predetermined bills50/50 – each contribute equally to poolProportionate Contribution – each contribute percentage of his/her income 2-28