Financial Decision Making © 2010 Pearson Education, Inc. All rights reserved Chapter 3

Learning Objectives Differentiate between cash inflow and cash outflow Explain the steps in financial decision making © 2010 Pearson Education, Inc. All rights reserved 0-2

Cash Flows and Your Financial Future Cash inflows include all the money you receive from all sources Cash outflows are all the monies you have going out Cash flows are important to each component of a financial plan Each component of the plan reflects decisions about how you get or use cash Figure 3.1 shows the central role of cash in your financial plan Figure 3.2 shows example of questions you might have as you build your financial plan © 2010 Pearson Education, Inc. All rights reserved 0-3

Figure 3.1 © 2010 Pearson Education, Inc. All rights reserved 0-4

Figure 3.2 © 2010 Pearson Education, Inc. All rights reserved 0-5

Check Your Financial IQ What are cash inflows and cash outflows? © 2010 Pearson Education, Inc. All rights reserved 0-6

Check Your Financial IQ Cash inflows include all the money you receive from all sources. Cash outflows are all the monies you have going out. © 2010 Pearson Education, Inc. All rights reserved 0-7

The Step-by-Step Decision-Making Process: Step 1 Establish your financial goals –Short term goals are those you plan to accomplish within the next year –Intermediate-term goals are those you achieve within the next 1 to 5 years –Long-term goals will take more than 5 years to accomplish Set realistic goals! Take a look at Figure 3.3 for an example of financial goals © 2010 Pearson Education, Inc. All rights reserved 0-8

Goals become effective when they are SMART S-M-A-R-T GOAL CRITERIA S pecific M easurable T ime-Limited R ealistic A ttainable 1-G

SMART Goals S pecific…….. M easurable… T ime-Limited.. R ealistic……. A ttainable….. “Pay for lodging, transportation, meals for a 5-day trip to Washington, D.C.” “$300 through fundraising, $50 from birthday money, save $25 a week.” “If I stick to my plan, I’ll have the money when I need it.” “ I still have enough money to live on while I work toward this goal.” “I need to have all the money by 6 months from now.” 1-H

S pecific Which one is Specific? a) I want to go somewhere over Christmas break that’s fun. b) I want to go to Copper Mountain in Colorado for a week over Christmas break.

M easurable Which one is Measurable? a) I need $250 for my share of the hotel room, gas, and food for the week. b) I need some money to pay for the trip.

A ttainable Which one is Attainable? a) I’ll hope my grandma comes through with some really “ big ” birthday money this year to help me pay for the trip. b) I’ll save $20 a week as soon as Labor Day is over to pay for the trip.

R ealistic Which one is Realistic? –I plan to drive to Colorado in about 5 hours, and I’ll bring along lots of food so I don’t have to spend any money for food on the road. –I plan to drive to Colorado in about 10 hours and split the driving, each of us will drive about 5 hours. I’ll need $20.00 for food and snacks on the road.

T ime-bound Which one is Time-bound? a) I’ll have the $ I need for the trip by the end of the first week in December. b) I want to save up enough money by Christmas.

Figure 3.3 © 2010 Pearson Education, Inc. All rights reserved 0-16

Math for Personal Finance Dewanna needs to save $1,500 by August to pay for her tuition. She only has 12 weeks remaining before school starts, and her boss is letting her work 20 hours per week. She brings home about $9 an hour after taxes are withdrawn from her check. Is it possible for her to save the $1,500? © 2010 Pearson Education, Inc. All rights reserved 0-17

Math for Personal Finance Solution: Yes, it is possible. She makes $9 an hour x 20 hours per week = $180 per week x 12 weeks = $2,160 she will make prior to school starting. © 2010 Pearson Education, Inc. All rights reserved 0-18

The Step-by-Step Decision-Making Process: Step 2 Evaluate your current financial position Your decisions on how much money to spend or to save depend on your current situation Financial goals are tied to your income Better the income = loftier goals © 2010 Pearson Education, Inc. All rights reserved 0-19

The Step-by-Step Decision-Making Process: Step 2 Forecast is a projection about what will happen in the future Income is cash inflow Making accurate forecasts will help you achieve your goals This involves making projections about cash flows Cash flows (income) can come from external sources such as a job or a scholarship © 2010 Pearson Education, Inc. All rights reserved 0-20

Math for Personal Finance Jared anticipates working 10 hours a week during the 34-week school year. He will work 40 hours per week for the remaining 18 weeks when school is out. Assuming he makes $8 an hour, what is his forecast for income next year? © 2010 Pearson Education, Inc. All rights reserved 0-21

Math for Personal Finance Solution: 34 weeks x 10 hours per week = 340 hours worked during the school year. Forty hours per week x 18 weeks while not in school = 720 hours. His total hours worked = = 1,060 hours x $8 an hour = $8,480 in forecasted income. © 2010 Pearson Education, Inc. All rights reserved 0-22

The Step-by-Step Decision-Making Process: Step 2 An expense is anything on which we spend money People also have to consider cash outflows (expenses) Examples include phone bill or car payment Expenses can be fixed or variable © 2010 Pearson Education, Inc. All rights reserved 0-23

The Step-by-Step Decision-Making Process: Step 2 A fixed expense remains the same from period to period A variable expense changes from one period to the next An example of a fixed expense is a car payment An example of a variable expenses is a phone bill Take a look at Figure 3.4 to see an example of a cash flow forecast © 2010 Pearson Education, Inc. All rights reserved 0-24

Figure 3.4 © 2010 Pearson Education, Inc. All rights reserved 0-25

The Step-by-Step Decision-Making Process: Step 3 Identify and evaluate your options for achieving your goals There are several ways to achieve a financial goal What will the best decision to make in the long run? Take a look at Figure 3.5 for an example of how to evaluate options Refer to Figure 3.6 for an example of making a pros and cons list © 2010 Pearson Education, Inc. All rights reserved 0-26

Figure 3.5 © 2010 Pearson Education, Inc. All rights reserved 0-27

Figure 3.6 © 2010 Pearson Education, Inc. All rights reserved 0-28

The Step-by-Step Decision-Making Process: Step 4 Risk if often defined as the likelihood of loss Pick the best plan Choose the goal that is more realistic Your tolerance for risk and your self discipline often determine which plan is the best option for achieving a specific goal © 2010 Pearson Education, Inc. All rights reserved 0-29

The Step-by-Step Decision-Making Process: Step 4 Some people choose plans with a higher level of risk of loss These plans also have a higher potential payoff Others choose plans with lower risk that are more certain to accomplish the ultimate goal Refer to Figure 3.7 for an example of how there can be different paths to the same goal © 2010 Pearson Education, Inc. All rights reserved 0-23

Figure 3.7 © 2010 Pearson Education, Inc. All rights reserved 0-31

The Step-by-Step Decision-Making Process: Step 5 Periodically evaluate your plan Monitor your progress Sometimes plans may get off track This will help you notice if there is a problem or if you should make adjustments © 2010 Pearson Education, Inc. All rights reserved 0-32

Math for Personal Finance Lesia’s original financial plan required that she save $100 a month for two years in order to have $2,400 for the down payment on a car. However, after one year she has only managed to save $1,000. What will Lesia need to do in order to accomplish her original goal? © 2010 Pearson Education, Inc. All rights reserved 0-33

Math for Personal Finance Solution: Lesia needs to save another $1,400 to reach her original goal or $2,400 - $1,000 she has saved = $1,400. To accomplish that goal in 12 months she will need to save $1,400/12 = per month. She will have to increase her savings to per month to accumulate the original $2,400 by the end of next year. © 2010 Pearson Education, Inc. All rights reserved 0-34

The Step-by-Step Decision-Making Process: Step 6 Revise your financial plan as necessary If the plan becomes unachievable or too restrictive, adjust it If you need to revise one part of your plan, other aspects might also need to be revised as well © 2010 Pearson Education, Inc. All rights reserved 0-35

Check Your Financial IQ What are the steps of financial decision making? © 2010 Pearson Education, Inc. All rights reserved 0-36

Check Your Financial IQ 1. Establish your goals 2. Evaluate your current financial position 3. Identify and evaluate the options for reaching your goals 4. Pick the best plan 5. Evaluate your plan periodically 6. Revise your plan as necessary © 2010 Pearson Education, Inc. All rights reserved 0-30

Summary Financial decisions and planning start with questions about cash flows Decisions about cash inflows and outflows affect each component of your financial plan © 2010 Pearson Education, Inc. All rights reserved 0-38

Summary There are 6 steps for making financial decisions and creating your financial plan: 1. Establish your goals 2. Evaluate your current financial position 3. Identify and evaluate the options for reaching your goals 4. Pick the best plan 5. Evaluate your plan periodically 6. Revise your plan as necessary © 2010 Pearson Education, Inc. All rights reserved 0-39

Vocabulary Cash inflow Cash outflow Expense Fixed expense Forecast Income Long-term goal Middle-term goal Risk Short-term goal Variable expense © 2010 Pearson Education, Inc. All rights reserved 0-40

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