Chapter 2 Money Management Strategy: Financial Statements and Budgeting 2-1 Kapoor Dlabay Hughes Ahmad Prepared by Cyndi Hornby, Fanshawe College  2006 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

 2006 McGraw-Hill Ryerson Ltd. Learning Objective # 1 Recognize relationships among financial documents and money management activities. 2-3

 2006 McGraw-Hill Ryerson Ltd. 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 2-4

 2006 McGraw-Hill Ryerson Ltd. Opportunity Cost & Money Management Every decision made means you give up something else Comparison shopping can save money but takes your valuable time 2-5

 2006 McGraw-Hill Ryerson Ltd. Major Money Management Activities Create and implement a plan for spending (budgeting) and saving. Create personal financial statements of income and outflow (balance sheet and cash flow). 2-6 Store and maintain personal financial records and documents.

 2006 McGraw-Hill Ryerson Ltd. Learning Objective # 2 Create a system for maintaining personal financial records 2-7

 2006 McGraw-Hill Ryerson Ltd. Why Keep Financial Records? 2-8 Handling daily business affairs, including paying of bills on time Planning and measuring financial progress Completing required tax forms Making effective investing decisions Determining available resources for current and future buying

 2006 McGraw-Hill Ryerson Ltd. What to Keep in Your Home File Items 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 2-9

 2006 McGraw-Hill Ryerson Ltd. 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 2-10

 2006 McGraw-Hill Ryerson Ltd. 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 2-11

 2006 McGraw-Hill Ryerson Ltd. Learning Objective # 3 Develop a personal balance sheet and cash flow statement 2-12

 2006 McGraw-Hill Ryerson Ltd. Purpose of Personal Financial Statements Summarize the value of the items you own and the amounts that you owe Track your cash inflows by source and your outflows by type Identify strengths and weaknesses in your current financial situation Measure progress towards your financial goals Provide data for use in filing your income tax return or applying for credit 2-13

 2006 McGraw-Hill Ryerson Ltd. Balance Sheet A financial statement that reports what an individual or family owns or owes; also called a net worth statement - = 2-14 Items of value (what you own) Amounts Owed (what you owe) Net Worth (your wealth)

 2006 McGraw-Hill Ryerson Ltd. The main categories of assets are usually listed first, and typically in order of liquidity Assets are followed by the liabilities

 2006 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 owe Current liabilities Long term liabilities Net Worth. Assets minus liabilities Insolvent means liabilities far exceed assets 2-15

 2006 McGraw-Hill Ryerson Ltd. Assets = liabilities + owner's equity Looking at the equation in this way shows how assets were financed Borrowing money (liability) Using the owner's money (owner's equity) Balance sheets are usually presented with assets in one section and liabilities and net worth in the other section with the two sections balance out

 2006 McGraw-Hill Ryerson Ltd. Types of Balance Sheet A balance sheet summarizes an organization or individual's assets, equity and liabilities at a specific point in time (month/ year) Individuals and small businesses tend to have simple balance sheets Larger businesses tend to have more complex balance sheets, and these are presented in the organization's annual report A balance sheet is often presented alongside one for a different point in time (typically the previous year) for comparison

 2006 McGraw-Hill Ryerson Ltd. Personal Balance Sheet Current assets such as cash in checking accounts and saving accounts Long-term assets such as common stock and real estate Current liabilities such as loan debt and mortgage debt due, or overdue Long-term liabilities such as mortgage and other loan debt

 2006 McGraw-Hill Ryerson Ltd. US Small Business Balance Sheet A small business balance sheet lists Current assets such as cash, accounts receivable Inventory, fixed assets such as land, buildings, and equipment Intangible assets such as patents, and liabilities such as accounts payable, accrued expenses, and long-term debt Contingent liabilities such as warranties are noted in the footnotes to the balance sheet

 2006 McGraw-Hill Ryerson Ltd. Statement of cash flows or funds flow statement A financial statement that summarizes cash receipts and payments for a given period of time + + = 2-16 Cash Flow Statement Total cash received during that time period Cash outflows during the time period Cash surplus or deficit

 2006 McGraw-Hill Ryerson Ltd. Cash Flow Statement Shows how changes in balance sheet accounts and income affect cash and cash equivalents Breaks the analysis down to operating, investing, and financing activities Essentially, the cash flow statement is concerned with the flow of cash in and cash out

 2006 McGraw-Hill Ryerson Ltd. Why cash flow statement is important? Help to get a clear picture of financial health Cash surplus or deficit Cash surplus (positive balance): build wealth Cash deficit: destroy wealth

 2006 McGraw-Hill Ryerson Ltd. If your cash flow statement is positive, then you have some additional cash each month that you can use to help you reach your financial goals Build emergency fund, pay down debt, invest, etc. If your cash flow statement is negative, then it is time to look for ways to makes changes Look for areas you can trim back on expenses, and ways to increase income

 2006 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. 2-17

 2006 McGraw-Hill Ryerson Ltd. Analyzing Your Current Financial Situation Measure your progress toward your financial goals Save and invest on a regular basis Identify how your assets are distributed among the different categories Each asset has its purpose Calculate your current asset allocation Allocation of financial assets between cash, fixed income and equity investments 2-18

 2006 McGraw-Hill Ryerson Ltd. Analyzing Your Current Financial Situation Identify whether your investments are tax efficient Provide you with highest after-tax return Identify assets that may be lost, stolen, damaged or destroyed May require insurance coverage Summarize the types and extent of your indebtedness Borrowed to finance depreciating or appreciating assets Many credit cards may inflate your debt ratio 2-19

 2006 McGraw-Hill Ryerson Ltd. Analyzing Your Current Financial Situation Compiling your latest cash flow statements will Highlight your sources of income Reveal whether you are overspending Help assess your spending and saving patterns 2-20

 2006 McGraw-Hill Ryerson Ltd. Learning Objective # 4 Create and implement a budget. 2-21

 2006 McGraw-Hill Ryerson Ltd. Creating and Implementing a Budget Budget: A specific plan for spending income Purpose: Live within your budget Spend your money wisely Prioritize and attain your financial goals Prepare for financial emergencies Develop wise financial management habits 2-22

 2006 McGraw-Hill Ryerson Ltd. The Budgeting Process Step 1: Setting Financial Goals Plans for future activities that require you to plan your spending and investing Should be realistic; stated in specific, measurable terms; have a definite time frame; imply type of action to be taken 2-23

 2006 McGraw-Hill Ryerson Ltd. The Budgeting Process Step 2: Estimating Income Estimate available money for given period of time – usually one month Based on number of times income received each month, spending should be planned accordingly Difficult if your earnings vary by season or income is irregular 2-24

 2006 McGraw-Hill Ryerson Ltd. The Budgeting Process Step 3: Budgeting Emergency Fund and Savings Recommend 3-6 months of living expenses be established Step 4: Budgeting Fixed Expenses Will depend on your current needs and plans for the future Step 5: Budgeting Variable Expenses Will fluctuate by household situation, time of year, health, economic conditions, etc. 2-25

 2006 McGraw-Hill Ryerson Ltd. The Budgeting Process Step 6: Recording Spending Amounts Record actual income and expenses Budget Variance – difference between amount budgeted & the actual amount received or spent Deficit – actual spending exceeds planned spending Surplus – actual spending less than planned spending 2-26

 2006 McGraw-Hill Ryerson Ltd. The Budgeting Process Step 7: Reviewing Spending and Saving Patterns Review your financial progress Revise your goals and budget allocations 2-27

 2006 McGraw-Hill Ryerson Ltd. Successful Budgets Are... Well planned Realistic Flexible Clearly communicated 2-28

 2006 McGraw-Hill Ryerson Ltd. Learning Objective # 5 Calculate savings needed to achieve financial goals. 2-29

 2006 McGraw-Hill Ryerson Ltd. 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. 2-30

 2006 McGraw-Hill Ryerson Ltd. 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 institution Payroll deduction Direct deposit Saving coins at end of each day 2-31

 2006 McGraw-Hill Ryerson Ltd. Suggestions for Dual-Income Households Pooled Income – incomes combined and bills paid from pool Sharing the Bills – each responsible for predetermined bills 50/50 – each contribute equally to pool Proportionate Contribution – each contribute percentage of his/her income 2-28

 2006 McGraw-Hill Ryerson Ltd. Summary of Learning Objectives Recognize relationships among financial documents and money management activities Requires effective coordination of personal financial records, personal financial statements and budgeting activities Create a system for maintaining personal financial records Foundation of effective money management Should provide easy access as well as security 2-33

 2006 McGraw-Hill Ryerson Ltd. Summary of Learning Objectives Develop a personal balance sheet and cash flow statement Net worth statement lists all items of value (assets) and all amounts owed to others (liabilities) Difference is your net worth Person income and expenditures statement is a summary of cash receipts and payments for a given period of time Provides data on your income and spending patterns 2-34

 2006 McGraw-Hill Ryerson Ltd. Summary of Learning Objectives Create and implement a budget Seven-step process will help you live within your means and channel your resources toward the attainment of prioritized financial goals Calculate savings needed to achieve financial goals Future and present value calculations may be used to compute the increased value of savings for achieving financial goals 2-35