Chapter 4 PPT

Report
Chapter 4
Budgets and Balance
Sheets: Your Personal
Financial Statements
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All rights reserved
Learning Objectives
• Explain the steps involved in creating a
budget
• Explain the steps involved in creating a
personal balance sheet
• Analyze the importance of budgeting in your
financial plan
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Creating a Budget
• A budget is a
forecast of
future cash
inflows and
outflows
• Creating a budget is a key part of
your financial plan
• A budget provides guidance for
reaching your personal goals
• It gives you a detailed roadmap to
your financial future
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Step 1: Create a Personal Cash Flow
Statement
• Identify your current cash inflows and cash
outflows
• Many cash inflows include salary, hourly
wages, or allowance
• Cash outflows include car payment, rent, or
phone bill
• See Figure 4.1 for an example of a Personal
Cash Flow Statement
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Figure 4.1
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Step 2: Turning Your Cash Flow
Statement into a Budget
• Forecast your net cash flows for a period a
time into the future
• Think of how the cash flows might change
from month to month
• Be sure to include expected, yet irregular
expenses, such as school activity fees or
vacation
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Step 2: Turning Your Cash Flow
Statement into a Budget
• A good budget should include unexpected expenses
• Adjust the budget as necessary as you get more
information
• An annual budget helps identify times where you
can save money and times when you will be
spending more money
• See Figure 4.2 for an example of an annual budget
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Figure 4.2
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Working with and Improving Your
Budget
• A budget will help you save money for:
– major purchases
– unexpected expenses
– unexpected opportunities
• A budget will help you anticipate future cash
shortfalls
• A budget is a great planning tool
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Assessing the Accuracy of the Budget
• A forecast error is
the difference
between what you
forecast to happen
and what actually
happened
• Evaluate your forecasts and
compare those with the actual cash
flows
• Keep an expense journal to track
your spending
• After looking at your forecast
error, you may need to adjust your
spending
• Look at Figure 4.3 for an example
forecast errors
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Figure 4.3
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Check Your Financial IQ
• What are the steps involved in creating a
budget?
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Check Your Financial IQ
• Step 1: Creating a personal cash flow
statement
• Step 2: Turning a cash flow statement into a
budget
• Step 3: Working with and improving your
budget
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Personal Balance Sheet
• Personal balance
sheet tells you what
your financial
position is at a point
in time.
• A personal balance sheet helps you
make decisions on how to use extra
money
• Knowing where you are financially
will help guide in deciding how to
manage:
– your liquidity
– your use of credit and borrowing,
– your investments
– and more
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Assets
• Assets on a balance sheet can be classified in
several ways:
– Liquid assets
– Household assets
– investments
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Liquid Assets
• Liquid assets are
financial assets that
are either cash or can
be easily converted to
cash without
significant loss of
value
• Liquid assets include money in
checking and savings accounts
• They are necessary for covering
unexpected emergency
expenses
• It is important that they have
quick availability,
• It is also important for them to
be making money
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Math for Personal Finance
• Jeff has $1,000 in a savings account, $340 in
his checking account, and $2,100 in stock
that his grandmother gave him. He also owns
his car, which is worth about 43,200
• How much does Jeff have in liquid assets?
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Math for Personal Finance
• Solution: Jeff’s liquid assets consist of the
money in his savings and checking accounts,
which is $1,000 + $340 = $1,340.
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Household Assets
• Household assets
include those assets
owned by a
household – cars,
houses, furniture
• The market value
of something is
what it would be
worth if you sold it
today
• Another type of asset is
household assets
• While creating your personal
balance sheet, evaluate the true
market value of these assets
• Kelley Blue Book (for cars),
EBay, and other internet sites are
good resources for determining
the value of these assets
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Investments
• An investment is
something you
acquire with the
ultimate goal of
making money
• Investments are the third major
category of assets
• Investments are something you
buy that you believe will increase
in value over time
• Some common investment assets
are:
– Stocks
– Bonds
– Real estate
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Investments
• Bonds are basically
certificates that
function like IOUs—
promises to repay a
certain amount of
money at some future
time
• When you buy a bond, you are
essentially loaning the issuer money
• The issuer pays you interest until the
maturity date
• People buy bonds expecting to
receive interest income while they
hold the bond and getting their money
back when the bond matures
• Investing in bonds involves some
risks
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Investments
• Stocks are
certificates that
represent
fractional
ownership of a
firm
• People buy stocks expecting that
the company will do well and the
value will increase
• Each share of ownership represents
a percentage of the business and is
called a share of stock
• Stocks can be risky
• It is possible that the value will
decline or disappear altogether
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Math for Personal Finance
• Emily owns 50 shares of Company Y’s stock
that is currently selling for $170 a share. She
also owns 65 shares of Company Z’s stock
worth about $47 a share.
• What is the total value of her stock holdings?
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Math for Personal Finance
• Solution:
Company Y
50 x $170 = $8,500
Company Z
65 x $47 = $3,055
Total = $11,555
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Investments
• Mutual funds are
created so investors can
pool their money in
order to invest in a
larger variety of
financial assets, such as
stocks and bonds from
many different
companies
• Mutual funds are managed by
professionals who decide which
stocks/bonds to purchase
• Individual investors who buy
shares in the fund do not have
to be experts in stock or bond
selection
• The risk of loss is usually
spread across many different
investments
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Investments
• Real estate includes
homes, rental
property, farms, and
other land
• Real estate is another type of
investment
• People invest in this hoping it
will generate revenue over time
and increase in value
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Liabilities
• Liabilities represent the amount of debt a
person owes
• These debts can be put into 2 categories:
– Current liabilities
– Long-term liabilities
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Liabilities
• Current liabilities
are debts that must
be paid off within 1
year
• Credit card balances are the
most common form of current
liabilities for people
• A credit card acts like a short
term loan that “should” be paid
of every month
• When you pay the credit card
bill, you are eliminating the
current liability
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Liabilities
• Long-term
liabilities are debt
that will take
longer than 1 year
to pay off
• Examples of long-term liabilities
include student loans, car loans, and
home mortgages
• Each payment includes an interest
component and some amount that will
reduce the initial liability (principal)
• Note that many people use credit
cards this way
• This leads to paying more money than
originally intended
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Net Worth
• Net worth is the
difference between
your assets and your
liabilities
• Figuring your net worth is an
easy way to measure your
wealth
• You can figure your net worth
with a personal balance sheet
• Refer to Figure 4.4 for an
example of figuring out your net
worth
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Figure 4.4
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Math for Personal Finance
• Lakisha’s car is worth about $6,000 and she
still owes $1,200 on it. She has an
outstanding credit card balance of $450.
• What is her net worth?
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Math for Personal Finance
• Solution: Lakisha’s net worth is $6,000 $1,200 - $450 = $4,350
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Changes in the Personal Balance Sheet
• Your Personal Balance Sheet changes as you
acquire new assets or liabilities
• This will affect your net worth
• There are 2 ways to increase your net worth
1. The value of your assets needs to increase by more
than your liabilities
2. To pay down debt on your liabilities
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Analysis of Your Personal Balance
Sheet
• Lenders look at your personal balance sheet to
determine if you can pay the loan
• Loan officers use a debt-to-asset ratio to determine
if you have borrowed too much money
• Keep your personal balance sheet in good shape
• It can influence the options you have for making
financial decisions and having a good financial plan
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Check Your Financial IQ
• What are the steps in creating a personal
balance sheet?
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Check Your Financial IQ
• To see your net worth, you need to identify
all your assets, identify all your liabilities,
and then subtract your liabilities from you
assets.
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Budgeting and Your Financial Plan
• Your cash flows feed into your balance sheet
• If cash flows exceeds cash outflows, you will
either increase assets or reduce liability
• Take a look at figure 4.5 to see how this will
show up on your balance sheet in the form of
increased net worth
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Figure 4.5
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Budgeting and Your Financial Plan
• Budgeting helps in financial planning
because it makes you answer the following
questions:
– How can I improve my net cash flows in the
near term?
– How can I improve my net cash flows in the
long term?
– What decisions should I make about using
credit, borrowing, and investing?
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Check Your Financial IQ
• What is the importance of budgeting to your
financial plan?
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Check Your Financial IQ
• Budgeting helps you evaluate your current
financial condition and determine how to
improve net cash flows and make wise
credit, borrowing, and investment decisions.
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Summary
• The budgeting process allows you to monitor
and control cash inflows and outflows
• Examine the difference between your
forecast and actual cash inflows and
outflows
• You can anticipate future problems and
make necessary adjustments
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Summary
• Your personal balance sheet tells you your financial
position at a point in time
• It is a summary of your assets, your liabilities, and
your net worth
• Assets can be listed as liquid assets, household
assets, and investments
• Liabilities represent the amount of debt you owe
• Liabilities can be split into two categories:
– Current liabilities
– Long-term liabilities
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Summary
• Budgeting can help you manage your cash
flows to increase your net worth
• You can use this in building a financial plan
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Vocabulary
•
•
•
•
•
•
•
Bond
Budget
Current liability
Forecast error
Household asset
Investment
Liability
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•
•
•
•
•
•
•
•
Liquid asset
Long-term liability
Market value
Mutual fund
Net worth
Personal balance sheet
Real estate
Stock
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Websites
• www.forbes.com
• www.kbb.com (Kelley Blue Book)
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