Chapter 3

Money Management Strategies

Opportunity Costs & Money Management

• Money management—planning how to get the most out of your money

• Trade-offs—sometimes your time is worth more than the extra money you will save on a particular item

• Consider your values and goals when making money management decisions

What Are Financial Documents?

• Paycheck stubs• Bank statements• Receipts• Automobile titles• Birth certificates• Tax forms• Social security cards• Paid bills• Credit card information

• Contracts• Wills• Safe deposit box information• Certificates of Deposit (CDs)• Investment information• Loan information• Housing records• Insurance records• Retirement information

Where to Keep Your Financial Documents

• 1. Home file– Make sure it’s fireproof– Keep in a secure place– Arrange information according to the type of

document– Label each folder– File information as soon as it’s received

• 2. Safe deposit box– Two keys—yours and the bank—both needed to

open the box– Usually insured– Rented

• 3. Home computer– Be sure to back up– Password information– Good tool to plan future

Benefits of Organizing Your Financial Documents

• Plan and measure your financial progress• Handle routine money matters, such as paying

bills on time• Determine how much money you will have

now and in the future• Make effective decisions about how to save

money• Keep information all in one place (Ex: can look

up utility bills when selling your home)

Ask Yourself

• How will organizing your financial documents help you manage your money?

• What steps would you take to create a home filing system?

• What are the advantages of using a safe-deposit box to store your personal financial documents?

Personal Financial Statements

• Personal Balance Sheet– Also called a Net Worth Statement– Lists items of value owned, debts owed and a

person’s net worth– Net worth—a measure of your current financial

position

• Cash Flow Statement– Provides information about a person’s current

financial position– Presents a summary of income and spending– Helps you determine what you owe and own– Tracks financial activities and progress– Helps to organize information

Personal Balance Sheet

• Steps to complete a personal balance sheet1. List assets—anything that is owned

1. Liquid assets2. Real estate3. Personal possessions4. Investment assets

2. List liabilities—the debts you owe3. Calculate your net worth = Assets - Liabilities

Types of Assets

• Liquid assets—those assets most easily converted to cash (Ex: cash, savings)

• Real Estate—land and structures on it– Recorded at market value—the price at which the

property would sell– Long-term—not liquid or easily converted to cash

• Personal possessions—cars and other things owned that are not real estate (Ex: tv, car, expensive jewelry)

Types of Liabilities

• Current liabilities– Short-term debts that can be paid within one year– Bills that take longer than one month to repay– Does not include utility bills like phone bills– Examples include:

• Medical bills• Cash loans• Taxes

• Long-term liabilities– Debts that have to be fully repaid for at least one year– Examples include:

• Car loans• Student loans• Mortgages• Some medical bills

What Is Your Net Worth?

• Net worth is the difference between your total assets and total liabilities

• If you have a net worth of $50,000, does that mean you can spend $50,000? Why or why not?

• Net worth is an indication of your general financial situation.

• Insolvency—when you are not able to pay all your debts (liabilities are greater than assets).

Evaluate Your Financial Situation

• Update your balance sheet every few months

• You want your net worth to keep increasing!

• If it’s decreasing, where do you need to make changes?

• Increase your net worth by:– Increasing your savings or

investments– Decreasing your expenses

and debts

Cash Flow Statement

• Cash Flow is the money you actually have to spend and save—divided into two parts:– Cash inflow—income or money received

• Paycheck• Allowance• Interest on savings

– Cash outflow—money you spend• Fixed expenses—cable tv, rent, etc.• Variable expenses—utilities, clothing, food

• Gives you information on your income and spending patterns

Creating a Cash Flow Statement

1. Record your income– Income includes take-home pay—amount of

money left after taxes and other deductions (not your salary)

– Interest earned on investments– Savings

2. Record your expenses– Fixed—the same each month

– Variable—change each month3. Determine your net cash flow– Subtract your expenses from your income– If positive, you have a surplus (net worth

increases)– If negative, you have a deficit (net worth

decreases)

By the NumbersDebt Ratio

Liabilities/net worth

$250/$500 = 0.5

Low debt ratio is best

Liquidity Ratio

Liq. Assets/ monthly expenses

$10,000/$4,000 = 2.5

# of months take to pay; higher better

Debt-payment Ratio

Monthly credit payments/net pay

$540/$3,600 = 15%

Less than 20% best

Savings Ratio

Amnt saved/ gross income

$600/$5000 = 12%

At least 10%

Ask Yourself

1. How do you calculate your net worth when preparing a balance sheet?

2. How should you record your income on a cash flow statement?

3. If your personal financial statements indicate that you have a deficit, what might you do to change your financial situation?

Preparing a Practical Budget

• Budget—a plan for using money to meet wants and needs

• Learn how to live within your income• Learn how to spend your money wisely

• 7 steps in preparing a budget1.Set your financial goals2.Estimate your income3.Unexpected expenses4.Fixed expenses5.Variable expenses6.Record what you spend7.Review spending and saving patterns

Budgeting for Income

• Do include your take-home pay (salary less taxes and other deductions from your paycheck)– Taxes– Voluntary deductions

• Do include interest earned on investments if it is regular interest

• Do NOT include bonuses

Budget for Expenses

• Unexpected expenses– You should set aside some savings to help with or

pay for unexpected expenses– Set aside 3-6 months living expenses

• Fixed expenses—insurance, mortgage• Variable expenses– Look at previous year’s costs for some expenses

such as heating/cooling– Take a year’s average for things such as car repairs

What Are Reasonable Expense Levels?

• Use guidelines published by experts telling us what percentage of income should be spent on various items

• Compare what you spend with the Consumer Price Index (CPI)– Produced by the US Department of Labor– A measure of the changes in prices for commonly

purchased goods and services in the US• Compare your information with a friend’s

Keep Track of Actual Income & Expenses

• Use two columns to list income and expenses– 1st column—budgeted amounts– 2nd column—actual amounts

• Use a column to record the budget variance– The difference between the budgeted amount and

the actual amount spent– Can end up with a surplus (you spent less than you

thought you would) or a deficit (you spent more).

Budgeting Is a Continual Process

• Prepare a budget summary

• Review your budget monthly

• Revise it several times per year

Adjusting Your Budget

• After reviewing your budget, you may need to revise it

• If you decide to cut expenses, you may need to revise or at least review your financial goals

Budgeting Successfully

• Plan your budget carefully

• Be practical• Be flexible• Write it out where you

can look at it often (make it accessible)

Increase Your Savings

• Money that is saved earns interest income• Have a plan to increase your savings– Pay yourself first—set aside a fixed amount

monthly– Use payroll savings if available—forced savings– Spend less each day

• Bring a pop instead of buying one from a machine• Read your favorite magazine at the library instead of

buying it• Car pool

Ask Yourself

1. What are some practical ways to budget for variable expenses?

2. If you continually experience budget deficits, how can you decide which expenses to cut?

3. What are three methods you might use to increase your savings?

Money Management Strategies

Chapter 3 Review

Know All Your Terms

• Money management• Safe deposit box• Personal financial statement• Personal balance sheet• Net worth• Assets• Wealth• Liquid assets• Real estate• Market value• Liabilities

• Insolvency• Cash flow• Income• Take-home pay• Discretionary income• Surplus• Deficit• Budget• Consumer price index (CPI)• Budget variance• Trade-offs

Where to Organize Financial Documents*

• 1. Home file– Make sure it’s fireproof– Keep in a secure place– Arrange information according to the type of document– Label each folder– File information as soon as it’s received

• 2. Safe deposit box– Two keys—yours and the bank—both needed to open the box– Usually insured– Rented

• 3. Home computer– Be sure to back up– Password information– Good tool to plan future

Benefits of Organizing Your Financial Documents

• Plan and measure your financial progress• Handle routine money matters, such as paying

bills on time• Determine how much money you will have

now and in the future• Make effective decisions about how to save

money• Keep information all in one place (Ex: can look

up utility bills when selling your home)

*Personal Financial Statements

• Personal Balance Sheet– Also called a Net Worth Statement– Lists items of value owned, debts owed and a

person’s net worth– Net worth—a measure of your current financial

position

• Cash Flow Statement– Provides information about a person’s current

financial position– Presents a summary of income and spending– Helps you determine what you owe and own– Tracks financial activities and progress– Helps to organize information

Preparing a Practical Budget

• Budget—a plan for using money to meet wants and needs• Learn how to live within your income• Learn how to spend your money wisely

• 7 steps in preparing a budget1. Set your financial goals2. Estimate your income3. Unexpected expenses4. Fixed expenses5. Variable expenses6. Record what you spend7. Review spending and saving patterns

*Increase Your Savings

• Money that is saved earns interest income!• Have a plan– Pay yourself first—set aside a fixed amount

monthly– Use payroll savings if available—forced savings

• Spend less each day– Bring a pop instead of buying one from a machine– Read your favorite magazine at the library instead

of buying it– Car pool