CH-3 Money Management Strategy: Financial Statements and Budgeting – Personal Finance : Chapter Notes

3 MONEY MANAGEMENT STRATEGY: FINANCIAL STATEMENTS AND BUDGETING CHAPTER OVERVIEW Successful money management is based on organized financial records, accurate personal financial statements, and effective budgeting. This chapter offers a discussion of the importance and type of financial documents. This is followed by an explanation of the components and procedures for preparing personal financial statements—the balance sheet and the cash flow statement. Next, the chapter covers the basics of developing, implementing, and evaluating a budget. Finally, savings techniques for achieving financial goals are discussed. LEARNING OBJECTIVES CHAPTER SUMMARY After studying this chapter, students will be able to: LO 3-1 Recognize relationships among financial documents and money management activities. Successful money management requires effective coordination of personal financial records, personal financial statements, and budgeting activities. Your system for organizing personal financial records and documents is the foundation of effective money management. This structure should provide ease of access as well as security for financial documents that may be impossible to replace LO 3-2 Develop a personal balance sheet and cash flow statement. A personal balance sheet, also known as a net worth statement, is prepared by listing all items of value (assets) and all amounts owed to others (liabilities). The difference between your total assets and your total liabilities is your net worth. A cash flow statement is a summary of cash receipts and payments for a given period, such as a month or a year. This report provides data on your income and spending patterns. LO 3-3 Create and implement a budget. The budgeting process involves four phases: (1) assessing your current personal and financial situation; (2) planning your financial direction by setting financial goals and creating budget allowances; (3) implementing your budget; and (4) evaluating your budgeting program. LO 3-4 Relate money management and savings activities to achieve financial goals The relationship among the personal balance sheet, cash flow statement, and budget provides the basis for achieving long-term financial security. Future value and present value calculations may be used to compute the increased value of savings for achieving financial goals. 3-1 INTRODUCTORY ACTIVITIES • Ask students to comment on their responses to the “My Life” chapter opening exercise (pp. 87-88). • Point out the learning objectives (p. 87) in an effort to highlight the key points in the chapter. • Ask students to provide examples of problems that could result from not having a system for storing personal financial records and documents. • Point out common methods of budgeting that help a household achieve financial goals and prevent money problems. WHAT'S NEW TO THIS EDITION Topics, Features Benefits for the Teaching-Learning Environment New content: Storing financial documents "in the cloud" Provides guidelines for electronically storing and maintaining a system for personal financial documents. Revised visual: "Where to Keep Your Financial Records Suggests a a format for a computerized system for personal financial documents. New feature: How to…Conduct A Money Management SWOT Analysis Allows students to identify and assess their money management strengths, weaknesses, opportunities, and threats. New examples: Calculating net work and a budget variance Presents specific numeric examples for determining net worth and a budget variance. New case: "Adjusting the Budget" Provides students an opportunity to make recommendations to revise a household budget. CHAPTER 3 OUTLINE I. Successful Money Management A. Opportunity Cost and Money Management B. Components of Money Management A System for Personal Financial Records A. Money Management Records B. Personal and Employment Records C. Tax Records D. Financial Services Records E. Credit Records F. Consumer Purchase Records G. Housing and Automobile Records H. Insurance Records I. Investment Records J. Estate Planning and Retirement Records II. Personal Financial Statements 3-2 A. The Personal Balance Sheet: Where Are You Now? 1. Listing Items of Value 2. Determining Amounts Owed 3. Computing Net Worth B. Evaluating Your Financial Position C. The Cash Flow Statement: Where Did Your Money Go? 1. Record Income 2. Record Cash Outflows 3. Determine Net Cash Flow III. Budgeting for Skilled Money Management A. The Budgeting Process Step 1. Setting Financial Goals Step 2. Estimating Income Step 3. Budgeting Emergency Fund and Savings Step 4. Budgeting Fixed Expenses Step 5. Budgeting Variable Expenses Step 6. Recording Spending Amounts Step 7. Reviewing Spending and Saving Patterns B. Characteristics of Successful Budgeting IV. Money Management and Achieving Financial Goals A. Identifying Savings Goals B. Selecting a Savings Technique C. Calculating Savings Amounts 3-3 CHAPTER 3 LECTURE OUTLINE Instructional Suggestions I. SUCCESSFUL MONEY MANAGEMENT (p. 88) • Money management refers to the day-to-day financial activities necessary to handle current personal economic resources while working toward long-term financial security. Opportunity Cost and Money Management (p. 88) • Trade-offs are associated with every spending, saving, borrowing, and investing decision. • Text Highlight: The list on pages 88 points out trade-offs associated with money management activities and decisions. • Use PPT slides 3-2 to 3-6 Components of Money Management (p. 89) • Personal financial records, financial statements, and spending plans (budget) are the foundation for planning and implementing money management activities. 3-4 A SYSTEM FOR PERSONAL FINANCIAL RECORDS (p. 89) • Organized money management requires a system of financial records including the following categories: 1. money management records 2. personal and employment records 3. tax records 4. financial services records 5. credit records 6. consumer purchase records 7. housing and automobile records 8. insurance records 9. investment records 10. estate planning and retirement records • As more documents are provided electronically, and people are storing financial records “in the cloud,” consider the following actions: > Download copies of all statements and forms to your local storage area using a logical system of files and folders. > Back up files on external media or use an online backup service. > Secure data with complex passwords and encryption. > Scan copies of documents so you no longer need to keep paper versions > Take appropriate action to completely erase files when discarding items no longer needed. • Hard copies may Hard copies may still be required, such as car titles, birth certificates, property deeds, and life-insurance policies. Original receipts may be needed for returns or warranty service. • Exercise: Have students suggest methods that could be used to organize and quickly access personal financial documents and records. • Use PPT slides 3-7 to 3-11. • Practice Quiz 3-1 (p. 91) 3-5 CHAPTER 3 LECTURE OUTLINE Instructional Suggestions II. PERSONAL FINANCIAL STATEMENTS (p. 91) • A personal balance sheet and cash flow statement provide information about a person’s or household’s current financial position and a summary of current income and spending. The Personal Balance Sheet: Where Are You Now? (p. 92) • A balance sheet, also known as a net worth statement, specifies what you own and what you owe. • Items of value minus amounts owed equals net worth. • Assets, the first item on the balance sheet, are cash and other property that has a monetary value. • Liquid assets are cash and items of value that can easily be converted into cash. • Real estate includes a home, condominium, vacation property, or other land that a person or family owns. • Personal possessions are the major portion of assets for most families. • Investment assets consist of money set aside for long- term financial needs. • Liabilities are amounts owed to others but do not include items not yet due, such as next month’s rent. • Current liabilities are debts that must be paid within a short time, usually less than a year. • Long-term liabilities are debts that are not required to be paid in full until more than a year from now. • Your net worth is the difference between your total assets and your total liabilities: Assets - Liabilities = Net worth • The balance sheet of a business is usually expressed as: Assets = Liabilities + Net worth • Insolvency is the inability to pay debts when they are due; it occurs when a person’s liabilities far exceed his or her available assets. Rations for Evaluating Financial Progress (p. 97) • A person or household experiences financial improvement if net worth increases over time. • Debt ratio—liabilities divided by net worth—may be used to indicate a person’s financial situation; a low debt ratio is desired. • Current ratio—liquid assets divided by current liabilities—how well a person will be able to pay upcoming debts. • Use PPT slide 3-12. • Discussion Question: How accurate is a balance sheet for measuring the financial progress of an individual or household? • Use PPT slides 3-13 to 3-15. • Text Highlight: Exhibit 3-3 (p. 93) provides an overview of the process for preparing a personal balance sheet. • Text Highlight: The "Financial Planning Calculations" feature (p. 97) provides a summary of financial ratios 3-6 CHAPTER 3 LECTURE OUTLINE Instructional Suggestions • Liquidity ratio—liquid assets divided by monthly expenses—indicates the number of months that expenses can be paid if an emergency arises. • Debt-payment ratio—monthly credit payments divided by take-home pay—provides an indication of how much of a person’s earnings goes for debt payments (excluding a home mortgage). • Savings ratio—amount saved each month divided by gross income—financial experts recommend a savings rate of about 10 percent. The Cash Flow Statement: Where Did Your Money Go? (p. 95) • Cash flow is the actual inflow and outflow of cash during a given time period. • A cash flow statement is a summary of cash receipts and payments for a given period, such as a month or a year. • Income is the inflows of cash to an individual or a household. For most people, the main source of income is money received from a job. • Cash payments for living expenses and other items make up the second component of a cash flow statement. • Fixed expenses are payments that do not vary from month to month. • Variable expenses are flexible payments that change from month to month. • The difference between your income and your cash outflows can be either a positive (surplus) or negative (deficit) cash flow. A deficit exists if more cash goes out than comes in during a month. This amount must be made up by withdrawals from savings or borrowing. • Discussion Question: What information does a cash flow statement provide that is not available on a personal balance sheet? • Use PPT slides 3-16 to 3-18. • Text Highlight: Exhibit 3-4 (p. 94) provides an overview of the process for preparing a personal cash flow statement. • Exercise: Have students list possible sources of income (cash inflows available for spending) for people in our society. • Discussion Question: What relationship exists between the balance sheet and cash flow statement? • Practice Quiz 3-2 (p. 98) 3-7 CHAPTER 3 LECTURE OUTLINE Instructional Suggestions III. BUDGETING FOR SKILLED MONEY MANAGEMENT (p. 98) • A budget, or spending plan, is necessary for successful financial planning. The main purposes of a budget are to help you 1. live within your income 2. spend your money wisely 3. reach your financial goals 4. prepare for financial emergencies 5. develop wise financial management habits • Use PPT slide 3-19. • Text Highlight: Exhibit 3-5 (p. 99) provides an overview of the process for creating and implementing a budget. The Budgeting Process (p. 98) • A personal balance sheet is an effective scorecard for assessing personal economic progress. • Your lifestyle is how you spend your time and money and is strongly influenced by your career, family, and personal values. Step 1. Set Financial Goals (p. 99) • Financial goals are plans for future activities that require you to plan spending, savings, and investing. • How much you budget for various items will depend on current needs and plans for the future. Sources that can assist with planning your spending include:  your cash flow statement  sample budgets from government reports  articles in personal financial planning magazines  estimates of future income and expected inflation Step 2. Estimate Income (p. 99) • Available money should be estimated for a given time period—such as a month. • Income variations (due to seasonal work or sales commissions) should be based on the recent past and realistic expectations. Step 3. Budget an Emergency Fund & Savings (p. 100) • An emergency fund and savings for irregular payments should be first set aside to avoid not having anything left for savings. Step 4. Budget Fixed Expenses (p. 101) • Definite obligations (rent, mortgage, and credit payments) should be allocated first. • Assigning amounts to spending categories can be based on your cash flow statement, government data, current magazine articles, and estimates of future income and expenses. • Discussion Question: Is every individual and household forced to budget, with some more organized and planned than others? • Exercise: Have students suggest common financial goals. • Use PPT slides 3-20, 3-21. 3-8 CHAPTER 3 LECTURE OUTLINE Instructional Suggestions • A “spending diary” of past expenses can also assist with this task. Step 5. Budget Variable Expenses (p. 102) • Planning for variable expenses is more difficult than fixed expenses. • These expenses will fluctuate based on household situation, time of the year, health, economic conditions, and other factors. • Text Highlight: Exhibit 3-8 (page 102) provides suggested budget allocations for different life situations. • Exercise: Have students allocate budget categories (using percentages) for different household situations. Step 6. Record Spending Amounts (p. 103) • A budget variance is the difference between amount budgeted and the actual amount received or spent. A deficit exists when actual spending exceeds planned spending. A surplus is when actual spending is less than planned spending. Step 7. Review Spending and Saving Patterns (p. 104) • The results of your budget may be obvious—having extra cash, falling behind in payments. Or the results may need to be reviewed in detail to determine areas of needed changes. The most common overspending areas are entertainment and food, especially away- from-home meals. • At this point of the budgeting process, you should also evaluate, reassess, and revise your financial goals. Characteristics of Successful Budgeting (p. 104) • A successful budget should be:  well-planned  realistic  flexible  clearly communicated • Use PPT slides 3-22 and 3-23. • Discussion Question: What factors can contribute to unsuccessful budgeting? How can these situations be avoided? Types of Budgeting Systems (p. 105) • The commonly used budgeting systems are : 1. A mental budget exists only in a person’s mind. 2. A physical budget with envelopes, folders, or containers to hold money or slips of paper.. 3. A written budget with a detailed plan for spending. 4. A computerized budgeting system using spreadsheet software. 5. An online budget through a website. 6. A budgeting app on your cell phone or tablet • Practice Quiz 3-3 (p. 105) • Text Highlight: The "How To…" feature on page 106 provides students with an opportunity to prepare a S-W-O-T analysis of their money management activities. 3-9 CHAPTER 3 LECTURE OUTLINE Instructional Suggestions IV. MONEY MANAGEMENT AND ACHIEVING FINANCIAL GOALS (p. 106) • The personal financial statements and budget can be used to achieve financial goals with 1. the balance sheet reporting your current financial position—where you are now. 2. the cash flow statement: telling you what you received and spent over the past month. 3. the budget: planning spending and saving to achieve financial goals. • People commonly prepare a balance sheet on a periodic basis, such as every three or six months. Between those points in time, the budget and cash flow statement help you plan and measure spending and saving activities. • The budget would serve to plan your spending and saving between these points in time, and your cash flow statement of income and outflows would document your actual spending and saving. • Changes in net worth result from cash inflows and outflows. In periods when outflows exceed your inflows, you must draw on savings or borrow (buy on credit). When this happens, lower assets (savings) or higher liabilities (due to the use of credit) result in a lower net worth. When inflows exceed outflows, putting money into savings or paying off debts will result in a higher net worth. • PPT Slide 3-24 • Text Highlight: Page 107 shows the relationship among a cash flow statement, the personal balance sheet, and a budget. Identifying Saving Goals (p. 107) • Common reasons for saving include:  to set aside money for irregular or unexpected expenses  to replace expensive items  to buy special items  to provide for long-term expenses  to earn interest for additional income Selecting a Savings Technique (p. 107) • Since most people find saving difficult, financial advisers suggest several methods:  write a check each payday or smartphone app to deposit amount in a distant financial institution  use payroll deduction  save coins; spend less on certain items • Use PPT slide 3-25. • Current Example: People unable to save regularly are usually:  individuals without specific savings goals  people who always seem to use up savings for unexpected expenses  those who overuse credit  people who buy to have the same things as others  individuals who lack common financial goals with other family members 3-10 CHAPTER 3 LECTURE OUTLINE Instructional Suggestions Calculating Savings Amounts (p. 108) • To achieve financial objectives, you should convert your savings goals into specific amounts. • Use PPT slide 3-26. • Your use of an interest-earning savings plan is vital to the growth of your money and the achievement of your financial goals. • Practice Quiz 3-4 (p. 108) CONCLUDING ACTIVITIES • Point out the chapter summary (p. 110) and key terms in the text margin. • Use the “My Life Stage” feature (p. 109) to highlight the main financial planning activities from the chapter for various ages and life situations. • Discuss selected end-of-chapter Financial Planning Problems, Financial Planning Activities, and Life Situation Case. • Use the Chapter Quiz in the Instructor’s Manual. WORKSHEETS FROM PERSONAL FINANCIAL PLANNER FOR USE WITH CHAPTER 3 Use the “Your Personal Financial Planner in Action” (p. 114) activities to encourage students to plan and implement various personal financial decisions. Sheet 14 Financial Documents and Records Sheet 15 Personal Balance Sheet Sheet 16 Personal Cash Flow Statement Sheet 17 Cash Budget Sheet 18 Annual Budget Summary Sheet 19 College Education Cost Analysis/Savings Plan 3-11 CHAPTER 3 QUIZ ANSWERS True-False Multiple Choice 1. F (p. 89) 6. A (p. 98) 2. T (p. 92) 7. C (p. 92) 3. F (p. 92) 8. D (p. 93) 4. T (p. 94) 9. B (p. 95) 5. T (p. 103) 10. B (p. 96, 101) 3-12 Name ________________________________________ Date____________________________ CHAPTER 3 QUIZ TRUE-FALSE _____1. Most financial records should be kept in a safe-deposit box. _____2. A personal balance sheet reports the financial position of a person or family on a given date. _____3. Assets represent amounts owed to others that must be paid within the next year. _____4. Spending less than your income will increase net worth. _____5. A budget deficit exists when actual spending exceeds projected spending. MULTIPLE CHOICE _____6. A(n) __________ is a specific plan for spending. a. budget b. balance sheet c. income statement d. bank statement _____7. An example of a liquid asset would be a. a home. b. an automobile. c. a checking account. d. retirement account. _____8. __________ represents amounts owed to others. a. Current assets b. Expenses c. Mutual funds d. Liabilities _____9. A personal cash flow statement presents a. amounts earned from savings. b. income and payments. c. assets and liabilities. d. amounts owed to others. _____10. Definite financial obligations are referred to as a. variable expenses. b. fixed expenses. c. equity. d. investment assets. 3-13 SUPPLEMENTARY LECTURE Financial Ratios to Measure and Evaluate Financial Progress Type Calculations Example A. Debt ratio liabilities divided by net worth $50,000/$40,000 = 1.25 Interpretation: These items express the relationship between your debts and personal net worth. A lower debt ratio is desired. B. Current ratio liquid assets divided by current liabilities $7,000/$4,000 = 1.75 Interpretation: Indicates how well you will be able to pay upcoming debts. A higher number is more desirable. C. Liquidity ratio liquid assets divided by monthly expenses $7,000/$2,800 = 2.5 Interpretation: Indicates the number of months a person will be able to pay expenses if an emergency situation arises. Again, a higher number is desired especially if uncertainty exists regarding continual employment. D. Solvency ratio total assets divided by total liabilities $98,000/$67,000 = 1.46 Interpretation: Shows the relationship between the value of assets and what is owed. A higher number is desired. E. Debt Payments ratio monthly credit payments divided by monthly take $450/$2,500 = 0.18 Interpretation: Expresses portion of monthly earnings going for credit payments. A lower ratio is desired. F. Savings ratio additions to savings plans divided by take-home pay $2,080/$32,800 = 0.065 Interpretation: Presents the portion of annual earnings that has been saved. G. Investment assets ratio investment assets divided by net worth $77,000/$101,000 = 0.76 Interpretation: Indicates portion of net worth that contributes to long-term financial goals. 3-14 ANSWERS TO PRACTICE QUIZZES, FINANCIAL PLANNING PROBLEMS, FINANCIAL PLANNING ACTIVITIES, FINANCIAL PLANNING CASE, AND CONTINUING CASE PRACTICE QUIZZES Practice Quiz 3-1 (p. 91) 1. What opportunity costs are associated with money management activities? • Spending money on current living expenses reduces the amount that can be used for saving and investing toward long-term financial security. • Saving and investing for the future reduce the amount that can be spent now. • Buying on credit results in payments later and a reduction in the amount of future income available for spending. • Using savings for purchases results in lost interest earnings and an inability to use savings for other purposes. • Engaging in comparison shopping can save money and improve the quality of purchases but uses up something of value that cannot be replaced—your time. • Non-monetary opportunity costs associated with money management activities include time and effort for creating and maintaining a financial record keeping system; a personal decision to have an organized financial existence; possible disagreements among family members due to poor financial records; or weak budgeting techniques. (p. 88) 2. What are the three major money management activities? • The three major money management activities are (1) storing and maintaining financial records and documents, (2) creating personal financial statements, and (3) creating and implementing a budget. (p. 89) 3. What are the benefits of an organized system of financial records and documents? The benefits of an organized financial record system are: • Handling daily business affairs, including the payment of bills on time. • Planning and measuring financial progress. • Completing required tax reports. • Making effective investment decisions. • Determining available resources for current and future buying. (p. 89) 4. What suggestions would you give for creating a system for organizing and storing financial records and documents? Financial documents will be kept in a home file, in a computer file, online, or in a safe-deposit box depending on the importance and need to access the record. Documents that are difficult to replace (birth certificates, contracts, stock certificates) should be kept in a safe-deposit box. (Exhibit 3-2, p. 91) 3-15 Practice Quiz 3-2 (p. 98) 1. What are the main purposes 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 data that you can use when preparing tax forms or applying for credit. (p. 92) 2. What does a personal balance sheet tell about your financial situation? A balance sheet consists of assets (items of value), liabilities (amounts owed to others), and net worth (the difference between the total assets and total liabilities. (pp. 92-94) 3. How can you use a balance sheet for personal financial planning? Net worth can be used to measure overall progress of your personal financial planning activities. Reductions in your debts can also be an indication of financial progress. (pp. 94, 97) 4. What information does a cash flow statement present? The cash flow statement summarizes actual inflows and outflows of cash during a given time period. The cash flow statement is a report of your spending patterns and can be used to create budget amounts for various expense categories. (pp. 95-98) Practice Quiz 3-3 (p. 105) 1. What are the main purposes of a budget? The main purposes of a budget are to help you: • Live within your income. • Spend your money wisely. • Reach your financial goals. • Prepare for financial emergencies. • Develop wise financial management habits. (p. 98) 2. How does a person’s life situation affect goal setting and amounts allocated for various budget categories? Different life situations will affect household goals and plans for spending based on needs and desires of those involved. Delayed marriage might mean more spending for travel and leisure; deferred parenthood might be due to plans for advanced career training and returning to school; divorce will affect housing size needs and could mean child care expenses. 3. What are the main steps in creating a budget? The main budgeting steps are (1) set financial goals, (2) estimate income, (3) budget savings, (4) budget fixed expenses, (5) budget variable expenses, (6) record actual cash inflows and outflows, and compare actual amounts to budgeted amounts, and (7) review spending patterns. (pp. 99-104) 3-16 4. What are commonly recommended qualities of a successful budget? A successful budget should be well planned, realistic, flexible, and clearly communicated. (pp. 104- 105) 5. What actions might you take when evaluating your budgeting program? An evaluation of a budget situation may require reduced spending or efforts to increase income. (pp. 103-104) Practice Quiz 3-4 (p. 108) 1. What are some suggested methods to make saving easy? Suggested savings methods include “pay yourself first,” payroll deduction, saving coins, and eliminating spending on a certain item. (pp. 107-108) 2. What methods are available to calculate amounts needed to reach savings goals? Future value and present value calculations may be used to determine amounts needed to reach savings goals. FINANCIAL PLANNING PROBLEMS (p. 111) 1. Creating Personal Financial Statements. Based on the procedures presented in the chapter, prepare your current personal balance sheet and a cash flow statement for the next month. Solution: A balance sheet represents the financial position of an individual or family on a given date; refer to text pages 92-94 for the process of preparing one and an example. A cash flow statement covers income and payments for a certain time period (such as a month); refer to text pages 95-98 the process and an example. LO: 3-2 Topic: Creating Personal Financial Statements LOD: Medium Bloom’s tag: Application 2. Calculating Balance Sheet Amounts. Based on the following data, compute the total assets, total liabilities, and net worth. Liquid assets, $4,670 Household assets, $93,780 Investment assets, $26,910 Long-term liabilities, $76,230 Current liabilities, $2,670 Solution: Total assets = $125,360 ($4,670 + 26,910 + 93,780) Total liabilities = $78,900 ($2,670 + $76,230) Net worth = $46,460 ($125,360 - $78,900) LO: 3-2 Topic: Calculating Balance Sheet Amounts LOD: Medium 3-17 Bloom’s tag: Application 3. Preparing a Personal Balance Sheet. Use the following items to prepare a balance sheet and a cash flow statement. Determine the total assets, total liabilities, net worth, total cash inflows, and total cash outflows. Rent for the month, $650 Monthly take-home salary, $1,950 Cash in checking account, $450 Savings account balance, $1,890 Spending for food, $345 Balance of educational loan, $2,160 Current value of automobile, $7,800 Telephone bill paid for month, $65 Credit card balance, $235 Loan payment, $80 Auto insurance, $230 Household possessions, $3,400 Stereo equipment, $2,350 Payment for electricity, $90 Lunches/parking at work, $180 Donations, $70 Home computer, $1,500 Value of stock investment, $860 Clothing purchase, $110 Restaurant spending, $130 Solution: Total assets = $18,250 ($450 + 1,890 + 7,800 + 2,350 + 1,500 + 3,400 + 860) Total liabilities = $2,395 ($235 + $2,160) Net worth = $15,855 ($18,250 - $2,395) Total cash inflows = $1,950 Total cash outflows = $1,950 ($650 + 345 + 230 + 180 + 110 + 65 + 80 + 90 + 70 + 130) LO: 3-2 Topic: Preparing a Personal Balance Sheet. LOD: Hard Bloom’s tag: Application 4. Computing Balance Sheet Amounts. For each of the following situations, compute the missing amount. a. Assets $45,000; liabilities $12,600; net worth $ _____. b. Assets $78,980; liabilities $ _____ ; net worth $13,700. c. Assets $44,280; liabilities $12,965; net worth $ _____. d. Assets $ _____; liabilities $38,345; net worth $53,795. Solution: a. $32,400 ($45,000 – $12,600) b. $65,280 ($78,980 – $13,700) c. $31,315 ($44,280 – $12,965) d. $92,140 ($38,345 + $53,795) LO: 3-3 Topic: Computing Balance Sheet Amounts LOD: Medium Bloom’s tag: Application 5. Calculating Financial Ratios. The Fram family has liabilities of $128,000 and a net worth of $340,000. What is their debt ratio? How would you assess this? Solution: $128,000 / $340,000 = 0.376 represents a ratio of less than 40 percent, which would need to be assessed in relation to previous trends and the ratio of comparable households. 3-18 LO: 3-2 Topic: Calculating Financial Ratios. LOD: Medium Bloom’s tag: Application, analysis 6. Determining Financial Process. Carl Lester has liquid assets of $2,680 and current liabilities of $2,436. What is his current ratio? What comments do you have about this financial position? Solution: $2,680 / $2,436 = 1.1, which might be viewed as lower than would be desirable. LO: 3-2 Topic: Determining Financial Progress. LOD: Medium Bloom’s tag: Application, Analysis 7. Determining Budget Variance. Fran Bowen created the following budget: Food, $350 Clothing, $100 Transportation, $320 Personal expenses and recreation, $275 Housing, $950 She actually spent $298 for food, $337 for transportation, $982 for housing, $134 for clothing, and $231 for personal expenses and recreation. Calculate the variance for each of these categories, and indicate whether it was a deficit or surplus. Solution: Food $52 surplus; transportation $17 deficit; housing $32 deficit; clothing $34 deficit; personal expenses $44 surplus. LO: 3-3 Topic: Determining Budget Variances. LOD: Medium Bloom’s tag: Application 8. Calculating the Effect of Inflation. Bill and Sally Kaplan have an annual spending plan that amounts to $36,000. If inflation is 3 percent a year for the next three years, what amount will the Kaplans need for their living expenses three years from now? Solution: $36,000  1.158 (FV$1, 5%, 3 years) = $41,688 LO: 3-3 Topic: Calculating the Effect of Inflation LOD: Medium Bloom’s tag: Application 9. Computing the Time Value of Money for Savings. Use future value and present value calculations (see Chapter 1 appendix) to determine the following. a. The future value of a $400 savings deposit after eight years at an annual interest rate of 3 percent. b. The future value of saving $11,800 a year for five years at an annual interest rate of 4 percent. c. The present value of a $6,000 savings account that will earn 3 percent interest for four years. Solution: 3-19 a. $400  1.267 = $506.0 b. $11,800  5.416 = $63,908.80 c. $6,000  0.885 = $5,310 LO: 3-4 Topic: Computing the Time Value of Money for Savings. LOD: Medium Bloom’s tag: Application 10. Calculating Present Value of a Savings Fund. Hal Thomas wants to establish a savings fund from which a community organization could draw $800 a year for 20 years. If the account earns 3 percent, what amount would he have to deposit now to achieve this goal? Solution: $800  14.877 = $11,901.60 LO: 3-4 Topic: Calculating Present Value of a Savings Fund LOD: Medium Bloom’s tag: Application 11. Future Value of Reduced Spending. Brenda plans to reduce her spending by $80 a month. Calculate the future value of this increase in saving over the next 10 years. (Assume an annual deposit to her savings account, and an annual interest rate of 5 percent.) Solution: $80 × 12 = $960 × 12.578 (future value of annuity) = $12,074.88 LO: 3-4 Topic: Future Value of Reduced Spending LOD: Medium Bloom’s tag: Application 12. Future Value of Savings. Kara George received a $4,000 gift for graduation from her uncle. If she deposits the entire amount in an account paying 3 percent, what will be the value of this gift in 15 years? Solution: $4,000 × 1.558 = $6,232 LO: 3-4 Topic: Future Value of Savings. LOD: Easy Bloom’s tag: Application FINANCIAL PLANNING ACTIVITIES (p. 112) 1. Researching Money Management Information. Talk to two or three people regarding wise and poor money management actions they have taken in their lives, and about the system they use to keep track of various financial documents and records. Based on this information, what actions might you take now or in the future? This activity will provide students with an opportunity to gain insight into various issues and topics related to money management. 3-20 2. Creating Personal Financial Statements. Using Sheets 15 and 16 in the Personal Financial Planner, or some other format you find online, prepare a personal balance sheet and cash flow statement. This will help students start thinking about the practical aspects of personal financial statements for their situations. 3. Researching Money Management Apps. Conduct research to identify various budgeting and money management apps. Determine the features, ease of operation, and information provided by these apps. Which app would you consider using for your budgeting and money management activities? Various money management apps are available. Encourage students to analyze these apps in relation to benefits for improved money management and budgeting activities. 4. Analyzing Budgeting Situations. Discuss with several people how the budget in Exhibit 3-7 might be changed based on various budget variances. If the household faced a decline in income, what spending areas might be reduced first? This activity can help students better understand problems associated with money management and cash flow. In addition, students can obtain practical advice on coping with this situation. Opinions on this item will vary. Students should be ready to accept different points of views that reflect a person’s life situation, goals, and personal values. 5. Analyzing Savings Habits. Talk to a young single person, a young couple, and a middle-aged person about their financial goals and saving habits. What actions do they take to determine and achieve various financial goals? This activity can help students appreciate differences in money management activities based on differences in life situations. FINANCIAL PLANNING CASE Adjusting the Budget (p. 113) 1. What situations might have created the budget deficit for the Constantine family? Possible answers include: a lack of planning, not monitoring spending actions, not setting financial goals, and unexpected expenses due to an emergency or other circumstances. 2. What amounts would you suggest for the various categories for the family budget? While student answers will vary, some suggested actions might include reduced spending in certain areas (food away from home, cable and internet, and more careful spending for groceries) along with a revised budget and perhaps actions to increased household income. 3. Describe additional actions for the Constantine family related to their budget or other money management activities. Possible answers might include: involve all family members in the budgeting process, assessing current 3-21 and future insurance needs, setting financial goals and regular savings to achieve those goals. CONTINUING CASE Money Management Activities (p. 114) Questions 1. Since a budget is made up of fixed expenses and variable expenses, identify which of Shelby’s expenses fall into each category. Then total each category and compare it to her monthly income to determine if she has a surplus or deficit. a. Fixed expenses: rent $400 + utilities $75 + car insurance $100 = $575 b. Variable expenses: cell phone $50 + credit card payment $40 + gas/car maintenance $100 + cable/internet $45 + groceries $300 + clothing $50 + gifts & donations $50 = $635 c. Monthly income (after taxes) $1450 – (fixed expenses $575 + variable expenses $635 = $1,210) = $240 surplus. 2. Based on the information above, how much should Shelby have in an emergency fund? What steps should she take to reach this amount? Shelby should try to set aside an emergency fund of three to six months of living expenses (fixed and variable expenses combined). Her living expenses totaled $1,210. Therefore, she should aim to set aside between $3,630 and $7,260 in an emergency fund. 3 months of living expenses = $1,210 x 3 = $3,630 6 months of living expenses = $1,210 x 6 = $7,260 Her budget in question 1 above indicates that she should have a surplus of $240 each month. She should set aside a portion of this money each month specifically for her emergency fund until she reaches her goal. 3. Describe how Shelby might use the following Personal Financial Planner sheets for assessing her financial condition (Creating a Personal Balance Sheet, Creating a Personal Cash Flow Statement, and Developing a Personal Budget). Although student responses may vary, some good answers to this question are: a. Creating a Personal Balance Sheet Shelby can use this form to determine her net worth or current financial position. It identifies her total assets and total liabilities. b. Creating a Personal Cash Flow Statement Shelby can use this form to identify what income she received and what she spent over the past month. By using this form to track her spending, she will be able to identify expenses that can be reduced to help meet her goals. c. Developing a Personal Budget This worksheet will allow Shelby to determine how well she is managing her money to achieve her financial goals. She will be able to identify variances (differences) between her planned activities (planned spending and planned savings) and her actual activities. This will help her to make better money management decisions on a monthly basis. 3-22 DAILY SPENDING DAIRY (p. 115) This activity will help students better plan their spending for both short-term and long-term financial decisions. 3-23 Name ______________________________________ Chapt er 3: M oney M anagem ent St r at egy : F inancial St at em ent s and Budget ing 2. The actual inflow and outflow of cash during a given time period. 3. Cash and other property with a monetary value. 6. Amounts owed to others. 10. A private storage area at a financial institution with maximum security for valuables. 11. Debts you must pay within a short period of time, usually less than a year. 12. A specific plan for spending income. 13. Reports what you own and what you owe. 14. Money left over after paying for housing, food, and other necessities. 15. Cash and items of value that can easily be converted to cash. 16. Inflows of cash to an individual or a household. 1. Earnings after deductions for taxes and other items; also called disposable income. 2. A summary of cash receipts and payments for a given period. 4. The difference between total assets and total liabilities. 5. The difference between the amount budgeted and the actual amount received or spent. 6. Debts you do not have to pay in full until more than a year from now. 7. The inability to pay debts when they are due because liabilities far exceed the value of assets. 8. The amount by which actual spending is less than planned spending. 9. Day-to-day financial activities necessary to manage current personal economic resources while working toward long-term financial security. 14. The amount by which actual spending exceeds planned spending. Across Down C U R R E N T L I A B I L I T I E S C A S H F L O W S T A T E M E N T L O N G T E R M L I A B I L I T I E S D I S C R E T I O N A R Y I N C O M E M O N E Y M A N A G E M E N T S A F E D E P O S I T B O X B U D G E T V A R I A N C E L I Q U I D A S S E T S B A L A N C E S H E E T T A K E H O M E P A Y L I A B I L II T I E S N S O L V E N C Y N E T W O R T H C A S H F L O W S U R P L U S D E F I C I T I N C O M E B U D G E T A S S E T S 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Instructor Manual for Personal Finance Jack R. Kapoor, Les R. Dlabay , Robert J. Hughes, Melissa M. Hart 9780077861643, 9781260013993