Chapter 2: Money management strategy, financial statements and budgeting

Question 1

what is money management

Answer 1

day to day financial activities necessary to manage current personal economic resources while working toward long-term financial security

Question 2

what are opportunity costs and examples

Answer 2

• choices you make and the cost of them
• spending money on current lving expenses reduce amount you can save
• saving and investing for future reduces what you can spend now

buying on credit results in payments later and a reduction in amount of future income available for spending

• using savings for purchases results in loss of interest earnings and in inability to use savings for other purposes

Question 3

what are teh three major money management activities

Answer 3

• storing and maintaining personal financial records and documents
• creating personal financial statements (balance sheets and cash flow statements of income and outflows)
• creating and implementing a plan for spending and saving (budgeting)

Question 4

what are the 10 categories to organize financial records?

Answer 4

• personal and empolyment records

tax records

credit records

housing records

investment records

money management records

financial services records

consumber purchase & automobile

insurance records

estate planning and retirement

Question 5

how do you make a personal balance sheet

Answer 5

• also called net worth statement
• items of value (what you won) - amount of debt (what you owe) = net worth
• what you own determined by: liquid assets = money in chequings and savings accounts, real estate, personal possessions and investment assets
• what you owe determined by: current liabilities (debts to be paid in less than a year, credit, taxes, mortgages) and long term (loans, mortgage)

* inc net worth by inc savings, reducing spendings (inc assets and can dec liabilities), inc vlaue of investments, reducing amount of debt (dec liabilities)

*Net worth is not the money available to you but it indicated financial position*

Question 6

How do you create a cash flow statement

Answer 6

• also called personal income and expenditure statement
• summary of cash receipts and payments over a period of time (month or year)

1. Record income
   
   • wages/salaries/comissions, self employment business income, savings/investment income, government payments etc.
   • either use net pay (takes out taxes and CPP contribution or take it out yourself)
2. Record cash outflows
   
   • fixed expenses (monthly payments) and variable (clothing, food, recreation)
3. Determine net cashflow

Question 7

what is disposable income

Answer 7

amount a person or household has available to spend

Question 8

what is discretionary income

Question 9

how do you analyze your current financial situation

Answer 9

• use balance sheet and cash flow statements
• relationship indicates financial position, can calcuate financial ratios

Question 10

what is debt ratio

Answer 10

• liabilities/ net worth
• Shows relationship between debt and net worth. For many creditors. 0.5 is the maximum acceptable limit; a lower debt ratio would be better.

Question 11

what is the Current ratio

Answer 11

liquid assests/ current liabilities

• ex $4000/$20000

Indicates $2 in liquid assets for every $1 of current liabilities

-For many analysts, a ratio of 2 is considered good; a high current ratio is desirable to have cash available to pay bills.

Question 12

liquidity ratio

Answer 12

• liquid assets/monthly expenses
• indicates the number of months living expenses can be paid if an emergency arises
• want a high liquidity ratio

Question 13

Debt payments ratio

Answer 13

• monthly credit / take home pay
• indicates how much of a person’s earings are going for debt payments (excluding mortgage)
• more advisors recommend a debt ratio of less than 20%

Question 14

savings ratio

Answer 14

amount saved each month/gross income

• want monthly savings of at least 10%

Question 15

purpose of budget

Answer 15

• spend less than your income
• understand your sources and uses of cash
• prioritize and attain your financial goals
• prepare an emergency fund
• develop wise financial management habits

Question 16

what are the 7 steps to budgeting

Answer 16

1. set financial goals (consider cash flow, balance sheet (where you are now) and budgeting)
2. estimate income (only include moeny you are sure you will recieve
3. budget emergency fund and savings (3-6 months of living expenses)
4. budget fixed expenses
5. budgeting variable expenses
6. recording spending amounts
7. reviewing spending and saving patters

Question 17

what is a buget varients

Answer 17

difference between amount bdgeted and the actual amount received or spent

• may be a deficit or surplus

Question 18

characteristics of a successful budget include:

Answer 18

• well planned
• realistic
• flexible
• cleary communicated

Question 19

what are different savings techniques

Answer 19

• automatic debit: mony form bank account is transferred periodically to an investment account, savings may be a % of income of fixed dollar amount
• payroll deduction: available at diff places of employment under direct deposit system, automatically deducted from salary into savings or investment account
• just making concious decisions to spend less

Question 20

strategies for multi income households

Answer 20

1. Pooled income: all incomes are combined, bills paid from the pool (requires trust, shared goals and values)
2. Sharing the bills: each person responsible for paying pre determined bills
3. 50/50: each person contributes an equal amount into the pool to cover shared expenses
4. Proportionate contributions: each person contributes a percentage of their income