Chapter 3: Planning with Personal Financial Statements

Question 1

personal cash flow statement

Answer 1

A financial statement that measures a person’s income and expenses.

Question 2

what are the inflows of income?

Answer 2

salary, types of savings accounts and debt investments that can generate interest income. dividends and capital gains

Question 3

net cash flows

Answer 3

Disposable (after-tax) income minus expenses.

Question 4

Creating a Personal Cash Flow Statement

Answer 4

You can create a personal cash flow statement by recording how you received income over a given period and how you used cash for expenses.

Question 5

Factors Affecting Income

Answer 5

the stage of your career path, your job skills, and the number of income earners in your household.

Question 6

Factors affecting expenses

Answer 6

a person’s family status, age, and personal consumption behaviour.

Question 7

Budget

Answer 7

A cash flow statement that is based on forecasted cash flows (income and expenses) for a future time period.

Question 8

Forecasting Net Cash Flows over Several Months

Answer 8

. You should assume that you will likely incur some unexpected expenses for repairs on a car or on household items over the course of several months. Thus, your budget may not be perfectly accurate in any specific month, but it will be reasonably accurate over time. If you do not account for such possible expenses over time, you will likely experience lower net cash flows than expected.

Question 9

Alternative Budgeting Strategies

Answer 9

Envelope Method.

Pay Yourself First Method.

Question 10

Envelope Method.

Answer 10

forces you to stick to a cash-only budget for some of your expense categories. The expense categories that you should target for the envelope method are the ones that are the hardest to control, or the ones for which you are able to pay in cash.

Question 11

Pay Yourself First Method.

Answer 11

Another popular budgeting method relies on taking money out of your bank account before you have a chance to spend any of it.
. Using this method, you would arrange to have an automatic transfer of money from your chequing account to your savings account for the amount that you wish to save

Question 12

A personal balance sheet

Answer 12

A summary of your assets (what you own), your liabilities (what you owe), and your net worth (assets minus liabilities).

Question 13

assets on the balance sheet

Answer 13

liquid assets
household assets
investments

Question 14

liquid assets

Answer 14

financial assets that can be easily converted into cash without a loss in value (cash, chequing accounts, savings accounts )

Question 15

household assets

Answer 15

items normally owed by a household (car, furniture )

Question 16

what are common investments

Answer 16

bonds, stocks, mutual funds

Question 17

bonds

Answer 17

are certificates issued by borrowers (typically, firms and government agencies) to raise funds

Question 18

stocks

Answer 18

Certificates representing partial ownership of a firm.

Question 19

mutual funds

Answer 19

Investment companies that sell units to individuals and invest the proceeds in an overall portfolio of investment instruments such as bonds or stocks.

Question 20

real estate

Answer 20

Rental property and land.

Question 21

rental property

Answer 21

Housing or commercial property that is rented out to others.

Question 22

Liabilities

Answer 22

Liabilities represent personal debts (what you owe) and can be segmented into current liabilities and long-term liabilities.

Question 23

current liabilities

Answer 23

Personal debts that will be paid in the near future (within a year).

Question 24

long-term liabilities

Answer 24

Debt that will be paid over a period longer than one year.

Question 25

Net Worth

Answer 25

Your net worth is the difference between what you own and what you owe. Net Worth = Value of Total Assets − Value of Total Liabilities

Question 26

Creating a Personal Balance Sheet

Answer 26

You should create a personal balance sheet to determine your net worth. Update it periodically to monitor how your wealth changes over time.

Question 27

Changes in the Personal Balance Sheet

Answer 27

If you earn new income this month but spend it all on products or services that are not personal assets (such as rent, food, and concert tickets), you will not increase your net worth. As you invest in assets, your personal balance sheet will change.

Question 28

How Cash Flows Affect the Personal Balance Sheet

Answer 28

This relationship explains how you build wealth (net worth) over time. If you use net cash flows to invest in more assets, you increase the value of your assets without increasing your liabilities. Therefore, you increase your net worth.

Question 29

Analysis of the Personal Balance Sheet

Answer 29

Liquidity
amount of your debt
ability to save

Question 30

liquidity

Answer 30

. You need to monitor your liquidity over time to ensure that you have sufficient funds when they are needed. Your liquidity can be measured by the liquidity ratio, which is calculated as: Liquidity Ratio = Liquid Assets/Current Liabilities A high liquidity ratio indicates a higher degree of liquidity.

Question 31

amount of you debt

Answer 31

You also need to monitor your debt level to ensure that it does not become so high that you are unable to cover your debt payments.
Debt-to-Asset Ratio = Total Liabilities/Total Assets
a high debt to asset ratio indicates an excessive amount of debt

Question 32

savings rate

Answer 32

To determine the proportion of disposable income that you save, you can measure your savings over a particular period in comparison to your disposable income (income after taxes are taken out) using the following formula: Savings Rate = Savings during the Period/Disposable Income during the Period