personal finance ch. 2

financial planning allows: -greater wealth-financial security-attainment of financial goals
financial plans road map that shows you the way
personal financial statements planning tools that provide an up-to-date evaluation of your financial well-being and help you to identify potential financial problems; allow you to make better-informed financial decisions
budgets detailed, short-term financial forecasts that compare estimated income with estimated expenses; allow you to monitor and control expenses and purchases in a matter that is consistent with your financial plans
balance sheet describes your financial position at a given point in time
income and expense statement measure financial performance over time; tracks income earned and expenses made; helps you control future expenses and purchases so you will have funds needed to carry out your financial plans
parts of a balance sheet: 1. assets2. liabilities3. net worth
balance sheet equation net worth = total assets – total liabilities
assets the things we own
liquid assets low risk financial assets held in the form of cash or instruments that can be converted to cash quickly, with little/no loss in value; EX: cash on hand/in checking or savings accounting, money market deposit accounts or mutual funds, certificates of deposit that mature within 1 year
investments assets acquired to earn a return rather than provide a service; EX: business ownership, retirement funds, cash value of life insurance plans
real property immovable; land and anything fixed to it; may appreciate (increase in value)
personal property movable property; EX: cars, recreational equipment, household furnishings, appliances, clothing, jewelery, electronics
40% _______ of the average household’s assets is financial assets?
50% ________ of the average household’s assets is real property?
fair market value the actual value of the assets or the price which the asset can reasonably be expected to sell in the open market
liabilities represent an individual’s or family’s debts
current/short term liabilitiy any debt currently owed and due within 1 year of the date on the balance sheet
open account credit obligations outstanding balances against established credit lines (usually through credit card purchases)
long term liability debt due 1 year or more from the date of the balance sheet
principal amount of debt you owe at a given time
net worth amount of actual wealth (equity) that an individual or family has in owned assets
insolvent net worth < 0; in debt
solvent net worth > 0
balance sheet format/prep 1. list all assets at their fair market value2. list all current and long-term liabilities3. calculate net worth
3 parts of the income and expense statement: 1. income2. expenses3. cash surplus/deficit
income cash in
expenses cash out
gross income what income do you use on the income/expense statement?
gross income the number before taxes and other payroll deductions
fixed expenses usually contractual, predetermined, and involving equal payments each period (EX: mortgage payments, insurance premiums)
variable expenses amounts change from one period to the next (EX: gas, food, clothing)
cash surplus positive figure; expenses were less than the income
cash deficit negative value; expenses exceeded income
preparing the income and expense statement: 1. record your income from all sources for the chosen period2. establish meaningful expense categories3. subtract total expenses from total income to get the cash surplus
balance sheet ratios -solvency ratio-liquidity ratio
solvency ratio total net worth/total assetsdegree of exposure to insolvency (cushion to protect from insolvency)
liquidity ratio total liquid assets/total current debtshow long you could continue to pay current debts in the event of an income loss
income and expense statement ratios -savings ratio-debt service ratio
savings ratio cash surplus/net income (after tax)relative amount of cash surplus achieved during a given period
debt service ratio total monthly loan payments/monthly gross income (before tax)provides a measure of the ability to pay debts promptly
budgets help you: 1. maintain necessary information to monitor and control your finances2. decide how to allocate your income to reach your financial goals3. implement a system of disciplined spending4. reduce needless spending so you can increase funds going towards savings and investment5. achieve your long-term financial goals
cash budget takes into account estimated monthly cash receipts and cash expenses for the coming year
3 stages of a cash budget: 1. estimating income2. estimating expenses3. finalizing the cash budget
balanced budget total income for the year equals or exceeds total expenses
2 ways to deal with deficits: -shift expenses from months with budget deficits to months with surpluses-use savings, investments, or borrowing to cover temporary deficits
budget control schedule compares actual income and expenses with the various budget categories and shows the variances

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