Personal Finance

3 Financial Statements, Tools, and Budgets

YOU MUST BE KIDDING, RIGHT?

The world of personal finances is getting more complicated and challenging each year. Recent economic times have been tough with some negative impacts on people's personal finances. Which one of the following statements is false?

A. Half of Americans have less than one month's income saved for a rainy day.

B. Half of adults say they do not budget.

C. Sixty percent of Americans say they live paycheck-to-paycheck.

D. Forty percent of Americans say they find it difficult to meet monthly expenses.

The answer is “none of the above” because all the statements are true. Clearly, many Americans are experiencing trouble with their personal finances. You can get smart about personal finances so these statements do not apply to you!

LEARNING OBJECTIVES

After reading this chapter, you should be able to:

 Identify your financial values, goals, and strategies.

 Use balance sheets and cash-flow statements to measure your financial health and progress.

 Collect and organize the financial records necessary for managing your personal finances.

 Achieve your financial goals through budgeting.

WHAT DO YOU RECOMMEND?

Austin and Rachel Patterson, both age 26, have been married for four years and have no children. Austin is a licensed electrician earning $46,000 per year, and Rachel earns $41,000 annually as a middle-school teacher. Austin would like to go to half time on his job and return to school on a part-time basis; he is one year short of finishing his bachelor's degree in engineering. His education expenses would be about $20,000 for the year, which could be partially covered by student loans. He has not yet discussed his plans with Rachel.

Austin and Rachel have recently started saving for retirement through their employment and have set aside some savings for emergencies. They have substantial credit card debt and are still paying off their student loans. The couple rents a two-bedroom apartment. Austin always thought it smart to save all of their receipts, bank statements, and other financial documents. His system for organizing their records is very simple; each month he puts everything in a manila envelope and then puts the 12 envelopes into a box at the end of the year.

Austin knows that his educational plans will have financial implications for the couple. He wants to factor these financial issues into his discussion with Rachel about his plans. To this point, they have never developed financial statements or explicit financial goals.

What do you recommend to Austin for his talk with Rachel on the subject of financial planning regarding:

1. Setting financial goals?

2. Determining what they own and owe?

3. Using the information in Austin's newly prepared financial statements to summarize the family's financial situation?

4. Evaluating their financial progress?

5. Setting up a record-keeping system to better serve their needs?

6. Starting a budgeting process to guide saving and spending?

Sixty percent of all adults say they do not budget. Four in ten say they are living beyond their means and rate themselves as fair or poor in managing money. A similar percentage say they find it difficult to meet monthly expenses. They live paycheck-to-paycheck, and they often turn to credit cards. They are incompetent in money matters, and their choices will forever make them the “have nots” in society rather than the “haves.” Living above your means can lead to financial ruin at a young age. If you always live below your means, you will always have means. That's the secret.

To not mess up your financial life you must avoid living paycheck-to-paycheck because this lets your spending dictate your savings. Save first so you can spend later. To succeed you need to follow a spending plan that includes savings, take appropriate actions to achieve results, and regularly measure your financial strength and progress. No matter what your previous financial background, applying the knowledge within this chapter will help you enjoy financial decision making and be successful in managing your money.

What is important is not how much money you have. It is how well you spend your money. At its essence wealth is not measured by how much you make, rather it is how much you hang onto.

3.1 FINANCIAL VALUES, GOALS, AND STRATEGIES

LEARNING OBJECTIVE 1

Identify your financial values, goals, and strategies.

Identifying your financial values and goals sets the stage for financial success. Values and goals help you keep a balance between spending and saving and make you stay committed to your financial plans. Once goals are set, you can develop the strategies necessary for their achievement. Financial planning, which is the process of developing and implementing a coordinated series of financial plans, can help you achieve financial success. By planning your personal finances, you seek to manage your income and wealth so that you reach your financial goals throughout your lifetime.

Figure 3-1  provides an overview of effective personal financial planning.  Table 3-1  illustrates one couple's (Harry and Belinda Johnson) overall financial plan.

Figure 3-1  How to Achieve Financial Goals

Table 3-1 Financial Plans, Goals, and Objectives for Harry (Age 23) and Belinda (Age 22) Johnson, Prepared in February 2015

Financial Plan Areas	Long-Term Goals and Objectives	Short-Term Goals and Objectives
FOR SPENDING
Evaluate and plan major purchases	Purchase a new car in two years.	Begin saving $200 a month for a downpayment for a new car.
Manage debt	Keep installment debt under 10 percent of take-home pay.	Pay off charge cards at the end of each month and do not finance any purchases of appliances or other similar products.
FOR RISK MANAGEMENT
Medical costs	Avoid large medical costs.	Maintain employer-subsidized medical insurance policy by paying $135 monthly premium.
Property and casualty losses	Always have renter's or homeowner's insurance. Always have maximum automobile insurance coverage.	Make semiannual premium payment of $220 on renter's insurance policy. Make premium payments of $440 on automobile insurance policy.
Liability losses	Eventually buy $1 million liability insurance.	Rely on $100,000 policy purchased from same source as automobile insurance policy.
Premature death	Have adequate life insurance coverage for both as well as lots of financial investments so the survivor would not have any financial worries.	Maintain employer-subsidized life insurance on Belinda. Buy some life insurance for Harry. Start some investments.
Income loss from disability	Buy sufficient disability insurance.	Rely on sick days and seek disability insurance through private insurers.
FOR CAPITAL ACCUMULATION
Tax fund	Have enough money for taxes (but not too much) withheld from monthly salaries by both employers to cover eventual tax liabilities.	Confirm that employer withholding of taxes is sufficient. Have extra money withheld to cover additional tax liability because of income on trust from Harry's deceased father.
Revolving savings fund	Always have sufficient cash in local accounts to meet monthly and annual anticipated budget expense needs.	Develop cash-flow calendar to ascertain needs. Put money into revolving savings fund to build it up quickly to the proper balance. Keep all funds in interest-earning accounts.
Emergency fund	Build up monetary assets equivalent to three months' take-home pay.	Put $150 per month into an emergency fund until it totals one month's take-home pay.
Education	Maintain educational skills and credentials to remain competitive. Have employer assist in paying for Belinda to earn a master of business administration (MBA). Have Harry complete a master of fine arts (MFA), possibly a PhD in interior design.	Both take one graduate class per term.
Savings	Always have a nice-size savings balance. Regularly save to achieve goals. Save a portion of any extra income or gifts. Save $26,000 for a down payment on a home to be bought within five years.	Save enough to pay cash for the newest smart phone. Pay off Visa credit card balance of $390 soon. Begin saving $400 per month for a down payment on a new home.
Investment	Own substantial shares of a conservative mutual fund that will pay dividends equivalent to about 10 percent of family income at age 45.	Start investing in a mutual fund before next year.
Retirement	Own some real estate and common stocks. Retire at age 60 or earlier on income that is the same as the take-home pay earned just before retirement.	Establish individual retirement accounts (IRAs) for Harry and Belinda before next year. Contribute the maximum possible amount to employer-sponsored retirement accounts.
Estate planning	Provide for surviving spouse.	Each spouse makes a will.

YOUR NEXT FIVE YEARS

In the next five years, you can start achieving financial success by doing the following related to financial statements, tools, and budgets:

1. Develop financial goals and update them annually.

2. Develop a cash-flow statement and spending plan every month to ensure that you spend less than you make.

3. Track your net worth and financial ratios annually to assess your financial progress.

4. Use an uncomplicated but effective personal financial record-keeping system.

5. Openly and honestly communicate about money matters with key loved ones on a regular basis.

Such excellent managerial efforts help push them toward achieving financial success. The couple has made plans in 15 specific areas spread across three broad categories: (1) spending, (2) risk management, and (3) capital accumulation. Some people choose not to make a financial plan. The fact is that not having a financial plan is still a plan, it is just a really bad plan.

3.1a   Values Define Your Financial Success

Your  values  provide the underlying support and rationale for your financial and lifestyle goals. Your values are your fundamental beliefs about what is important, desirable, and worthwhile. They serve as the basis for your goals. All of us differ in the ways we value education, spiritual life, health, employment, credit use, family life, and many other factors. Personal financial goals grow out of these values because we inevitably consider some things more important or desirable than others. We express our values, in part, by the ways we spend, save, invest, and donate our money.

values Fundamental beliefs about what is important, desirable, and worthwhile.

3.1b   “Sacrifice Now or Suffer Later” Is a Key Value

One major benefit of financial planning is using money wisely. People who are smart about personal finance typically value saving some of their income. They adhere to the personal finance philosophy of “Pay myself first.” If you earn money, shouldn't you be “paid” first? Successful money managers do this instead of spending it all or, even worse, spending even more than they earn by using credit. They establish a current spending level based on the necessities of life. They set aside money for future spending, such as for a vehicle purchase, home, child's education, vacation home, and living expenses during the years of retirement. They live well while preparing for the future. If you do not save early in life, you definitely will have a lower level of living later.

3.1c   Financial Goals Follow from Your Values

Successful financial planning evolves from your financial goals.  Financial goals  are the specific long-, intermediate-, and short-term objectives to be attained through financial planning and management efforts. Financial and lifestyle goals should be consistent with your values. To serve as a rational basis for financial actions, they must be stated explicitly in terms of purpose, dollar amounts, and the projected dates by which they are to be achieved.

financial goals Specific objectives addressed by planning and managing finances.

Set Specific Goals Setting goals helps you visualize the gap between your current financial status and where you want to be in the future. Make a list of your goals. Examples of general financial goals include finishing a college education, paying off credit card debts, repaying education loans, meeting financial emergencies, taking a vacation, owning a home, accumulating funds to send children through college, owning your own business, creating peace of mind, ensuring family harmony, and having financial independence at retirement.

The path toward turning a wish into reality begins with writing it down. If buying a condo is your goal, tape a photograph of a beautiful one onto your refrigerator. Then tell others about your financial goal. The public affirmations and constant reminders will help you make it into a reality.

Put Target Dates on Your Financial Goals Setting target dates for financial goals is important for success. Consider the example of Stephanie Vogel, a dance instructor from Champaign, Illinois. Stephanie has just made the last $347 payment on her four-year car loan. She does not like being in debt, so she does not want to take out such a large loan again. Stephanie would like to put at least part of the money she has been paying monthly for the loan into a savings account, which would allow her to replace her current vehicle in four or five years. Stephanie figures that it would take about $22,500 to buy a similar inexpensive high-mileage used vehicle in five years. She assumes she could earn a 2 percent return on her savings and, using  Appendix A.3 , has determined that she would need to save $4323 per year ($22,500 ÷ 5.2040 for five years at 2 percent interest), or roughly $360 per month.

Stephanie's thinking offers a good example of how proper financial goal setting works. She recognized the value she put on staying out of debt and proceeded to the general goal of trying to pay cash for her next car. After determining an overall dollar amount needed, she broke that amount down into first annual and then monthly amounts. For only $13 more per month than she has been paying on her loan ($360−$347), Stephanie will be able to pay cash for her next car. This is the sacrifice she is willing to make to avoid using credit to buy a vehicle in the future.

Prioritize Your Goals Once your financial goals are clearly identified, you can decide which are the most important. You simply prioritize the list by making trade-off decisions on what you can do with your finances in the near term as well as in the more distant future.

3.1d   Financial Goals Require Wealth-Building Principles

Following are several wealth-building principles that may help you achieve your financial goals:

1. Set clear financial goals both in the short and long term.

2. Save by paying yourself first out of your paycheck.

3. Pay credit card balances in full each month.

4. Spend less than you earn.

5. Participate in the retirement plan at work.

6. Take full advantage of your employer's match on retirement savings.

7. Buy a home for the tax advantages.

8. Pay off your home before retirement.

9. Be patient when investing for the long term.

10. Live every day knowing that your financial future is under control.

3.1e   Financial Strategies Guide Your Financial Success

Financial strategies  are pre-established plans of action to be implemented in specific situations. Stephanie Vogel implemented an effective strategy in the preceding example. That is, when a loan has been repaid, start a savings program with the same monthly payment amount. Saving may be easier for Stephanie if she arranges for the amount she would like to save to be automatically deposited from her paycheck into her savings account. Another useful savings strategy is to arrange for as much as 75 percent of any raises or bonuses to go into savings before you become accustomed to the additional income.

financial strategies Pre-established action plans implemented in specific situations.

 CONCEPT CHECK 3.1

1. Summarize the financial planning process.

2. Explain the relationships among financial values, goals, and strategies.

3.2 FINANCIAL STATEMENTS MEASURE YOUR FINANCIAL HEALTH AND PROGRESS

LEARNING OBJECTIVE 2

Use balance sheets and cashflow statements to measure your financial health and progress.

Financial statements  are compilations of personal financial data that describe an individual's or family's current financial condition. They present a summary of assets and liabilities as well as income and spending of an individual or family. The two most useful statements are the balance sheet and the cash-flow statement.

financial statements Snapshots that describe an individual's or family's current financial condition.

DID YOU KNOW  

Money Topics to Discuss with Your Partner

When you find the right partner, it is smart to do the following:

• Change beneficiaries. Life insurance policies, mutual fund accounts, and retirement accounts all have beneficiaries (the people who will receive the funds at your death) named when you set them up. (See chapters 12, 15, and 17.)

• Coordinate employee benefits. Couples often have two incomes today, so each has a menu of employee benefits from which to choose. As a result, one spouse may drop a benefit that is being received via the other's plan. (See chapter 1.)

• Update life insurance coverage. Focus on term life insurance for the bulk of your needs. (See chapter 12.)

• Review auto and homeowner's insurance coverages. Also inventory your personal property. (See chapter 10.)

• Update names with government agencies. If one or both partners' names are changed as a result of your new status, you need to notify the Social Security Administration and driver's licensing office of that change. You will need to show your marriage certificate as proof of the change.

• Close redundant bank accounts. Reducing the number of accounts that each partner brings into the marriage can save money on account fees. Decide which accounts are “yours, mine, or ours.” (See chapters 5 and 6 for more on managing accounts.)

• Get out of debt. One or both of you may bring debts into the new family. Because a couple can live together a little more cheaply than two individuals who live apart, funds can be freed up to pay off credit cards, student loans, and other borrowing. (See chapters 6, 7, and 9.)

• Decide on how to manage money. Decide on who pays what bills and makes investment decisions. Decide on whether or not each person will have individual control over certain money. Decide on who pays for the debt that precedes the relationship. Decide on who pays for gift giving. Decide on what money tasks you will do together, such as establishing annual financial goals, making purchases with debt, and agreeing on which expenditures require joint agreement, like an expense over $300. (See chapter 5 for how to effectively discuss money matters.)

• Save for retirement separately. Day-to-day living expenses will go down somewhat when you team up as a couple. use some of that money to allocate additional amounts to your individual retirement plans. (See chapter 17.)

• Update estate transfer plans. With a new “number one” in your life, you should change (or set up) your will, durable power of attorney, living will, and health care proxy. (See chapter 11.)

A  balance sheet  (or  net worth statement ) describes an individual's or family's financial condition on a specified date (often January 1) by showing assets, liabilities, and net worth. It provides a current status report and includes information on what you own, what you owe, and what the net result would be if you paid off all of your debts. It answers the question, “Where are you financially right now?”

balance sheet or net worth statement Snapshot of assets, liabilities, and net worth on a particular date.

A  cash-flow statement  (or  income and expense statement ) lists and summarizes income and expense transactions that have taken place over a specific period of time, such as a month or a year. It tells you where your money came from and where it went. It answers the question, “Where did your money go?”

cash-flow statement or income and expense statement Summary of all income and expense transactions over a specific time period.

3.2a   The Balance Sheet Is a Snapshot of Your Financial Status Right Now

To benchmark where you are on the wealth-building scale, determine your net worth. If you are indeed serious about your financial success, then you will sit down soon with pencil and paper or at your computer to see exactly where you stand. You do so by preparing your balance sheet, which summarizes the value of what you own minus what you owe. Your balance sheet should be updated at least once each year and compared to previous ones, so save all your old financial statements. Then you can assess your progress over the years. Net worth grows slowly, but it definitely increases over time. If you are successful in your career and follow the basic principles outlined in this book, there is no reason why you cannot have a net worth of $1 million, or $2 million or more, later in your life. Net worth typically peaks for people in their 50s or 60s (see  Figure 3-2  on page 73) and declines thereafter as one lives off their financial nest egg in retirement.

Components of the Balance Sheet A balance sheet consists of three parts: assets, liabilities, and net worth. Your  assets  include everything you own that has monetary value. Your  liabilities  are your debts—amounts you owe to others. Your  net worth  is the dollar amount left when what is owed is subtracted from the dollar value of what is owned—that is, if all the assets were sold at the listed values and all debts were paid in full. Your net worth is the true measure of your financial wealth.

assets Everything you own that has monetary value.

liabilities What you owe.

net worth What's left when you subtract liabilities from assets.

What Is Owned—Assets Are “The Things You Own.” The assets section of the balance sheet lists items valued at their fair market value—what a willing buyer would pay a willing seller, not the amount originally paid or what it might be worth a year from now. It is useful to classify assets as monetary, tangible, or investment assets.

Monetary assets  (also known as  liquid assets  or  cash equivalents ) include cash and low-risk near-cash items that can be readily converted to cash with little or no loss in value such as checking and savings accounts. They are primarily used for maintenance of living expenses, emergencies, savings, and payment of bills.

monetary assets/liquid assets/cash equivalents Assets that can be used as cash.

Tangible  (or  use  or  lifestyle ) assets are personal property whose primary purpose is to provide maintenance of one's everyday lifestyle. Tangible assets, such as furniture and vehicles, generally depreciate in value over time.

tangible/use/lifestyle assets Personal property used to maintain your everyday lifestyle.

Investment assets  (also known as  capital assets ) include tangible and intangible items that have a relatively long life and high cost and that are acquired for the monetary benefits they provide, such as generating additional income and appreciation (or increasing in value). Examples include stocks and bonds. Investment assets generally appreciate and are dedicated to the maintenance of one's future level of living.

investment/capital assets Tangible and intangible items acquired for their monetary benefits.

Following are some examples of each kind of asset.

Monetary Assets

• Cash (including cash on hand, checking accounts, savings accounts, savings bonds, certificates of deposit, and money market accounts)

• Tax refunds due

• Money owed to you by others

Tangible Assets

• Automobiles, motorcycles, boats, bicycles

• House, condominium, mobile home

• Household furnishings and appliances

• Personal property (jewelry, furs, tools, clothing)

• Other “big ticket” items

Investment Assets

• Stocks, bonds, mutual funds, gold, partnerships, art, IRAs

• Life insurance and annuities (cash values only)

• Real property (and anything fixed to it)

• Personal and employer-provided retirement accounts

What Is Owed—Liabilities Are “The Money You Owe”The liabilities section of the balance sheet summarizes debts owed, including both personal and business-related debts. The debt could be either a  short-term  (or  current )  liability , an obligation to be paid off within one year, or a  long-term  (or  noncurrent ) liability, debts that do not have to be paid in full until more than a year from now. To be accurate, record debt obligations at their current payoff amounts (excluding future interest payments). Following are some examples of items to include in the liabilities section of a balance sheet, with some suggested subheadings.

short-term (current) liability Obligation paid off within one year.

long-term (noncurrent) liability Debt that comes due in more than one year.

Short-Term (or Current) Liabilities

• Personal loans owed to other people

• Credit card and charge account balances

• Other open-end credit obligations

• Professional services unpaid (doctors, dentists, chiropractors, lawyers)

• Taxes unpaid

• Past-due rent, utility bills, and insurance premiums

Long-Term Liabilities

• Automobile loans

• Real estate mortgages

• Home equity (second mortgage) loan

• Consumer installment loans and leases (although a lease is technically not a debt)

• Education loans

• Margin loans on securities

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Net Worth—What Is Left Is “A Measure of Your Financial Worth” Net worth is determined by subtracting liabilities from assets, as indicated in (Equation 3.1) the net worth formula:

or

This formula assumes that if you converted all assets to cash and paid off all liabilities, the remaining cash would be your net worth. For example, if your items of value had a fair market value of $8000 and the amount you owe to others is $4500, your net worth, or wealth, is $3500($8000-$4500).  Figure 3-2  shows household net worth figures by age group. College students typically have more debts than assets; thus they are technically  insolvent  because they have a negative net worth. When students graduate and take on full-time jobs, typically their balance sheets change dramatically after a few years.

insolvent When a person owes more than he or she owns and the person has a negative net worth.

Sample Balance Sheet The total assets on a balance sheet must equal the total liabilities plus the net worth. Both sides must balance, which is the source of the name “balance sheet.” You decide how much detail to include to show your financial condition accurately on a given date. The balance sheet shown in  Table 3-2  (page 74) reflects the degree of detail and complexity that might be included for a couple with two children (Victor and Maria Hernandez).

3.2b   Strategies to Increase Your Net Worth

You can increase your net worth by increasing assets, decreasing liabilities, or doing both. One way to increase assets and net worth is to cut back on spending. Perhaps consider forgoing the cup of coffee or soda you buy each day as you head to class, as any decrease in spending leaves money in the bank as an asset ($5 day × 200 days = $1000). Reducing expenses on high-cost items, such as housing and transportation, will have an even greater effect on assets. A second way to increase net worth is to increase income to build assets or pay down debts. For example, as you earn more money, perhaps consider saving half or more of the difference between your new income and your old income rather than using the added money for more spending. Third, paying off debt, especially high-interest credit card balances, can quickly increase net worth.

Figure 3-2  Median Net Worth by Age

3.2c   The Cash-Flow Statement Tracks Where Your Money Came From and Went

The cash-flow (or income and expense) statement summarizes the total amounts that have been received and spent over a period of time, usually one month or one year. It shows whether you were able to live within your income during that time period. It reflects the flow of funds in and out.

A cash-flow statement includes three sections: income (total income received);  expenses  (total expenditures made); and  surplus  (or  net gain  or  net income ), when total income exceeds total expenses, or deficit (or net loss), when expenses exceed income. Such statements are usually prepared on a  cash basis , *  meaning the only transactions recorded are those involving actual cash received or cash that was spent.

expenses Total expenditures made in a specified time such as reported on a cash-flow statement.

surplus (or net gain or net income) When total income exceeds total expenses such as reported on a cashflow statement.

cash basis Only transactions involving actual cash received or cash spent are recorded.

Income/Cash Coming In: Where Your Money Comes From You may think of income as simply what is earned from salaries or wages, but there are other types of income that you should include on a cash-flow statement, such as the following:

• Bonuses and commissions

• Child support and alimony

• Public assistance

• Social Security benefits

FINANCIAL POWER POINT  

Income Does Not Create Wealth, Investments Do

People do not get wealthy by earning an income. Real wealth comes from increases in the value of assets over time such as the growth of investments within a 401(k) retirement program.

Table 3-2 Balance Sheet for a Couple with Two Children—Victor and Maria Hernandez, January 1, 2015

DO IT IN CLASS

• Pension and profit-sharing income

• Scholarships and grants

• Interest and dividends received (from savings accounts, investments, bonds, or loans to others)

• Income from the sale of assets

• Other income (gifts, tax refunds, rent, royalties, capital gains)

Expenses/Cash Going Out: Where Your Money Goes All expenditures made during the period covered by the cash-flow statement should be included in the expenses section. The number and type of expenses shown will vary for each individual and family. Many people categorize expenses according to whether they are fixed or variable.

Fixed expenses  are usually paid in the same amount during each time period; they are typically inflexible and often contractual. Examples of such expenses include rent payments and automobile installment loans. It usually takes quite an effort to reduce a fixed expense.

fixed expenses Expenses that recur at fixed intervals.

Variable expenses  (or  flexible expenses ) are expenditures over which an individual has considerable control. Food, entertainment, and clothing are variable expenses, for example. Some categories, such as savings, can be listed twice, as both fixed and variable expenses. The following are examples of fixed and variable expenses that you might include in a cash-flow statement:

variable expenses (or flexible expenses) Expenses over which you have substantial control.

Fixed Expenses

• Savings and investments

• Retirement contributions (employer's plan, IRA)

• Housing (rent, mortgage, loan payment)

• Automobile (installment payment, lease)

• Insurance (health, life, liability, disability, renter's, homeowner's, automobile)

• Installment loan payments (appliances, furniture)

• Internet service

• Taxes (federal income, state income, local income, real estate, Social Security, Medicare, personal property)

Variable Expenses

• Meals (at home and away)

• Utilities (cell phone, electricity, water, gas)

• Transportation (gasoline and maintenance, licenses, registration, public transportation, tolls)

• Medical expenses

• Child care (nursery, baby-sitting)

• Clothing and accessories (jewelry, shoes, handbags)

• Snacks (candy, soft drinks, other beverages)

• Education (tuition, fees, books, supplies)

• Household furnishings (furniture, appliances, curtains)

• Cable television (beyond basic services)

• Personal care (beauty shop, barbershop, cosmetics, dry cleaner)

• Entertainment and recreation (hobbies, socializing, health club, downloads/tapes/CDs, movie rentals, movies)

• Charitable contributions (gifts, church, school, charities)

• Magazine subscriptions

• Vacations and long weekends

• Credit card payments

• Savings and investments

• Miscellaneous (postage, books, magazines, newspapers, personal allowances, domestic help, membership fees)

There is no rigid list of categories to be used in the expenses section, but you do need to classify all of your expenditures in some way that suits your needs. Rather than just use fixed and variable expenses categories, you might also separate expenditures into savings/investments, debts, insurance, taxes, and household expenses. The more specific your categories, the deeper your understanding of your outlays.

When reducing variable expenses, cut back or eliminate overpriced items like café' lattes and make bigger budget cuts elsewhere.

DID YOU KNOW  

Money Websites for Financial Statements, Tools, and Budgets

Informative websites for financial statements, tools, and budgets, including managing your spending are:

Buxfer ( www.buxfer.com/ )

CNNMoney ( money.cnn.com/pf/ )

HelloWalle ( www.hellowallet.com )

LearnVest ( www.learnvest.com )

Manilla ( www.manilla.com )

Mint ( www.mint.com )

Mvelopes ( www.mvelopes )

Pageonce ( check.me/ )

Cash Surplus (or Cash Deficit) The surplus (deficit) section shows the amount of cash remaining after you have itemized income and subtracted expenditures from income, as illustrated by the following calculations using Equation (3.2), the surplus/deficit formula. A business would call this amount its net profit or net loss.

A surplus demonstrates that you are managing your financial resources successfully and do not have to use savings or borrow money to make financial ends meet. When the calculation shows a surplus, that amount is then available (in your checking and savings accounts) to spend, save, invest, or donate. A surplus is not really cash lying around on the kitchen table; it is the cash value reflected in the accounts on your balance sheet.  Figure 3-3  shows the typical personal financial situation over the life cycle in present value dollars, from the wealth accumulation years through retirement.

Sample Cash-Flow Statements  Table 3-3  shows the cash-flow statement for a couple with two children (Victor and Maria Hernandez). It vividly highlights the additional income needed to rear children and shows the increased variety of expenditures that characterize a family's (rather than an individual's) lifestyle. As a person earns more income, the cash-flow statement usually becomes more involved and detailed.

DO IT IN CLASS

Figure 3-3  Personal Finance over the Life Cycle

Table 3-3 Cash Flow Statement for a Couple with Two Children—Victor and Maria Hernandez, January 1-December 31, 2015

	Dollars	Percent
INCOME
Victor's gross salary	63,180	70.99%
Maria's gross salary	15,500	17.42%
Interest and dividends	1,800	2.02%
Bonus	600	0.67%
Tax refunds	200	0.22%
Net rental income	7,720	8.67%
Total Income	89,000	100.00%
EXPENDITURES
Fixed Expenses
Mortgage loan payments	14,400	16.18%
Real estate taxes	2,400	2.70%
Homeowner's insurance	1,200	1.35%
Automobile loan payments	4,400	4.94%
Automobile insurance and registration	2,190	2.46%
Life insurance premiums	1,200	1.35%
Medical insurance (employee portion)	2,980	3.35%
Emergency fund savings	2,400	2.70%
Revolving savings fund	1,800	2.02%
Federal income taxes	11,300	12.70%
State income taxes	4,200	4.72%
City income taxes	1,600	1.80%
Social Security taxes	6,020	6.76%
Personal property taxes	950	1.07%
Retirement IRAs	6,000	6.74%
Total Fixed Expenses	$63,040	70.83%
Variable Expenses
Food	4,900	5.51%
Utilities	2,100	2.36%
Gasoline and maintenance	3,100	3.48%
Medical expenses	3,400	3.82%
Medicines	1,750	1.97%
Clothing and upkeep	1,950	2.19%
Church	2,400	2.70%
Gifts	1,400	1.57%
Personal allowances	2,400	2.70%
Children's allowances	2,080	2.34%
Miscellaneous	480	0.54%
Total Variable Expenses	$25,960	29.17%
Total Expenses	$89,000	100.00%
SURPLUS (DEFICIT)	$0	0.00%

 CONCEPT CHECK 3.2

1. Distinguish between the balance sheet and cash-flow statement.

2. How should assets and liabilities be valued for the balance sheet?

3. Distinguish between fixed and variable expenses.

DID YOU KNOW  

Ratios for Evaluating One's Financial Progress

Financial ratios  are numerical calculations designed to simplify the process of evaluating your financial strength and the progress of your financial condition. Ratios serve as tools or yardsticks to develop saving, spending, and credit-use patterns consistent with your goals. They are illustrated below using data from the Hernandez family shown in  Table 3-2  and  Table 3-3 . calculators for these ratios can be found on the  Garman/Forgue  companion website.

financial ratios Calculations designed to simplify evaluation of financial strength and progress.

DO IT IN CLASS

3.3 COLLECT AND ORGANIZE YOUR FINANCIAL RECORDS TO SAVE TIME AND MONEY

LEARNING OBJECTIVE 3

Collect and organize the financial records necessary for managing your personal finances.

Financial records  are documents that evidence financial transactions, such as bills, receipts, credit card receipts and statements, bank records, tax returns, brokerage statements, and paycheck stubs. Your financial records will help determine where you are, where you have been, and where you are going financially. They also help you save money as well as make money. Good records enable you to review the results of financial transactions as well as permit other family members to find them in an emergency. Organized records help you take advantage of all available tax deductions when filing income taxes and provide you with more dollars to spend, save, invest, or donate.

financial records Documents that evidence financial transactions.

Table 3-4  shows categories of financial records and the contents that might be included in each. Many people keep duplicates of important records in an envelope at their workplace or with relatives because the likelihood of records at both locations being stolen or destroyed simultaneously is very small. You can purge or shred some of your records when you no longer need them, such as non-tax-related checks and credit card receipts more than a year old, out-of-date warranties, expired insurance policies for which there will be no claims, records from automobiles you no longer own, and financial reports when replaced with updated reports.

Some records may be safely stored at home in a fire-resistant file cabinet or a safe. Other records should be kept in a safe-deposit box. Safe-deposit boxes are secured lock boxes available for rent ($25 to $250 per year) in banks. Two keys are used to open such a box. The customer keeps one key, and the bank holds the other.

FINANCIAL POWER POINT  

Before You Buy, Ask Yourself These Questions

If you want to save $1,000 this year, ask yourself these questions before you buy!

ADVICE FROM A PROFESSIONAL

Get-Tough Ways to Cut Spending

If you always run out of money before the month is over, you may need to take some drastic steps to get your finances under control. Consider the following:

1. Stop paying bank fees by maintaining minimum balances and eliminating overdrafts.

2. Stop making ATM withdrawals that assess fees.

3. Stop getting cash back from debit or credit card purchases to use for pocket money.

4. Spend only cash or money that you have, and leave debit and credit cards at home.

5. Stop using credit cards.

6. Refinance credit card debt at a credit union.

7. Do not eat out.

8. Cut back on telephone use if it costs money.

9. Avoid paying for entertainment; rather do activities that are free.

10. Reduce or stop spending on luxuries such as clothing, movies, entertainment, memberships, hobbies, CDs, DVDs, phones, and expanded cable channels.

11. Drop landline telephone service and use only a cell phone.

12. Find cheaper auto insurance.

13. Increase your 401(k) retirement contribution as it reduces income taxes.

14. Change income tax withholding to increase take-home pay.

15. Take a list when shopping, and stick to it.

16. Avoid shopping malls and discount stores.

17. Sell an asset, especially one that requires additional expenses, such as a boat or second car.

18. Build up an emergency fund of savings even if it means temporarily decreasing retirement-plan contributions.

19. Only buy used items.

20. Consider making Christmas a “nonspend” holiday.

21.ve to lower-cost housing.

22. Increase income by working overtime or finding a second job.

Alena C. Johnson

Utah State University

Table 3-4 Financial Records: What to Keep and Where

	Contents
Category	In Home Files and Fireproof Home Safe	In Safe-Deposit Box
Financial plans/ budgeting	Financial plans Balance sheets and cash-flow statements Current budget List of safe-deposit box contents Names and contact information for financial advisers	Names and contact information for financial advisers copy of written financial plans, goals, and budgets
Career and employment	Current resume College transcripts Letters of recommendation Employee benefits descriptions Written career plans	Employer retirement plan correspondence
Banking and financial services	Checkbook, unused checks, and canceled checks List of locations and account numbers for all bank accounts Checking and savings account statements Locations and access numbers for safe-deposit boxes Account transaction receipts	List of financial institutions and account numbers for all financial services accounts Certificates of deposit
Taxes	Copies of all income tax returns, both state and federal, for the past three years, including all supporting documentation Receipts for all donations of cash or property Log of volunteer expenses Receipts for property taxes paid	Copies of all income tax filings, both state and federal, for the past three years Records of securities purchased and sold
Credit	Utility and telephone bills Monthly credit card statements Receipts of credit payments List of credit accounts and telephone numbers to report lost/stolen cards Unused credit cards Credit reports and scores	List of credit accounts and telephone numbers to report lost/stolen cards Loan discharge notice when it is paid off Credit card bills for seven years if they support tax deductions
Housing, vehicles, and consumer purchases	Copies of legal documents (leases, mortgage, deeds, titles) Property appraisals and inspection reports Home repair/home improvement receipts Warranties Owner's manuals for purchases Auto registration records Vehicle service and repair receipts Receipts for important purchases	Original legal documents (leases, mortgage, deeds, titles) Copies of property appraisals Vehicle purchase contracts (until vehicle is sold) Photographs or videos of valuable possessions
Insurance	Original insurance policies List of insurance policies with premium amounts and due dates Premium payment receipts Calculation of life insurance needs Insurance claims forms and reports Medical records for family, including immunization records and list of prescription drugs	List of all insurance policies with company and agent names and addresses and policy numbers Listing with photographs or videotape of personal property
Investments	Records of stock, bond, and mutual fund transactions and certificate numbers Mutual fund statements Statements from brokers Reports from financial planner Company annual reports Retirement plan quarterly and annual reports Documents on business interests Written investment philosophy Written investment strategies	Contact information for all investment needs Stock and bond certificates Rare coins, stamps, and other collectibles
Retirement and Estate Planning	Pension and retirement plan information Retirement statements Copies of all retirement plan transactions Copy of Social Security card Trust agreements Information on Social Security Copy of current will Copies of advance directives (wills, living wills, medical powers of attorney, durable powers of attorney with originals with physician/attorney) Copies of trust documents (originals with executor, trustees/attorney)	Extra copy of all retirement plan transactions and statements Social Security statements (newest one) Copy of will (original of all estate planning documents should be placed in attorney's office)
Personal information	Copy of birth certificate and marriage license Religious documents Copy of divorce decree, property settlement, and custody agreement Receipts for alimony and child support payments Custodial information for your children, relatives, and/or elderly parent	Passports while not being used Military and adoption papers Originals of birth, marriage, death certificates Originals of Social Security cards Originals of divorce decrees, property settlements, and custody agreements Master list of all important documents and their location Flash drive or cD containing soft copies of many financial records (update once a year)

 CONCEPT CHECK 3.3

1. List some advantages of keeping good financial records.

2. Name three financial records that might be best kept in a safe-deposit box.

3.4 REACHING YOUR GOALS THROUGH BUDGETING: YOUR SPENDING/SAVINGS ACTION PLAN

LEARNING OBJECTIVE 4

Achieve your financial goals through budgeting.

Your financial success is largely a matter of choice, not a matter of chance. Your budget is where you make and implement those choices. Your budget is your plan for spending and saving. Budgeting forces you to consider what is important in your life, what things you want to own, how you want to live, what it will take to do that, and, more generally, what you want to achieve in life. The budgeting process gives you control over your finances, and it empowers you to achieve your financial goals while simultaneously (and successfully) confronting any unforeseen events. In short, budgeting answers the question, “What is my spending/savings action plan?” Another advantage of budgeting is that it reduces stress because making and following a budget helps you get more of what you want.

Some people do all their budgeting mentally—and do so successfully. Good for them! Many of us, however, need to see the actual numbers on paper or on a computer screen. A  budget  is a paper or electronic document used to record both planned and actual income and expenditures over a period of time. Your budget represents the major mechanism through which your financial plans are carried out and goals are achieved.

budget Paper or electronic document used to record both planned and actual income and expenditures over a period of time.

Figure 3-4  illustrates how to think about financial statements and budgeting. The cash-flow statement focuses on  where you have been  financially, the balance sheet shows  where you are  financially at the current time, and the budget indicates  where you want to go  in the future. Creating and following a spending plan has three stages: before, during, and after.

3.4a Action Before: Set Financial Goals

Before establishing your budget, take action to set financial goals.  Long-term goals  are financial targets or ends that an individual or family wants to achieve perhaps more than five years in the future. Such goals provide direction for overall financial planning as well as shorter-term budgeting. An example of a long-term goal is to create a $1 million retirement fund by age 60. Goals must be specific. They should contain dollar-amount targets and specific dates for achievement.

long-term goals Financial targets to achieve more than five years in the future.

If you have a small income or large debts, it may be unrealistic to think of long-term goals until any current financial difficulties are resolved. You may be unable to do much more than take care of immediate necessities, such as housing and vehicle expenses, food, and utility bills. In such instances, you need to focus on short-term efforts to improve your financial situation. You may need to focus on paying down debt, not adding to it.

Figure 3-4  About Financial Statements and Budgets

FINANCIAL POWER POINT  

Savings Is The Secret to Success in Personal Finance

If you have some money in emergency savings, perhaps $500 or $2000, depending upon your income, you probably will always have enough money to pay for vehicle repairs and unexpected travel. Thus, you may not have to pay with plastic for things that are not in your budget. Only one-fourth of people have six months or more of savings; another one-fourth have zero, and fully one-half have less than one month's income saved for a rainy day.

Establishing unrealistic short-term goals sets up a high likelihood of failure. Instead, set financial targets that are almost too easy to meet. For example, you may want to save $350 per month to use as a down payment on a home in five years. That may seem like a lot. Start perhaps painlessly by saving $100 per month for a few months. Then put away $150 for two months, $200 for two months, then $250, then $300, and finally $350 so that by the end of the first year you are on target.

Intermediate-term goals  are financial targets that can be achieved between one year and perhaps three to five years. Examples of intermediate -term goals are creating an emergency fund amounting to three months of income within four years, saving $22,500 within three years for a down payment on a home, taking a $4000 vacation to Asia in two years, paying off $8000 in credit card debt in one-and-a-half years, and paying off a $12,000 college loan in five years.  Short-term goals  are financial targets or ends that can be achieved in less than a year, such as finishing college, paying off an auto loan, increasing savings, purchasing assets (i.e., vehicle, furniture, television, stereo, clothes), reducing high-interest debt, taking an annual vacation, attending a wedding, buying life insurance, and making plans for retirement.

intermediate-term goals Financial targets that can be achieved within one to five years.

short-term goals Financial targets or ends that can be achieved in less than a year.

You need to be as clear as possible about what your financial goals are. The goals worksheet in  Figure 3-5  provides examples of how much to save to reach long-, intermediate-, and short-term goals. People can view such savings as a fixed expenditure (such as withholding from a paycheck to contribute to an employer's retirement plan or to transfer to a savings account). Additional savings, such as saving what is left over after all expenditures are made, will be a variable expense.

Prioritizing your goals makes sense. But what are your most important goals? One certain priority should be to pay off high-interest credit cards as soon as possible because paying 18 percent interest is foolish. Another is to contribute as much as you can afford to a retirement plan at least up until you receive the employer's full matching contribution. Many college graduates buy a new car soon after getting their first job to celebrate having “made it.” Before you're lured into following suit, give careful consideration to your priorities and remember that every action carries not only the dollar cost of the action taken but also the opportunity cost of the alternatives forgone. To achieve your long-term goals, you may have to sacrifice by deferring some of your short-term desires. Thus, you might consider buying a used car or a lower-cost new one.

3.4b Action Before: Make and Reconcile Budget Estimates

Before the month begins, you identify how you are spending money now in the process of making and reconciling budget estimates of income and expenditures. Here you resolve conflicting needs and wants by revising estimates as necessary. You can't have everything in life—especially this month—even though you might want it.

Budget Estimates Gets You from Gross Income to What's Available for Variable Expenses  Budget estimates  are the projected dollar amounts in a budget that one plans to receive or spend during the period covered by the budget. Begin by estimating total gross income from all sources. For example, Jonathan Depp's annual gross income is $60,000. Typical withholdings from your paycheck and noted as percentages of gross income are: federal income taxes (12%), Social Security taxes (7%), state income taxes (6%), employer retirement plan (6%), health insurance premiums (10%), and Roth IRA (5%). This totals 46% leaving Jonathan with 54% in  take-home pay  (also called  disposable income ). This is the pay received after employer withholdings for such things as taxes, insurance, and union dues, and it is available for budgeting for spending, saving, investing, and donating.

budget estimates Projected dollar amounts to receive or spend in a budgeting period.

take-home pay/disposable income Pay received after employer with-holdings for such things as taxes, insurance, and union dues, and it is available for budgeting for spending, saving, investing, and donating.

Figure 3-5  Goals Worksheet for Harry and Belinda Johnson

Now Jonathan subtracts money for fixed expenses, such as rent (4%), emergency savings (2%), student loans (2%), auto loan (1%), and auto insurance (1%). This totals (10%) for  discretionary  or controllable expenses, which make up the bulk of money available to pay for one's various expenses. After paying his fixed expenses Jonathan has 44% of his pay left to spend (100%−46%−10%) for such variable items as food, electricity, Internet, cable television, phone, gasoline and maintenance, church and charity, entertainment, and miscellaneous.

discretionary income Money left over after necessities such as housing and food are paid for.

Table 3-5  presents budget estimates for a college student, a single working person, a young married couple, a married couple with two young children, and a married couple with two college-age children. The college student's budget requires monthly withdrawals of previously deposited savings to make ends meet. The single working person's budget allows for an automobile loan, but not much else. The young married couple's budget permits one automobile loan, an investment program, contributions to retirement accounts, and significant spending on food and entertainment. The budget of the married couple with two young children allows for only an inexpensive automobile loan payment even though one spouse has a part-time job to help with the finances.

Table 3-5 Sample Monthly Budgets for Various Family Units

DID YOU KNOW  

Bias Toward Putting Off Decisions

People engaged in financial statements, tools, and budgets have a bias toward certain behaviors that can be harmful, such as a tendency toward putting off difficult decisions. People often delay reducing their spending even to save for worthy causes like vacations, putting money into a college fund, or contributing to a retirement account. What to do? Reject this tendency and take timely action to save and achieve what is important to you.

The budget of the married couple with two college-age children permits a home mortgage payment, ownership of two paid-for automobiles, savings and investment programs, and a substantial contribution for future college expenses.

It is essential to make reasonable budget estimates. If you have seven holiday gifts to buy and expect to spend $50 for each, it's easy to make an estimate of $350. If you want to go out to dinner once each week with a friend at $60 per meal, estimate an expense of $240 per month. Avoid using unrealistically low figures by simply being fair and honest in your estimates. Then add up your totals.

Revise Budget Estimates to Create a “Balanced Budget” When trying to make your spending conform to your budget goals, sometimes you will find the math is alarming! When initial expense estimates exceed income estimates, three choices are available: (1) earn more income, (2) cut back on expenses, or (3) try a combination of more income and fewer expenses. The process of reconciling needs and wants is a healthy exercise. It helps identify your priorities by telling you what is important in your life at the current time, and it identifies areas of sacrifice that you might make. Revising your short-term financial goals may also be required.

FINANCIAL POWER POINT  

Cut the Dollars and the Pennies

If you are often spending $5 per day (rather than $1.50) on fancy coffee, you end up spending $700 more per year ($5 − $1.50 = $3.50 × 200 workdays). So, when reducing variable expenses, cut back or eliminate things like café lattes, overpriced vitamin water, and energy drinks, and make bigger budget cuts elsewhere, like housing, care, preschool, health care, and frequent treats.

You must reconcile conflicting wants to revise your budget until total expenses do not exceed income. You have no choice! Perhaps you can change some “must have” items to “maybe next year” purchases. Perhaps you can keep some quality items but reduce their quantity. For example, instead of $240 for four meals for you and a friend at restaurants each month, consider dining out twice each month at $70 per evening out. You'll save $100 a month and still have two really nice meals. Your actions on money matters override your words, so act accordingly. Eventually you will finalize your “balanced budget” by making sure planned income equals or exceeds projected expenses.

Unfinished Budget Estimates for Harry and Belinda  Table 3-6  presents the projected annual budget for Harry and Belinda Johnson and reflects their efforts to reconcile their budget estimates. Wisely Harry and Belinda are “paying themselves first.” They plan to save $100 a month in a savings/emergency fund, put away $300 per month to save to buy their own home, and contribute to both their retirement plans at work. However, the Johnsons have failed to complete their budget because their total planned expenses are $1310 more than their total planned income. The Johnsons have a little ways to go to fully reconcile their annual budget estimates.

3.4c Action Before Budgeting Period: Plan Cash Flows

Before the month begins, you plan your cash flows or where the money will go. Income usually remains somewhat constant month after month, but expenses do rise and fall, sometimes sharply. As a result, people occasionally complain that they are “broke, out of money, and sick of budgeting.” This challenge can be anticipated by using a cash-flow calendar and eliminated by using a revolving savings fund.

Cash Flow Calendar for Harry and Belinda Johnson The budget estimates for monthly income and expenses in  Table 3-6  have been recast in summary form in  Table 3-7 , providing a  cash-flow calendar  for the Johnsons. Annual estimated income and expenses are recorded in this calendar for each budgeting time period in an effort to identify surplus or deficit situations. In the Johnsons' case, planned annual expenses still exceed income. The couple starts out the year with five months of income meeting expenses, and then they face planned monthly deficits for the remainder of the year.

cash-flow calendar Budget estimates for monthly income and expenses.

Table 3-6 2015 Unfinished Annual Budget Estimates for Harry and Belinda Johnson Table 3-7 Cash-Flow Calendar for Harry and Belinda Johnson

Effective management of cash flow can involve curtailing expenses during months with financial deficits, increasing income, using savings, or borrowing. If you borrow money and pay finance charges, the credit costs will further increase your monthly expenses.

Revolving Savings Fund for Harry and Belinda Johnson For this reason alone, it is smart to “borrow from yourself” by using a  revolving savings fund . This is a variable expense classification budgeting tool into which funds are allocated in an effort to create savings that can be used to balance the budget later so as to avoid running out of money. Establishing such a fund involves planning ahead—much like a college student does when saving money all summer (creating a revolving savings fund) to draw on during the school months.

revolving savings fund Variable budgeting tool that places funds in savings to cover emergency or higher-than-usual expenses.

You establish a revolving savings fund for two purposes: (1) to accumulate funds for large nonmonthly irregular expenses, such as automobile insurance premiums, medical costs, holiday gifts, and vacations; and (2) to meet occasional deficits due to income fluctuations.

Table 3-8  shows the Johnsons' revolving savings fund. When preparing their budget, the Johnsons realized that in June, November, and December they were going to have significant deficits. Thus they decided to begin setting aside $250 per month to cover the June deficit, so by June they had $1250 in their revolving savings fund to cover that amount. Continued use of the revolving savings fund helped them meet the November deficit as well.

Harry and Belinda Argue About Budgeting Alternatives The Johnsons will still be $1530 short in December. Lacking that much money, the couple has a number of alternatives: (1) reduce some planned spending throughout the year to create sufficient surpluses, (2) use some of Harry's trust fund interest income to cover the deficit, (3) dip into their emergency savings in December, and/or (4) utilize credit cards to get through the end-of-year expenses. Ideally, the Johnsons want to have sufficient emergency funds by the end of the year to establish their revolving savings fund for the following 12 months.

Table 3-8 Revolving Savings Fund for Harry and Belinda Johnson

The Johnsons disagree about their budget priorities. Belinda wants to spend less on food out and to open a credit card account to pay for the deficits later in the year, while Harry wants to spend less on clothing and entertainment and to skip their planned anniversary dinner party. They both wonder how they can earn so much money and still have such challenging budgeting problems. The Johnsons might benefit by considering the suggestions in  Chapter 5  (see pages 159–163) on how to talk with a significant other about financial matters. The Johnsons need to discuss their spending priorities and make decisions so they can reconcile their budget estimates for the year.

3.4d   Action During the Budgeting Period: Control Spending

Budget controls are techniques to maintain control over personal spending so that planned amounts are not exceeded. They give feedback on whether spending is on target and provide information on overspending, errors, emergencies, and exceptions or omissions. Following are several examples of budget controls:

Budget for Shopping Trips Set a budget for every shopping trip, and don't spend a penny more.

Record the Purpose of Expenditures Checks contains a space to record the purpose of expenditures. The check stub or register also provides a place to record explanations of expenditures. If you use automatic teller machines (ATMs) to withdraw cash or use debit cards to pay for day-to-day expenditures, record these withdrawals in the check register immediately. Retain the paperwork, and write the purpose of each expense on the back of each. Deposit all checks received to your checking account without receiving a portion in cash; if you need cash, write a check or make an ATM withdrawal. If you get cash back when using a credit card, be sure to record why on the receipt.

Keep Track of Credit Transactions People often do not record their credit transactions until they receive a statement. Then it is easy to continue buying on credit without recognizing the amount of indebtedness until the statement arrives. Instead you should record each credit transaction when it occurs. If you spend $40 on clothing using a credit card, record the expenditure as clothing expenditure and reduce the amount you have remaining to spend for the month in that category.

ADVICE FROM A PROFESSIONAL

Secrets of Super Savers

How do some people enjoy the good comfortable life and still find ways to save 20 to 30 percent or more of their incomes? Like most many people, such super savers have home mortgages, pay tuition bills, and take vacations. And they tend to have peace of mind about their finances because they have built up a sizeable cushion of savings and investments. Some of their secrets include:

• Be goal-oriented about savings and investments to achieve results.

• Ignore impulses to spending (ask “Do I really need it?”) and choose to postpone buying anything expensive for a few months to see if the “need” is still strong.

• Avoid debt (auto loans and installment loans for computers, TVs, cell phones, and furniture) and using credit cards so you will not spend money you do not have.

• Cut back on spending on expensive items such as homes (not the largest in the neighborhood) and cars (drive older ones), and enjoy creative vacations that are not too pricey.

• Choose to spend wisely on everyday expenses by comparison shopping, clipping and using coupons, buying cheaper discounted goods and services, and being careful and mindful about entertainment expenses.

• Track spending by writing down every purchase, perhaps on a small tablet, so you know where money goes.

• Make savings automatic by diverting the maximum contribution to your employer's retirement plan, and sign up for automatic transfers from a checking to a savings account as well as to a brokerage account, a 529 plan, a Roth IRA, and/or a high-yield savings account. Save more as income rises.

Dorothy B. Durband

Kansas State University

To help keep to a budget, write checks as often as possible instead of using cash. Also record the purpose of the expenditure on the lower left of the check.

Monitor Unexpended Balances to Control Overspending the Number One method to control overspending is to monitor unexpended balances in each of your budget classifications. You can accomplish this task by using a budget design that keeps a declining balance, as illustrated by parts (a) and (b) of  Figure 3-6 . Other budget designs, such as those shown in parts (c) and (d) of  Figure 3-6 , need to be monitored differently. As illustrated in parts (c) and (d) of the figure, simply calculate subtotals every week or so, as needed, during a monthly budgeting period. You can also track your spending using Quicken software or an online program.

DO IT IN CLASS

Justify Exceptions to Avoid Lying to Yourself  Budget exceptions  occur when budget estimates in various classifications differ from actual expenditures. Exceptions usually take the form of overexpenditures but can also occur in the over-or underreceipt of earnings. Simply spending extra income instead of recording it is not being honest with yourself. Recording the truth—by writing a few words to explain the exception—gives you the information to control your finances. If the exception is an expenditure, then immediately determine how to make up for the overexpenditure by trying to reduce other expenses in your spending plan.

budget exceptions When budget estimates differ from actual expenditures.

Use a Subordinate Budget A  subordinate budget  is a detailed listing of planned expenses within a single budgeting classification. For example, an estimate of $1200 for a vacation could be supported by a subordinate budget as follows: motels, $700; restaurants, $300; and entertainment, $200.

subordinate budget Detailed listing of planned expenses within a single budgeting classification.

Use the Envelope System for the Strongest Control The  envelope system  of budgeting entails placing exact amounts of money into envelopes for purposes of strict budgetary control. Here you place money equal to the budget estimate for the various expenditure classifications in envelopes at the start of a budgeting period and write the classification name and the budget amount on the outside of each envelope. As expenditures are made, record them on the appropriate envelope and remove the proper amounts of cash. When an envelope is empty, funds are exhausted for that classification. Of course, you must safeguard your cash.

envelope system Placing exact amounts into envelopes for each budgetary purpose.

3.4e Action After: Evaluate Budgeting Progress to Make Needed Changes

Evaluation occurs at the end of each budgeting cycle. The purpose is to determine whether the earlier steps in your budgeting efforts have worked, and it gives you feedback to use for the next budget cycle. You review by comparing actual amounts with budgeted amounts, evaluating whether your objectives were met, and assessing the success of the overall process as well as your progress toward your short- and long-term goals. The evaluation process helps you to make any needed changes.

In some budget expenditure classifications, the budget estimates rarely agree with the actual expenditures—particularly in variable expenses. A  budget variance  is the difference between the amount budgeted and the actual amount spent or received. The remarks column, as illustrated in parts (c) and (d) of  Figure 3-6 , can help clarify why variances occurred. Overages on a few expenditures may cause little concern. If large variances have prevented you from achieving your objectives or making the budget balance, then take some action. Serious budget controls might have to be instituted or current controls tightened.

budget variance Difference between amount budgeted and actual amount spent or received.

DID YOU KNOW  

Your Worst Financial Blunders in Financial Statements, Tools, and Budgets

Based on others' financial woes, you will make mistakes in personal finance when you:

1. Fail to plan for non-monthly irregular expenditures.

2. Underestimate how much you plan to spend each month.

3. Use credit card purchases to “balance” your budget.

Whatever your goals, it feels good when you make progress toward them, and it is thrilling to achieve them. If you did not achieve some of your objectives, you can determine why and then adjust your budget and objectives accordingly. It is okay to revise your plans. Suppose at the end of the month Robert Chen finds that he is unable to set aside a planned amount of $250 in monthly savings. By evaluating his budget, perhaps Robert will find that unexpected emergency car repairs led him to spend more than budgeted for the month. Because Robert understands why the objective was not achieved, he can set his sights on reaching the goal during the next budgeting time period.

Figure 3-6  Record-keeping Formats

DID YOU KNOW  

Turn Bad Habits into Good Ones

Do You Do This?

Spend all your income

Overspend

Can't find financial records

Do not know how much you owe

Can't pay for auto insurance premium or vacation

Run out of money every few months

Do This Instead!

Save 10 percent or more

Utilize budget controls to reduce spending

Create a record-keeping system

Make a balance sheet

Save for large irregular expenses

Create a cash-flow calendar

Record Keeping In the process of budgeting,  record keeping  is the process of recording the sources and amounts of dollars earned and spent. Recording the estimated and actual amounts for both income and expenditures helps you monitor your money flow. Keeping track of income and expenses is the only way to collect sufficient information to evaluate how close you are to achieving your financial objectives. For those who keep records on paper,  Figure 3-6  shows four samples of self-prepared recordkeeping formats that vary in complexity. Most people record earnings and expenditures when they occur. When writing in the “activity” and “remarks” columns in your record, be descriptive because you may need the information later.

record keeping Recording sources and amounts of dollars earned and spent.

Adding Up Actual Income and Expenditures After the budgeting period has ended—usually at the beginning of a new month—you need to add up the actual income received and expenditures made during that period. You can perform this calculation on a form for each budget classification, as shown in parts (a) and (b) of  Figure 3-6  or on a form with all income and expenditure classifications, as in parts (c) and (d) of  Figure 3-6 . Such calculations indicate where you may have overspent within your budget categories. If you are new at budgeting, do not be too concerned about overspending.

It occurs in some classifications almost always, only to be balanced by underspending in other categories. Use such information to refine your budget estimates in the future. In three or four months, you will be able to estimate your expenses much more accurately. The  Garman/Forgue  companion website provides budgeting software as well as numerous other templates, calculators, and worksheets that you can use in your own personal financial planning.

What to Do with Budgeted Money Left Over at the End of the Month At the end of the budgeting time period, some budget classifications may still have a positive balance. For example, perhaps you estimated the electric bill at $100, but it was only $80. You may then ask, “What do I do with the $20 surplus?” You also may ask, “What happens to budget classifications that were overspent?”

People handle the  net surplus  (the amount remaining after all budget classification deficits are subtracted from those with surpluses) in any of the following ways:

net surplus Amount remaining after all budget classification deficits are subtracted from those with surpluses.

• Put the money into savings (and this allows the budget to total out to zero)

• Carry the surpluses forward to the following month

• Pay toward credit card debt

• Put surpluses toward a mortgage or other loan

• Put the money into a retirement account

• Spend surpluses like “mad money” on anything you want

DID YOU KNOW  

Save Money When Shopping by Using Coupons

You can save hundreds of dollars every year by taking advantage of coupons and discounts. It's fun getting a “$25-off coupon at Ruby Tuesdays,” a “$5-off coupon for Pepsi or Coke at Walgreens,” or “$50 off a phone.” Try the following:

• Take advantage of Facebook or Twitter to sign up for coupons and discounts by liking your favorite brands.

• Receive daily coupon notices on local deals at BuyWithMe, groupon.com, and livingsocial.com.

• Use your phone to check out ShopSawy's app that scans an item barcode, sees who has it for less, and locates those sellers.

• In addition, it can send price alerts when items drop below the prices you've already seen.

• Utilize the Google Shopper app, which uses your phone's camera to recognize products by cover art, barcode scanning, voice, and text, and then provides reviews and specs. Also try Coupon Sherpa, Shopkick, and Scoutmob for your phone.

• Search for air, car rental, and hotel coupon codes at  promotional/codes.com  or  couponwinner.com .

• Try out “price comparison” programs such as  bizrate.com , InvisibleHand,  nextag.com , price-grabber.com, and RedLaser.

• Redeem Sunday newspaper coupons that provide discounts for hundreds of products.

• Stop by the U.S. Post Office for an envelope of coupons if you are moving from one address to another or if you think you might move.

• Take grocery store coupons attached to products, on tear pads, and on bottlenecks as well as from cashiers upon checkout.

• Go online to obtain coupons and do so by setting up a separate e-mail account for coupons and then registering at the sites. Examples are  restaurant.com ,  coupons.com ,  coolsavings.com ,  smartsource.com ,  grocerycoupons.com ,  couponmom.com ,  retailmenot.com , and  grocerysmarts.com .

• Go to the websites for local radio stations, where they may have downloadable coupons for local restaurants and entertainment venues.

• Purchase valid coupons on eBay for only 10 to 25 cents on the dollar.

DID YOU KNOW  

Sean's Success Story

Sean has done well financially since he started working for his current employer three years ago. In addition to earning better-than-average raises, he has received an annual bonus of $3000 each year. One of Sean's major life goals is to enjoy an early retirement, perhaps beginning at age 55. He creates financial statements every year to track his progress. Sean now has a net worth of over $20,000 because he saved the after-tax amount of each bonus ($2500) and contributed the maximum amount to his employer's 401(k) retirement plan ($3000), which includes a 100 percent match ($3000 a year). Sean uses Quicken software to manage his personal finances. He lives below his income and is saving about $300 a month for emergencies, irregular expenses, and occasional splurges.

The budgeting form in part (d) of  Figure 3-6  (page 92) allows for carrying balances forward to the next period. Some people carry forward deficits, with the hope that having less available in a budgeted classification the following month will motivate them to keep expenditures low. Because variable expense estimates are usually averages, it is best not to change the estimate based on a variation that occurs over just one or two months. If estimates are too high or low for a longer period, you will want to make adjustments.

Using financial software for budgeting, like Quicken, takes the drudgery out of making and using a spending plan. And it gets to be easy after a few months.

DO IT NOW!

You know more about personal finance after reading this chapter, so get started right now by:

1. Putting a notepad in your pocket to record every single expense of $1 or more for one month.

2. Preparing a cash-flow statement at the end of the month.

3. Setting up a spending plan for next month that provides for savings for at least one of your goals.

3.4f   Some Final Suggestions

Here are some final suggestions for successful budgeting: (1) Keep it simple, (2) make it personal, (3) keep it flexible, and (4) keep a positive attitude. A smart thing to do is to list the benefits to yourself that will occur when you reach a particular financial goal. You are likely to achieve a financial goal when you are convinced that it is your own goal, when you make an emotional commitment to the goal, when your short-term goals lead to your long-term goals, and when you can visualize receiving the benefits of your goals.

 CONCEPT CHECK 3.4

1. Identify two actions that should be performed before establishing a budget.

2. What are budget estimates? Offer some suggestions on how to go about making budget estimates for various types of expenses.

3. Distinguish between a cash-flow calendar and a revolving savings fund, and tell why each is important.

4. Offer three suggestions for effective budget controls.

DID YOU KNOW  

Income Inequality Continues

Rising income inequality worries many Americans. continuing a three-decade trend, the wealthiest Americans—the richest 1 percent who have a pre-tax family income above $394,000—earned more than 23 percent of the country's household income in a recent year. And they earned 95 percent of the increase in income in the post-crisis recovery. The top 10 percent of earners—those with pre-tax income exceeding $114,000—captured 48 percent of total earnings. Reasonable people can be fairly certain that there is a problem here.

WHAT DO YOU RECOMMEND NOW?

Now that you have read the chapter on financial planning, what do you recommend to Austin for his talk with Rachel on the subject of financial planning regarding:

1. Setting financial goals?

2. Determining what they own and owe?

3. Using the information in Austin's newly prepared financial statements to summarize the family's financial situation?

4. Evaluating their financial progress?

5. Setting up a record-keeping system to better serve their needs?

6. Starting a budgeting process to guide saving and spending?

BIG PICTURE SUMMARY OF LEARNING OBJECTIVES

LO1 Identify your financial values, goals, and strategies.

By identifying your financial values, goals, and strategies, you can always keep a balance between spending and saving and stay committed to your financial success. You may create financial plans in three broad areas: plans for spending, plans for risk management, and plans for capital accumulation.

LO2 Use balance sheets and cash-flow statements to measure your financial health and progress.

Financial statements are compilations of personal financial data designed to furnish information on money matters. The balance sheet provides information on what you own, what you owe, and what the net result would be if you paid off all your debts. The cash-flow statement lists income and expenditures over a specific period of time, such as the previous month or year.

LO3 Collect and organize the financial records necessary for managing your personal finances.

Your financial records will help determine where you are, where you have been, and where you are going financially. They also help you make money.

LO4 Achieve your financial goals through budgeting.

Budgeting is all about logical thinking about your finances. Budgeting forces you to consider what is important in your life, what things you want to own, how you want to live, what it will take to do that, and, more generally, what you want to achieve in life. A budget is a process used to record both projected and actual income and expenditures over a period of time, and it represents the major mechanism through which your financial plans are carried out and goals are achieved.

LET'S TALK ABOUT IT

1. Families. During sluggish economic times, the federal government's budgeting priority is to borrow so it can spend much more money than it takes in. What happens to families that try that, and why?

2. Your Values. What are your three most important personal values? Give an example of how each of those values might influence your financial plans.

3. Cash Flow. College students often have little income and many expenses. Does this reduce or increase the importance of completing a cash-flow statement on a monthly basis? Why?

4. Financial Ratios. Of the financial ratios described in this chapter, which two might be most revealing for the typical college student? Which two might be the most revealing for a retiree?

5. Why Budget. Do you have a budget? Why or why not? What do you think are the major reasons why people do not make formal written budgets?

6. Control Spending. What can a person do to control spending to better achieve financial success?

7. Budgeting Mistake. What is the biggest budget-related mistake that you have made? What would you do differently now?

8. Personal Finances over the Life Cycle. Areas of financial decision making change over one's life-cycle. Based on the information provided in  Figure 3-3  on page 76 contrast your own areas of concern with those of your parents.

DO IT IN CLASS PAGE 76

DO THE MATH

1. Ratio Analyses for Victor and Maria. Review the financial statements of Victor and Maria Hernandez ( Table 3-2  and  Table 3-3 ) and respond to the following questions:

(a) Using the data in the Hernandezes' balance sheet, calculate an investment assets-to-net worth ratio. How would you interpret the ratio? The Hernandez family appears to have too few monetary assets compared with tangible and investment assets. How would you suggest that they remedy that situation over the next few years?

(b) Comment on the couple's diversification of their investment assets.

(c) Calculate the asset-to-debt ratio for Victor and Maria. How does this information help you understand their financial situation? How do their total assets compare with their total liabilities?

(d) The Hernandezes seem to receive most of their income from employment rather than investments. What actions would you recommend for them to remedy that imbalance over the next few years?

(e) The Hernandezes want to take a two-week vacation next summer, and they have only eight months to save the necessary $2400. What reasonable changes in expenses might they consider to increase net surplus and make the needed $300 per month?

2. Calculating Net Worth and Net Surplus. Jennifer Pontesso wants to better understand her financial situation. Use the following balance sheet and cashflow statement information to determine her net worth and her net surplus for a recent month. Liquid assets: $10,000; home value: $210,000; monthly mortgage payment: $1300 on $170,000 mortgage; investment assets: $90,000; personal property: $20,000; total assets: $330,000; short-term debt: $5500 ($250 a month); total debt: $175,500; monthly gross income: $9000; monthly disposable income: $6800; monthly expenses: $6000.

DO IT IN CLASS PAGE 72

3. Ratio Analyses. Now that Jennifer better understands her situation she wants to do some analysis of what she has found. Given her balance sheet and cash-flow statements calculate the following ratios:

(a) Liquidity ratio

(b) Asset-to-debt ratio

(c) Debt-to-income ratio

(d) Debt payments-to-disposable income ratio

(e) Investment assets-to-total assets ratio

DO IT IN CLASS PAGE 76

4. Cash Flow Surplus/Deficit. Cody Sebastion earns $40,000 a year. He pays 30 percent of his gross income in federal, state, and local taxes. He has fixed expenses in addition to taxes of $1200 per month and variable expenses that average $900 per month. What is his net cash flow (surplus or deficit) for the year?

5. Construct Financial Statements. Thomas Green has been a retail salesclerk for six years. At age 35, he is divorced with one child, Amanda, age 7. Thomas's salary is $36,000 per year. He regularly receives $400 per month for child support from Amanda's mother. Thomas invests $100 each month ($50 in his mutual fund and $50 in U.S. savings bonds). Using the following information, construct a balance sheet and a cash-flow statement for Thomas.

DO IT IN CLASS PAGE 78

ASSETS	Amount
Vested retirement benefits (no employee contribution)	$3,000
Money market account (includes $150 of interest earned last year)	5,000
Mutual fund (includes $200 of reinvested dividend income from last year)	4,000
Checking account	1,000
Personal property	5,000
Automobile	3,000
U.S. savings bonds	3,000

LIABILITIES	Outstanding Balance
Dental bill (pays $25 per month and is included in uninsured medical/dental)	$ 450
Visa (pays $100 per month)	1,500
Student loan (pays $100 per month)	7,500

ANNUAL EXPENSES	Amount
Auto insurance	$ 780
Rent	9,100
Utilities	1,200
Phone	680
Cable	360
Food	3,000
Uninsured medical/dental	1,000

ANNUAL EXPENSES	Amount
Dry cleaning	480
Personal care	420
Gas, maintenance, license	2,120
Clothes	500
Entertainment	1,700
Vacations/visitation travel	1,300
Child care	3,820
Gifts	400
Miscellaneous	300
Taxes	4,600
Health insurance	2,440

6. Budgeting and Income Projections. Leyia and Aldolfo DeVaney of Monument, Colorado, have decided to start a family next year, so they are looking over their budget (illustrated in  Table 3-5  as the “young married couple”). Leyia thinks that she can go on half-salary ($1050 instead of $2100 per month) in her job as a graduate assistant for about 18 months after the baby's birth; she will then return to full-time work.

(a) Looking at the DeVaneys' current monthly budget, identify categories and amounts in their $4315 budget where they realistically might cut back $1050. (Hint: Federal and state taxes should drop about $290 as their income drops.)

(b) Assume that Leyia and Aldolfo could be persuaded not to begin a family for another two to three years until Leyia finishes graduate school. What specific budgeting recommendations would you give them for handling (i) their fixed expenses and (ii) their variable expenses to prepare financially for an anticipated $1050 loss of income for 18 months as well as the expenses for the new baby?

(c) If the DeVaneys' gross income of $4315 rises 3 percent per year in the future, what will their income be after five years? (Hint: See  Appendix A.1  or the  Garman/Forgue  companion website.)

FINANCIAL PLANNING CASES

CASE 1

The Financial Statements of Harry and Belinda Johnson Suggest Budgeting Problems

Harry graduated with a bachelor's degree in interior design last spring from a large Midwestern university near his hometown. Belinda has a degree in information technology from a university on the West Coast and is employed in a medium-size public relations firm. Harry and Belinda both worked on their schools' student newspapers and met at a conference during their junior year in college. They were married last June and live in an apartment in Kansas City. They will face many financial challenges over the next 20 years, as they buy their first home, decide on life insurance needs, begin a family, change jobs, and invest for retirement.

Harry works at a medium-size interior design firm and, during the last half of last year, earned a gross salary of $3100 per month. He also receives $3000 in interest income per year from a trust fund set up by his deceased father's estate; the trust fund will continue to pay that amount until 2028. He anticipates a raise of $150 a month in his salary by next January. Belinda works as a salesperson for a regional stock brokerage firm.

She earned a salary of $4750 per month last year. Belinda has many job-related benefits, including life insurance, health insurance, a retirement plan, and a credit union. Since she is a new employee Belinda does not expect a raise at the end of the year. The Johnsons live in an apartment located approximately halfway between their places of employment; however, their rent will increase by $100 a month next July. Harry drives about ten minutes to his job, and Belinda travels about 15 minutes via public transportation to reach her downtown job. Harry and Belinda's apartment is very nice, but small, and it is furnished primarily with furniture given to them by their families. Soon after starting their first jobs, Harry and Belinda decided to begin their financial planning. Fortunately each had taken a college course in personal finance. After initial discussion, they worked together for two evenings to develop the two financial statements presented below.

(a) Briefly describe how Harry and Belinda probably determined the fair market prices for each of their tangible and investment assets.

(b) Using the data from the cash-flow statement developed by Harry and Belinda, calculate a liquidity ratio, asset-to-debt ratio, debt-to-income ratio, debt payments-to-disposable income ratio, and investment assets-to-total assets ratio. What do these ratios tell you about the Johnsons' financial situation? Should Harry and Belinda incur more debt, such as credit cards or a new car loan?

(c) The Johnsons enjoy a high income because both work at well-paying jobs. They have spent parts of three evenings over the past several days discussing their financial values and goals together. As shown in the upper portion of  Figure 3-5 , they have established three long-term goals: $3000 for a European vacation to be taken in 2018, $5000 needed in October 2019 for a down payment on a new automobile, and $18,900 for a down payment on a home to be purchased in December 2020. As shown in the lower portion of the figure, the Johnsons did some calculations to determine how much they had to save for each goal—over the near term—to stay on schedule to reach their long-term goals as well as pay for two vacations and an anniversary party. After developing their balance sheet and cash-flow statement (shown below), the Johnsons made a budget for the year (shown in  Table 3-6  on page 87). They then reconciled various conflicting needs and wants until they found that total annual income was close to the total of planned expenses. Next, they created a revolving savings fund ( Table 3-8  on page 89) in which they were careful to include enough money each month to meet all of their short-term goals. When developing their cash-flow calendar for the year ( Table 3-7  on page 88), they noticed a problem: substantial cash deficits toward the end of the year. In fact, despite their projected high income, they anticipate a deficit of $1530 for the year. To solve this problem, they do not anticipate increasing their income, using savings, or borrowing. Instead, they are considering modifying their needs and wants to reduce their budget estimates to the point where they would have a positive balance for the year. Make specific recommendations to the Johnsons on how they could make reductions in their budget estimates. Do not offer suggestions that would alter their new lifestyle drastically, as the couple would reject these ideas.

Balance Sheet for Harry and Belinda Johnson

January 1, 2015

ASSETS
Monetary Assets
cash on hand	1,178	5.48%
Savings (First Federal Bank)	890	4.14%
Savings (Far West Savings Bank)	560	2.60%
Savings (Homestead credit Union)	160	0.74%
Checking (First Federal Bank)	752	3.50%
Total monetary assets	$3,540	16.45%
Tangible Assets
Automobile (3-year-old Toyota)	11,000	51.13%
Personal property	2,300	10.69%
Furniture	1,700	7.90%
Total tangible assets	$15,000	69.72%
Investment Assets
Harry's retirement account	1,425	6.62%
Belinda's retirement account	1,550	7.20%
Total investment assets	$ 2,975	13.83%
Total Assets	$21,515	100.00%

LIABILITIES
Short-Term Liabilities
Visa credit card	390	1.81%
Target credit card	45	0.21%
Dental bill	400	1.86%
Total short-term liabilities	$ 835	3.88%
Long-Term Liabilities
Vehicle loan (First Federal Bank)	3,800	17.66%
Student loan (Belinda)	8,200	38.11%
January 1, 2015
Total long-term liabilities	$12,000	55.78%
Total Liabilities	$12,835	59.66%
Net Worth	$ 8,680	40.34%
Total Liabilities and Net Worth	$21,515	100.00%

Cash-Flow Statement for Harry and Belinda Johnson July 1-December 31, 2014 (First Six Months of Marriage)

Cash Flow	Dollars	Percent
INCOME
Harry's gross income ($3100×6)	18,600	37.11%
Belinda's gross income ($4750×6)	28,500	56.86%
Interest on savings account	24	0.05%
Harry's trust fund	3,000	5.99%
Total Income	$50,124	100.00%

EXPENDITURES
Fixed Expenses
Rent	6,600	13.17%
Renter's insurance	220	0.44%
Automobile loan payments	2,980	5.95%
Automobile insurance	850	1.70%
Health insurance (withheld from salary)	1,200	2.39%
Student loan payments	3,600	7.18%
Life insurance (withheld from salary)	90	0.18%
Cable TV and Internet	720	1.44%
Health club	420	0.84%
Savings/emergencies	600	1.20%
Harry's retirement plan (6% of salary)	1,115	2.22%
Belinda's retirement plan (4% of salary)	1,140	2.27%
Federal income tax (withheld from salary)	4,600	9.18%
State income tax (withheld from salary)	1,600	3.19%
Social Security (withheld from salary)	3,600	7.18%
Automobile registration	300	0.60%
Total Fixed Expenses	$29,635	59.12%
Variable Expenses
Food (groceries)	2,600	5.19%
Food (out)	1,800	3.59%
Utilities	750	1.50%

Cash Flow	Dollars	Percent
Cell phones	450	0.90%
Gasoline and maintenance	700	1.40%
Doctor's and dentist's bills	710	1.42%
Medicines	350	0.70%
Clothing and upkeep	1,200	2.39%
Church and charity	1,200	2.39%
Gifts	1,070	2.13%
Public transportation	720	1.44%
Personal allowances	4,160	8.30%
Entertainment	960	1.92%
Vacation (holiday)	600	1.20%
Vacation (summer)	1,200	2.39%
Miscellaneous	480	0.96%
Total Variable Expenses	$18,950	37.81%
Total Expenses	$48,585	96.93%
SURPLUS (DEFICIT)	$1,539	3.07%

CASE 2

Victor and Maria Hernandez

Victor and Maria, both in their late 30s, have two children: John, age 13, and Joseph, age 15. Victor has had a long sales career with a major retail appliance store. Maria works part-time as a medical records assistant. The Hernandezes own two vehicles and their home, on which they have a mortgage. They will face many financial challenges over the next 20 years, as their children drive, go to college, and leave home and go out in the world on their own. Victor and Maria also recognize the need to further prepare for their retirement and the challenges of aging.

Victor and Maria spent some time making up their first balance sheet, which is shown in  Table 3-2 . Victor and Maria are a bit confused about how various financial activities can affect their net worth.

(a) Assume that their home is now appraised at $192,000 and the value of their automobile has dropped to $9500. Calculate and characterize the effects of these changes on their net worth and on their asset-to-debt ratio.

(b) If Victor and Maria take out a bank loan for $1545 and pay off their credit card debts totaling $1545, what effects would these changes have on their net worth?

(c) If Victor and Maria sell their New York 2028 bond and put the cash into the savings account, what effects would this have on their net worth and liquidity ratio?

CASE 3

Julia Price Thinks About Financial Statements, Tools, and Budgets

Julia graduated six years ago in aeronautical engineering and changed job once. Her income is more than sufficient for her needs. Julia contributes the maximum into her employer's retirement account and additionally saves about $400 a month. She has only about $1000 in credit card debt and makes a monthly car payment of $520. With such a strong financial position, she thinks it would be a waste of time to prepare financial statements and create a budget. Offer your opinions about her thinking.

CASE 4

Budget Control for a Recent Graduate

Seo-yeon, a political scientist from Lubbock, Texas, graduated from college eight months ago and is having a terrible time with his budget. Seo-yeon has a regular monthly income from her job and no really large bills, but she likes to spend. She exceeds her budget every month, and her credit card balances are increasing. Choose three budget control methods that you could recommend to Seo-yeon, and explain how each one could help her gain control of her finances.

DO IT IN CLASS PAGES 89–91

CASE 5

A Couple Creates an Educational Savings Plan

Stanley Marsh and Wendy Testaburger of South Park, Colorado, have two young children and have been living on a tight budget. Their monthly budget is illustrated in  Table 3-5  on page 85 as the “married couple with two young children.” Wendy and Stanley are nervous about not having started an educational savings plan for their children. Wendy has just begun working on a part-time basis at a local accounting firm and earns about $860 per month; this income is reflected in the Marsh-Testaburgers' budget. They have decided that they want to save $200 per month for the children's education, but Wendy does not want to work more hours away from home.

(a) Review the family's budget and make suggestions about how to modify various budget estimates so that they could save $200 per month for the education fund.

(b) Briefly describe the effect of your recommended changes on the Marsh-Testaburgers' lifestyle.

BE YOUR OWN PERSONAL FINANCIAL MANAGER

1. Financial Plan. Use  Table 3-1  on page 67 as a guide to making your financial plans, goals, and objectives for spending, risk management, and capital accumulation. Write up your findings.

2. Balance Sheet. Use  Table 3-2  on page 74 as a guide to create a balance sheet or complete Worksheet 10: My Balance Sheet from “My Personal Financial Planner” to create your own detailed annual balance sheet. Write up your findings.

3. Cash-Flow Statement. Use  Table 3-3  on page 77 as a guide to create a cash-flow statement or complete Worksheet 11: My Cash-Flow Statement from “My Personal Financial Planner” to create your own cash-flow statement. Write up your findings.

4. Evaluate Your Financial Ratios. Use the financial ratios on pages 78 to help evaluate your personal financial condition or complete Worksheet 12: My Financial Ratios from “My Personal Financial Planner” to record your financial ratios.

5. Categorize Your Financial Records. Review  Table 3-4  “Financial Records: What to Keep and Where” on pages 80–81 to develop a system for your own records or complete Worksheet 13: My Financial Records from “My Personal Financial Planner” to record what records will be placed in your home file, safe-deposit box, or another place.

6. Monthly Saving to Reach Your Goals. Use  Figure 3-5  “Goals Worksheet for Harry and Belinda Johnson” on page 84 as a guide to develop your own personal savings goals or complete Worksheet 14: Monthly Savings to Reach My Financial Goals from “My Personal Financial Planner” to record the dollar amount, time, and interim short-term goals.

7. Nonmonthly Expenses. Complete Worksheet 15: Determining Monthly Budget Amounts for My Nonmonthly Expenses from “My Personal Financial Planner” to carefully plan for your nonmonthly expenses over the year.

8. Revolving Savings Fund. Review  Table 3-8  “Revolving Savings Fund for Harry and Belinda Johnson” on page 89 to develop a plan for yourself or complete Worksheet 16: My Revolving Savings Fund from “My Personal Financial Planner” to record how you can save to pay for irregular expenses throughout the year.

9. Create Your Budget. Use  Table 3-6  on page 87 as a guide to create a 12-month budget or complete Worksheet 17: My Budget from “My Personal Financial Planner” to do so.

10. Control Spending with Budget Worksheets. Complete Worksheet 18: My Budget Category Ledger Worksheets from “My Personal Financial Planner” to create a system to monitor and control spending.

11. Organize Your Financial Records. Use  Table 3-4  on pages 80–81 as a guide to helping you get your financial records in order. Write down some notes about your thinking on what documents you will need and where to keep them.

ON THE NET

Go to the Web pages indicated to complete these exercises.

1. Online Calculators. Visit MoneyChimp's website ( www.moneychimp.com/ ). There you will find an assortment of calculators that can be used in various present and future value calculations. Select three that you believe would be particularly useful in the aspects of personal financial planning that were discussed in this chapter.

2. More Online Calculators. Visit CNNMoney's website ( cgi.money.cnn.com/tools/ ). Select three calculators to try out that you think would be useful in personal finance.

3. Input Your Budget and Compare to Your Projected Expenditures. Visit the website  www.kiplinger.com/tool/spending/T007-S001-budgeting-worksheet-a-household-budget-for-today-a/index.php  and use the budgeting worksheet and input your projected monthly living costs in various categories. It will compare your projections to what you actually spent.

4. Can You Make It Through the Month? ”Spent” is an online game that simulates the struggles of homelessness. Accept the challenge and take 10 minutes to play Spent ( playspent.org/ ).

ACTION INVOLVEMENT PROJECTS

1. Money Discussion Topics. Use the list in the box “Did You Know? Money Topics to Discuss with Your Partner” as a guide to interview three married couples. Ask them which of the topics they discussed with their partners within the first year of marriage. Make a table that summarizes your findings.

2. Financial Mistakes. Survey five people to learn about their financial mistakes in life. Ask each person to cite two financial mistakes he/she has made. Make a table that summarizes your findings.

3. Short-Term Financial Goals. Survey five people to ascertain their financial goals. Ask each person, “What are your top two short-term financial goals?” Make a table that summarizes your findings.

4. Long-Term Financial Goals. Survey five people to ascertain their financial goals. Ask each person, “What are your top three long-term financial goals?” Make a table that summarizes your findings.

Visit the Garman/Forgue companion website at  www.cengagebrain.com .

*  An alternative method is accrual-basis budgeting that recognizes earnings and expenditures when money is earned and expenditures are incurred, regardless of when money is actually received or paid.