Chapter 3: Planning with Personal Financial Statements Flashcards Preview

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Flashcards in Chapter 3: Planning with Personal Financial Statements Deck (32)
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1

personal cash flow statement

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

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what are the inflows of income?

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

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net cash flows

Disposable (after-tax) income minus expenses.

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Creating a Personal Cash Flow Statement

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

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Factors Affecting Income

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

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Factors affecting expenses

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

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Budget

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

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Forecasting Net Cash Flows over Several Months

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

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Alternative Budgeting Strategies

Envelope Method.
Pay Yourself First Method.

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Envelope Method.

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

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Pay Yourself First Method.

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

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A personal balance sheet

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

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assets on the balance sheet

liquid assets
household assets
investments

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liquid assets

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

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household assets

items normally owed by a household (car, furniture )

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what are common investments

bonds, stocks, mutual funds

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bonds

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

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stocks

Certificates representing partial ownership of a firm.

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mutual funds

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

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real estate

Rental property and land.

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rental property

Housing or commercial property that is rented out to others.

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Liabilities

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

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current liabilities

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

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long-term liabilities

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

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Net Worth

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

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Creating a Personal Balance Sheet

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

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Changes in the Personal Balance Sheet

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

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How Cash Flows Affect the Personal Balance Sheet

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

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Analysis of the Personal Balance Sheet

Liquidity
amount of your debt
ability to save

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liquidity

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