Chapter 3 – Budgeting (Finance 123)
There are five topics in this chapter that I want to highlight:
I. Personal Record Keeping
Home file – receipts, bank statements, copies of tax returns, etc.
Safety Deposit Box – (tax deductible as an itemized deduction) – passport, social security card, insurance policies, contents of wallet (list of credit cards and phone numbers to call to cancel if stolen)
Personal Computer System – especially good for Excel – personal balance sheet and personal cash flow statement – with columns for budget, actual, and variance.
II. Personal Balance Sheet
Assets minus liabilities equals net worth
Also, notice, that the assets and liabilities are presented at MARKET value (not book value, as is the case on corporate balance sheets).
Assets are listed from most liquid to least liquid. (Remember, liquidity is the ability to easily turn the asset into cash).
Sample personal balance sheet:
Assets:
Liquid Assets
Real Estate
Personal Possessions
Investments
Total Assets
Liabilities:
Current Liabilities
Long Term Liabilities (includes mortgage)
Total Liabilities
Net Worth
Notice that Net Worth is the Assets minus the Liabilities.
III. Personal Cash Flow Statement
Discretionary income – cash flow after housing, food, necessities.
Sample Personal Cash Flow Statement:
CASH INFLOWS:
Salary (gross)
Less payroll deductions
Take Home Pay
Interest on Savings
Earnings on Investments
Total Cash Inflows
CASH OUTFLOWS:
Expenses:
Fixed
Variable
Total Cash Outflows
Cash Surplus or Deficit
Allocation of Surplus
IV. Ratios to Evaluate Financial Condition
These ratios are helpful in determining your financial position. These ratios are also used by loan companies in determining your eligibility for a mortgage (we’ll cover in a few weeks).
Debt ratio = liabilities / net worth
Current ratio = liquid assets / current liabilities
Liquidity ratio = liquid assets / monthly expenses
Debt Payment ratio = credit payments (excluding mortgage) / take home pay
Savings ratio = monthly addition to savings / gross income
V. Budgeting
For example, marketing companies have known this for years. They segment the population into “target markets” determined by stage of life. Luxury goods are marketed to “Yuppies” (young, upcoming professionals), DINK’s (double income no kids), and even, OINK’s (one income no kids). The baby boom (due to its large demographic size) is often the center of marketing efforts. One economist refers to the baby boomers as a “bowling ball moving thru a garden hose”.