Budgets

“Directly or indirectly, you’ve probably already spent some money today.”

Personal Budget

• A working tool that helps you take control of your money

• A plan for managing your money, for a specific period of time

• Directs the flow of cash received towards financial goals

• Helps you achieve the things you value most

• Is flexible and serves as a guideline

…cont Personal Budget

• It takes discipline to stick to a budget!• In a working budget, spending and

income balance each other out; expenses should NOT exceed income!

• Because of limited resources, people who use a budget must make choices about how to spend their money– Opportunity Costs– Delayed Gratification

Two Simples Parts to a Budget

• Income (positive value)– Money received from any source

(wages, interest, gifts, allowances, etc.)

• Spending/Expenses (negative value)– The money you spend on various

items (needs and wants)

Income (positive value)

• Gross Income– The money you make before any deductions

• Net Income– The money you make after deductions

– Common Deductions:

• Union dues, health insurance, contributions to savings plans, contributions to charities, TAXES

• Four common Tax deductions:– Federal Income Tax– State Income Tax– Social Security Tax (FICA Tax)– Medicare Tax (FICA Tax)

Spending/Expenses (negative value)

• Fixed Expenses– Any expense/deduction from income that stays

consistent (the same) each month/payment

• Paying yourself first (P.Y.F.), Rent, child care, health insurance, contributions to savings, IRA contributions, loan payments, insurance, etc.

• Variable Expenses– Any expense/deduction from income that

changes each month/payment

• Utilities, phone, clothing, personal items, gas, food, entertainment, etc.

• Use comparison shopping to cut variable expenses!

– Coupons, buying in bulk, garage sales, thrift stores, etc.

Keeping Track of Your Money

• Checking Account– Checks, ATM card, Debit card– Charges, fees, and other costs

• Minimum balances, annual or monthly fees, overdraft protection, insufficient funds charge, ATM fees

• Good Record Keeping– The “Envelope System”– Checking account statements– Savings and investments– Insurance– Tax documents– Pay stubs– Loan papers– Big-ticket item receipts and warranties

Preparing a Practical Budget

• To prepare a budget, follow these steps:– Step 1: Set Your Financial Goals– Step 2: Estimate Your Income– Step 3: Budget for Unexpected

Expenses and Savings– Step 4: Budget for Fixed Expenses– Step 5: Budget for Variable

Expenses– Step 6: Record What You Spend– Step 7: Review Spending and

Saving Patterns

Budget for Pat Doe for the week of June 6th

Money coming in (+ value):

Work (after taxes)

Gifts/Allowance

Other

Total Income

$ 190

$ 190

Money going out (- value):

Fixed Expenses

P.Y.F.

Car Payment

Auto Insurance

Total Fixed Expenses

Variable Expenses

Gas

Food

Clothing

Fun Stuff

Big Events

Total Variable Expenses

$ 20

50

25

$ 25

20

15

5

30

$ 95

$ 95

Total Outgoing (fixed + variable expenses) $ 190

Any money left over? (income minus outgoing) $ 0

Charting Where Your Money Goes

EXPENSE PLANNED $

% OF TOTAL $

Savings $30 10%

Clothing $45 15%

Transportation $90 30%

Food $60 20%

Entertainment $45 15%

School $15 5%

Other $15 5%

Total $300 100%

Breaking Down a Dollar

Savings Clothing School Other Transportation Food Entertainment

10% 15% 5% 5% 30% 20% 15%

Graphing Where Your Money Goes

17%

6%

6%

32%

22%

17%

Clothing School OtherTransportation Food Entertainment

How to Budget Successfully

• A budget should have several important characteristics:– 1st: a good budget is carefully planned

• Your estimates cannot be wild guesses, your spending categories must cover all expenses

– 2nd: a good budget is practical• If your first full-time job pays you

$1,500/month, don’t expect to buy a sports car anytime soon

– 3rd: a good budget is flexible• Throughout your life you will encounter

unexpected expenses and probably unexpected shifts in income as well

• Your budget needs to be easy to revise when changes occur

– 4th: a good budget must be written and easily accessible

Personal Balance Sheet

• Balance Sheet (net worth statement)– A financial statement that lists

the items of value that you own, the debts that you owe, and your net worth

– Net Worth• The difference between the

amount that you own and the debts that you owe

• A measure of your current financial position

Personal Balance Sheet

• To create a Personal Balance Sheet, follow these steps:

– Step 1: Determine Your Assets

– Step 2: Determine Your Liabilities

– Step 3: Calculate Your Net Worth

– Step 4: Evaluate Your Financial Situation

Step 1: Determine Your Assets

• Assets– Any items of value that you own,

including cash, property, personal possessions, and investments

• Liquid Assets

• Real Estate

• Personal Possessions

• Investment Assets

Liquid Assets

• Cash and items that can be quickly converted to cash– Money in your savings and

checking accounts

Real Estate Assets

• Land that a person/family owns and anything that is on it, such as a house or any other building

• Amount recorded on the Balance Sheet is the property’s Market Value– Market Value

• The price at which you could sell the property

Personal Possession Assets

• Cars and any other “valuable” belongings that are not real estate– No old clothes or used CDs

• May list personal possessions on the Balance Sheet at their original cost OR market value

Investment Assets

• Retirement accounts and securities such as stocks and bonds

• Amount you record should reflect the value of the assets at the time when you prepare the balance sheet

Step 2: Determine Your Liabilities

• Liabilities– The debts that you owe

• Current Liabilities– Short-term debts that have to be paid within a year

• Medical bills, cash loans, taxes, and insurance payments

• Long-Term Liabilities– Debts that don’t have to be fully repaid in a year

• Car loans, student loans, and mortgage loans

• Liabilities includes only money that you will owe for longer than a month– A telephone bill doesn’t qualify as a liability– Utility bills, etc. don’t qualify as a liability

Step 3: Calculate Your Net Worth

• Formula– Assets – Liabilities = Net Worth– $3,000 - $700 = $2,300

• Net Worth is only an indication of your general financial situation– A net worth of $62,300 doesn’t mean that you

have $62,300 to spend. Much of your wealth may be in stocks, real estate, and personal possessions, which can’t be easily converted to cash.

• Although you may have a high net worth, you can still have trouble paying your bills

• Insolvency– The condition that occurs if your liabilities are

greater than your assets

Step 4: Evaluate Your Financial Situation

• You can use a balance sheet to track your financial progress

• Up-date your balance sheet, or make a new one, every few months

• Chart changes over time

• You can increase your net worth by increasing your savings, increasing the value of your investments, reducing your expenses, and/or reducing your debts

Financial Ratios

• Debt Ratio

• Liquidity Ratio

• Debt-Payments Ratio

Debt Ratio

• Liabilities divided by Net Worth

• $25,000 / $50,000 = 0.5

• Compares your Liabilities to your Net Worth

• A low Debt Ratio is desirable

Liquidity Ratio

• Liquid Assets divided by monthly Expenses

• $10,000 / $4,000 = 2.5

• Indicates the number of months you would be able to pay your living expenses in case of a financial emergency

• The higher the Liquidity Ratio, the better

Debt-Payments Ratio

• Monthly credit payments divided by take-home/net pay

• $540 / $3,600 = 0.15 (15%)

• Indicates how much of a person’s earnings goes to pay debts (excluding a home mortgage)

• Most financial experts recommend a debt-payment ratio of less than 20%