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Chapter 4
Budgets and
Balance Sheets:
Your Personal
Financial
Statements
Essential Question:
Why is a budget such a key
component of the financial
plan?
Learning Objectives
• Explain the steps involved in creating a
budget
• Describe the steps involved in creating a
personal balance sheet
• Understand the importance of budgeting in
your financial plan
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Creating a Budget
• Budget
• Creating a budget is a key
part of your financial plan
– A forecast of
future cash
• A budget provides guidance
inflows and
for reaching your personal
outflows
goals
• It gives you a detailed
roadmap to your financial
future
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Step 1: Create a Personal Cash
Flow Statement
• Identify your current cash inflows and cash
outflows
• Many cash inflows include salary, hourly
wages, or allowance
• Cash outflows include car payment, rent, or
phone bill
• See Figure 4.1 for an example of a Personal
Cash Flow Statement
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Figure 4.1: Terris’s Personal
Cash Flow Statement
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Step 2: Turn Your Cash Flow
Statement into a Budget
• Forecast your net cash flows for a period a
time into the future
• Think of how the cash flows might change
from month to month
• Be sure to include expected, yet irregular
expenses, such as school activity fees or
vacation
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Step 2: Turn Your Cash Flow
Statement into a Budget
• A good budget should include unexpected
expenses
• Adjust the budget as necessary as you get
more information
• An annual budget helps identify times where
you can save money and times when you
will be spending more money
• See Figure 4.2 for an example of an annual
budget
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Figure 4.2: Terris’s Annual
Budget
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Working with and Improving
Your Budget
• A budget will help you save money for:
– major purchases
– unexpected expenses
– unexpected opportunities
• A budget will help you anticipate future cash
shortfalls
• A budget is a great planning tool
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Assessing the Accuracy of the
Budget
• Forecast error
– The difference
between what you
forecast to happen
and what actually
happened
• Evaluate your forecasts and
compare those with the actual
cash flows
• Keep an expense journal to
track your spending
• After looking at your forecast
error, you may need to adjust
your spending
• Look at Figure 4.3 for an
example forecast errors
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Figure 4.3: Terris’s Actual Versus
Forecast Cash Flows
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What are the steps involved in creating a
budget?
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Step 1: Creating a personal cash flow
statement
Step 2: Turning a cash flow statement into
a budget
Step 3: Working with and improving your
budget
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Personal Balance Sheet
• Personal
balance sheet
– Statement that
tells you what
your financial
position is at a
point in time
• A personal balance sheet helps
you make decisions on how to
use extra money
• Knowing where you are
financially will help guide in
deciding how to manage:
– your liquidity
– your use of credit and
borrowing
– your investments
– and more
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Assets
• Assets on a balance sheet can be classified
in several ways:
– Liquid assets
– Household assets
– investments
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Liquid Assets
• Liquid assets
– Financial assets
that are either
cash or can be
easily converted to
cash without
significant loss of
value
• Liquid assets include money in
checking and savings accounts
• They are necessary for
covering unexpected
emergency expenses
• It is important that they have
quick availability
• It is also important for them
to be making money
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Math for Personal Finance
• Jeff has $1,000 in a savings account, $340
in his checking account, and $2,100 in stock
that his grandmother gave him. He also
owns his car, which is worth about $3,200
• How much does Jeff have in liquid assets?
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Math for Personal Finance
• Solution: Jeff’s liquid assets consist of the
money in his savings and checking accounts,
which is $1,000 + $340 = $1,340.
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Household Assets
• Household
assets
– Include those
assets owned by
a household –
cars, houses,
furniture
• Market value
– What something
would be worth if
you sold it today
• Another type of asset is
household assets
• While creating your personal
balance sheet, evaluate the
true market value of these
assets
• Kelley Blue Book (for cars),
EBay, and other internet sites
are good resources for
determining the value of these
assets
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Investments
• Investment
– Something you
acquire with the
ultimate goal of
making money
• Investments are the third major
category of assets
• Investments are something you
buy that you believe will increase
in value over time
• Some common investment
assets are:
– Stocks
– Bonds
– Real estate
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Investments
• When you buy a bond, you are
Certificates that
essentially loaning the issuer
function like IOUs—
money
promises to repay a
certain amount of • The issuer pays you interest
money at some
until the maturity date
future time
• People buy bonds expecting to
receive interest income while
they hold the bond and getting
their money back when the
bond matures
• Investing in bonds involves
some risks
• Bonds
–
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Investments
• Stocks
– certificates that
represent
fractional
ownership of a
firm
• People buy stocks expecting that
the company will do well and the
value will increase
• Each share of ownership
represents a percentage of the
business and is called a share of
stock
• Stocks can be risky
• It is possible that the value will
decline or disappear altogether
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Math for Personal Finance
• Emily owns 50 shares of Company Y’s stock
that is currently selling for $170 a share.
She also owns 65 shares of Company Z’s
stock worth about $47 a share.
• What is the total value of her stock
holdings?
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Math for Personal Finance
• Solution:
Company Y
50 x $170 = $8,500
Company Z
65 x $47 = $3,055
Total = $11,555
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Investments
• Mutual funds
– Professionally
managed
investments that
allow investors to
pool their money in
order to invest in a
larger variety of
financial assets such
as stocks and bonds
from many different
companies
• Mutual funds are managed by
professionals who decide
which stocks/bonds to
purchase
• Individual investors who buy
shares in the fund do not have
to be experts in stock or bond
selection
• The risk of loss is usually
spread across many different
investments
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Investments
• Real estate
– Homes, rental
property, farms,
and other land
• Real estate is another
type of investment
• People invest in this
hoping it will generate
revenue over time and
increase in value
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Liabilities
• Liabilities
– Represent the amount of debt a person owes
• These debts can be put into 2 categories:
– Current liabilities
– Long-term liabilities
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Liabilities
• Current liabilities
– Debts that must be
paid off within 1 year
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• Credit card balances are the
most common form of
current liabilities for people
• A credit card acts like a short
term loan that “should” be
paid off every month
• When you pay the credit card
bill, you are eliminating the
current liability
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Liabilities
• Long-term
liabilities
– Debt that will take
longer than 1 year
to pay off
• Examples of long-term liabilities
include student loans, car loans,
and home mortgages
• Each payment includes an interest
component and some amount that
will reduce the initial liability
(principal)
• Note that many people use credit
cards this way
• This leads to paying more money
than originally intended
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Net Worth
• Net worth
– The difference
between your
assets and your
liabilities
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• Figuring your net worth is an
easy way to measure your
wealth
• You can figure your net
worth with a personal
balance sheet
• Refer to Figure 4.4 for an
example of figuring out your
net worth
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Figure 4.4: Terris’s Personal Balance
Sheet
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Math for Personal Finance
• Lakisha’s car is worth about $6,000 and she
still owes $1,200 on it. She has an
outstanding credit card balance of $450.
• What is her net worth?
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Math for Personal Finance
• Solution: Lakisha’s net worth is $6,000 $1,200 - $450 = $4,350
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Changes in the Personal Balance
Sheet
• Your Personal Balance Sheet changes as you
acquire new assets or liabilities
• This will affect your net worth
• There are 2 ways to increase your net worth
1. The value of your assets needs to increase
by more than your liabilities
2. To pay down debt on your liabilities
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Analysis of Your Personal
Balance Sheet
• Lenders look at your personal balance sheet
to determine if you can pay the loan
• Loan officers use a debt-to-asset ratio to
determine if you have borrowed too much
money
• Keep your personal balance sheet in good
shape
• It can influence the options you have for
making financial decisions and having a
good financial plan
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What are the steps in creating a personal
balance sheet?
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You need to identify and then add up all of
your assets and all of your liabilities. You
then subtract the total of your liabilities
from the total of your assets to determine
your net worth.
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Budgeting and Your Financial
Plan
• Your cash flows feed into your balance sheet
• If cash inflows exceeds cash outflows, you
will either increase assets or reduce liability
• Take a look at Figure 4.5 to see how this will
show up on your balance sheet in the form
of increased net worth
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Figure 4.5: Your Cash Flows and
Balance Sheet
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Budgeting and Your Financial
Plan
• Budgeting helps in financial planning
because it makes you answer the following
questions:
– How can I improve my net cash flows in the near
term?
– How can I improve my net cash flows in the long
term?
– What decisions should I make about using credit,
borrowing, and investing?
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EQ: Why is a budget such a key component of
the financial plan?
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Budgeting helps you evaluate your current
financial condition and determine how to
improve net cash flows and make wise
credit, borrowing, and investment
decisions.
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Summary
• The budgeting process allows you to
monitor and control cash inflows and
outflows
• Examine the difference between your
forecast and actual cash inflows and
outflows
• You can anticipate future problems and
make necessary adjustments
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Summary
• Your personal balance sheet tells you your
financial position at a point in time
• It is a summary of your assets, your liabilities, and
your net worth
• Assets can be listed as liquid assets, household
assets, and investments
• Liabilities represent the amount of debt you owe
• Liabilities can be split into two categories:
– Current liabilities
– Long-term liabilities
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Summary
• Budgeting can help you manage your cash
flows to increase your net worth
• You can use this in building a financial plan
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Key Terms and Concepts
•
•
•
•
•
•
•
•
Bond
Budget
Current liability
Forecast error
Household asset
Investment
Liability
Liquid asset
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•
•
•
•
•
Long-term liability
Market value
Mutual fund
Net worth
Personal balance
sheet
• Real estate
• Stock
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Websites
• www.forbes.com
• www.kbb.com (Kelley Blue Book)
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