Financial Statements & Budgeting

Financial Values, Goals, and Strategies

Financial Planning

Definition: Process of developing and implementing coordinated financial plans
Purpose: Manage income and wealth to reach financial goals
Foundation: Values and goals balance spending and saving

Values Define Success

Underlying support for financial and lifestyle goals
Personal priorities: education, health, employment, family, credit use
Financial goals grow from values

Financial Goals

Definition

Specific long-, intermediate-, and short-term objectives
Achieved through financial planning and management
Must be consistent with values

Characteristics of Good Goals

Measurable: Specific dollar amounts
Attainable: Realistic given income/expenses
Relevant: Aligned with values
Time-related: Clear deadlines

Types of Goals

Long-Term Goals (5+ years)

Examples:
- Create $1 million retirement fund by age 60
- Pay off mortgage
- Fund children’s education

Intermediate-Term Goals (1-5 years)

Examples:
- Emergency fund (3 months income) in 4 years
- Save $22,500 for home down payment in 3 years
- $4,000 vacation in 2 years
- Pay off $8,000 credit card debt in 1.5 years
- Pay off college loan in 5 years

Short-Term Goals (< 1 year)

Examples:
- Save $100 per month
- Build $1,000 emergency fund
- Pay off small debt

Financial Strategies

Definition

Pre-established plans of action for specific situations

Example Strategy

When loan is paid off:

Start savings program with same monthly payment amount
Automatic paycheck deduction to savings
“Pay yourself first”

Financial Statements

Two Main Types

1. Balance Sheet (Net Worth Statement)

Shows: Financial condition on a specific date
Components: Assets, Liabilities, Net Worth
Frequency: Often prepared January 1

2. Cash-Flow Statement (Income & Expense Statement)

Shows: Income and expense transactions over a period
Period: Usually one month or one year
Basis: Cash basis (actual cash received/spent)

Balance Sheet Components

Formula

Net Worth = Assets - Liabilities

Assets (What You Own)

Monetary Assets (Liquid Assets)

Cash on hand
Checking accounts
Savings accounts
Savings bonds
Tax refunds due
Money owed to you

Tangible Assets

Automobiles, motorcycles, boats
House, condominium
Personal property (jewelry, tools, clothing)

Investment Assets (Capital Assets)

Stocks, bonds, mutual funds
Life insurance and annuities
Retirement accounts (personal and employer-provided)
Real estate investments

Valuation: Fair market value (what willing buyer would pay)

Liabilities (What You Owe)

Short-Term (Current) Liabilities (< 1 year)

Personal loans
Credit card balances
Unpaid professional services
Taxes unpaid
Past-due rent, utilities, insurance

Long-Term Liabilities (> 1 year)

Automobile loans
Real estate mortgages
Education loans

Net Worth

Calculation: Assets - Liabilities
Meaning: True measure of financial wealth
Negative Net Worth: Technically insolvent (common for students)

Strategies to Increase Net Worth

Since: Assets - Liabilities = Net Worth

Method 1: Increase Assets

Cut back on spending
Save more money
Invest wisely
Increase income

Method 2: Decrease Liabilities

Pay off debts
Avoid new debt
Refinance high-interest debt

Method 3: Both

Most effective approach
Save income increases instead of spending them

Cash-Flow Statement Components

Three Sections

1. Income (Cash Coming In)

Salaries and wages
Bonuses and commissions
Public assistance
Social Security benefits
Scholarships and grants
Interest and dividends
Income from sale of assets
Other: gifts, tax refunds, rent, royalties, capital gains

2. Expenses (Cash Going Out)

Fixed Expenses (same amount each period, inflexible):

Housing (rent, mortgage)
Automobile (payment, lease)
Insurance (life, health, auto)

Variable Expenses (considerable control):

Meals (home or away)
Utilities (electricity, water, gas, phone)
Transportation (gas, maintenance, registration)
Medical expenses
Entertainment
Clothing

3. Surplus or Deficit

Formula:

Surplus (Deficit) = Total Income - Total Expenses

Surplus: Successfully managing resources, no need to borrow

Deficit: Expenses exceed income, need to use savings or borrow

Budgeting

Definition

Paper or electronic document recording planned and actual income/expenditures
Your spending/savings action plan

Purpose

Forces consideration of priorities
Helps achieve financial goals
Provides spending control

Budgeting Process

Action Before: Set Financial Goals

Establish long-term goals
Break into intermediate-term goals
Create short-term action steps
Start small, increase gradually

Action Before: Make Budget Estimates

Key Income Terms:

Gross Income: Total before deductions
Take-Home Pay (Disposable Income): After taxes and withholdings
Discretionary Income: After paying necessities (housing, food, utilities, car)

Example:

Gross income: $60,000
Take-home pay: $48,000
Discretionary income: $18,000

Action Before: Revise Budget Estimates

If Expenses > Income:

Earn more income
Cut back on expenses
Combination of both

Example:

Original: $200 for 4 restaurant meals
Revised: $120 for 2 nice meals
Savings: $80

Action Before: Plan Cash Flows

Cash-Flow Calendar:

Record estimated income and expenses by month
Identify surplus or deficit months
Plan ahead for deficits

Managing Deficits:

Curtail expenses
Increase income
Use savings
Borrow (last resort)

Revolving Savings Fund:

Accumulate funds for large irregular expenses
Meet occasional deficits
“Borrow from yourself” (no interest!)

Action During: Control Spending

Methods:

Monitor unexpended balances in each category
Set budget for each shopping trip
Subordinate/itemized budget: Detailed listing within category
- Example: Vacation $1,200 = Motel $700 + Restaurants $300 + Entertainment $200
Envelope system: Place exact cash amounts in envelopes for strict control

Action After: Evaluate Progress

Budget Variance:

Difference between budgeted and actual amount
Common in variable expenses
Use for feedback in next cycle

Net Surplus Options:

Carry forward to next month
Put into revolving savings fund
Build cash reserve in savings account
Pay down debt
Invest in retirement account

Key Terms & Definitions

Term	Definition
Balance Sheet	Shows assets, liabilities, net worth on specific date
Cash-Flow Statement	Lists income and expenses over a period
Assets	Everything you own with monetary value
Liabilities	Debts owed to others
Net Worth	Assets minus liabilities
Liquid Assets	Cash and near-cash items easily converted
Fair Market Value	What willing buyer would pay willing seller
Insolvent	Negative net worth (liabilities > assets)
Fixed Expenses	Same amount each period, inflexible
Variable Expenses	Fluctuate, considerable control
Disposable Income	Take-home pay after taxes
Discretionary Income	Money left after paying necessities
Budget	Document recording planned/actual income and expenses
Budget Variance	Difference between budgeted and actual
Revolving Savings Fund	Fund for irregular expenses and deficits

Important Formulas

Net Worth = Assets - Liabilities

Surplus (Deficit) = Total Income - Total Expenses

Discretionary Income = Disposable Income - Necessities

Exam Tips

✅ Know the difference between balance sheet and cash-flow statement
✅ Understand: Net Worth = Assets - Liabilities
✅ Know types of assets: monetary, tangible, investment
✅ Know types of liabilities: short-term vs. long-term
✅ Understand fixed vs. variable expenses
✅ Know: Disposable income vs. Discretionary income
✅ Negative net worth = insolvent
✅ Budget variance is normal, especially in variable expenses
✅ Revolving savings fund helps avoid borrowing

Common Mistakes to Avoid

❌ Valuing assets at purchase price instead of fair market value
❌ Forgetting to include all types of income
❌ Not distinguishing between fixed and variable expenses
❌ Confusing disposable and discretionary income
❌ Not planning for irregular expenses
❌ Borrowing instead of using revolving savings fund

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