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2-11 Describe the cash budget and its three parts. How does a budget deficit differ from a budget
surplus?
2-12 The Gonzales family has prepared their annual cash budget for 2016. They have divided it into 12
monthly budgets. Although only 1 monthly budget balances, they have managed to balance the overall
budget for the year. What remedies are available to the Gonzales family for meeting the monthly budget
deficits?
2-13 Why is it important to analyze actual budget surpluses or deficits at the end of each month?
2-14 Why is it important to use time value of money concepts in setting personal financial goals?
2-15 What is compounding? Explain the rule of 72.
Interest is earned over a given period of time. When interest is compounded, this given period of time is
2-16 When might you use future value? Present value? Give specific examples.
Solutions to Critical Thinking Cases
2.1 The Becker’s Version of Financial Planning
Terry and Evelyn Becker are a married couple in their mid-20s. Terry has a good start as an electrical
engineer and Evelyn works as a sales representative. Since their marriage four years ago, Terry and
Evelyn have been living comfortably. Their income has exceeded their expenses, and they have
accumulated an enviable net worth. This includes $10,000 that they have built up in savings and
investments. Because their income has always been more than enough for them to have the lifestyle they
desire, the Beckers have done no financial planning.
Evelyn has just learned that she’s two months pregnant. She’s concerned about how they’ll make ends
meet if she quits work after their child is born. Each time she and Terry discuss the matter, he tells her
not to worry because “we’ve always managed to pay our bills on time.” Evelyn can’t understand his
attitude because her income will be completely eliminated. To convince Evelyn that there’s no need for
concern, Terry points out that their expenses last year, but for the common stock purchase, were about
equal to his take-home pay. With an anticipated promotion and an expected 10 percent pay raise, his
income next year should exceed this amount. Terry also points out that they can reduce luxuries (trips,
recreation, and entertainment) and can always draw down their savings or sell some of their stock if they
get in a bind. When Evelyn asks about the long-run implications for their finances, Terry says there will
be “no problems” because his boss has assured him that he has a bright future with the engineering firm.
Terry also emphasizes that Evelyn can go back to work in a few years if necessary.
Despite Terry’s arguments, Evelyn feels that they should carefully examine their financial condition in
order to do some serious planning. She has gathered the following financial information for the year
ending December 31, 2016:
Salaries Take-home Pay Gross Salary
Terry $52,500 $76,000
Evelyn 29,200 42,000
Item Amount
Food $ 5,902
Clothing 2,300
Mortgage payments, including property taxes of $1,400 11,028
Travel and entertainment card balances 2,000
Gas, electric, water expenses 1,990
Household furnishings 4,500
Telephone 640
Auto loan balance 4,650
Common stock investments 7,500
Bank credit card balances 675
Federal income taxes 22,472
State income tax 5,040
Social security contributions 9,027
Credit card loan payments 2,210
Cash on hand 85
2012 Nissan Sentra 10,500
Medical expenses (unreimbursed) 600
Homeowner’s insurance premiums paid 1,300
Checking account balance 485
Auto insurance premiums paid 1,600
Transportation 2,800
Cable television 680
Estimated value of home 185,000
Trip to Europe 5,000
Recreation and entertainment 4,000
Auto loan payments 2,150
Money market account balance 2,500
Purchase of common stock 7,500
Addition to money market account 500
Mortgage on home 148,000
Critical Thinking Questions
1. Using this information and Worksheets 2.1 and 2.2, construct the Becker’s balance sheet and
income and expense statement for the year ending December 31, 2016.
Critical Thinking 2-1 part 1
Date
Liquid Assets: Current Libaiblities
Cash on hand 85.00$ Utilities
Cash in checking 485.00 Rent
Savings accounts Insurance premiums
Taxes
2,500.00 Medical/dental bills
Repair bills
Total Liquid Assets 3,070.00$ 675.00
Investments
Stocks 7,500.00$ 2,000.00
Other
Total Personal Property
15,000.00$ Net Worth 55,245.00$
Total Assets 210,570.00$ Total Liabilities and Net Worth 210,570.00$
Money market funds and deposits
Certificates of deposit <1 yr to
maturity
Balance Sheet
Names(s) Terry and Evelyn Becker
31-Dec-16
Assets
Liabilities and Net Worth
Bank credit card balances
Department store credit
card balances
Travel and entertainment
card balances
Critical Thinking 2-1, Part 1 -- Worksheet 2.2
Name(s) Terry and Evelyn Becker
For the Year Ending 31-Dec-16
Income
Wages and salaries Name Terry 76,000.00$
Name Evelyn 42,000.00
Name
Sale of securities
Other
Pensions and annuities
Other income Reimbursements for Travel Exp
Total Income 118,000.00$
Repairs, maintenance, improvements
Utilities Gas, electric, water 1,990.00
Phone 640.00
Doctor, dentist, hospital, medicines 600.00
Clothing Clothes, shoes, and accessories 2,300.00
Insurance Homewoner's (if not covered by mortgage) 1,300.00
Life (not provided by employer)
Auto 1,600.00
Taxes Income and Social security 36,539.00
Property (if not included in mortgage)
Income and Expense Statement
2. Comment on the Becker’s financial condition regarding (a) solvency, (b) liquidity, (c) savings,
and (d) ability to pay debts promptly. If the Becker’s continue to manage their finances as
described, what do you expect the long-run consequences to be? Discuss.
3. Critically evaluate the Becker’s approach to financial planning. Point out any fallacies in
Terry’s arguments, and be sure to mention (a) implications for the long term, as well as (b) the
potential impact of inflation in general and specifically on their net worth. What procedures
should they use to get their financial house in order? Be sure to discuss the role that long- and
short-term financial plans and budgets might play.
2.2 Brooke Stauffer Learns to Budget
Brooke Stauffer recently graduated from college and moved to Atlanta to take a job as a market research
analyst. She was pleased to be financially independent and was sure that, with her $45,000 salary, she
could cover her living expenses and have plenty of money left over to furnish her studio apartment and
enjoy the wide variety of social and recreational activities available in Atlanta. She opened several
department-store charge accounts and obtained a bank credit card. For a while, Brooke managed pretty
well on her monthly take-home pay of $2,893, but by the end of 2016, she was having trouble fully paying
all his credit card charges each month. Concerned that her spending had gotten out of control and that
she was barely making it from paycheck to paycheck, she decided to list her expenses for the past
calendar year and develop a budget. She hoped not only to reduce her credit card debt but also to begin a
regular savings program.
Brooke prepared the following summary of expenses for 2016:
Item
Annual Expenditure
Rent
$12,000
Auto insurance
1,855
Auto loan payments
3,840
Auto expenses (gas, repairs,
and fees)
1,560
Clothing
3,200
Installment loan for stereo
540
Personal care
424
Phone
600
Cable TV
440
Gas and electricity
1,080
Medical care
120
Dentist
70
Groceries
2,500
Dining out
2,600
Furniture purchases
1,200
Recreation and entertainment
2,900
Other expenses
600
After reviewing his 2016 expenses, Brooke made the following assumptions about her expenses for 2017:
1. All expenses will remain at the same levels, with these exceptions:
a. Auto insurance, auto expenses, gas and electricity, and groceries will increase 5 percent.
b. Clothing purchases will decrease to $2,250.
c. Phone and cable TV will increase $5 per month.
d. Furniture purchases will decrease to $660, most of which is for a new television.
e. She will take a one-week vacation to Colorado in July, at a cost of $2,100.
2. All expenses will be budgeted in equal monthly installments except for the vacation and these items:
a. Auto insurance is paid in two installments due in June and December.
b. She plans to replace the brakes on her car in February, at a cost of $220.
c. Visits to the dentist will be made in March and September.
3. She will eliminate her bank credit card balance by making extra monthly payments of $75 during each
of the first six months.
4. Regarding her income, Brooke has just received a small raise, so her take-home pay will be $3,200 per
month.
Critical Thinking Question
1. a. Prepare a preliminary cash budget for Brooke for the year ending December 31, 2016,
using the format shown in Worksheet 2.3.
b. Compare Brooke’s estimated expenses with his expected income and make
recommendations that will help him balance her budget.
2. Make any necessary adjustments to Brooke’s estimated monthly expenses, and revise her annual
cash budget for the year ending December 31, 2016, using Worksheet 2.3.
3. Analyze the budget and advise Brooke on her financial situation. Suggest some long-term,
intermediate, and short-term financial goals for Brooke, and discuss some steps she can take to
reach them.
Case 2.2, Problem 1a
Income and Expense Statement
Name:
Brooke Stauffer
For the Year Ending December 31, 2016
Income
2016
2017
Salary
Alex’s take-home pay of $2,893/mo in
2016 and $3,200/mo in 2017 .
$ 34,716
$ 38,400
Other income
(I) Total Income
$ 34,716
$ 38,400
Expenses
Housing
Rent
$12,000
$12,000
Repairs
Utilities
Gas, electric, water
1,080
1,134
Phone
600
660
Cable TV and other
440
500
Food
Groceries
2,500
2,625
Dining out
2,600
2,600
Transportation
Auto loan payments
3,840
3,840
Auto related expenses
1,560
1,638
Other transportation expenses
Medical
Health-related insurance
Doctor, dentist, hospital, medicines
190
190
Clothing
Clothes, shoes, accessories
3,200
2,250
Insurance
Homeowner's
Life
Auto
1,855
1,948
Taxes
Income and social security
Property (if not included in mortgage)
Appliances, furniture &
other major purchases
Loan payments
540
540
Purchases and repairs
1,200
660
Personal care
Laundry, cosmetics, hair care
424
424
Recreation &
entertainment
Vacations
2,100
Other recreation and entertainment
2,900
2,900
Other items
Misc.
600
600
Credit card pmts: 6 mo.@$75/mo.
450
450
Other expenses
(II) Total Expenses
$ 35,979
$ 37,059
CASH SURPLUS (OR DEFICIT) [(I) – (II)]
$ (1,263)
$ 1,341
Case 2.2, Problem 2—Worksheet 2.3
ANNUAL CASH BUDGET BY MONTH
Name(s)
Brooke Stauffer
For
the
Year
ending
December 31, 2017
INCOME
Jan.
Feb.
Mar.
Apr.
May
June
July
Aug
.
Sept
.
Oct.
Nov.
Dec.
Total
Take-home pay
3,200
3,200
3,200
3,200
3,200
3,200
3,200
3,200
3,200
3,200
3,200
3,200
38,400
[1] Total Income
3,200
3,200
3,200
3,200
3,200
3,200
3,200
3,200
3,200
3,200
3,200
3,200
38,400
EXPENDITURES
Rent
1000
1000
1000
1000
1000
1000
1000
1000
1000
1000
1000
1000
12,000
Gas & electricity
94
94
94
94
94
94
95
95
95
95
95
95
1,134
Phone
55
55
55
55
55
55
55
55
55
55
55
55
660
Cable TV
41
41
41
41
42
42
42
42
42
42
42
42
500
Groceries
218
218
218
219
219
219
219
219
219
219
219
219
2,625
Dining out
216
216
216
216
217
217
217
217
217
217
217
217
2600
Auto loan
payments
320
320
320
320
320
320
320
320
320
320
320
320
3,840
Car expenses
129
220
128
129
129
129
129
129
129
129
129
129
1,638
Medical care,
dentist
10
10
45
10
10
10
10
10
45
10
10
10
190
Clothing
187
187
187
187
187
187
188
188
188
188
188
188
2,250
Auto insurance
0
0
0
0
0
974
0
0
0
0
0
974
1,948
Installment loan
for stereo
45
45
45
45
45
45
45
45
45
45
45
45
540
Personal care
35
35
35
35
35
35
35
35
36
36
36
36
424
Vacation
0
0
0
0
0
0
2,100
0
0
0
0
0
2,100
Other recreation &
entertainment
241
241
241
241
242
242
242
242
242
242
242
242
2,900
Appliance
purchases
55
55
55
55
55
55
55
55
55
55
55
55
660
Miscellaneous
expenses
50
50
50
50
50
50
50
50
50
50
50
50
600
Credit card
payments
75
75
75
75
75
75
0
0
0
0
0
0
450
Roth IRA
contributions
[2] Total
Expenditures
2,771
2,862
2,805
2,772
2,775
3,749
4,802
2,702
2,738
2,703
2,703
3,677
37,059
MONTHLY
CASH
SURPLUSES
(DEFICIT) [1-2]
429
338
395
428
425
(549)
(1,602)
498
462
497
497
(477)
CUMULATIVE
CASH SURPLUS
(DEFICIT)
429
767
1,162
1,590
2,015
1,466
(136)
362
824
1,321
1,818
1,341
1,341
3. Analyze the budget and advise Brooke on her financial situation. Suggest some long-term,
intermediate, and short-term financial goals for Brooke, and discuss some steps she can take to reach
them.
Terms Found in the Chapter
annuity
A fixed sum of money that occurs annually.
assets
Items that one owns.
balance sheet
A financial statement that describes a person’s financial
position at a given point in time.
budget
A detailed financial report that looks forward, based on
expected income and expenses.
budget control
schedule
A summary that shows how actual income and expenses
compare with the various budget categories and where
variances (surpluses or deficits) exist.
budget variance
The difference between the budgeted and actual amount
paid out or received.
cash basis
A method of preparing financial statements in which only
transactions involving actual cash receipts or actual cash
outlays are recorded.
cash budget
A budget that takes into account estimated monthly cash
receipts and cash expenses for the coming year
cash deficit
An excess amount of expenses over income, resulting in
insufficient funds as well as in decreased net worth.
cash surplus
An excess amount of income over expenses that results in
increased net worth.
compounding
When interest earned each year is left in an account and
becomes part of the balance (or principal) on which interest
is earned in subsequent years.
current (short-
term) liability
Any debt due within 1 year of the date of the balance sheet.
debt service ratio
Total monthly loan payments divided by monthly gross
(before-tax) income; provides a measure of the ability to
pay debts promptly.
discounting
The process of finding present value; the inverse of
compounding to find future value.
equity
The actual ownership interest in a specific asset or group of
assets.
expenses
Money spent on living costs and to pay taxes, purchase
assets, or repay debt.
fair market value
The actual value of an asset, or the price for which it can
reasonably be expected to sell in the open market.
financial plans
Describes financial goals and provides the action plans for
their achievement
future value
The value to which an amount today will grow if it earns a
specific rate of interest over a given period.
fixed expenses
Contractual, predetermined expenses involving equal
payments each period.
income and
expense statement
A financial statement that measures financial performance
over time.
income
Earnings received as wages, salaries, bonuses, commissions,
interest and dividends, or proceeds from the sale of assets.
insolvency
The financial state in which net worth is less than zero.
investments
Assets such as stocks, bonds, mutual funds, and real estate
that are acquired in order to earn a return rather than
provide a service.
liabilities
Debts such as credit card charges, loans, and mortgages.
liquid assets
Assets that are held in the form of cash or that can readily
be converted to cash with little or no loss in value.
liquidity ratio
Total liquid assets divided by total current debts; measures
the ability to pay current debts.
long-term liability
Any debt due 1 year or more from the date of the balance
sheet.
net worth
An individual’s or family’s actual wealth; determined by
subtracting total liabilities from total assets.
open account
credit
obligations
Current liabilities that represent the balances outstanding
against established credit lines.
personal financial
statement
Balance sheets and income and expense statements that
serve as essential planning tools for developing and
monitoring personal financial plans
present value
The value today of an amount to be received in the future;
it’s the amount that would have to be invested today at a
given interest rate over a specified time period to
accumulate the future amount.
personal property
Tangible assets that are movable and used in everyday life.
real rate of return
The rate of return earned after adjusting for the effect of
inflation, also referred to as the real interest rate
real property
Tangible assets that are immovable: land and anything fixed
to it, such as a house.
rule of 72
A useful formula for estimating about how long it will take
to double a sum at a given interest rate.
savings ratio
Cash surplus divided by net income (after tax);indicates
relative amount of cash surplus achieved during a given
period.
solvency ratio
Total net worth divided by total assets; measures the degree
of exposure to insolvency.
timeline
A graphical presentation of cash flows.
time value of
money
The concept that a dollar today is worth more than a dollar
received in the future.
variable expenses
Expenses involving payment amounts that change from one
time period to the next.
Chapter Outline
Learning Goals
I. Mapping Out Your Financial Future
A. The Role of Financial Statements in Financial Planning
B. Interlocking Network of Financial Plans and Statements
II. The Balance Sheet: How Much Are You Worth Today?
A. Assets: The Things You Own
B. Liabilities: The Money You Owe
C. Net Worth: A Measure of Your Financial Worth
D. Balance Sheet Format and Preparation
E. A Balance Sheet for Jack and Lily Taylor
III. The Income and Expense Statement: What We Earn and Where It Goes
A. Income: Cash In
B. Expenses: Cash Out
C. Cash Surplus (or Deficit)
D. Preparing the Income and Expense Statement
E. An Income and Expense Statement for Jack and Lily Taylor
IV. Using Your Personal Financial Statements
A. Keeping Good Records
B. Managing Your Financial Records
C. Tracking Financial Progress: Ratio Analysis
D. Balance Sheet Ratios
E. Income and Expense Statement Ratios
V. Cash In and Cash Out: Preparing and Using Budgets
A. The Budgeting Process
B. Forecasting Income
C. Forecasting Expenses
D. Finalizing the Cash Budget
E. Dealing with Deficits
F. A Cash Budget for Jack and Lily Taylor
E. Using Your Budgets
VI. The Time Value of Money: Putting a Dollar Value on Financial Goals
A. Future Value
B. Future Value of a Single Amount
C. Future Value of an Annuity
D. Present Value
1. Present Value of a Single Amount
2. Present Value of an Annuity
3. Other Applications of Present Value
VII. Inflation and Interest Rates
A. Impact of inflation on financial plan
B. Fisher equation
Planning over a Lifetime
Financial Impact of Personal Choices
Financial Planning Exercises
