The Financial Advisor Guide to Money & How to Manage It

The Financial Advisor Guide to Money & How to Manage It

Self Study Course # 11

MANAGING YOUR MONEY

Managing money in today’s world is increasingly complicated. Not only do we have more spending options than in the past, we now have more choices of how to pay – cash, cheque, credit card, debit card, pre-authorized withdrawals and through the Internet.

We all use our money in different ways, reflecting our values and priorities. Regardless of our financial personalities, what we decide to do with our money today will impact our lives tomorrow. That’s why taking control of our money right now – where it comes from and where it goes – is the first step towards a secure future.

Managing your money means paying attention to the money you have and how you use it.

Financial Planning by its very nature is the process of arranging your financial affairs in such a fashion as to achieve long-term goals such as wealth creation and ultimately Estate Planning to arrange for its orderly dispersal. Various Financial Planning strategies will provide divergent approaches to achieving these goals.

Money management deals with cash management over a relatively short period. Cash management includes debt and credit management. Financial management covers broader territory and such long-term issues as the growth of investments to provide wealth creation and its dispersal. It could include such planning strategies as mortgage elimination or funding of education.

TAKE CONTROL OF YOUR FINANCES

The World is full of Temptation

Holidays, new clothes, electronic gadgets, cars, restaurants, new furniture... and the list goes on and on. Should you fix the roof, paint the kitchen, take the kids to the zoo, buy the latest DVD or replace your old watch?

Then there are the financial considerations – putting money into an RRSP, paying down the mortgage or reducing credit card debt. These are just some of the money decisions Canadians constantly face.

While it’s tempting to indulge in an extravagance – and save for the future at the same time – it’s usually not possible.

Of course, there are credit cards, personal lines of credit and even borrowing against the equity in your home. But for many of us, these aren’t always the best options.

In fact, without knowing your financial worth and priorities, you may get in over your head financially. On the other hand, an accurate financial picture allows you to plan for the future, whether it is three months or 10 years down the road.

Handling money wisely is a talent few of us are born with. But it is a skill that can easily be learned. The place to start is with budgeting.

The more we earn, the more we spend

The following section will deal with the professional management of your money by way of cash flow management, budgets and the wise use of available credit. All of us have a money handling philosophy, partially learned from our parents, our peers, the media and our own experiences.

We all have met (or are) one of the following:

The Hoarder:

A dollar saved is a dollar earned and the more saved the better.

The Borrower:
The more credit available, the more successful we are.

The Flasher:
The more we spend on appearance the farther up the social ladder we appear.

The Plunger:
Just one more scheme and I will achieve the wealth I so richly deserve, which so far has eluded me.

The Power Broker:
Money is power, the more I have the more control I can exert.

Mr. Cool:

I have got through life this far without saving, so why should I stop spending now?
Did you see that new…?

THE MONEY MANAGEMENT PLANNING PROCESS

1. Set Money Management objectives.
2. Collect and analyze income and spending patterns.
3. Determine money management strategies.
4. Commence budget and cash flow systems.
5. Monitor cash flow.

1. Money Management Objectives

There is considerable difference between a money management objective and a financial planning objective. A money management objective is specific, can be measured, it is actionable, realistic and it has an end point. A well thought out objective is the key to overall success. Successive objectives are stepping-stones to long-term wealth creation.

Financial planning objectives on the other hand are long term by nature and are broad scoped. Your financial planning objectives may be to pay off your mortgage and create a secure retirement fund, while your money management objective will require cash accumulation over a shorter period.

Money management objectives must be specific to your individual situation, create motivation and be achievable.

If you write down your money management objectives, they might look like this:

A.Save $6,000 by next September when my mortgage renews, to reduce the principal.

B.Save $4,500 by January to use as a down payment on a trailer in Florida.

C.Pay off all my credit cards by year’s end.

These short-term objectives could fit into long-term retirement objectives or investment strategies.

1. Collecting and Analyzing Information:

To provide realistic goals we must first analyze our current income and expense patterns. To do this we use the same tools a business uses to control their revenue and expenditures and the data obtained is used for both the financial planning and the money management process.

The Financial Statements used include:

1. Balance Sheet
2. Statement of Net Worth
3. Statement of Lifestyle Expenditures
4. Statement of Cash Flow

A.The Balance Sheet

The Balance Sheet presents a snapshot of your financial position at the current moment only. It at best will compare last year to this year. It usually has the Assets listed at the top, and the liabilities following at the bottom.

Assets

Assets are properties purchased and owned by the individual or company. They are physical and can be valued, but they do not represent all the assets. Fixed assets, rather than reflecting current market value are most often listed at their purchase price, less depreciation where applicable.

This is known as “book value” or “carrying costs”. This is a basic accounting concept that avoids manipulation of the asset figures and is consistent with a conservative point of view.

Assets are listed in order of their liquidity:

• Liquid
• Investment
• Personal

Current assets are the most liquid and are the working assets. These assets can include cash or that which will be turned into cash within one year of the reporting date.

Assets are known as quick current assets or regular current assets and are listed such as cash, any shares owned as well as any Canada Savings Bonds etc.

Other assets cover a wide variety of items not expected to be converted into cash within one year, and are not used actively to produce the company’s products.

This includes items such as:

• Cash value of life insurance policies and Mortgages receivables.
• Prepaid expenses or deferred charges in excess of one year.
• Investments in other companies or intangible assets that can include leases, patents, copyrights, franchises and trademarks that the individual may own.

Liabilities

Liabilities are an individual’s obligation to outsiders and represent debt, which must be paid at some time in the future. They represent creditor’s claims on the asset values of the individual

Liabilities are listed on the balance sheet at the current value owed, not due, plus accumulated interest. Liabilities can be categorized as either current or long term. The more liquid the liability, the higher it is placed in the liability section.

Any liabilities such as credit card balances, mortgages, car payments etc. are considered in this section.

Notes to the following Balance Sheet

Please note the following financial transactions and their affect:

• Proceeds of the sale of the cottage used to pay off their residential mortgage.
• Purchased a Ski Chalet for rental purposes, thereby acquiring a new mortgage.
• Increased their RRSP contributions significantly.
• Increased their personal debt – Credit Cards.

The Balance Sheet is a valuable tool for money management since it outlines the assets and liabilities as well as details the short-term debt position.

SAMPLE BALANCE SHEET -AS AT DECEMBER 31, 2011
ASSETS / 2010 / 2011
Liquid Assets
Cash / $5,300 / $3,392
Short Term Investments / $4,200 / 0
Other Liquid Investments / $1,265 / $2,776
Total / $10,765 / $ 6,168
Investment and Business Assets
RRSP – Harry / $28,720 / $36,300
RRSP – Mary / $500 / $6,860
Registered Pension Plan / $14,500 / $17,140
Canada Savings Bonds / $10,000 / $0
Common Shares / $4,500 / $5,000
Rental Ski Chalet / $0 / 99,750
Mutual Funds / 32,000 / 36,000
Other Investments / 0 / 21,000
Total / $90,220 / $222,050
Personal Assets
Residence / 125,000 / 137,500
Furnishings / 17,000 / 17,000
Vehicles – Two cars / 21,000 / 21,000
Cottage / 90,000 / 0
Other Personal Assets / 263,000 / 185,000
Total Assets / $363,985 / $413,718
LIABILITIES AND NET WORTH
Short Term Obligations
Credit Cards / $3,200 / $5,200
Personal Loans / $3,000 / $4,000
Total / $6,200 / $9,200
Investment and Business Loans
Bank Loans / $25,000 / $25,000
Mortgage on Ski Chalet / 0 / $72,000
Total / $25,000 / $97,000
Loans to Purchase Personal Assets
Mortgage on Residence / $70,000 / 0
Car Loans / $12,000 / $9,800
Mortgage on Cottage / $24,000 / 0
Total / $106,000 / $9,800
Estimated Deferred Income Taxes / $18,249 / $26,870
Net Worth / $208,536 / $270,848
Liabilities and Net Worth / $363,985 / $413,718

1. Balance Sheet is similar to a Statement of Net Worth

Once we have completed the balance sheet, the data can be used to determine a statement of Net Worth.

Net Worth = Assets – Liabilities

The statement includes your liquid assets, equity in investments, equity in personal assets and deferred Income taxes. It provides the clearest picture of your current financial position.

SAMPLE STATEMENT OF NET WORTH AS AT DECEMBER 31, 2011
2010 / Equity Ratio / 2011 / Equity Ratio
Liquidity
Liquid Assets / $10,765 / $6,168
Short Term Obligation / ($6,200) / ($9,200)
$4,565 / 42% / ($3,332) / (49%)
Equity in Investments
Investment Assets / $90,220 / $222,050
Investment Loans / ($25,000) / ($97,000)
$65,220 / 72% / $125,050 / 56%
Equity in Personal Assets
Personal Assets / $263,000 / $185,500
Long Term Personal Loans / ($106,000) / ($9,800)
$157,000 / 60% / $175,700 / 95%
Deferred Income Taxes / ($18,249) / ($26,870)
NET WORTH / $208,536 / $270,848

Three ratios can be determined from this statement.

The “Equity Ratio” measures the relationship between your total Assets and liabilities.

Equity Ratio = (Total Assets – Liabilities)

Total Assets

1) Equity Ratios for Liquidity
The equity ratio for your Liquid Assets and short-term debt provides a measurement of your ability to pay short-term debt as required.

2) Equity Ratio for Investment Assets

The equity ratio for Investment Assets shows the extent to which you are leveraging your investments. If you finance investments with loans, the interest charged is tax deductible.

3) Equity Ratio for Personal Finance

This ratio shows the extent to which you have borrowed to finance thepurchases of your personal assets. Interest charged for these loans are generally not tax deductible.

1. Statement of Lifestyle Expenditures

This statement presents a clear picture of the household spending patterns that support your lifestyle. You will note that cost of accommodation only includes rent or in interest paid on the mortgage. It does not include the cash down payment or principal repayments. A car purchase follows a similar pattern.

Contributions to RRSP's, increases in Credit Card Debt, Income Tax remittance also does not appear on this statement. The value of this statement is that it provides a tool to analyze your spending patterns and with this information, improve your cash flow.

SAMPLE STATEMENT OF LIFESTYLE EXPENDITURES FOR THE YEAR
ENDING DECEMBER 31, 2011
2010 / 2011
Mortgage (Interest Only) / 8,460 / 0
Property Taxes / 1,900 / 1,995
Insurance / 700 / 735
Utilities / 2,300 / 2,415
Maintenance / 1,600 / 1,600
Garden Upkeep / 500 / 500
Housing Costs / 15,460 / 7,245
Food / 4,600 / 4,830
Household Expenses / 700 / 735
Telephone / 900 / 900
Personal Care / 1,200 / 1,260
Clothing / 4,300 / 4,500
Other / 500 / 500
Food, Household, etc. / 12,200 / 12,725
Car Payments (Interest Only) / 1,400 / 1,100
Insurance / 700 / 770
Gasoline / 2,100 / 2,200
Maintenance / 1,200 / 1,200
Public Transportation / 500 / 500
Transportation / 5,900 / 5,820
Entertainment / 1,500 / 1,500
Eating Out / 1,200 / 1,200
Gifts / 1,400 / 1,400
Fees, Accounting etc. / 1,700 / 1,800
Holidays / 1,200 / 2,200
Other / 5,300 / 0
Discretionary / 12,300 / 7,100
Medical Expenses / 600 / 650
Life and Disability Insurance / 300 / 1,000
Payroll Deductions (Sundry) / 1,800 / 2,000
Bank Charges / 240 / 270
Credit Card Interest / 580 / 630
Other / 1,320 / 1,600
Miscellaneous / 4,840 / 6,150
Basic Lifestyle Expenditures / $50,700 / $39,040

1. Statement of Cash Flow

This statement shows the source of Cash Flow both in and out of your accounts. It will detail income not only from remuneration, but also income from net investments as well as net personal assets.This statement is measured over a distinct period, such as 3 months to 3 years. It will determine if you have any cash left over at the end of the reporting time. Using this statement you can create a budget.

SAMPLE STATEMENT OF CASH FLOW FOR THE YEAR ENDING DECEMBER 31, 2011
2010 / 2011
Cash From Source of Income
Employment and self-employed Income / 72,000 / 76,500
Pension Income / 0 / 0
Dividends, Interest and Rents / 12,015 / 12,045
Totals / 84,015 / 88,545
Cash Outlays for Expenses
Income Taxes / (17,520) / (17,104)
Lifestyle Expenditures / (50,700) / (39,040)
Interest Expense for Investments / (5,160) / (11,640)
Other Cash Outlays for Expenses / 0 / 0
Unaccountable for Difference in Cash / 430 / 44
Total / (72,950) / (67,740)
Cash Flow From Income and Expenses / 11,065 / 20,805
Cash Flow From Net Investment Assets
RRSP – Harry / (500) / (5,815)
RRSP – Mary / (1,800) / (1,134)
Registered Pension Plan / 0 / 10,000
Canada Savings Bonds / 0 / 0
Common Shares / 0 / 0
Rental Property / 0 / 0
Mutual Funds / 0 / (20,000)
Other Investment / (500) / 54,000
Investment Loans / 0 / 0
Total / (4,500) / 32,798
Cash Flow From Net Personal Assets
Residence / 0 / 0
Furnishings / 0 / 0
Vehicles – Two Cars / 0 / 0
Cottage / 0 / 35,000
Other Personal Assets / (500) / 0
Loans to Purchase Personal Assets / (3,500) / (96,200)
Total / (4,000) / (61,200)
Total Cash From All Activities / $2,565 / ($7,597)

1. Determine Money Management Strategies

To improve the financial picture revealed by the four statements will probably require some changes in money management technique and the adoption of some basic strategies.

The following steps are simple to understand, but somewhat more difficult to initiate.

a)Invest in Yourself First

If you remove money from income before you pay anything else, it will result in growth in your savings investments and emergency accounts.

b)This can be arranged either by source deduction from your employer or automatic transfer by your bank when you deposit your paycheque.

c)Track Your Expenditures

If you diligently record your daily spending habits, it will allow you to analyze your spending habits. Once a month, sit down and review, in hindsight, whether the expenditure was necessary or could have been saved. The amount you are paying yourself first may be increased by the amount of the revealed unnecessary expenditures.

d)Limit Pocket Money

Carry only the amount of cash necessary for daily purchases. This may also extend to money that is easily accessible with your Bank or Debit Card. Carrying large amounts of cash makes it difficult to track its dispersal.

e)Track Realistically

If your record keeping is too precise and does not allow for personal enjoyment and personal habits, you may decide that the “Gain is not worth the Pain”. The goal is to improve the overall picture, not the elimination of life’s small pleasures.

f)Instant Credit Use

It is practically impossible to live today without the use of Credit Cards and/or Debit Cards. Purchases, at the stores, over the phone, by fax or by the computer, require a guaranteed method of payment.

For many of us, since this isn’t “money” as such, it’s easy to lose track of how much we have expended on a daily basis until the middle of the month following. The interest charges on the unpaid balance are onerous and total repayment may not be possible.

g)Bank Charges

Bank Charges are a necessary part of handling money, but unnecessary charges for bounced cheques (NSF) and prolonged use of overdraft protection can eat into the amount of cash available for personal use or investing.

h)Emergency Fund

The best prevention for avoiding financial distress is the establishment of a buffer account we will call an Emergency Fund. It may not be an actual savings account, but it will be easily accessible in a short-term period. It is a good technique to have three to six months living expenses available in the event of life’s reoccurring disasters. For most of us, this will be accomplished with small savings over a period deposited into some form of short-term investment. Credit is not advisable, and must be paid back and a credit line should be used only for short duration only.

i)Take a Credit Holiday

A couple of times a year, it is wise to take a month, and not use any of your credit devices and pay cash or do without until the following month. This allows you to ease the month end burden of bill paying, and gives you a chance to see what is important enough that you are willing to spend “cash” on it.

j)Know the Income Tax Act

A good working knowledge of the Tax Act is essential to eliminating unnecessary taxation.

1. Starting the Process

There are many ways to budget – on a day-to-day, week-to-week, or month-to-month basis. The more detailed approach is likely to give you a more accurate picture, but bear in mind that a monthly budget is just fine. If you get paid every two weeks it may just be easier to let your budget follow your pay schedule.

When you create your budget, you can use a spreadsheet on your computer or write it on a sheet of paper. We’ve provided some handy charts to help you calculate your income and expenses. Feel free to photocopy these or make your own charts complete with your unique categories. The quicker you get started, the better.

Figuring out Your Income

How much money do you have to work with? Calculate your available income based on your take-home pay (after taxes and other deductions). Remember, your income can come from many sources – salary, tips, pensions, rental property income, social assistance, child support, alimony, commissions or bonuses, interest and investments. If you earn income irregularly, you need to average what you earn to get a monthly income.

Don’t count on overtime pay as regular income. Overtime pay can seldom be relied on consistently, so don’t include it as income in your budget. Instead use occasional overtime to help contribute to goals.