Financial Decision Making

Chapter 3

Objectives

• Differentiate between cash inflow and cash outflow• Explain the steps in financial decision making

Objective 1: Differentiate between cash inflow and cash outflow

Cash Inflow vs. Cash Outflow

Inflow = money received from various sources

Outflow = money paid out or spent

Decisions about Cash

• Budgeting Decisions (Comp 1)• determine how much of your income you spend on products and services• Determines how much money you have left over

• Leftover money is related to Plans to Manage Liquidity (Comp 2)• How much cash do you have?

• How much do you finance?• How much do you invest?

• How much do you rely on credit to meet your needs and wants?

Objective 2: Explain the steps in financial decision making

Step-by-Step Decision Making Process1. Establish your financial goals.2. Evaluate your current financial position.3. Identify and evaluate options for accomplishing your goals.4. Pick the best plan.5. Periodically evaluate your plan6. Revise your financial plan as necessary.

Step 1: Establish Your Financial Goals• You can’t reach goals if you do not know what they are. Establishing

clear goals is essential to any successful plan.• There are many different types of goals:• Make a particular purchase• Get out of debt• Move into your own apartment• Get a college education• Start your own business• Have $200,000 in total wealth by 40 years old

Three Types of Goals

• Short-term: you plan to accomplish within the next year• Intermediate-term: you aim to meet within the next 5 years• Long-term: will take more than 5 years to accomplish

When Setting Financial Goals:

• Set realistic goals• Make them achievable• Encourages you when you accomplish it or when you see progress being

made

• Unrealistic goals will cause you to become discouraged• As goals become more involved, you will need a more specific

financial plan• Set goals for each of the components of your financial plan

Step 2: Evaluate Your Current Financial Position• Before you can effectively make plans for your financial future, you need

to evaluate your current financial position • Decisions about how much money to spend/save/use credit depend on your

current situation• Someone with low debt and a lot of assets will make a different decision about

spending than someone with high debt and no assets• People with children vs. no children• An 18 year old vs. a 50 year old• Married vs. single

• Financial goals are tied to your income, level of education, and career choice• Better income = loftier goals

Forecasts: helps us understand our financial position now and in the future and

plan budgets accordingly

• A projection about what will happen in the future• Typically involve making projections about cash flows most important to financial forecast

• Parts of a financial forecast• Expenses (anything we spend money on)

• Variable: change from one period to the next• Fixed: remain the same from period to period

• Income (cash inflow)• From job• Allowance from parents• Scholarships• Saving/investing

Profit = Cash Inflow – Cash Outflow

Alicia’s inflow = $11,920Alicia’s outflow = $15,600

Profit = -$3,680 (negative)

Her expenses > income

Step 3: Identify Goals and Evaluate Options for Accomplishing Your Goals• There are several ways for a person to achieve their financial goals• More options increase chances you’ll find one you like• List different optionsExample below: Alicia wants to move out after high school. Here are options:

After looking at options, list pros and cons for each: (best way to evaluate)

Step 4: Pick the Best Plan

• After developing multiple ways to achieve a goal, decision which option is most realistic and works for you• Your tolerance for risk and your self-discipline determine which option

is best for you• Risk is the likelihood of loss• A financial plan with a higher level of risk is likely to also have a higher

potential payoff than one with a lower level of risk

Step 5: Periodically Evaluate Your Plan• Monitor your progress in case your plans falter or get off track

Step 6: Revise Your Financial Plan as Necessary

• Revise if your plan is unachievable or too restrictive• Remember, any revision to one part of your financial plan may impact

other aspects of your plan