Financial Decision Making All of us face decisions every day about a basic financial challenge: trying to balance our cash inflow and outflow. Having a responsible approach to these decisions can be the basis for good financial planning for your future. Cash Flow and Your Financial Future Each component of your personal financial plan reflects decisions about how you get and use cash. Budgeting decisions require you to determine how much of your income you spend on goods and services, and how much you will have left over. How much you have left over relates to your plans to manage liquidity—how much cash you have available, and how much you plan to save. Responsible financial planning also requires you to decide how much you will rely on credit to satisfy your needs and wants. Step-­‐by-­‐Step Decision Making Process There is a step-­‐by-­‐step process for facing these key personal finance questions: STEP ONE: Establish Your Financial Goals Ask yourself what are your goals—what do you want to accomplish in the future? You can categorize your financial goals in terms of when you hope to accomplish them: • Short-­‐term goals are those you plan to accomplish within the next year. For example, you might want to save $1000 to buy a used car, or get a new job that will pay you at least $100 more per week than you are earning now. • Middle-­‐term goals are those that you aim to meet within one to five years. For example, you may plan to graduate from college or trade school and get a full-­‐time job. You may want to buy a better car than you can afford this year. You may set a goal to have saved at least $5000 by the end of the next five years. • Long-­‐term goals will take more than five years to accomplish. You may want to accumulate $20,000 for a down payment on a house. You may want to go back to school for an advanced degree. You may want to accumulate at least $50,000 in savings by the time you are forty. Remember to make your goals realistic! Otherwise, when you don’t achieve them, you will find yourself discouraged and may give up on more sensible financial goals. STEP TWO: Evaluate Your Current Financial Position A realistic financial plan has to be based on accurate information and reliable forecasts. When making a financial plan, you not only need to look at your current sources of income (job, parents, student loan), but also your potential future sources of income (better-­‐paying job, interest earned on savings, sale of an asset). Predicting your future sources of income is called making a financial forecast. Your level of education has a direct effect on your potential earnings. You need to take into consideration your educational plans when making an accurate financial forecast for yourself. Your financial plan also has to be realistic about your expenses. Some expenses are “fixed”—that is, we are obliged to pay them every month. Expenses such as rent, car payments, and insurance are fixed expenses. Other expenses are “variable”—they can change from one period to the next. Your phone bill is a variable expense, as is your credit card bill. Your goal is to have your income exceed your expenses. The difference between your cash inflow (income) and cash outflow (expenses) is your profit. Your profit is what you can use to start to save money for the future, or for unexpected expenses. STEP THREE: Identify and Evaluate Options for Accomplishing Your Goals There may be multiple ways to achieve the same goal. Like taking a trip, there may be many different roads to reach the same destination. For example, if your goal is to save up $1000 to buy a car, you could work extra hours at your existing job or you could try to find a job that pays more per hour. If your goal is to go to college and live in an apartment, you could find an apartment with a roommate to save on rent and utilities. You could take a year off and work full-­‐time to save money for college, or you could apply to take out a student loan. You can also consider the cost of a community college versus a four-­‐year institution. STEP FOUR: Pick the Best Plan After you have developed multiple plans to achieve your goal, you need to decide which approach is more realistic and likely to work for you. List your options and make a table of pros and cons for each. (see pp. 44-­‐45 for example). STEP FIVE: Periodically Evaluate Your Plan After you develop a plan, you need to periodically monitor your progress to make sure you are staying on track. If there are variables in your plan—for example, if your pay depends on tips, or is seasonal—you need to check to see if you are reaching your projected earning goals. If not, you need to make adjustments in your plan in order to make it work. STEP SIX: Revise Your Financial Plan as Necessary If your plan proves to be unrealistic or too conservative, then change it! Just remember, any change to one part of your plan may require changes to other parts as well.