Why is financial literacy important to good personal finance management?

 

Do you have a plan for your future? The answer is most likely a quick YES!

Does that plan include a financial plan (a budget to control your spending, saving and dictate your invesments)? The answer more likely a NO! 

Many make plans for the future without including a financial plan in them. Why do they ignore this all important map and means to get to their goals? It's most probably because they don't have a financial literacy. 

What is financial literacy?

Financial literacy is the acquisition of at least,  a basic financial knowledge that helps you to know how to fill your needs, spend responsibly and still set aside (save) a portion of your income for the future. 

Why is it important to save a portion of your income? So that you can have a significant portion of capital that may be required to invest, grow and secure a lifetime financial stability

Also for the sake of the protection of your investments (and your entire personal finance) against future risks and unertainties , financial literacy is very very important.

The possession of quality financial literacy therefore, improves personal financial decisions about budgeting (the primary importance), savings, investments, insurance and the building of a reliable nest egg (retirement savings). 

It's worthy to note that;

 

"An investment in knowledge pays the best interest." — Benjamin Franklin.

An investment in financial knowledge pays the best interest that is large enough to guarantee financial freedom and stability in the present and in the future.

What are personal financial activities? They are explained below;

1. Budgeting - 

The simplest definition of a budget is “telling your money where to go.” – Tsh Oxenreider.

Budgeting is the process of preparing a detailed short term personal financial plan that is expressed in monetary terms.

The process of budgeting yields a financial plan ( an estimate/a budget) of expected revenue and expected expenses for a given period, usually one financial year.

A good personal financial budget should make the effective control of control of spending possible. It should also encourage savings and  the development of a sound investment habit.

2. Spending -

A sound financial knowledge gives you the power to keep your spending within budget, on filling absolutely necessary needs and avoiding unnecessary spending. Unnecessary spending creates indebtedness and discourages savings.

3. Savings - 

Revenue for a specific period - Expenses for the same period = Savings for that period.

As mentioned in (2) above, a good personal financial knowledge should help you weed out unnecessary spending and save a substantial amount within a specific period.

Why is it important to have savings?

4. Investment -

Investment is one of the primary reasons to have a substantial amount of savings at a given time.

This is because as Muhtar Kent correctly observes, "Without investment there will not be growth, and without growth there will not be employment." 

So, when you invest, you create opportunities for yourself and for others to grow and be employed.

A good investment is an asset that generates positive returns. These returns could form a significant equity contribution to a small-to-medium scale business startup capital, which would create jobs.

5. Insurance -

Life is full of risks and uncertainties. Tomorrow is promised to no one. 

There are no guarantees that uncertainties would not arise  tomorrow to destroy today's certain source of survival. 

This is a reality of life and this reality makes it necessary to protect (insure) your personal finance.

This protection may be in the form of taking out relevant insurance policies but you must know the relevant insurance policies to go for. 

How would you know the insurance policies needful and relevant to you, your family and your business? This is where the acquisition of a sound financial knowledge is useful. You need a financial knowledge to guide you to experts.

Other forms of protection against possible loss of financial stability in future are investment in less volatile assets like real estate and building a sufficient nestegg.

6.  Nest egg - 

Often  many self-employed business owners don't see the need to save a substantial amount of money for retirement. A nest egg could be used to take care of unexpected emergencies.

The above benefits of having a substantial retirement savings are a product of financial literacy.

Marketable securities meaning and examples.

What are marketable securities as a short term investment option?

First, what are marketable securities?

Many businesses prefer to invest most of their liquid resources in marketable resources instead of keeping them in idle cash.

Businesses prefer holding a greater portion of their liquid resources in this form, because marketable securities can be easily and quickly bought or sold (they are highly liquid, that is, easily converted into cash) at quoted market prices daily, on securities exchanges.    

Marketable securities consist basically of bonds and common stock of publicly owned companies. Investments in marketable securities yield returns in the form of interest and dividends. 

When marketable securities are bought, how is the purchase price calculated?

ABC Company makes a short term investment by buying 10,000 shares of the common stock of XYC Company at $0.35 per share. ABC also pays a brokerage commission of $500. The purchase price is $4,000 (10,000 x $0.35 + $500).

What happens when marketable securities are sold?

Either of two things happens when marketable securities are sold. The sales of a short term investment in marketable securities can either produce a gain or result in a loss.

A gain is produced when the sales price is more than the cost. For an example,  if ABC Company sells the entire 10,000 shares  of its XYC company for $0.50 per share and paid a brokerage commission of $500, the gain is $500 (10,000 x $0.50 - $500) - $4,000).

A sale at $0.40 plus a brokerage commission of $500 will result in a loss of $500.

A gain on sale of marketable securities by ABC Company could result in an increase in its market value. A loss on the other hand, could result in decrease in its market value.

Businesses classify their marketable securities on the basis of the length of time they decide to hold the securities. So, marketable securities may be classified as any of;

 

1. available for sale (APS) securities,

2. held-to-maturity (HTM) securities and,

3. trading securities.

1. Available-for-Sale (AFS) Securities.

Businesses hold available-for sale securities in both equity and debt for a while but can sell them as they often have a ready market price available. Most businesses classify their securities as AFS.

2. Held-to-Maturity Securities:

Held-to-maturity (HTM) securities are purchased and held until maturity. 

Held-to-maturity investments are commonly made in the form of bonds. Bonds have fixed maturity date and predetermined payment dates. Also, investors usually purchase bonds with the intent of holding them until they mature.

3. Trading securities

Trading marketable securities are bought and held for sale in the short term. The purpose for holding them is to make a profit from quick trade as opposed to holding them until maturity.  

What Is Personal Income Statement ?

What to know about inflation.

 

What Is Inflation?

Inflation reduces the purchasing power of money (purchasing power, the quantity of goods bought by an amount of money).

 Inflation reduces the purchasing power of money in a growing economy by triggering rising prices of consumer goods and services.

`A slow and steady rising of prices caused by an inflation rate of at about 2% is okay. But when the rate rises faster, sometimes to double digits, then it can have a negative impact on personal financial management.

For instance, as a consumer, you would be time consuming to compare and determine best prices to get goods and services at a given moment.

How is inflation measured?

Inflation is measured by using the Consumer Price Index (CPI) and the Personal Consumption Expenditures (PCI) tools. 

The Consumer Price Index tracks prices for individual goods and services which households are buying. 

The Personal Consumption Expenditures, PCE, tracks changes in prices of consumer goods and services which businesses are selling.

The CPI reports a higher inflation rate than PCE but the PCE is considered the more reliable indicator.

What are the types of inflation?

The three main types of inflation are the demand-pull inflation, the cost-push inflation,    and the built-in-inflation.

The demand-pull-inflation is an economic situation where the demand for goods and services drive up their prices. Consumer demand pulls up prices when quantity supplied falls below quantity demanded. 

The cost-push-inflation occurs at the peak of demand-pull-inflation. It is an economic situation where increase in costs of raw materials is transferred to final consumers through increase in retail prices. 

The built-in-inflation occurs as a result of increase in wages or salaries and increase in prices of consumer goods and services. The consequence of demand-pull-inflation and cost-push-inflation, which is, increase in prices, affect all consumers including workers. To continue to afford basic goods and services, these workers are going to ask for a pay raise. When this request is granted, a built-in-inflation occurs.  

As a consumer, what should you do during inflation?

Have a good budget and stick to it. Your budget should include provisions for timely settlement of debts and investments in commodities, gold, silver, equities and real estate.

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What is the difference between break-even analysis and payback period in terms of cashflow?

 First, what is cash flow>

Cash flow is defined as an increase or decrease in an amount of cash.

And what is cash?

Cash is defined as ‘cash held  in hand’ and any deposits repayable on demand with banks and any other qualifying financial institution, less overdrafts from a bank and any qualifying institution, repayable on demand. 

What then is the difference between break- even analysis and payback period on the basis of cash flow?

The term break-even analysis as commonly used, does not capture the true meaning of the interrelationships it explores. Break-even analysis is not only concerned with the level of activity which produces the break-even point (where neither profit nor loss is produced). It is more concerned with how costs and profits behave at other levels. This is why the alternative term. Cost-volume-profit (c-v-p) is often used. 

Break-even analysis or c-v-p analysis is relied upon for short term planning and decision making. It uses principles of marginal costing to explore relationships that exist among costs, small changes in output levels, revenue and profit.

The application of break-even analysis depends on some basic assumptions. Some of them include;

There will be no uncertainty,

All costs can be accurately resolved into fixed and variable costs,

Fixed costs will remain constant and variable costs will vary proportionately with activity,

Volume is the only factor that affects costs and revenues

No stock level changes or that stocks are valued at marginal cost only and,

That break-even analysis relates to a single product or constant sales mix.

How can break-even (c-v-p) be analyzed by formula?

Break-even point (in units) = fixed costs/contribution per unit   (contribution = selling price – marginal cost),

Break-even point ($ sales) = fixed costs/contribution per unit x sales price/unit.

What is payback?

Payback as an investment appraisal technique, is defined as the time required for the cash inflows from a capital investment project to equal the cash outflows.

Payback is a method used to reduce risks and uncertainties associated with a project. The usual decision rule is to accept the project with the shortest payback period.

In applying a payback time limit, either a project in addition to paying back within a certain time limit should show a positive net present value (NPV) from its net cash flows. Or a project is expected to pay back in discounted cash flows within a certain time period.

Payback is the most popular project appraisal technique because it is simple to calculate and understand. It other advantages include;

 it favors quick return projects and thus, minimizes time related risks and,

Its objectivity (it uses project cash flows instead of accounting profits).

However, payback analysis is not a measure of the overall worth of a project.

House rich (asset rich), cash poor? What should you do?

House (asset) rich, cash poor is a product of you putting most of your wealth (equity) in real estate that's difficult to convert into cash. 

Investing in real estate is a good financial decision but it may constitute a problem if you don't have sufficient liquid cash in the pocket and bank to maintain your lifestyle and, pay short term debts as they mature.

Being house rich, cash poor is an uncomfortable position where the struggle to hold onto real estate would cause you to keep on postponing, enjoying the benefits of being a homeowner.

To solve this problem, you striking a balance between your real estate asset and your liquid assets (top among them is cash) is necessary. This stability would translate into having sufficient funds in your savings or checking accounts to settle current liabilities as they fall due.

Apart from cash, other highly liquid assets are stocks and bonds, but it's more complicated to convert them into cash.

How do interest rate fluctuations affect your money?

 

Why should you be bothered about nterest rates?

"Interest rates are to asset prices what gravity is to the apple. When there are low interest rates, there is a very low gravitational pull on asset prices." - Warren Buffett.

Prices of assets, cost of borrowing and rewards for savings are tied to the rise, fall and stability of interest rates.

Interest rate for borrowing (cost of borrowing) is the percentage of the loan amount. The higher this percentage is, the more the interest to be paid back in addition to the principal..

At lower interest rates, borrowing to buy big assets is more attractive than borrowing to aave. 

At lower savings rate, a percentage of savings paid into a savings account is less than at higher savings rate. So, it makes more sense to borrow to spend and buy assets rather than borrow to save and be rewarded with low interests.

At lower interest rates, spenders pay less interest and have more money to increase their spendings on consumer goods. This leads to increase in the production of goods and to the creation of more job opportunities.

Higher interest rates are going to force you, the consumer, to reduce your spending as you're going to have less money to spend. Why would you have less money to spend?

It's obvious that a higher interest rates, banks would give more stringent conditions to prospective borrowers. The result of tough requirements would produce few with the capacity to meet them. Therefore, fewer loans are going to be given