109.jack R. Kapoor
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Jack R. Kapoor Les R. Dlabay
Professor of Business and Economics Professor of Business
Business and Services Division Department of Economics and Business
College of DuPage Lake Forest College
Glen Ellyn, Illinois Lake Forest, Illinois
Robert J. Hughes William B. Hoyt
Professor of Business Contributing Editor
Dallas County Community Colleges Wilton High School
Dallas, Texas Wilton, Connecticut
About the Authors
Jack R. Kapoor Les R. Dlabay Robert J. Hughes
Jack R. Kapoor is professor of Les R. Dlabay teaches in the Robert J. Hughes teaches
business and economics in the Department of Economics and business, management, and
Business and Services Division Business at Lake Forest College. finance courses at Dallas County
at College of DuPage, where He received his Bachelor of Community Colleges. He
he has taught since 1969. He Science in Accounting from received his Bachelor of Arts in
received his Bachelor of Arts in University of Illinois, his Master Business Administration from
Business Administration and of Business Administration in Southern Nazarene University
Master of Science in International Business Management from and his Master of Business
Business from San Francisco State DePaul University, and his Administration and Doctor of
College. He received his Doctor Doctor of Education in Business Education from the University
of Education from Northern and Economic Education from of North Texas. Dr. Hughes
Illinois University. Dr. Kapoor Northern Illinois University. He is has taught at the high school,
was awarded the Business and a founding member of the Illinois community college, and four-
Services Division’s Outstanding Consumer Education Association. year university levels for 36
Professor Award for l999–2000. years. He received the Excellence
in Teaching Award at Richland
College and has 15 years of
experience teaching personal
finance courses.
NOTICE: Information on featured companies, organizations, and their products and
services is included for educational purposes only, and it does not present or imply
endorsement of the Business and Personal Finance program.
Copyright © 2007 by The McGraw-Hill Companies. All rights reserved. Except as permitted under the United States Copyright Act,
no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system,
without prior written permission of the publisher.
Printed in the United States of America.
Send all inquiries to:
Glencoe/McGraw-Hill
21600 Oxnard Street, Suite 500
Woodland Hills, California 91367-4906
ISBN-13: 978-0-07-868712-9 (Student Text)
ISBN-10: 0-07-868712-8 (Student Text)
ISBN-13: 978-0-07-869846-0 (Teacher Annotated Edition)
ISBN-10: 0-07-869846-4 (Teacher Annotated Edition)
2 3 4 5 6 7 8 9 027 09 08 07 06 05
Reviewers
Rosella Bannister Paul Jussila Betty Tobler
Jump$tart Personal Finance South Windsor High School St. Louis Public Schools
Clearinghouse South Windsor, Connecticut St. Louis, Missouri
Ann Arbor, Michigan
Mike Kelly Mark Van Hoy
Janet Barnes Hazelwood East High School Hazelwood West High School
Hazelwood West High School St. Louis, Missouri Hazelwood, Missouri
Hazelwood, Missouri
Jason Lee Patty Wamble
Thelma Brooks Olympia High School Cape Central High School
Educational Consultant Orlando, Florida Cape Girardeau, Missouri
Columbus, Ohio
Diane Manley Elizabeth Watt
Edlena Carmon St. Louis, Missouri North Education Center
Marion Franklin High School Columbus, Ohio
Greg Moore
Columbus, Ohio
Columbus, Ohio Ken Watts
Sharon Clemons Montclair High School
Jeff Noyes
Thomas Worthington High Montclair, New Jersey
Minnetonka High School
School
Minnetonka, Minnesota Polly White
Worthington, Ohio
Wawasee High School
Verta Parks
John E. Clow, Ph.D. Syracuse, Indiana
Marion Franklin High School
State University of New York
Columbus, Ohio Tamara Wickline
Oneonta, New York
Dublin Coffman High School
Kevin Richberg
Joe Cook Dublin, Ohio
Montclair High School
Southeast Career Center
Montclair, New Jersey Susie Wright
Columbus, Ohio
Walnut Ridge High School
Verlin Samples
Diane W. Culpepper Columbus, Ohio
Hamilton Local
Winter Park Tech
Columbus, Ohio Glenn Zipfel
Winter Park, Florida
Christian Brothers High
James C. Scharer
Joy Davis School
Fremont Ross High School
Delaware Area Career Center St. Louis, Missouri
Fremont, Ohio
Delaware, Ohio
Natalie Schaublin
Laneita Dunphy
Westerville North High
Montclair High School
School
Montclair, New Jersey
Westerville, Ohio
Ernestine Gordon
Ken Schnitzer
Montclair High School
Montclair High School
Montclair, New Jersey
Montclair, New Jersey
Georgia Hoover
Julie Smith
Dublin Scioto High School
Southeast Career Center
Dublin, Ohio
Columbus, Ohio
Contents iii
Welcome to Business and Personal Finance
Each day you are surrounded by new choices for shopping, watching television, and other
activities. You also have many choices about how to spend your money. Business and Personal
Finance can help you make the right decisions. You will develop financial literacy through inte-
grated academics, real-world examples, and practical advice. By learning how to make informed
decisions related to spending, saving, borrowing, and investing, you can build a solid foundation
for your financial security now and in the future.
Brief Table of Contents
Unit 1 Planning Personal Finances
Chapter 1 Personal Financial Planning
Chapter 2 Finances and Career Planning
Chapter 3 Money Management Strategy
Chapter 4 Consumer Purchasing and Protection
Unit 2 Banking and Credit
Chapter 5 Banking
Chapter 6 Consumer Credit
Chapter 7 The Finances of Housing
Unit 3 Investing Financial Resources
Chapter 8 Saving and Investing
Chapter 9 Stocks
Chapter 10 Bonds and Mutual Funds
Chapter 11 Real Estate and Other Investments
Unit 4 Protecting Your Finances
Chapter 12 Planning Your Tax Strategy
Chapter 13 Home and Motor Vehicle Insurance
Chapter 14 Health, Disability, and Life Insurance
Chapter 15 Retirement and Estate Planning
Unit 5 Business Ownership and Planning
Chapter 16 Types of Business Ownership
Chapter 17 Developing a Business Plan
Chapter 18 Developing a Financial Plan
Unit 6 Business Finance Basics
Chapter 19 Sources of Funding
Chapter 20 Financial Accounting
Chapter 21 Managing Payroll and Inventory
Chapter 22 Pricing, Costing, and Growth
iv Contents
Table of Contents
To the Student xvi
UNIT 1 Planning Personal Finances 2
WebQuest Internet Project One Life to Plan 2
Finance File Which Adviser Knows the Way? 3
Chapter 1 Personal Financial Planning 4
Section 1.1 Financial Decisions and Goals 6
Section 1.2 Opportunity Costs and Strategies 19
Go Figure Annual Interest 21
Go Figure The Future Value of a Single Deposit 21
Ask Standard & Poor’s 5
Global Financial Landscape India 15
Academic Connection Language Arts 13
Careers in Finance Personal Banker 11
Document Detective Monthly Budget Worksheet 12
Chapter 1 Review and Activities 26
What’s Your Financial ID? Your Spending Profile 28
Your Financial Portfolio Getting Your Own Wheels 29
Chapter 2 Finances and Career Planning 30
Section 2.1 Planning Your Career 32
Section 2.2 Employment and Career Development 40
Ask Standard & Poor’s 31
Global Financial Landscape Japan 38
Academic Connection Science 34
Careers in Finance Cashier 49
Document Detective IRS Form W-4 42
Chapter 2 Review and Activities 54
What’s Your Financial ID? Find Your Personality Traits 56
Your Financial Portfolio Applying for a Job 57
Contents v
Chapter 3 Money Management Strategy 58
Section 3.1 Organizing Financial Records 60
Section 3.2 Personal Financial Statements 65
Section 3.3 Budgeting for Financial Goals 74
Go Figure Net Worth 68
Go Figure Net Cash Flow 71
Ask Standard & Poor’s 59
Global Financial Landscape
South Korea 80
Academic Connection History 75
Careers in Finance Financial Advisor 69
Document Detective Personal Balance Sheet 81
Chapter 3 Review and Activities 84
What’s Your Financial ID? Money Management Quiz 86
Your Financial Portfolio What Is Your Net Worth? 87
Chapter 4 Consumer Purchasing and
Protection 88
Section 4.1 Consumer Purchasing 90
Section 4.2 Resolving Consumer Complaints 104
Go Figure Unit Pricing 101
Ask Standard & Poor’s 89
Global Financial Landscape
Ecuador 106
Academic Connection Language Arts 108
Careers in Finance Retail Sales Associate 109
Document Detective A Warranty 102
Chapter 4 Review and Activities 112
What’s Your Financial ID? Are You a Smart Shopper? 114
Your Financial Portfolio Your Budget 115
UNIT 1 LAB Get a Financial Life!
Setting Up a Career Plan 116
vi Contents
UNIT 2 Banking and Credit 118
WebQuest Internet Project Your Own Home 118
Finance File Consumer Debt 119
Chapter 5 Banking 120
Section 5.1 Financial Services and Institutions 122
Section 5.2 Savings Plans and Payment
Methods 132
Go Figure Interest Compounded Monthly 136
Go Figure Rate of Return 137
Ask Standard & Poor’s 121
Global Financial Landscape Switzerland 140
Academic Connection History 141
Careers in Finance Bank Teller 124
Document Detective Checking Account Bank
Statement 138
Chapter 5 Review and Activities 148
What’s Your Financial ID? Basic Banking Quiz 150
Your Financial Portfolio Comparison Shopping
for Banking Services 151
Chapter 6 Consumer Credit 152
Section 6.1 What Is Consumer Credit? 154
Section 6.2 The Costs and Methods of Obtaining Credit 162
Section 6.3 Protecting Your Credit 178
Section 6.4 Managing Your Debts 186
Go Figure Debt Payments-to-Income Ratio (DPR) 163
Go Figure Simple Interest on a Loan 166
Ask Standard & Poor’s 153
Global Financial Landscape Israel 164
Academic Connection History 174
Careers in Finance Credit Analyst 167
Document Detective Credit Card Statement 171
Chapter 6 Review and Activities 192
What’s Your Financial ID? Your Credit Profile 194
Your Financial Portfolio Credit Cards: Getting
the Best Deal 195
Contents vii
Chapter 7 The Finances of Housing 196
Section 7.1 Housing Options 198
Section 7.2 Renting a Residence 202
Section 7.3 Buying and Selling a Home 209
Ask Standard & Poor’s 197
Global Financial Landscape Spain 220
Academic Connection Math 217
Careers in Finance Real Estate Agent 213
Document Detective Calculating a Mortgage Payment 214
Chapter 7 Review and Activities 228
What’s Your Financial ID? Where Would
You Like to Live? 230
Your Financial Portfolio Renting or Buying
Your Home 231
UNIT 2 LAB Get a Financial Life! Home Ownership 232
UNIT 3 Investing Financial
Resources 234
WebQuest Internet Project Nest Egg 234
Finance File The Best Homes for
Rollover IRAs 235
Chapter 8 Saving and Investing 236
Section 8.1 Preparing for a Savings or
Investment Program 238
Section 8.2 Savings and Investment
Options 250
Section 8.3 Reducing Risk and Sources
of Information 257
Go Figure Inflation Rates and Investments 245
Go Figure A Bond’s Market Price When Interest
Rates Go Up 246
Go Figure A Bond’s Market Price When Interest
Rates Go Down 247
Ask Standard & Poor’s 237
Global Financial Landscape China 259
viii Contents
Academic Connection Language Arts 246
Careers in Finance Investment Analyst 252
Document Detective Savings Goals Worksheet 253
Chapter 8 Review and Activities 266
What’s Your Financial ID? Are You a Risk Taker? 268
Your Financial Portfolio Avoiding Future Shock 269
Chapter 9 Stocks 270
Section 9.1 Common and Preferred Stocks 272
Section 9.2 Evaluating Stocks 277
Section 9.3 Buying and Selling Stocks 291
Go Figure Current Yield of a Stock Investment 286
Go Figure Total Return 287
Go Figure Earnings Per Share 288
Go Figure Price-Earnings Ratio 288
Ask Standard & Poor’s 271
Global Financial Landscape
United Kingdom 279
Academic Connection Economics 292
Careers in Finance Stockbroker 289
Document Detective Stock Confirmation Report 282
Chapter 9 Review and Activities 300
What’s Your Financial ID? Taking Stock 302
Your Financial Portfolio Investing in Stock 303
Chapter 10 Bonds and Mutual Funds 304
Section 10.1 Corporate and Government Bonds 306
Section 10.2 Investing in Bonds 319
Section 10.3 Mutual Funds 326
Section 10.4 Investing in Mutual Funds 335
Go Figure A Bond’s Annual Interest 307
Go Figure Approximate Market Value of a Bond 312
Go Figure Dollar Amount of Return on a T-Bill 315
Go Figure Rate of Return on a T-Bill 316
Go Figure Current Yield of a Bond Investment 323
Go Figure Net Asset Value 328
Go Figure Capital Gain 340
Go Figure Percentage of Asset Growth Withdrawal 344
Contents ix
Ask Standard & Poor’s 305
Global Financial Landscape Brazil 333
Academic Connection Government 321
Careers in Finance Certified Financial Planner 329
Document Detective Mutual Fund Account Statement 324
Chapter 10 Review and Activities 346
What’s Your Financial ID? What’s Your Investing IQ? 348
Your Financial Portfolio Evaluating Mutual Funds 349
Chapter 11 Real Estate and Other Investments 350
Section 11.1 Real Estate Investment 352
Section 11.2 Precious Metals, Gems,
and Collectibles 361
Ask Standard & Poor’s 351
Global Financial Landscape
South Africa 365
Academic Connection Geography 364
Careers in Finance Commercial Property Manager 359
Document Detective County Real Estate Valuation 356
Chapter 11 Review and Activities 370
What’s Your Financial ID? All that Glitters 372
Your Financial Portfolio Collecting Treasures 373
UNIT 3 LAB Get a Financial Life! Investment Strategies 374
UNIT 4 Protecting Your Finances 376
WebQuest Internet Project Avoiding Financial Fraud 376
Finance File So What’s the Plan? 377
Chapter 12 Planning Your Tax Strategy 378
Section 12.1 Income Tax Fundamentals 380
Section 12.2 Preparing an Income Tax Return 389
Section 12.3 Tax Assistance and Strategies 401
Go Figure 1040EZ Tax Due 396
Ask Standard & Poor’s 379
Global Financial Landscape
Saudi Arabia 382
x Contents
Academic Connection Math 385
Careers in Finance Tax Preparer 390
Document Detective Form W-2 404
Chapter 12 Review and Activities 406
What’s Your Financial ID? Test Your Tax Facts 408
Your Financial Portfolio Take It EZ 409
Chapter 13 Home and Motor Vehicle Insurance 410
Section 13.1 Insurance and Risk Management 412
Section 13.2 Home and Property Insurance 419
Section 13.3 Motor Vehicle Insurance 430
Ask Standard & Poor’s 411
Global Financial Landscape Germany 423
Academic Connection Language Arts 424
Careers in Finance Insurance Claims Adjuster 428
Document Detective Auto Insurance Declaration 435
Chapter 13 Review and Activities 438
What’s Your Financial ID? Vehicle Insurance Quiz 440
Your Financial Portfolio The Price of Car Insurance 441
Chapter 14 Health, Disability, and Life Insurance 442
Section 14.1 Health Insurance and
Financial Planning 444
Section 14.2 Private and Government Plans 453
Section 14.3 Disability Insurance 460
Section 14.4 Life Insurance 464
Ask Standard & Poor’s 443
Global Financial Landscape Canada 448
Academic Connection Art 449
Careers in Finance Insurance Agent 458
Document Detective Life Insurance Policy Statement 469
Chapter 14 Review and Activities 472
What’s Your Financial ID? Insurance Facts
and Fiction 474
Your Financial Portfolio Comparing Life Insurance 475
Contents xi
Chapter 15 Retirement and Estate Planning 476
Section 15.1 Retirement Planning 478
Section 15.2 Planning Retirement Income 486
Section 15.3 Estate Planning and Taxes 499
Ask Standard & Poor’s 477
Global Financial Landscape Mexico 491
Academic Connection Language Arts 495
Careers in Finance Estate Administrator 483
Document Detective Projected Retirement
Budget Worksheet 494
Chapter 15 Review and Activities 514
What’s Your Financial ID? What Is Your Personality? 516
Your Financial Portfolio Saving for Retirement 517
UNIT 4 LAB Get a Financial Life!
Making Retirement Plans 518
UNIT 5 Business Ownership
and Planning 520
WebQuest Internet Project Be Your Own Boss 520
Finance File Good Works—
with a Business Plan 521
Chapter 16 Types of Business Ownership 522
Section 16.1 Sole Proprietorship and Partnership 524
Section 16.2 The Corporation 534
Ask Standard & Poor’s 523
Global Financial Landscape
Netherlands 537
Academic Connection Marketing 542
Careers in Finance General Contractor 526
Document Detective Application for Employer
ID Number 531
Chapter 16 Review and Activities 544
What’s Your Financial ID? What Kind of Business? 546
Your Financial Portfolio Setting Up a Partnership 547
xii Contents
Chapter 17 Developing a Business Plan 548
Section 17.1 A Plan for Business 550
Section 17.2 Financial Management 561
Ask Standard & Poor’s 549
Global Financial Landscape Greece 555
Academic Connection Social Studies/Marketing 560
Careers in Finance Bookkeeper 566
Document Detective Job Description 562
Chapter 17 Review and Activities 568
What’s Your Financial ID? What’s Your
Business Personality? 570
Your Financial Portfolio Planning for Success 571
Chapter 18 Developing a Financial Plan 572
Section 18.1 Identifying Required Capital 574
Section 18.2 Case Study: A Financial Plan 589
Ask Standard & Poor’s 573
Global Financial Landscape Russia 586
Academic Connection Language Arts 591
Careers in Finance Controller 593
Document Detective Personal Financial Statement 587
Chapter 18 Review and Activities 600
What’s Your Financial ID? Are You a Persuader? 602
Your Financial Portfolio Start with a Plan 603
UNIT 5 LAB Get a Financial Life! A Business Is Born 604
UNIT 6 Business Finance Basics 606
WebQuest Internet Project Franchise Ownership 606
Finance File Cycling Back to the Future 607
Chapter 19 Sources of Funding 608
Section 19.1 Analyzing Financial Needs 610
Section 19.2 Sources of Funding 625
Go Figure A Home Equity Loan 618
Contents xiii
Ask Standard & Poor’s 609
Global Financial Landscape Estonia 619
Academic Connection Language Arts 622
Careers in Finance Commercial Loan Officer 613
Document Detective Application for Business Loan 615
Chapter 19 Review and Activities 630
What’s Your Financial ID? Are You a Go-Getter? 632
Your Financial Portfolio Tanya’s Toys 633
Chapter 20 Financial Accounting 634
Section 20.1 The Accounting Cycle:
The First Five Steps 636
Section 20.2 Financial Statements for a Business 650
Ask Standard & Poor’s 635
Global Financial Landscape France 658
Academic Connection International Finance/Math 652
Careers in Finance Accounting Teacher 639
Document Detective Income Statement 643
Chapter 20 Review and Activities 660
What’s Your Financial ID? Do You Think Logically
or Intuitively? 662
Your Financial Portfolio Income Statements 663
Chapter 21 Managing Payroll and Inventory 664
Section 21.1 Managing Payroll 666
Section 21.2 Managing Inventory 680
Go Figure Gross Earnings and Overtime 668
Go Figure FICA Deduction 671
Go Figure Unemployment Taxes 678
Go Figure Average Inventory 689
Go Figure Inventory Turnover 689
Go Figure Number of Days in Stock 690
Ask Standard & Poor’s 665
Global Financial Landscape Singapore 676
Academic Connection Language Arts 671
Careers in Finance Purchasing Agent 667
xiv Contents
Document Detective Paycheck Stub 685
Chapter 21 Review and Activities 692
What’s Your Financial ID? Stocking Up on Knowledge 694
Your Financial Portfolio Keeping Track of Inventory 695
Chapter 22 Pricing, Costing, and Growth 696
Section 22.1 Merchandise Pricing and Costing 698
Section 22.2 Planning For Growth 709
Go Figure Break-Even Point 707
Go Figure Target Sales 712
Ask Standard & Poor’s 697
Global Financial Landscape Vietnam 702
Academic Connection Math 704
Careers in Finance Chief Financial Officer 701
Document Detective Break-Even Analysis 706
Chapter 22 Review and Activities 716
What’s Your Financial ID? Creative Thinking 718
Your Financial Portfolio Business Expansion Magic 719
UNIT 6 LAB Get a Financial Life! Growing a Business 720
Appendix Math Skills Builder 722
Glossary 746
Index 758
Features Index 774
Contents xv
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xvi To the Student
To the Student
Understanding the Chapter
Each unit of Business and Personal Finance focuses on an aspect of finance that will apply
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s 7HEN CHOOSING A LOAN OR CREDIT CARD s -ANAGE DEBT PROBLEMS BY CONTACTING
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research skills. Resources can
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5NIT "ANKING AND #REDIT lNANCEGLENCOECOM #HAPTER #ONSUMER #REDIT Online Learning Center at
finance07.glencoe.com.
Reviewing Key Concepts Review ques- BusinessWeek Online Go to the Stu-
tions are correlated to the chapter objec- dent Center of the book’s Online Learn-
tives to help you check your understanding ing Center, and you will find a complete
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xx To the Student
To the Student
Focus on Reading
Top 10 Reasons to Become a Better Reader
10. Give yourself more choices in life. Read-
ing well opens the door to a wider variety of
interesting career options.
9. Empower yourself through the written
word. Teach yourself sailing, computer skills,
the latest techniques in skateboarding. Dis-
cover how to create your own Web site.
8. Improve your chances of getting into
and graduating from an institution of
higher learning. On average, a person who
gets a postsecondary education makes three
times more money than a high school
dropout!
7. Increase your chances of getting a job when you look for one. That
is important, considering that the average person will hold 11 different jobs
over his or her lifetime.
6. Advance more quickly in your chosen career. In many positions, peo-
ple with strong reading skills are ten times as likely to receive training from
their employer as those with limited reading skills.
5. Make the country economically stronger. More people reading well
means more people contributing to the progress and prosperity of the
country.
4. Save money and gain confidence in many real-life situations. For
example, you will be able to pass your driver’s test and read the lease for your
first apartment.
3. Be more civic minded. People who read well are more likely to vote and to
participate in democratic elections and in civic life.
2. Once learned, never forgotten. Reading is a lifelong skill, like riding a
bicycle—once you learn, you will never forget!
1. Enjoy life more! Reading well can not only help you get ahead and stay
ahead in life—it’s fun!
To the Student xxi
To the Student
Reading Strategies
Reading Strategies
How can you get the most from your reading?
Effective readers are active readers. Get involved with the text. Think of your textbook as
a tool that helps you learn more about the world around you. The material is a form of
nonfiction writing—it describes real-life ideas, people, events, and places. Use the read-
ing strategies listed in the Reading Strategies box at the beginning of each chapter along
with strategies in the margins to help you read actively.
Before As You
You Read Read
PREDICT RELATE
Make educated guesses about what the Draw parallels between what you are
section is about by combining clues in the reading and the events and circumstances
text with what you already know. Predict- in your own life.
ing helps you anticipate questions and stay
alert to new information. Ask yourself:
• What do I know about the topic?
Ask yourself: • How do my experiences compare to the
• What does this section heading mean? information in the text?
• What is this section about? • How could I apply this information to
• How does this section tie in with what I my own life?
have read so far? • Why is this information important in
• Why is this information important in understanding the subject?
understanding the subject?
As You After You
Read Read
QUESTION REACT
Ask yourself questions to help clarify the React to what you are reading. Form
reading as you go along. opinions and make judgments about the
section while you are reading—not just
Ask yourself: after you have finished.
• Do I understand what I have read so far?
• What is this section about? Ask yourself:
• What does this mean? • Does this information make sense?
• Why is this information important in • What can I learn from this section?
understanding the subject? • How can I use this information to start
planning for my financial future?
• Why is this information important in
understanding the subject?
xxii To the Student
To the Student
More Reading Strategies
Use this menu for more reading strategies to help you get the most from your reading.
Before You Read
Set a purpose
• Why are you reading the textbook?
• How does the subject relate to your life?
• How might you be able to use what you learn in your own life?
Preview
• Read the chapter title to preview the topic.
• Read the subtitles to see what you will learn about the topic.
• Skim the photos, charts, graphs, or maps. How do they support the topic?
• Look for key terms that are boldfaced. How are they defined?
Draw from your background
• What have you read or heard concerning new information on the topic?
• How is the new information different from what you already know?
• How will the information that you already know help you understand the new information?
As You Read
Predict
• Predict events or outcomes by using clues and information that you already know.
• Change your predictions as you read and gather new information.
Connect
• Think about people, places, and events in your own life. Are there any similarities with
those in your textbook?
• Can you relate the textbook information to other areas of your life?
Question
• What is the main idea?
• How do the photos, charts, graphs, and maps support the main idea?
Visualize
• Pay careful attention to details and descriptions.
• Create graphic organizers to show relationships that you find in the information.
Notice Comparison and Contrast Sentences
• Look for clue words and phrases that signal comparison, such as similarly, just as, both,
in common, also, and too.
• Look for clue words and phrases that signal contrast, such as on the other hand, in contrast
to, however, different, instead of, rather than, but, and unlike.
Notice Cause-and-Effect Sentences
• Look for clue words and phrases, such as because, as a result, therefore, that is why,
since, so, for this reason, and consequently.
Notice Chronological Sentences
• Look for clue words and phrases, such as after, before, first, next, last, during, finally,
earlier, later, since, and then.
After You Read
Summarize
• Describe the main idea and how the details support it.
• Use your own words to explain what you have read.
Assess
• What was the main idea?
• Did the text clearly support the main idea?
• Did you learn anything new from the material?
• Can you use this new information in other school subjects or at home?
• What other sources could you use to find more information about the topic?
To the Student 1
Unit 1
Planning
Personal
Finances
Internet
Project
One Life to Plan
Financial planners help people plan for paying for
college or retirement, and then show them how to
save to reach those goals. Life planners assist clients
to pinpoint what they want out of life, and then use
financial planning to help people achieve it. In this
project, you will weigh the pros and cons of each
career and decide which one might best suit you.
Log on to finance07.glencoe.com. Begin
your WebQuest by reading Task 1. Then
continue working on your WebQuest as you
study Unit 1.
Section 1.2 2.2 3.2 4.1
Page 25 52 71 96
2 finance07.glencoe.com
FINANCE FILE
Which Adviser
Knows the Way?
Almost anyone can claim to be a
financial planner or investment adviser.
If you’re looking for an adviser for the first
time—you need to figure out how much
and what kind of advice you need. If all
you want are some suggestions for your
IRA or your investment portfolio, you
could get that through Charles Schwab or
Fidelity Brokerage Services for a fee of
about $250.
But there’s more to your financial
well-being than stocks and bonds. Do
you have a debt-management problem?
Do you have enough insurance, and is
your estate in order?
And what about credentials? Certi-
fied Financial Planner (CFP) is the most
recognized designation. CFPs have com-
prehensive education and must pass a
ten-hour certification exam and have
at least three years’ experience before
qualifying.
The irony is that most people seek
advisers to relieve the burden of man-
aging their finances themselves. But it’s
a burden in itself to make sure you’ve
got the right adviser.
— By Lewis Braham
with Amy Borrus
Write About It Why should
you know how to plan your
personal finances even if you can hire
a financial planner?
Log On To read the complete
BusinessWeek article and do the
BusinessWeek Extension activity to
help you learn more about financial
and life planning, go to
finance07.glencoe.com.
finance07.glencoe.com 3
1
CHAPTER
Personal Financial
Planning
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 1.1
• Define personal financial
planning.
• Name the six steps of financial
planning.
• Identify factors that affect
personal financial decisions.
Section 1.2
• Explain opportunity costs
associated with personal
financial decisions.
• Identify eight strategies for
achieving financial goals at
different stages of life.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
4 Unit 1 Planning Personal Finances
In the Real World . . .
L aurel Marquez is a high school senior who works part-
time at a sporting goods store. She hopes to make enough money to
attend junior college without having to get a student loan. Her brother Rick
is a junior who works at a bicycle shop. He is trying to save enough money to
go on a long-distance cycling trip during the summer.
Rick and Laurel enjoy going to restaurants and seeing movies and concerts.
However, to reach their goals, they will have to watch their spending. Al-
though they are still in high school, the financial habits they develop now
will pay off in the long run. Setting financial goals will help them
avoid debt and achieve financial security in the future.
As You Read Consider how personal values affect
Rick and Laurel’s financial goals.
The Money Plan
ASK Q: I am a high school student. I do not have
money for investments or buying property. So
what difference does it make how I spend my money now?
A: You will not always be a student. Learning to save and use money wisely now will
help you know how to achieve financial security in the future. While you are in high school,
financial planning can help you decide how to spend, save, and invest your money for
special purchases or activities that matter to you. You may even be able to buy stock!
Ask Yourself What item do you think you could buy if you saved some
money for several months? Explain why this would be financial planning.
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com Chapter 1 Personal Financial Planning 5
Section #.#
1.1
Focus on
Reading
Financial Decisions
and Goals
Read to Learn
• How to define personal Personal Financial Decisions
financial planning.
What are the benefits of financial planning?
• How to name the six
steps of financial What is personal finance? It is everything in your life that
planning. involves money. Personal financial planning is arranging to
• How to identify factors spend, save, and invest money to live comfortably, have financial
that affect personal security, and achieve goals. Everyone has different financial goals.
financial decisions. Goals are the things you want to accomplish. For example, getting
a college education, buying a car, and starting a business are goals.
Main Idea Planning your personal finances is important because it will help you
The financial planning to reach your goals, no matter what they are. It is up to you to make
process can help you
reach your financial goals.
and follow a financial plan.
Some of the benefits of planning are:
Key Terms • You have more money and financial security.
• personal financial • You know how to use money to achieve your goals.
planning • You have less chance of going into debt you cannot handle.
• goals
• You can help your partner and support your children, if you
• values
• opportunity cost have a family.
• liquidity Whether you are spending, saving, or investing money, planning
• service
can help you to make big or small financial decisions. The financial
• good
• economics planning process has six steps to help you reach your goals.
• economy
• supply STEP 1: Determine Your Current
• demand
• Federal Reserve System Financial Situation
• inflation
• consumer To figure out your current financial situation, make a list of
• interest items that relate to your finances:
• Savings
• Monthly income (job earnings, allowance, gifts,
and interest on bank accounts)
Before • Monthly expenses (money you spend)
You Read • Debts (money you owe to others)
PREDICT A good way to estimate your expenses is to keep a careful record
List three of your financial of everything you buy for one month. You can use a small notebook
goals. to track your expenses. When you have determined your financial
situation, you will be able to start planning.
6 Unit 1 Planning Personal Finances
STEP 2: Develop Your Financial Goals
To develop clear financial goals, think about your attitude
toward money and ask yourself some questions: Is it more important
TechByte
Using Software There
to spend your money now or to save for the future? Would you rather are many software prod-
get a job right after high school or continue your education? Do your ucts on the market today
personal values affect your financial decisions? Values are the beliefs designed to help you
and principles you consider important, correct, and desirable. Differ- keep track of your per-
sonal finances. One of
ent people value different things.
the first and most popu-
Needs and Wants Another important aspect of developing finan- lar is Quicken®. Features
cial goals is knowing the difference between your needs and your allow you to track and
pay bills and see if you
wants. A need is something you must have to survive, such as food,
have enough money to
shelter, and clothing. A want is something you desire or would like cover upcoming bills.
to have or do. For example, if you live in an area where the winter is You can also schedule bill
cold, you need a coat. So you may want a leather jacket, but other less payments and deposits.
expensive coats would also keep you warm.
Describe the infor-
Only you can decide what specific goals to pursue. For example, mation given on
you might want to save money. So, you could save $50 every month the Quicken monthly
or 15 percent of every paycheck. view screen by read-
ing information through
finance07.glencoe.com.
STEP 3: Identify Your Options
It is impossible to make a good decision unless you know all
your options. Generally, you have several possible courses of action.
Suppose that you are saving $50 a month. You might have these
options:
• Expand the current
situation. You may decide to
increase the amount of money
you save every month to $60.
• Change the current
situation. You could invest in
stocks instead of putting your
money into a savings account.
• Start something new. You
could use the $50 to pay off
your debts.
• Continue the same course of
action. You may choose not to
change anything.
However, in each case, be aware
that the costs of your decision may
outweigh the benefits.
䊳 MONEY MATTERS Your values affect
your spending habits. Why might people
shop at vintage clothing stores or swap meets?
finance07.glencoe.com Chapter 1 Personal Financial Planning 7
STEP 4: Evaluate Your Alternatives
In this step, you evaluate your alternatives as part of the finan-
cial planning process. Use the many sources of financial information
that are available. (See Figure 1.1.) Look at your situation in life,
your present financial situation, and your personal values. Consider
the consequences and risks of each decision you make.
Sources of Financial Information It is important to keep up-
to-date with social and economic conditions because they can affect
your financial situation. For example, a company that manufactures
the latest technology or designs the trendiest clothes may be a good
investment. On the other hand, if you learn that the company is being
sued, would you invest in it?
Consequences of Choices When you choose one option, you
eliminate other possibilities. You cannot choose all options. Suppose
that you want to become a full-time college student. You also want the
income you would earn at a full-time job. In choosing to pursue your
education, you give up the opportunity to work full time, at least for
the moment. An opportunity cost, or a trade-off, is what is given
up when making one choice instead of another. The opportunity cost
of going to college would be the benefit of having a full-time job.
Figure 1.1 Get the Facts
1 2
Information on
financial planning Financial Specialists: Technology: computer
can come from many accountants, bankers, software and the Internet
sources: financial planners, insur-
ance agents, tax attorneys,
and tax preparers
8 Unit 1 Planning Personal Finances
However, choosing involves more than knowing what you might
give up. It also involves knowing what you would gain. For example, As You
by going to college, you could gain a higher-paying job. Read
Understanding Risks If you decide to ride your bicycle on a very RELATE
busy city street, you are taking a risk of having an accident. When What are your financial
you make a financial decision, you also accept certain financial risks. goals? Which goals are
Some types of financial risks include: needs and which goals are
wants?
• Inflation Risk—If you wait to buy a car until next year, you
accept the possibility that the price may increase.
• Interest Rate Risk—Interest rates go up or down, which may
affect the cost of borrowing or the profits you earn when you
save or invest.
• Income Risk—You may lose your job due to unexpected
health problems, family problems, an accident, or changes in
your field of work.
• Personal Risk—Driving for eight hours on icy mountain
roads may be hazardous. The risk may not be worth the money
you would save on airfare.
• Liquidity Risk—Liquidity is the ability to easily convert
financial assets into cash without loss in value. Some long-term
investments, such as a house, can be difficult to convert quickly.
3
The Media: books,
magazines, newsletters,
newspapers, radio, and
television
4 Financial Institutions:
banks, credit unions,
insurance and investment
companies, and savings
and loan associations
5 Education: high school
and college courses and
seminars
Chapter 1 Personal Financial Planning 9
STEP 5: Create and Use Your Financial
Plan of Action
A plan of action is a list of ways to achieve your financial goals. If
your goal is to increase your savings, a plan of action could be to cut
back on spending. If you want to increase your income, you might
get a part-time job or work more hours at your present job. You could
use the extra money you earn to pay off debts, save money, purchase
stocks, or make other investments.
STEP 6: Review and Revise Your Plan
Financial planning continues as you follow your plan. As you
get older, your finances and needs will change. That means that your
financial plan will have to change too. You should reevaluate and
revise it every year.
Developing Personal
Financial Goals
What should you consider to set financial
goals for yourself?
Why do so many people have money problems? The main rea-
son is that they do not plan how they will use their money. You can
Common avoid money problems by planning with some clear financial goals
CENTS in mind.
Pay Yourself First Types of Financial Goals
When you receive your
paycheck, pay yourself Two factors will influence your planning for financial goals. The
first. This means that first factor is the time frame in which you would like to achieve your
before you pay bills or goals. The second factor is the type of financial need that inspires
buy anything, you should your goals.
put something into your
savings account—even a Time Frame of Goals Goals can be defined by the time it takes to
small amount. Think of achieve them:
it as paying yourself. Try
saving a percentage of • Short-term goals take one year or less to achieve (such as
your take-home pay or saving to buy a computer).
allowance—1 percent the • Intermediate goals take two to five years to achieve (such as
first month, 2 percent the saving for a down payment on a house).
second month, and so
forth. Then sit back and
• Long-term goals take more than five years to achieve (such
watch your money grow. as planning for retirement).
If your take-home pay is
Start with short-term goals that may lead to long-term ones.
$860 a month and you
save the percentages listed Some goals, such as having money for the holidays or other special
above for 12 months, how occasions, occur every year. Other goals, such as buying a car, may
much would you have? come up only occasionally. What are some of your short-term, inter-
mediate, and long-term financial goals?
10 Unit 1 Planning Personal Finances
Careers in Finance
CREDIT ANALYST
PERSONAL BANKER Jason Lee
National Bank
Working as a personal banker for National Bank, Jason develops, manages, and expands customer
relationships. His challenge is to recognize the needs of the customers and match them to the ser-
vices offered by his branch. His clients range from high school students, who are opening their first
savings and checking accounts, to businesspeople, who are seeking very precise financial products
and services. Jason enjoys working with a wide variety of customers and gains satisfaction from help-
ing them reach their financial goals.
SKILLS: Communication, customer-service, computer, interpersonal, math, sales,
cross-selling, and second language skills
PERSONAL TRAITS: Good judgment, likes working with people, tactful, detail oriented, ability to
adapt to a flexible schedule in a high-volume environment
EDUCATION: Associate degree or bachelor’s degree with a major in business administration
or economics
ANALYZE Banking services are increasingly offered via ATMs, the telephone, or online. Explain why
personal bankers are still in demand.
To learn more about career paths for personal bankers, visit finance07.glencoe.com.
Goals for Different Needs The need to have your hair cut at a salon
is different from the need to buy a new car. A haircut is a service, or a
task that a person or a machine performs for you. A new car is a good,
or a physical item that is produced and can be weighed or measured.
You might buy a soda every day. You might buy a new car every five or
six years. How you establish and reach your financial goals will depend
on whether a goal involves the need for consumable goods (such
as a soda), durable goods (such as a car), or intangible items (such
as an education):
• Consumable goods are purchases that you make often and
use up quickly. Food and products, such as shampoo and
conditioner, are in this category. Although the cost of such As You
items may not equal the cost of a car, the costs of consumable Read
goods add up. QUESTION
• Durable goods are expensive items that you do not purchase
often. Most durable goods, such as cars and large appliances, Think about consumable
goods, durable goods, and
will last three years or more when used on a regular basis.
intangibles. Over the long
• Intangible items cannot be touched but are often important term (ten years or more),
to your well-being and happiness. Examples of intangibles which category do you
include your personal relationships, health, education, and free think has the highest cost?
time. Intangibles are often overlooked but can be expensive.
finance07.glencoe.com Chapter 1 Personal Financial Planning 11
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: A Monthly Budget Your Motive: A monthly budget work-
Worksheet sheet helps you analyze and compare
A monthly budget worksheet contains the your monthly expenses to the income you
following information: receive each month. This analysis helps
you plan your spending.
• Income • Other income
• Payroll • Expenses
deductions • Income less
• Take-home pay expenses
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Key Points: You create a budget by Find the Solutions
determining your take-home income. Take- 1. Explain the difference between fixed
home income is the difference between your expenses and variable expenses.
wages and deductions. Taxes, union dues, 2. List other possible expenses that are not
and health insurance are wage deductions. listed on this worksheet.
3. Decide if Janet has enough monthly income
Expenses are also listed. Some expenses are
for monthly expenses.
fixed. They do not change. Variable expenses
4. Explain why utilities are a variable expense.
change each month. Discretionary expenses
5. Suggest ways this budget can be balanced.
do not include expenses for basic needs.
12 Unit 1 Planning Personal Finances
Guidelines for Setting Goals
How can you make good financial decisions? You must identify
your goals. Then identify the time frame for achieving each goal and the
type of need. However, these factors will change as you go through life.
The financial goals you set as a student will be different from the goals LANGUAGE ARTS
you may have if you marry or have children. Figure 1.2 shows exam- Look at Figure 1.2 and
consider setting some
ples of financial goals and activities related to various life situations.
financial goals for yourself.
When setting your financial goals, follow these guidelines: Think of three goals. Write
1. Your financial goals should be realistic. them down, explaining
how each meets the four
2. Your financial goals should be specific.
guidelines.
3. Your financial goals should have a clear time frame.
4. Your financial goals should help you decide what type of
action to take.
Figure 1.2 Financial Goals and Activities for Various Life Situations
Life Situation Financial Goals and Activities
Young single adult • Obtain career training.
• Become financially independent.
• Obtain health insurance.
• Develop a savings plan.
• Carefully manage your use of credit.
Young couple with no children • Create an effective financial record-keeping system.
• Obtain adequate health and life insurance.
• Implement a budget.
• Carefully manage your use of credit.
• Develop a savings and investment program.
Couple with young children • Purchase a home.
• Obtain adequate health and life insurance.
• Start a college fund.
• Make a will and name a guardian for your children.
Single parent with young children • Obtain adequate health, life, and disability insurance.
• Make a will and name a guardian for your children.
• Establish an emergency fund.
Middle-aged, single adult • Contribute to a tax-deferred retirement plan.
• Evaluate and select appropriate investments.
• Accumulate an adequate emergency fund.
• Review will and estate plans.
Older couple with no children at home • Plan retirement housing, living expenses, and activities.
• Obtain health insurance for retirement.
• Review will and estate plans.
Economic Conditions Your financial needs and goals change at different stages of life.
What are some goals you will have ten years from now that you
do not have today?
Chapter 1 Personal Financial Planning 13
Influences on Personal
Financial Planning
Good Financial What factors can influence your personal
Habits financial planning?
1. Save money every
time you get paid. Many factors will influence your day-to-day decisions about
2. Spend less than finances. The three most important factors are:
you make.
• Life situations
3. Work out a budget
• Personal values
and stick to it.
• Economic factors
4. Pay your bills and
taxes on time.
5. Balance your check- Life Situations and Personal Values
book every month.
As you enter adulthood, you will experience many changes.
You may go to college, start a new career, get married, have chil-
dren, or move to a new city. These new life situations will affect
your financial planning. Your personal values also influence your
financial decisions.
For example, Angela just graduated from high school and will be
going to college in the fall. She will move out of her parents’ house
and live in the college dorm. Angela is beginning a new and exciting
stage in her life. She values independence, and so she plans to move
to an apartment with a roommate in her sophomore year. She will
experience more personal freedom, but with her independence will
also come more financial responsibility.
Economic Factors
Economic factors across the country and around the world
can affect personal finances. They play a role in day-to-day finan-
cial planning and decision making for most people. Economics
is the study of the decisions that go into making, distributing, and
using goods and services. The economy consists of the ways in
which people make, distribute, and use their goods and services. To
understand economics and the economy, you need to be aware of
the market forces, financial institutions, global influences, and eco-
nomic conditions that affect global as well as personal decisions.
Market Forces The forces of supply and demand determine the
prices of products, or goods and services, you purchase. Supply is
the amount of goods and services available for sale. Demand is the
amount of goods and services people are willing to buy. When there is
a high demand for an item, such as a popular toy, or when a company
cannot manufacture enough of a certain product to keep up with the
demand, the price of the product rises. When there is little demand
for a product, or when a company produces more than it can sell, the
price of the product drops.
14 Unit 1 Planning Personal Finances
Financial Institutions Most people do business with financial
institutions, which include banks, credit unions, savings and loan
associations, insurance companies, and investment companies.
Financial institutions provide services that increase financial activity
in the economy. For example, they handle savings and checking
accounts, provide loans, sell insurance, and make investments for
their clients.
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis-
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals
to help them guide their financial decisions. .EW $ELHI
INDIA
Most travelers to India expect to see a country
carved out of 5,000-year-old traditions, but they also
find modern-day landmarks that look like home.
Driven by a booming economy and growing incomes
DATABYTES
in large cities, Indians have become avid consumers
of Western culture. Fast-food chains and sprawling
Capital New Delhi
malls dot the ancient landscape. Teenagers wear the
Population 1,086,572,000
latest fashions. In fact, India also boasts a growing
fashion design industry. Imported cosmetics are popu- Language Hindi, English, and 14 other
lar, and beauty pageants are national events. On a official languages
one-mile stretch of a typical city of India, construction Currency Indian rupee
takes place to accommodate more than 40,000 multi- Gross Domestic
national technology and service workers. Product (GDP) $3.02 trillion (2003 est.)
A decade ago, GDP per capita $2,900
when India opened its
Industry: Textiles, chemicals, food processing, steel,
doors to the world, crit-
transportation equipment, cement, and mining
ics labeled this kind
Agriculture: Rice, wheat, oilseed, cotton, cattle,
of expansion as cor-
and fish
ruptive. But as foreign
businesses pour billions Exports: Textile goods, gems and jewelry, engineering
into the country, some goods, chemicals, and leather
say the modernization Natural Resources: Coal, iron ore, manganese, mica,
is too slow. One young and bauxite
Indian laments, “Night
Think Globally
life is nonexistent.”
Working Indian teens spend money to keep up with the
times. Many of them like the same things American
teens like. Create a budget for a typical Indian teen.
Chapter 1 Personal Financial Planning 15
Among the various government agencies that regulate the finan-
cial activities of financial institutions, the Federal Reserve System has a
significant responsibility in the U.S. economy. The Federal Reserve
System, or the Fed, is the central banking organization of the United
States. Its primary role in the U.S. economy is the regulation of the
money supply. The Fed controls the money supply by determining
interest rates and by buying or selling government securities. Its deci-
sions affect the interest rate you earn on your savings, the interest
rate you pay when you borrow money, and to some extent the prices
of the products you buy.
Global Influences You and the money you spend are part of the
global marketplace, which is another economic factor that can affect
financial planning. Look at the items in your home or classroom and you
will discover that many of the products were made in other countries.
The economy of every nation is affected by competition with
other nations. Each country wants consumers in other countries to
buy their products. When other countries sell more goods to the
United States than U.S. companies can sell in those markets, more
money leaves the United States than enters it. Then less money is
available for spending and investing, and interest rates may rise.
These global influences also affect financial decisions.
Economic Conditions Current economic conditions also affect
your personal financial decisions. Figure 1.3 shows how economic
conditions can influence financial planning. There are three impor-
tant economic conditions:
1. Consumer prices
2. Consumer spending
3. Interest rates
• Consumer Prices Over time the prices of most products
go up. This rise in the level of prices for goods and services is
called inflation. During times of rapid inflation, it takes more
money to buy the same amount of goods and services. For
example, if the rate of inflation is 5 percent, then a computer
that cost $1,000 a year ago would now cost $1,050 if the
computer price increased at the inflationary rate.
The main cause of inflation is an increase in demand without
an increase in supply. For example, if people have more money
to spend because of pay increases or borrowing, but the same
amounts of goods and services are available, then prices will rise.
Inflation can be especially hard on certain groups, such as
retired people whose income may not increase. The inflation
rate affects consumer prices and varies from year to year. In
the early 1960s, the annual inflation rate was between 1 and
3 percent. In the late 1970s and early 1980s, the inflation rate
climbed to 10–12 percent each year. More recently it slowed to
2–4 percent each year.
16 Unit 1 Planning Personal Finances
• Consumer Spending A consumer is a person who
purchases and uses goods or services. You are a consumer
whenever you buy anything—a CD, books, clothes, lunch, or
even a haircut. Consumer spending affects the economy by
helping to create and maintain jobs. When people buy more
goods or services, companies have to hire extra employees
to meet the demand. This situation leads to a higher rate
of employment, making more jobs available. More people
work, and they have more money to spend. However, when
consumers buy fewer goods and services, companies have to
produce less and lay off workers. Then unemployment rises,
making jobs harder to find.
Figure 1.3 Economic Conditions and Financial Planning
Economic Condition What It Measures How It Influences Financial Planning
Consumer prices The value of a dollar; changes in If consumer prices increase faster than wages, the
inflation value of the dollar decreases—a dollar buys less
than it did before. Consumers tend to buy fewer
goods and services. Lenders charge higher interest
rates.
Consumer Demand for goods and services by Increased consumer spending usually creates more
spending individuals and households jobs and higher wages. Reduced consumer spending
causes unemployment to increase.
Interest rates Cost of money, cost of credit when Higher interest rates make borrowing money more
you borrow, and the return on expensive and make saving more attractive. When
your money when you save interest rates increase, consumer prices tend to
or invest increase.
Money supply The dollars available for spending The Federal Reserve System (Fed) sometimes
in our economy adjusts interest rates in order to increase or
decrease the amount of money circulating in the
economy. If the Fed lowers interest rates, the money
supply increases. If the Fed raises interest rates, the
money supply decreases.
Unemployment The number of people without Low unemployment increases consumer spending.
jobs who are willing and able High unemployment reduces consumer spending.
to work
Gross domestic Total dollar value of all the goods The GDP provides an indication of how well people
product (GDP) and services produced in a country are living in a country.
in one year
Economic Conditions Economic conditions you cannot control will affect your financial planning.
Choose an economic condition listed above, and explain how it
affects your life today.
Chapter 1 Personal Financial Planning 17
• Interest Rates Like everything else, money has a price,
and this price is called interest. Interest is the price that is
paid for the use of another’s money. Interest rates also affect
the economy. When you deposit your paycheck in a savings
account, the interest you receive is money the bank or another
financial institution pays you for the use of your money. The
bank, in turn, uses your money to make loans to people who
want to purchase items such as houses, automobiles, and new
businesses. Borrowers who receive the loans must pay a fee, or
interest to the bank or lending institution.
Interest rates represent the cost of money. When consumers
increase their savings and investments, the supply of money that is
available for others to borrow grows, and interest rates go down. When
consumers borrow more money, the demand for money increases,
and interest rates go up.
Interest rates on loans also rise during times of inflation. Inter-
est rates will affect your financial planning, whether you save, invest,
or obtain loans. The amount of earnings you receive from your sav-
ings account or the interest you pay on a loan depend on the current
interest rates. Interest rates are just one facet of the economic factors
that influence your personal financial planning.
Section 1.1 Assessment
QUICK CHECK Role-Play With a partner, role-play
1. What are the six steps used to create a a response to your friend’s philoso-
financial plan? phy. Explain how planning, more than
2. What is the relationship between the tim- luck, determines financial success or failure.
ing of your goals and the type of good or
SOLVE MONEY PROBLEMS
service that you want?
3. What are two economic factors that affect 6. Financial Planning Process Rosa and
financial decisions? How might these fac- her best friend, Linda, live in Chicago and
tors influence your financial planning? want to drive cross-country next year. Both
work part-time and earn $97 a week after
THINK CRITICALLY taxes. They need to save at least $500 each
4. Why is it important to distinguish between to pay for the trip. They plan to visit Rosa’s
your needs and your wants? aunt, who lives in Albuquerque, and Lin-
da’s brother in Los Angeles.
USE COMMUNICATION SKILLS Write About It Help Rosa and
5. Left to Chance? You are talking to a Linda apply the six steps of the finan-
friend who says that she never sets any cial planning process to reach their goal.
financial goals and that her financial suc- Write a six-step plan for them.
cess or failure happens by luck.
18 Unit 1 Planning Personal Finances
Section 1.2
Opportunity Costs Focus on
Reading
and Strategies
Read to Learn
• How to explain opportu-
Personal and Financial nity costs associated
Opportunity Costs with personal financial
decisions.
What are personal and financial opportunity costs? • How to identify eight
As discussed in Section 1.1, whenever you make a choice, you strategies for achieving
financial goals at differ-
have to give up, or trade off, some of your other options. When mak-
ent stages of life.
ing your financial decisions and plans, consider both the personal
and financial opportunity costs carefully. Main Idea
By recognizing the trade-
Personal Opportunity Costs offs of financial decisions
and learning to use your
Like financial resources, your personal resources—your health, money wisely now, you will
knowledge, skills, and time—require management. Do you eat a be able to live according to
lot of junk food and avoid exercise? Do you get enough sleep each your values and meet your
night? The decisions you make about your health now can have con- financial needs and goals
throughout your life.
sequences as you get older.
In much the same way, the financial decisions you make today
will affect your financial health in the future. For example, suppose
Key Terms
• time value of money
that you and your friends have tickets to a sold-out concert this Thurs-
• principal
day night. On Thursday afternoon your algebra teacher announces • future value
an important test for Friday. You must decide whether you will go to • annuity
the concert, study for the test, or somehow do both. The opportunity • present value
cost of going to the concert might be getting a good grade on the
test. You have to decide how to use your time to meet your needs, to
achieve your goals, and to satisfy your values.
Before
Financial Opportunity Costs You Read
You also must make choices about how you spend money. For PREDICT
example, would you buy the $129 pair of sneakers you saw at the Why do you think you may
mall or save that money? You cannot do both, because most people have to make trade-offs to
have a limited amount of money. To help make choices, consider meet your financial goals?
the time value of money, which is the increase of an amount of
money due to earned interest or dividends. If you decide to save or
invest the $129 instead of buying the sneakers, that money could be
worth more later because you would earn interest or dividends on it.
Chapter 1 Personal Financial Planning 19
䊱 TIMING YOUR FUN Managing your time by making trade-offs is as
important as managing your money. How can you use your time more
efficiently when studying so you will also have time to do things you enjoy?
On the other hand, perhaps your sneakers are worn out. In that case,
your current needs would determine that trading off interest earnings
is worthwhile.
Every time you spend, save, or invest money, think about the
time value of that money as an opportunity cost. For example, if you
start early in life to save money for retirement, you will probably be
able to live comfortably in the future.
Calculating Interest You can calculate the time value of your
savings by figuring out how much interest you will earn. To do this,
you need to know the principal, the annual interest rate, and the
length of time your money will be in an account.
For a savings account, the principal is the original amount of
As You money on deposit. (For a loan, the principal is the amount that you
Read borrow.) When you open a savings account, the bank or financial
RELATE institution identifies the interest rate for your account. This is usually
given as an annual percentage so that you know how much you will
Is it important to start plan- earn each year. By comparing interest rates at several financial insti-
ning your financial future tutions, you can figure out which one will make your money grow
and monitoring your costs
the fastest.
at your age now? Why or
why not? You can figure out how much interest your money will earn in
the first year by multiplying the principal by the annual interest rate.
20 Unit 1 Planning Personal Finances
GO FIGURE FINANCIAL MATH
ANNUAL INTEREST Formula: Principal Annual Interest Rate Inter-
est Earned for One Year
Synopsis: Interest is extra money earned from
money in an account. Solution: $1,000 .03 $30
Example: You just deposited $1,000 in a savings You will earn $30 in interest.
account. The bank will pay you 3 percent annual
interest. How much interest will you earn if you keep YOU FIGURE
your money in the bank for one year? What if your sister deposited $50 for one year at
the same interest? How much would she have?
Future Value of a Single Deposit Future value is the amount your
original deposit will be worth in the future based on earning a specific
interest rate over a specific period of time. Figure out how much your
savings will earn and grow by multiplying the principal by the annual
interest rate and then adding that interest amount to the principal.
You can determine the future value for two years, three years,
and so on. Each year, interest is earned on your principal and on pre-
viously earned interest.
To calculate the interest earned for the second year, add interest
earned in the first year to the principal. Then take that amount and
multiply it by the annual interest rate.
Future value computations are also called compounding. With
compounding, your money increases faster over time. If you make
deposits now, your money will have more time to increase.
GO FIGURE FINANCIAL MATH
THE FUTURE VALUE OF A Solution: ($1,000 $30) .03 $30.90
SINGLE DEPOSIT You will earn $30.90 in interest. Add this earned
Synopsis: When you earn interest from money you interest to your previous amount ($1,030 $30.90
deposit in the bank, your balance increases over time. $1,060.90). The future value of your original
$1,000 deposit will be $1,060.90 after two years.
Example: You just deposited $1,000 in a savings
account that will pay you 3 percent (.03) annual
interest. You earned $30 in interest after the first
year. How much will you earn after two years? YOU FIGURE
Formula: (Principal Previously Earned Interest) What if you decided to deposit more money,
Annual Interest Rate Interest Earned for the say, $1,500? With 3 percent annual interest, how
Second Year much would you have after three years?
Chapter 1 Personal Financial Planning 21
Future value tables simplify the process of figuring out the effect
As You of compounding. Many online future value calculators are available.
Read The table in Part A of Figure 1.4 shows the future value of a sin-
QUESTION gle deposit of $1. To use the table, find the annual interest rate that
your money is earning. Then see what the future value is at Year 5,
Why should you know the Year 6, and so on. Multiply the future value figure by the amount of
future value of a deposit
your deposit. For example, if you deposit $1 in a 7 percent account,
when making financial plans?
at the end of Year 7, you would have $1.61:
$1 1.606 $1.606
Future Value of a Series of Deposits Some savers and investors
like to make regular deposits into their savings. A series of equal
regular deposits is sometimes called an annuity. Use Part B of the
chart in Figure 1.4 (future value of a series of equal yearly deposits) to
find out the future value of $1,000 a year at 5 percent annual interest
for six years. At the end of the six years, you would have $6,802:
$1,000 6.802 $6,802
Present Value of a Single Deposit You can also calculate the
present value, which is the amount of money you would need to
deposit now in order to have a desired amount in the future. For
example, if you want to have $1,000 in five years for a down payment
on a car, and your savings account pays 5 percent annual interest, how
much money will you need to deposit now to accumulate $1,000?
Part C of Figure 1.4 will help you find the answer. Find Year 5 in the
left column, and look across to the 5 percent interest-rate column.
The value given is 0.784. Multiply this value by the amount of money
you want to have in five years:
$1,000 0.784 $784
You need to deposit $784 now to have $1,000 in five years.
Present Value of a Series of Deposits You can also use present
value calculations to determine how much you would need to deposit
so you can take a specific amount of money out of your savings
Put on account for a certain number of years. If you want to take $400 out
Your of your account each year for nine years, and your money is earning
interest at 8 percent a year, how much money would you need to
Financial deposit now? Part D of Figure 1.4 will help you find the answer. Find
Planner’s Year 9 in the left column and look across to the 8 percent interest-rate
Cap column. The value given is 6.247. Multiply this value by the amount
of money that you want to take out every year:
If you were planning an
investment for yourself, $400 6.247 $2,498.80
would you choose an
annuity? Why or why not?
You need to deposit $2,498.80 now to be able to take out $400
each year for nine years. This calculation is used for retirement.
22 Unit 1 Planning Personal Finances
Figure 1.4 Future and Present Value Tables
A. Future Value of a Single Deposit of $1
Annual Interest Rate
Year 5% 6% 7% 8% 9%
5 1.276 1.338 1.403 1.469 1.539
6 1.340 1.419 1.501 1.587 1.677
7 1.407 1.504 1.606 1.714 1.828
8 1.477 1.594 1.718 1.851 1.993
9 1.551 1.689 1.838 1.999 2.172
10 1.629 1.791 1.967 2.159 2.367
B. Future Value of a Series of Equal Annual Deposits
Year 5% 6% 7% 8% 9%
5 5.526 5.637 5.751 5.867 5.985
6 6.802 6.975 7.153 7.336 7.523
7 8.142 8.394 8.654 8.923 9.200
8 9.549 9.897 10.260 10.637 11.028
9 11.027 11.491 11.978 12.488 13.021
10 12.578 13.181 13.816 14.487 15.193
C. Present Value of a Single Deposit
Year 5% 6% 7% 8% 9%
5 0.784 0.747 0.713 0.681 0.650
6 0.746 0.705 0.666 0.630 0.596
7 0.711 0.665 0.623 0.583 0.547
8 0.677 0.627 0.582 0.540 0.502
9 0.645 0.592 0.544 0.500 0.460
10 0.614 0.558 0.508 0.463 0.422
D. Present Value of a Series of Equal Annual Deposits
Year 5% 6% 7% 8% 9%
5 4.329 4.212 4.100 3.993 3.890
6 5.076 4.917 4.767 4.623 4.486
7 5.786 5.582 5.389 5.206 5.033
8 6.463 6.210 5.971 5.747 5.535
9 7.108 6.802 6.515 6.247 5.995
10 7.722 7.360 7.024 6.710 6.418
Time Is Money Future value tables can save you time and reduce errors when you compute interest
over a long period of time. Present value tables can help you figure out how much
you need to deposit now in order to have a certain amount of money in the future.
How much money will you have if you save $2,000 a year for ten years
at 9 percent interest?
Chapter 1 Personal Financial Planning 23
After You Achieving Your Financial Goals
Read What strategies can you use to reach your
financial goals?
REACT
Throughout your life you will have many different financial
Do you think financial plan- needs and goals. By learning to use your money wisely now, you will
ning and the strategies
be able to achieve many of those goals.
provided in this book can
help you to achieve your Financial planning involves choosing a career, and then learn-
goals? If yes, in what ways? ing how to protect and manage the money you earn. By using eight
If no, why not? strategies, you can avoid many common money mistakes:
1. Obtain—Obtain financial resources by working, making
investments, or owning property. Obtaining money is the
foundation of financial planning because you will use that
money for all other financial activities.
2. Plan—The key to achieving your financial goals and finan-
cial security is to plan how you will spend your money.
3. Spend Wisely—Many people spend more than they can
afford. Other people buy things they can afford but do not
need. Spending less than you earn is the only way to achieve
financial security.
4. Save—Long-term financial security starts with a savings plan.
If you save on a regular basis, you will have money to pay
your bills, make major purchases, and cope with emergencies.
5. Borrow Wisely—When you use a credit card or take out
another type of a loan, you are borrowing money. Borrow-
ing wisely—and only when necessary—will help you achieve
your financial goals and avoid money problems.
6. Invest—People invest for two
main reasons: to increase their
current income and to achieve
long-term growth. To increase
current income, you can choose
investments that pay regular
dividends or interest. To achieve
long-term growth, you might
choose stocks, mutual funds, real
estate, and other investments that
have the potential to increase in
value in the future.
䊴 RISKY BUSINESS Accidents can
happen when you least expect them.
What are some ways to manage the
financial risks associated with sports
accidents?
24 Unit 1 Planning Personal Finances
7. Manage Risk—To protect your resources in case you are
ever seriously injured, get sick, or die, you will need insur-
ance coverage. Insurance will protect you and those who
depend on you.
8. Plan for Retirement—When you start to plan for retire- One Life to Plan
ment, consider the age at which you would like to stop Learn about how financial
working full time. You should also think about where you counselors help people
get out of debt and plan
will want to live and how you will want to spend your time:
for the future—just one
at a part-time job, doing volunteer work, or enjoying hob- aspect of a financial plan-
bies or sports. ner’s job.
To continue with
Developing and Using a Financial Plan Task 2 of your
WebQuest project, visit
A good personal financial plan includes assessing your present finance07.glencoe.com.
financial situation, making a list of your current needs, and deciding
how to plan for future needs. You can design a plan on your own,
hire a financial planner, or use a good money-management software
program. Making your financial plan work takes time, effort, and
patience, but you will develop habits that will give you a lifetime of
satisfaction and security.
Section 1.2 Assessment
QUICK CHECK Calculate Using the tables in Figure
1. What are the opportunity costs associated 1.4, calculate what amount Tanya will
with financial decisions? have available in five years to start her busi-
2. What is the time value of money? ness. How much more money will she need
3. What are the eight strategies you can apply to save?
to achieve your financial goals?
SOLVE MONEY PROBLEMS
THINK CRITICALLY 6. Saving Versus Spending Omar received
4. Using the concept of the time value of $1,525 in gifts when he graduated from
money, write an argument in favor of shop- high school. His parents want him to save
ping for a good interest rate. the money for college, but Omar wants to
buy new clothes, a watch, some CDs, and a
USE MATH SKILLS video game. He also needs new tires because
5. Saving Strategies Tanya wants to open the ones on his car are badly worn. Omar
her own pet-grooming business after she asks you for advice. How should he spend
graduates from high school. However, after his graduation money?
doing research, she realizes that she needs Analyze Working in a small group,
to save $18,000 for the start-up capital for discuss what Omar should do with
her business. Tanya plans to make a series of his money. Consider the various financial
deposits of $3,000 every year for five years. opportunity costs and the time value of
She estimates that she will earn an annual money.
interest rate of 5 percent on her savings.
finance07.glencoe.com Chapter 1 Personal Financial Planning 25
Chapter 1 Review & Activities
CHAPTER SUMMARY
• Personal financial planning means • The most important factors that
managing your money (spending, influence personal financial planning
saving, and investing) so that you can are your life situations, your personal
achieve financial independence and values, and outside economic factors.
security. • For all your financial decisions, you
• The six steps of financial planning are: must make choices and give up
(1) Determine your current financial something. These opportunity costs, or
situation; (2) develop financial goals; trade-offs, can be personal or financial.
(3) identify alternative courses of action; • The eight strategies for achieving your
(4) evaluate alternatives; 5) create and financial goals and avoiding money
use your financial plan of action; and problems are: Obtain, plan, spend, save
(6) review and revise your plan. wisely, borrow wisely, invest, manage
risk, and plan for retirement.
Communicating Key Terms
Find an article on unemployment, inflation, interest rates, or the value of the U.S. dollar. Use
8 to 12 of the terms below and write three paragraphs relating the information in the article to
personal financial planning.
• personal financial • demand
planning • Federal Reserve System
• goals • inflation
• values • consumer
• opportunity cost • interest
• liquidity • time value of money
• service • principal
• good • future value
• economics • annuity
• economy • present value
• supply
Reviewing Key Concepts
1. Explain personal financial planning and its importance.
2. Describe the six strategies of financial planning.
3. Describe the factors that affect personal financial decisions.
4. Explain opportunity costs and how they might affect your personal financial decisions.
5. List eight strategies for achieving financial goals.
26 Unit 1 Planning Personal Finances
Chapter 1 Review & Activities
Language Arts The prices of new electronic gadgets usually come
down over time.
Write About It Write a paragraph explaining why this might occur. Also
explain how those prices might affect your financial planning if you want to
buy certain items.
Current Interest Rates Find out from a bank or other financial
institution the current interest rate on a standard savings account. Find out
what other savings plans are available and their interest rates.
1. Calculate by using the interest rate on regular savings accounts to find
out the future value of your account after eight years if you deposit $1,600
in it every year.
2. Compute by using spreadsheet software to calculate and compare the
future values of your series of deposits based on the different interest rates
offered for other savings plans.
Connect with Global Economics Your brother works for a
company that makes components for DVD players. The company has started
to outsource some of its component assembly work to a country where
employees’ wages are much lower than in the United States. As a result,
the company can sell components at lower prices. However, your brother’s
employer has started to lay off employees at its U.S. plants. Your brother
believes he will have a job for two more years, but after that, he is not sure.
1. Research Use the Internet or library to research the trend to outsource
manufacturing of electronic products in countries such as China.
2. Think Critically Your brother comes to you and asks if you think he
should look for another job now. What would you say to him?
Interest Rates and Inflation Inflation (how much your money
will buy) and interest rates (how much your money will earn if saved) are
connected—and both of these economic factors should be considered in
your financial planning, particularly for long-term goals.
Log On Use an Internet search engine. Type “inflation and interest
rates.” Answer the following questions:
1. If inflation is low, how does that affect interest rates?
2. If inflation is high, how does that affect interest rates?
Newsclip: Internet Planning If your knowledge about personal
finance is limited, being Web and tech savvy will help you learn more.
O N L I N E
Finance is a frequent topic on the news and is easy to research.
Log On Go to finance07.glencoe.com and open Chapter 1. Learn
more about financial decisions and strategies. Write a list of ways you
can learn more about finance.
finance07.glencoe.com Chapter 1 Personal Financial Planning 27
Chapter 1 Review & Activities
YOUR SPENDING PROFILE
Being a saver or a spender is part of your personality. Here is a chance
to test your financial personality.
If someone gave you $200, what would you do with it? Read the options below and choose
three. Write the number of points for each of the three choices on a separate piece of paper.
Then add up your points.
_____ Take my closest friends out to eat and to the movies (5 points)
_____ Spend $50 on fun items and save the rest (3 points)
_____ Put the money toward my next car payment (1 point)
_____ Buy new clothes for school (3 points)
_____ Hit the nearest record store and buy several CDs (5 points)
_____ Buy a CD player (3 points)
_____ Get a cell phone (5 points)
_____ Buy a savings bond (1 point)
_____ Put it in a savings account for future education (1 point)
_____ Buy the hottest new concert tickets (5 points)
What do your choices say about you?
Big saver: If you scored 3–5, you are willing to give up things today so you can buy
something you want more tomorrow.
Middle of the roader: If you scored 7–11, you know how to use your money for current
needs while keeping an eye on the future.
Big spender: If you scored 13–15, you like to spend money!
28 Unit 1 Planning Personal Finances
Chapter 1 Review & Activities
Your Financial Portfolio
Getting Your Own Wheels
Are you dreaming of buying your own car? Olivia Johnson is. So far she has saved
$3,000. Olivia has her eye on a used car that costs $9,000. Olivia figures she can afford
a monthly car payment of no more than $200. Using the interest-rate table below,
Olivia calculates the monthly payment needed to repay her car loan by multiplying the
amount of the loan by the interest factor. She wants to pay off her loan in three years.
Olivia’s Loan Story
Cost of car $9,000.00
Less the down payment – 3,000.00
Amount of loan $6,000.00
Interest Rate of 8%
Months Interest Factor
12 (one year) 0.08698
24 (two years) 0.04522
36 (three years) 0.03133
48 (four years) 0.02441
Multiply loan amount by interest factor (0.03133) for 36 months
$6,000 X 0.03133 = $187.98
Olivia will pay $187.98 a month if she decides to borrow $6,000 for three years.
Calculate
Now look in your local newspaper for a car you would like to buy. How much will
it cost? Suppose you can afford 25 percent of the total price for a down payment. How
much money will you need to borrow to pay the complete cost of the car you want? On
a separate sheet of paper, calculate how much money you will need for your monthly
car payment. Calculate what your monthly payment will be if you paid off your loan in
1, 2, 3, or 4 years. (1) What is the total amount you will pay for your car if you pay it off
in 1, 2, 3, or 4 years? (2) How much interest will you pay on your loan? (3) Which pay-
ment plan would enable you to pay the least amount of money for your car? (4) Which
payment plan would have the lowest payments?
Chapter 1 Personal Financial Planning 29
2
CHAPTER
Finances and
Career Planning
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 2.1
• Identify the personal issues to
consider when choosing and
planning your career.
• Explain how education
and training affect career
advancement.
• Discuss the factors that
influence employment.
Section 2.2
• Describe effective strategies to
obtain employment.
• Identify sources of career
opportunities.
• Identify the financial and legal
issues to consider when looking
for employment.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
30
In the Real World . . .
G eorge Leonard is not sure what career to pursue. Since
graduating from high school, he has held jobs at a sandwich shop,
a bookstore, and an animal park. George learned about small businesses
while he was working. As a result, he has decided that he would like to run
his own business one day—perhaps a pet store.
Jessica Rodriguez, a high school junior, loves movies. She watches classic
films and edits her own short features on the computer. She hopes to work in
the film industry.
George and Jessica are not exactly sure what their careers will be, but
they realize they will need to make informed decisions.
As You Read Consider how education and training might
affect careers and job opportunities.
(overflow)
Planning for Life
ASK Q: Career plans are for people who do not know
what they want. I know already that I want a high-
paying job. So why should I bother thinking about career planning?
A: Money is just one motivation for work. You need to consider many other factors as
well. Career planning considers your personal values, goals, and interests—the basics
for any career decision. Since you will probably spend the majority of your life working,
consider the old adage: “Choose a career you love, and the money will follow.”
Ask Yourself What job would you love to do?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com Chapter 2 Finances and Career Planning 31
Section 2.1
Focus on
Reading
Planning Your Career
Read to Learn
Choosing a Career
What is the difference between a job and a career?
• How to identify the per-
sonal issues to consider Some people find true satisfaction in their work, while others
when choosing and work just to make money. Like many people, you may decide to get
planning your career.
a job —work that you do mainly to earn money. On the other hand,
• How to explain how edu-
you may decide to prepare for a career. A career is a commitment
cation and training affect
career advancement. to work in a field that you find interesting and fulfilling. Ensuring
that your career will fulfill your personal and financial goals requires
• How to discuss the
factors that influence planning.
employment.
Career Decision Trade-Offs
Main Idea
Choosing and planning for Your choice of career will affect the amount of money you make,
the right career will help the people you meet, and how much spare time you have. Some
you find fulfillment both people work just to maintain a standard of living, a measure of
personally and financially. quality of life based on the amounts and kinds of goods and services
a person can buy. They also work to pay for the hobbies and activi-
Key Terms ties they enjoy. Others pursue careers that provide them with both
• job money and personal fulfillment. They select careers that reflect their
• career interests, values, and goals.
• standard of living
Choosing a career will involve trade-offs, or opportunity costs.
• trends
• potential earning power Many people devote most of their time and energy to their work.
• aptitudes As a result, their family lives and personal satisfaction may suffer.
• interest inventories Recent trends—developments that mark changes in a particular
• demographic trends area—indicate that some people are making career decisions, such
• geographic trends as declining a promotion, that allow them to spend more time with
• service industries
their families or to enjoy their hobbies and interests.
You may select a career that is challenging and offers you the
chance to grow, even if it does not earn you a large salary. On the
other hand, you may choose to work in a job that is less satisfying
Before
but offers more money. You may look for part-time work or work situ-
You Read
ations with flexible hours so that you will have more time to spend
PREDICT with your family. You could also decide to give up the security of
working for someone else to take on the challenge of running your
Why will choosing the right
career help you find both own business.
personal satisfaction and The more you know about your own interests, values, needs,
financial security? and goals, the better you will be able to choose a career that will pro-
vide a balance between personal satisfaction and financial rewards.
32 Unit 1 Planning Personal Finances
WEIGHING YOUR OPTIONS Choosing a
career involves trade-offs. Some parents will
decline a job with a higher salary for a job that
offers a flexible schedule. What other trade-offs
might a parent have to make?
Career Training and Skill Development
Obtaining as much education as possible will help you meet
your financial goals. The more you know, the greater your chances
are for success. Having a college degree does not guarantee that you
will reach your goals and make a lot of money. However, acquiring
more education increases your potential earning power, which
is the amount of money you may earn over time. Your field of study
will also affect your salary. Some careers, such as law and medicine,
generally offer higher salaries than others, such as education and the
fine arts.
Education is not the only ingredient for success in your job or
career. By developing certain habits, you will become an asset to any
employer. For example, most successful people are able to work well
with others. They always strive to do their best. They do not allow
conflict with other employees or changes in their duties to affect
the quality of their work. They are creative when it comes to solving
problems. They communicate well. They understand themselves and
other people. These basic qualities and skills make success more likely
in most job situations. How do you measure up to this checklist for
success? If you think that you might fall short in some areas, what
might you do to improve?
Chapter 2 Finances and Career Planning 33
As You Personal Factors
Read You can take special tests to learn more about your own abilities,
RELATE interests, and personal qualities. These tests—called aptitude tests and
interest inventories—may give you an edge in choosing a career. You
Imagine yourself 15 years can usually find out more about such tests in your school’s guidance
from now. Will you have a office. If you would rather test yourself, you can find test materials in
career or a job? Would that
public libraries, bookstores, and on the Internet.
career or job fulfill personal
and financial goals? What Do You Do Best? Aptitudes are the natural abilities that
people possess. For example, you may have a beautiful singing voice,
excel at math, or be able to solve puzzles easily. These are all natural
aptitudes. Try taking an aptitude test to find out what you do best.
What Do You Enjoy? Interest inventories are tests that help
you identify the activities you enjoy the most. They match your
interests, likes, and dislikes with various kinds of work. For example,
someone who enjoys nature and the outdoors could become a
science teacher, nature photographer, or landscape designer. A person
who likes to make things could study to become a carpenter, clothes
designer, architect, or engineer. List some of your interests. What
types of careers can you think of that would match your interests?
The Right Fit Aptitude tests and interest inventories may not lead
you to the ideal career. They can only point you in the right direction.
Another important issue to consider is your personality. For example,
do you enjoy large parties, or would you rather stay at home and read
a book? Do you like to take chances, or do you prefer to play it safe?
Do you work well under pressure, or do you need time to do a job?
The goal is to find a job or career that gives you the right balance
between financial rewards and personal satisfaction. Some people
adapt easily to any work environment. Others are always looking for
SCIENCE something better. Because your work situation will never stop chang-
The world around us is ing, the key to success is to remain flexible.
constantly changing,
and the field of science Stages of Career Planning
is expanding to keep up
with it. There are many Before you make any decisions about your career, you should
careers in the science field, review your situation. Changes in your personal life and in society
such as cancer research, will affect your work life, and the reverse is also true. Figure 2.1
environmental science,
shows the stages of career planning, changes, and advancement. If
pharmaceutical research,
and genetic engineering. you are getting ready to enter the workforce, you will probably start
Choose three careers, one at Stage 1. That stage will involve determining your personal and
science-related, and find career interests.
out the educational require- The diagram in Figure 2.1 is only one plan of action. Your progress
ments and average salaries will depend on your opportunity costs, the choices that are available
for them. Which of the three
to you, and your career area. If you are unsure about your direction,
jobs pays more? Do you
think salary should affect talk to people in your field of interest. Ask them what they like and
your choice of career? dislike about their work and how they got into the field. Answers to
these questions can help you with your career planning.
34 Unit 1 Planning Personal Finances
&IGURE 3TAGES OF #AREER 0LANNING #HANGES AND !DVANCEMENT
0LAN AND IMPLEMENT A PROGRAM
FOR CAREER DEVELOPMENT
#ONSIDER JOB OFFERS !CCEPT A JOB THAT
MEETS FINANCIAL AND PERSONAL REQUIREMENTS
)NTERVIEW FOR AVAILABLE POSITIONS
)MPROVE INTERVIEWING SKILLS
$EVELOP A RÏSUMÏ AND COVER LETTER
!PPLY FOR JOBS #AREER %NTRY
#HANGE TO A $IFFERENT
)DENTIFY JOB OPPORTUNITIES IN #AREER
CHOSEN FIELD
#HANGE *OB WITHIN
3AME #AREER
!SSESS PERSONAL GOALS ABILITIES
AND INTERESTS 2ESEARCH CAREERS #AREER !DVANCEMENT
3OURCE &EDERAL 2ESERVE "ANK OF -INNEAPOLIS
3TARTING /VER )F YOU CHOOSE A CAREER AND ARE DISSATISIFIED WITH THE WORK THAT YOU ARE DOING
YOU HAVE THE OPTION OF CHANGING TO A DIFFERENT CAREER
7HAT ARE SOME WAYS TO MAKE A WISE CHOICE
External Factors
and Opportunities
Why should you consider external influences when
thinking about your career?
Before you begin your job search, you should think about how
external factors such as social influences, economic factors, and trends
might affect your career. These factors directly affect the job market
and the opportunities that are available to you. When you consider
your career options, you not only need to focus on your skills, train-
ing, and experience, you also need to view the “big picture” on a
national and global scale. You may have no control over these par-
ticular factors, but you can make some personal decisions based on
real-world influences.
Social influences include factors such as demographic trends
and geographic trends. Economic conditions include factors such as
interest rates, inflation, and consumer demand. Industry trends are
affected by factors such as foreign competition and the changing and
expanding uses of technology.
Chapter 2 Finances and Career Planning 35
Figure 2.2 Developing a Career Plan of Action
1
Personal and
If you want your Career Interests
career to start off on Make a list of things
the right foot, you need you enjoy doing.
a plan of action.You Think about how you
need to know where you could turn an activity
are, where you want to like that into a career.
go, when you want to
arrive, and how you are
going to get there.
2 Career Skills Think about work
experiences you have already had.
Which ones did you like? Which
ones did not go so well? What skills
did you learn?
3
Career Training and Education What
kind of education or training do you need for
the career you want?
36 Unit 1 Planning Personal Finances
4 Employment Position
Now begin to focus. Pinpoint
the particular work situation
that you would like.
Social Influences
Demographic trends are tendencies of people grouped by age,
gender, ethnicity, education, or income that change over time. These Common
developments can affect your employment opportunities. Several
demographic trends have affected the job market:
CENTS
• More working parents, which expands the supply of jobs in Career Center
child care and food services At your school’s career
center, you will find a vari-
• More leisure time, which boosts interest in health, physical
ety of free information that
fitness, and recreational products can help you with college
• More elderly people in the overall population, which produces choices, résumé prepara-
a greater need for workers in retirement facilities, health care, tion, job opportunities,
and travel services and career counseling.
• Greater demand for ongoing employment training, which How can researching differ-
ent careers that interest you
increases career opportunities for teachers and trainers
help your financial planning
Geographic trends are tendencies of people moving from one for the future?
area of the country to another as financial centers shift location. In
recent years, some of the fastest-growing job markets have included cit-
ies in Florida, Nevada, Arizona, Arkansas, New Jersey, and California.
Geographic location also influences earning level. Remember to
consider differences in earning levels as you decide where to look
for employment. Big cities, such as San Francisco, New York, and
Chicago, usually offer higher salaries, but the cost of living (the cost
of food, housing, transportation, and other expenses) is also higher
in such areas. If you accept a high-paying position in a big city, you
may actually have a lower standard of living than you would in an
area where income levels and the cost of living are lower.
Economic Factors
High interest rates, price increases, or decreased demand for cer-
tain goods and services can reduce career opportunities. The job mar-
ket changes as the economy does, and so the demand for certain
types of jobs changes. For example, in the 1990s many companies
were looking for people to work in the computer and technology
fields. As a result, there were a lot of jobs from which to choose, and
salaries were high. As we moved into the 21st century, however, the
demand for workers in those industries decreased, and salaries either
stayed the same or came down. You cannot control the effects of
economic factors on employment trends, so be aware of what jobs are As You
currently in high demand. Read
In addition, economic factors affect some businesses more than QUESTION
others. For example, high interest rates may reduce employment
What other employment
in housing-related industries, such as construction and real estate,
opportunities might be
because people are less likely to buy houses when interest rates are influenced by demographic
high. Being aware of current economic trends will help you to choose and geographic trends?
a career so that you can achieve your financial goals.
Chapter 2 Finances and Career Planning 37
Trends in Industry and Technology
Changes in industry and technology also affect the job market. In
recent years, the need for workers in manufacturing has decreased as a
result of several trends. First, increased competition from other countries
has reduced demand for American-made products. Second, automation
has taken over many tasks that used to be done by factory workers.
Perhaps you would like a career in the field of electronics tech-
nology. You know that your skills are valuable, but you also know that
constant technological advances can quickly outdate products and
jobs. As a result, you must accept some financial uncertainty.
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis-
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals 4OKYO
to help them guide their financial decisions.
JAPAN
Traditionally, the domain of Japanese women
has been the home and children. However, when the
first equal-opportunity law was passed in Japan in
the mid-1980s, many women began to shun mar- DATABYTES
riage for the workplace. In fact, in the past decade,
the number of unmarried women ages 25 to 29 has Capital Tokyo
grown from 40 to 54 percent. As a result, the birthrate Population 127,508,000
in Japan dropped steadily during that time. Japanese
Language Japanese
leaders fear that there will be a decrease in popula-
tion and consequent Currency yen
labor shortages in the Gross Domestic
future. In response to Product (GDP) $3.567 trillion (2003 est.)
this potential problem, GDP per capita $28,000
policymakers have Industry: Motor vehicles, electronic equipment,
suggested that com- machine tools, steel, and non-ferrous metals
panies provide better Agriculture: Rice, sugar, beets, vegetables, fruit,
job opportunities and pork, and fish
child-care programs to
Exports: Motor vehicles, semiconductors, office
the female workforce.
machinery, and chemicals
That way Japanese
women can opt for Natural Resources: Mineral resources and fish
marriage and having
children as well as Think Globally
successful careers. What trend in Japan might affect job opportunities
there? Why?
38 Unit 1 Planning Personal Finances
While opportunities have dwindled in some areas of the economy,
opportunities in other areas have grown. Service industries, which
are businesses that provide services for a fee, offer employment poten-
tial in coming years. There are numerous careers in these industries:
• Computer or telecommunications technology—systems
analysts, Web-site developers, service technicians
• Health care—medical assistants, physical therapists, home-
health workers
• Business services—employee benefit managers, trainers
• Social services—child-care workers, elder-care coordinators
• Hospitality services—travel agents, food service managers
• Management—employment service workers, recruiters
• Education—elementary, secondary, postsecondary, and adult
education teachers
• Financial services—insurance agents, investment brokers
Whatever career area you choose, having knowledge of a variety
of computer programs and the Internet will be essential.
Section 2.1 Assessment
QUICK CHECK SOLVE MONEY PROBLEMS
1. What are three characteristics of successful 6. Geographic Influences Tyrell has
people? Describe how each characteristic worked his way up from sales associate to
might be an asset at school or work. department supervisor for a large suburban
2. How can you learn more about your own discount store. Now he has been offered
abilities, interests, and personal qualities as a higher position in Atlanta. Currently,
they relate to career planning? Tyrell earns about $18,000 annually, which
3. What are three factors that influence covers the cost of food, housing, transpor-
employment opportunities? tation, and other living expenses. With
the new job, his salary would increase 20
THINK CRITICALLY percent, but the cost of living in Atlanta
4. Why do you think that the increase in the is much higher than it is in the suburbs.
number of working parents has contributed By doing some research, he found that the
to a higher demand for food services? rent for a one-bedroom apartment averages
$800 per month, and the round-trip train
USE COMMUNICATION SKILLS ride to work will cost about $4 per day.
5. New Career Choices Service industries Food will probably cost $65 per week.
will offer some of the greatest potential for
Calculate Assuming Tyrell works
jobs in coming years.
five days a week and 52 weeks a
Analyze With a partner, conduct year, help him calculate what his living
a survey of five students and identify expenses would total per year if he moved
their most popular career choices. to Atlanta.
Chapter 2 Finances and Career Planning 39
Section 2.2
Focus on
Reading
Employment and
Career Development
Read to Learn
• How to describe effec-
tive strategies to obtain
Employment Search Strategies
employment. What are steps to take when searching for a job?
• How to identify sources Meg filled out dozens of job applications but never received a
of career opportunities. call for an interview. Douglas went to many interviews and found a
• How to identify the challenging and satisfying job. What were the differences between
financial and legal issues these two people? The answer has to do with how well they commu-
to consider when looking
nicated the value of the experience they already had and how effec-
for employment.
tively they used proven employment strategies.
Main Idea
Learn effective strategies Obtaining Employment Experience
to help you get the job or
Many young people who are entering the world of work worry
career that meets your per-
sonal and financial goals. that they do not have enough experience. They may be overlooking
the importance of various kinds of work-related training:
Key Terms • Part-time work
• internship • Volunteer work
• cooperative education • Internships and cooperative education
• networking
• Class projects or after-school activities
• informational interview
• résumé Part-Time Work Summer and part-time jobs can provide valuable
• cover letter experience. If you have been a camp counselor during the summer,
• cafeteria-style employee
you may decide that you really enjoy working with children and
benefits
• pension plan would like to get a job in a day-care center. Perhaps you are a cashier
• mentor at a drugstore after school and on weekends. You may want to pursue
a career in pharmacology or business administration.
Many companies use temporary workers to fill various positions.
Working as a “temp” is a good way to gain experience and learn more
Before about a particular field. For the same reasons, part-time and tempo-
You Read rary work can be worthwhile for people who are changing careers.
PREDICT Volunteer Work You can learn new skills, develop good work
habits, and make professional contacts by volunteering. Many
What are some strategies nonprofit community organizations and some government agencies
you think might be effec-
include volunteers on their staffs. You might collect funds for a
tive in obtaining employ-
ment experience? disaster relief project or build houses with Habitat for Humanity.
Volunteering can help you develop skills that you can apply to other
work situations. Where could you volunteer in your community?
40 Unit 1 Planning Personal Finances
Internships and Cooperative Education An internship may
give you the experience you need to obtain employment. An
internship is a position in which a person receives training by
working with people who are experienced in a particular field. Money for College
Sometimes it can lead to permanent employment. You also get a 1. Ask your school
chance to practice your application and interviewing skills. counselor about
student loans,
Cooperative education programs allow students to enhance
grants, and
classroom learning with part-time work related to their majors and scholarships.
interests. For example, you would take your high school classes in the 2. Check the Internet,
morning, and in the afternoon you would work at a local business to using the keywords
apply the workplace skills you learned in class. college scholarships.
3. Ask for money for
Class Projects or After-School Activities Class assignments and
college instead of
school activities can be sources of work-related experience. They can gifts.
help you gain valuable career skills such as:
4. Apply for schol-
• Managing, organizing, and coordinating people arships offered
• Public speaking by your parents’
employers.
• Goal setting, planning, and supervising
5. Get a part-time job
• Financial planning and budgeting
and save as much
• Conducting research money as possible.
Career Information Sources
You need up-to-date information to make the best career deci-
sions. Many sources of information are available to you.
Libraries Most school and public libraries offer a variety of refer-
ences on careers. Start with such guides as the Occupational Outlook
Handbook, the O*NET Dictionary of Occupational Titles, and Occupa-
tional Outlook Quarterly Online.
VOLUNTEER Volunteer-
ing for a local or national
nonprofit organization can
provide work-related expe-
rience. What types of skills
might you gain by helping to
clean up a city park?
Chapter 2 Finances and Career Planning 41
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: An IRS Form W-4 Your Motive: By properly filling out a
A Form W-4 asks you for the following Form W-4, you will ensure that the appro-
• Your name and address priate amount of tax is deducted from your
• Your marital status paychecks. Withholding too little from your
• Number of allowances pay can result in penalties when you file your
• Additional withholdings yearly income tax return.
• Signature and date
Personal Allowances Worksheet (Keep for your records.)
A Enter “1” for yourself if no one else can claim you as a dependent A
兵 其
● You are single and have only one job; or
B Enter “1” if: ● You are married, have only one job, and your spouse does not work; or B
● Your wages from a second job or your spouse’s wages (or the total of both) are $1,000 or less.
C Enter “1” for your spouse. But, you may choose to enter “-0-” if you are married and have either a working spouse or
more than one job. (Entering “-0-” may help you avoid having too little tax withheld.) C
D Enter number of dependents (other than your spouse or yourself) you will claim on your tax return D
E Enter “1” if you will file as head of household on your tax return (see conditions under Head of household above) E
F Enter “1” if you have at least $1,500 of child or dependent care expenses for which you plan to claim a credit F
(Note. Do not include child support payments. See Pub. 503, Child and Dependent Care Expenses, for details.)
G Child Tax Credit (including additional child tax credit):
● If your total income will be less than $54,000 ($79,000 if married), enter “2” for each eligible child.
● If your total income will be between $54,000 and $84,000 ($79,000 and $119,000 if married), enter “1” for each eligible
child plus “1” additional if you have four or more eligible children. G
H Add lines A through G and enter total here. (Note. This may be different from the number of exemptions you claim on your tax return.) H
兵
For accuracy, ● If you plan to itemize or claim adjustments to income and want to reduce your withholding, see the Deductions
complete all and Adjustments Worksheet on page 2.
worksheets ● If you have more than one job or are married and you and your spouse both work and the combined earnings from all jobs
that apply. exceed $35,000 ($25,000 if married) see the Two-Earner/Two-Job Worksheet on page 2 to avoid having too little tax withheld.
● If neither of the above situations applies, stop here and enter the number from line H on line 5 of Form W-4 below.
Cut here and give Form W-4 to your employer. Keep the top part for your records.
Form W-4 Employee’s Withholding Allowance Certificate OMB No. 1545-0010
Department of the Treasury
Internal Revenue Service
Whether you are entitled to claim a certain number of allowances or exemption from withholding is
subject to review by the IRS. Your employer may be required to send a copy of this form to the IRS.
2005
20– –
1 Type or print your first name and middle initial Last name 2 Your social security number
Home address (number and street or rural route)
3 Single Married Married, but withhold at higher Single rate.
Note. If married, but legally separated, or spouse is a nonresident alien, check the “Single” box.
City or town, state, and ZIP code 4 If your last name differs from that shown on your social security
card, check here. You must call 1-800-772-1213 for a new card.
5 Total number of allowances you are claiming (from line H above or from the applicable worksheet on page 2) 5
6 Additional amount, if any, you want withheld from each paycheck 6 $
7 I claim exemption from withholding for 2005, and I certify that I meet both of the following conditions for exemption.
● Last year I had a right to a refund of all federal income tax withheld because I had no tax liability and
● This year I expect a refund of all federal income tax withheld because I expect to have no tax liability.
If you meet both conditions, write “Exempt” here 7
Under penalties of perjury, I declare that I have examined this certificate and to the best of my knowledge and belief, it is true, correct, and complete.
Employee’s signature
(Form is not valid
unless you sign it.) Date
8 Employer’s name and address (Employer: Complete lines 8 and 10 only if sending to the IRS.) 9 Office code 10 Employer identification number (EIN)
(optional)
For Privacy Act and Paperwork Reduction Act Notice, see page 2. Cat. No. 10220Q Form W-4 (20– –)
(2005)
Key Points: Employers are required to have Find the Solutions
each employee complete an IRS Form W-4 to 1. What is the purpose of the Form W-4?
determine the tax withholding. The number 2. On line 6, you may elect to withhold addi-
of dependents (people you are financially tional money from your pay. Why would
responsible for) you claim on Form W-4 someone choose to do this?
determines the amount of tax withheld from 3. How could a person be exempt from having
your paychecks. The tax rate varies by the withholdings taken from his or her pay?
number of dependents you claim. The more 4. Why is it necessary for the employee to sign
dependents, the less you pay in taxes. Because the form?
your tax situation may change, review your 5. Can a married person withhold at the same
withholdings each year. rate as a single person?
42 Unit 1 Planning Personal Finances
Mass Media Most newspapers feature business and employment
sections with articles on job hunting and career trends.
As You
Read
The Internet Log on to the Internet for a wealth of information
about jobs and employment. You will find tips and suggestions on
RELATE
everything from filling out applications to job interviewing. Make a list of people you
already know who may be
School Guidance Offices Visit your school guidance office for
able to offer you help as
materials and advice on career planning. Take advantage of any you prepare for a career.
placement services your school may offer.
Community Organizations Almost every community has busi-
ness and civic groups that can help you in your career search. Attending
their meetings gives you an opportunity to meet local businesspeople.
Professional Organizations Many professions have organiza-
tions dedicated to sharing information. The Encyclopedia of Associations
can help you find organizations representing careers that interest you.
Contacts Family, friends, coworkers, teachers, professors, and
former employers are the people you already know who can help you
to prepare for your career. Even people whom you do not know can
assist you in a job search. That is why it is never too late to begin
networking. Networking is a way of making and using contacts to
get job information and advice. The contacts you make may not be
people who can hire you, but they may know someone who can.
They may be able to arrange an informational interview,
which is a meeting with someone who works in your area of interest
who can provide you with practical information about the career or
company you are considering.
Identifying Job Opportunities TechByte
Job Hunting Online
What sources can you use to find an A wide selection of online
employment opportunity? resources awaits job
seekers interested in any
If you are going to find employment that is right for you, you
career. Many Web sites
need to know where to look for job openings. Explore sources such as have listings of current
job advertisements, job fairs, and employment agencies. job openings. Some sites
offer additional features,
such as tips on résumé
Job Advertisements writing and interviewing.
All newspapers have classified ads that include job listings. These online tools allow
job seekers to discover
Although most advertise only jobs that are available locally, some
job opportunities locally
major newspapers, such as The Wall Street Journal, list jobs from a and nationally.
wide geographic area.
The Internet is a valuable source for job opportunities. If you are Find and list two
jobs you are inter-
interested in working for a particular company, you can use a search
ested in pursuing in your
engine to find its Web site and learn more about it. Sometimes you city or town through
can also find that company’s list of current job openings. In addition finance07.glencoe.com.
to company Web sites, the Internet offers job-search Web sites with
job advertisements, advice, and résumé services.
finance07.glencoe.com Chapter 2 Finances and Career Planning 43
Job Fairs
At a job fair, recruiters from local and national companies set up
tables or booths where you can discuss job opportunities and submit
your résumé. To make the most of a job fair, be prepared to make your
best impression on several recruiters in a short amount of time. They
may call you for an in-depth interview at a later date.
Employment Agencies
Employment agencies are businesses that match job hunters
with employers. Most often the company that hires you pays the
employment agency fee. In some cases, you pay the fee, or you and
your new employer share the cost. Do not get involved with agencies
that ask you to pay a fee without promising you a job in return. The
government also supports employment services. To find out more
about them, contact your state’s employment service or department
of labor.
Other Ways to Find a Job
Your ability to find a job is limited only by your imagination and
energy. Remember that finding a job is a job in itself. There are also
other ways to find a job:
• Visit—Visit specific companies where you would like to work
and ask to speak to someone who might help you.
• Call—Check your local telephone directories for the names of
businesses in your field of interest, and contact them.
• Network—Talk to people with similar interests who have
already graduated from your school. They may be able to help
you focus your career search.
ANOTHER APPROACH
One way to find a job is to
write a letter to a company
that interests you. What
might be some of the benefits
of contacting companies even
if they are not advertising a
job opening?
44 Unit 1 Planning Personal Finances
Applying for a Job As You
What are the steps involved in the Read
job application process?
QUESTION
This morning the personnel director of a company to whom
Why would a skills résumé be
Christopher had sent his résumé and cover letter many weeks ago
a better choice for a recent
called him. In two days, he has an appointment for a job interview. high school graduate?
He is excited, but he knows that he has a lot to do to prepare.
Making the best possible presentation of your skills and experi-
ence is the key to landing a job. Your résumé is your most important
tool. A résumé is a one- or two-page summary of your education,
training, experience, and qualifications. It provides prospective
employers with an overview of the special contribution you may be
able to make to their companies.
The two basic types of résumés are the chronological résumé and
the skills résumé. The chronological résumé provides a year-by-year
(or longer periods) outline of your education, work experience, and
related information. This format is useful for job hunters who have
continuous work experience. A skills résumé highlights your skills
and abilities in specific categories, such as communications, supervi-
sion, or research. If you are a recent graduate or are changing careers,
a skills résumé might be the better choice for you.
When you send your résumé to an employer by regular mail,
e-mail, or fax, you will want to include a cover letter. A cover letter
is the personal letter that you present along with your résumé. While
the résumé serves as an overall summary of your qualifications, a
cover letter tells a potential employer why you are interested in a par-
ticular job and why you think that it would be worthwhile for him
or her to interview you. See Figure 2.3 on page 46 for examples of a
chronological résumé and a skills résumé, and Figure 2.4 on page 47
for a sample cover letter.
The interview is a formal meeting with your potential employer
that allows you to express why you think you are the best person for
the job. If you are granted an interview, you should obtain as much
information as you can about the company or industry before your
interview. Possible resources include the library, the Internet, and
informal interviews with people who are familiar with that company
or industry. Here are some typical questions an employer might ask:
• What education and training qualify you for this job?
• Why are you interested in working for this company?
• Other than past jobs, what experiences have helped prepare
you for this job?
• What are your major strengths? Major weaknesses?
• What do you plan to be doing five or ten years from now?
Most interviewers will end the interview by telling you when you
can expect a response. While you are waiting, send that person a note
reiterating your interest and expressing your thanks for the opportu-
nity to interview. You may also want to recall your performance dur-
ing the interview and think about how you might improve.
Chapter 2 Finances and Career Planning 45
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'ETTING TO +NOW 9OU 9OUR RÏSUMÏ SHOULD GIVE A CLEAR OVERVIEW OF YOUR EDUCATION TRAINING
EXPERIENCE AND QUALIFICATIONS
7HAT ARE SOME EXPERIENCES THAT YOU WOULD DESCRIBE IN YOUR
RÏSUMÏ
46 Unit 1 Planning Personal Finances
&IGURE #OVER ,ETTER
4HE )NTRODUCTION 9OUR COVER LETTER SHOULD BE SIMPLE INFORMATIVE AND FREE OF ERRORS
7HAT INFORMATION COULD YOU INCLUDE IN YOUR LETTER THAT WOULD SET
YOU APART FROM OTHER APPLICANTS
Considering a Job Offer
What factor would be most important to you when
considering a job offer?
You may go on several interviews and experience disappoint-
ment. Sooner or later, however, someone will say, “We’d like you to
work for us.” But before you accept an offer, you have to consider
several factors. Find out all you can about the company, the job itself,
the working environment, the salary, and any other benefits.
The Work Environment
As you go on interviews, you will notice differences in work-
places. The pace and pressure will vary. Even the way people behave
when they are at work will depend on the company.
Chapter 2 Finances and Career Planning 47
Ask about official company policies. How does the company
Put on handle pay increases? How does it measure the quality of employees’
Your work? How does it decide which employees to promote?
Financial
Planner’s Factors Affecting Salary
Cap Your beginning salary will depend on your education and expe-
rience, the size of the company, and the average salary for the job you
How would you determine
if the starting salary for a are considering. To make sure that you are starting with a fair salary,
particular job would cover talk to people with similar jobs at other companies or look for related
your expenses? information on the Internet.
Raises and promotions are a direct result of how well you do
your job. Once you have accepted a job offer and started to work,
meet regularly with your supervisor. Ask for feedback on your per-
formance and any suggestions for improvement. Let your supervisor
know that you are interested in increased responsibility. Meeting—or
exceeding—your supervisor’s expectations should bring the reward of
a raise. If it does not, you might want to look for another job.
Measuring Employee Benefits
You should also evaluate the types of benefits the company offers
besides a paycheck. Pay particular attention to health care, retirement
benefits, and the specific needs of your family.
WORK CULTURE The pace and pressure of work differ from com-
pany to company. What type of pace might be most appropriate for your
personality and work habits?
48 Unit 1 Planning Personal Finances
Careers in Finance
CREDIT
CASHIERANALYST Mark Leeds
Burlington Coat Factory
Mark has always wanted a job that balances his attention to detail with his ability to work with
customers. Working as a cashier for Burlington Coat Factory, Mark is responsible for providing out-
standing service and a friendly environment to each customer. His duties include handling money,
totaling bills, making change, and giving receipts. He also handles returns, exchanges, and gift cer-
tificates. Mark likes interacting with people and also appreciates that his schedule is flexible. If some-
thing comes up, he can usually trade shifts with another cashier. Sales, holidays, and a varied work
schedule provide diversity in the activity and intensity of a cashier’s job.
SKILLS: Communication, dexterity, computer, and math
PERSONAL TRAITS: Detail oriented, honest, likes working with people, tactful, neat, and able to
work weekends, holidays, and evenings
EDUCATION: High school diploma or equivalent, on-the-job training
ANALYZE What types of factors might a cashier examine before accepting a job?
To learn more about career paths for cashiers, visit finance07.glencoe.com.
Meeting Employee Needs Changes in society have brought
about changes in the types of benefits that employees receive. Today
single-parent families and households in which both parents work
are common. Businesses have responded to these changes in a variety
of ways.
Cafeteria-style employee benefits are programs that allow
workers to choose the benefits that best meet their personal needs.
A married employee with children may want more life and health
insurance, whereas a single parent may also be interested in child-
care services.
Because people today live longer, retirement programs are more
important than ever. In addition to Social Security benefits, some
companies contribute to a pension plan, which is a retirement plan
that is funded at least in part by an employer. The features of pension
plans vary among several basic types. Some plans provide you with
a fixed amount of money at retirement. If a business uses a profit-
sharing plan, it makes an annual contribution to a retirement fund
each year. The money in this fund builds up until you reach retire-
ment age. A third type of pension plan is a 401(k). You set aside a por-
tion of your salary from each paycheck to go into your 401(k) fund.
Your employer may match a percentage of your contribution.
finance07.glencoe.com Chapter 2 Finances and Career Planning 49
Comparing Benefits You can compare the dollar value of
employee benefits in several ways. The market value of a benefit is
what the benefit would cost if you had to pay for it yourself. For
example, the market value of free health insurance is what it would
cost you to buy the same insurance. Also, the market value of one
week’s (five days’) paid vacation is one week’s salary.
Taxes should also play a part in your decisions about employ-
ment benefits. There are two types of employment benefits: tax-
exempt and tax-deferred. A tax-exempt benefit is a benefit that is not
taxable. For example, medical insurance paid by an employer is tax
exempt. For example, if your employer pays $2,000 for your medi-
cal insurance, it equals $2,500 before taxes (for the 25 percent tax
bracket). A free life insurance policy for an employee is an example of
a tax-exempt benefit.
A tax-deferred benefit is a benefit for which you will have to pay
income tax sometime in the future, most likely after you retire. A
401(k) plan is an example of a tax-deferred benefit.
Your Rights as an Employee
Why should you know your legal rights as an employee?
As an employee, you have certain legal rights, which can also
affect your financial situation. You also have certain legal rights dur-
ing the hiring process:
• An employer cannot refuse to hire a woman or terminate her
employment because she is pregnant. A female employee who
stops working because she is pregnant must be given full credit
for previous service and for any retirement benefits.
• An employer cannot discriminate against a person for any
reason related to age, race, color, religion, gender, marital
status, national origin, or any mental or physical disabilities.
• In some cases, an employer must pay the minimum wage set by
the government as well as a certain amount for overtime work.
• An employer must pay for unemployment insurance,
contribute to Social Security, and provide for workers’
compensation funds in case of a work-related injury or illness.
Long-Term Career Development
What steps can you take to help make your career
a success?
A job is for today, but a career can last a lifetime. As you enter the
world of work, ask yourself: Will you always enjoy the work that you
do today? Will you be successful in the career you select? You cannot
predict the future, but you can develop skills and attitudes that will
increase your chances of being satisfied with your work in years to
come. Here are some basic guidelines to follow for career success:
50 Unit 1 Planning Personal Finances
YOUR RIGHTS An
employer cannot discrimi-
nate against a person during
the hiring process for any
reason related to age, race,
color, religion, gender, mari-
tal status, national origin,
or any mental or physical
disabilities. What would you
do if your legal rights were not
honored?
• Make a point of improving your communication skills—both
written and oral.
• Do your best to get along with your coworkers.
• Remain flexible and open to new ideas.
• Develop good work habits.
• Use lists, short-term and long-term goals, note cards, and
other time-management techniques. When you have a task to
complete, do it as well as you can.
• Be aware that problems may arise, and be ready to take action
when they do.
• Be creative in solving your own problems.
• Be willing to learn new techniques and technologies.
Training Opportunities
Advances in technology are changing the world of work at a
rapid pace. Many careers that people have today did not exist just
a few years ago. These changes will surely continue. A key to your
ongoing success will be your ability to keep up with changes in tech-
nology and to adapt to the global economy. Remember that you will
always be learning new skills and ideas.
How can you make sure that your skills remain up to date? Many
companies offer regular training programs, encourage attendance at
professional seminars, or help pay for college courses. Read as much
as possible on your own. Take advantage of the wealth of informa-
tion on business, economic, and social trends on the Internet and in
newspapers, magazines, and professional journals. Talk with others
in your field. Informal meetings with coworkers and associates from
other companies can be a valuable source of new information.
Chapter 2 Finances and Career Planning 51
&IGURE 3TAGES OF #AREER $EVELOPMENT
3TAGE 4ASKS #ONCERNS
0RE ENTRY AND s !SSESS PERSONAL INTERESTS s -ATCHING INTERESTS AND ABILITIES TO JOB
CAREER EXPLORATION s /BTAIN NECESSARY TRAINING s $EALING WITH DISAPPOINTMENT
s &IND AN ENTRY LEVEL JOB
#AREER GROWTH s /BTAIN EXPERIENCE DEVELOP SKILLS s $EVELOPING CAREER CONTACTS
s #ONCENTRATE ON AN AREA OF s !VOIDING CAREER BURNOUT
SPECIALIZATION
s 'AIN RESPECT OF COLLEAGUES
!DVANCEMENT s #ONTINUE TO GAIN EXPERIENCE AND s &INDING CONTINUED SATISFACTION
AND MID CAREER KNOWLEDGE s -AINTAINING SENSITIVITY TOWARD COLLEAGUES AND
ADJUSTMENT s 3EEK NEW CHALLENGES AND EXPANDED SUBORDINATES
RESPONSIBILITY
,ATE CAREER AND s -AKE FINANCIAL AND PERSONAL PLANS s $ETERMINING PROFESSIONAL INVOLVEMENT AFTER
PRERETIREMENT FOR RETIREMENT RETIREMENT
s 0LANNING PARTICIPATION IN COMMUNITY ACTIVITIES
.EW (ORIZONS %ACH STAGE OF CAREER DEVELOPMENT BRINGS NEW TASKS AND NEW CONCERNS
7HY MIGHT YOU DECIDE TO SEEK NEW CHALLENGES AND RESPONSIBILITIES
DURING THE MID CAREER ADJUSTMENT STAGE
Career Paths and Advancement
As time goes by, you will experience changes in your personal inter-
ests, values, and goals. Outside factors, such as economic conditions
and social trends, will also affect you. These changes will influence your
career choices and other financial decisions that you make. You will
probably go through a series of career stages, such as those shown in
Figure 2.5, and experience specific tasks and concerns with each one.
One way to make sure that your career develops in the right
direction is to gain support from someone with more experience and
knowledge. A mentor is an experienced employee who serves as a
teacher and counselor for a less-experienced person. A mentor can
give you one-on-one training and help you to meet other knowledge-
able people. He or she can also provide you with emotional support
during difficult times at work. Many organizations have formal men-
One Life to Plan toring programs. Some of the best mentors are retired people who are
Learn more about life
eager to share a lifetime of knowledge and experience.
planners and how you
can apply what they do In addition, you may know a small number of people who can
for people to your own provide opportunities and guidance on a personal basis. Mentors
life right now. can be role models, or they can be professionals outside your career
area who take an interest in your career. They can make suggestions,
To continue with
Task 3 of your inform you of opportunities, introduce you to key people, and help
WebQuest project, visit guide you through your career. Besides mentors, you probably know
finance07.glencoe.com. other people, friends and/or family, who can serve as role models and
supporters as you travel your career path.
52 Unit 1 Planning Personal Finances finance07.glencoe.com
Changing Careers After You
Most workers change jobs several times over the course of their Read
lives. Some seek a better position within the same field. Others move REACT
to new careers. There are various signs that it is time to move on:
Do you think the skills
• You feel bored or depressed at work. needed to embark on a
• Your job adversely affects you physically or emotionally. career are the same as those
• You receive a series of poor performance evaluations. needed to simply get a job?
• You have little opportunity to obtain a raise or promotion. How are they the same?
• You have a poor relationship with your supervisor or coworkers. How are they different?
At some point you may find yourself out of a job through no
fault of your own. This situation can cause emotional and finan-
cial stress. While you are looking for another job, continue to eat,
sleep, and exercise as usual. Stay involved in family and community
activities. You may find new career contacts anywhere. Improve your
skills through personal study, classes, or volunteer work. Think about
opportunities with nonprofit or government organizations.
Whether looking for a new job or your first job, always con-
sider how the financial and personal costs and benefits of your career
choice will affect your needs and goals.
Section 2.2 Assessment
QUICK CHECK Calculate If you consider the dollar
1. What are three ways through which you value of employee benefits, how
might obtain employment experience? much will Gustavo’s employment package
2. What factors will affect your salary? be worth if he accepts this job offer?
3. What are two methods that you might use
SOLVE MONEY PROBLEMS
to grow and develop your career?
6. Measuring Employee Benefits
THINK CRITICALLY Suzanne is a single mother who works full
4. Compare the advantages and disadvantages time and pays a sitter to take care of her two
of using the career information sources dis- children. She recently moved to another
cussed in this section. state and found a new job. The company
offers a variety of employee benefit plans.
USE MATH SKILLS Suzanne needs to determine which benefits
5. Employee Benefits Gustavo has will be best for her family.
received a promising job offer from XYZ Write About It Based on the infor-
Company. He would earn $25,000 a year. mation in the section on measur-
In addition, he would receive two weeks of ing employee benefits, what possibilities
paid vacation, five paid personal days, and might Suzanne have? What will she have
five sick days. He would also receive a free to consider in making her decision? Write a
health insurance plan that has an equiva- one-page report to help Suzanne make her
lent market value of approximately $5,000. decision.
Chapter 2 Finances and Career Planning 53
Chapter 2 Review & Activities
CHAPTER SUMMARY
• Personal issues to consider when • To evaluate career opportunities, use
choosing a career include your sources such as the Internet, libraries,
aptitudes, interests, personality, and newspapers, school guidance offices,
current personal situation. community organizations, and
• The more education and training you networking with people working in the
have, the greater your potential earning field you choose.
power will be. Also, the field of study • Financial issues to consider when
you select will affect your salary. looking for employment are your
• Employment opportunities are starting salary, opportunities for
affected by social influences, such promotions and raises, benefits, and the
as demographic trends, geographic cost of living. Legal issues to consider
trends, and economic factors, as well relate to the work environment of
as industry and technology trends. the company, its adherence to laws
• Gain experience through part-time regarding discrimination, minimum
work, volunteer work, internships, wage unemployment insurance, Social
cooperative education, and class Security, and workers’ compensation.
projects.
Communicating Key Terms
Using 8 to 12 of the terms below, write an article for a class or school newspaper on the
primary influences that will affect your personal career choice.
• job • demographic trends • résumé
• career • geographic trends • cover letter
• standard of living • service industries • cafeteria-style employee
• trends • internship benefits
• potential earning power • cooperative education • pension plan
• aptitudes • networking • mentor
• interest inventories • informational interview
Reviewing Key Concepts
1. List some of the personal issues you will need to consider when planning your career.
2. Describe factors that affect your potential earning power.
3. Explain how current demographic trends might influence your choice of career.
4. List some ways you might obtain job-related experience.
5. Identify sources of information to find out more about the career in which you are
interested.
6. Explain your rights as an employee.
54 Unit 1 Planning Personal Finances
Chapter 2 Review & Activities
Language Arts Review the information about the factors involved in
choosing a career. Choose a career you would be interested in pursuing.
Write About It Write a short essay about why you chose this career. Be
sure to discuss some of the personal issues that influenced you.
Cost of Living Use an Internet search engine to find a Web site that
compares the cost of living in cities in the United States. If you were offered
a salary of $35,000 in Columbus, Ohio, what salary would you need to
maintain the same standard of living in Chicago, Illinois? In Richmond,
Virginia? In San Diego, California?
1. Analyze and Calculate (a) What are the differences among the cities
in percent increases and decreases? (b) Use the cost of living information
and real estate Web sites to find out the reason for the difference in costs
of housing, insurance, and utilities.
2. Compute by using spreadsheet software to calculate and compare the
proportional differences in costs of living among the cities.
Connect with Communication Skills You are applying for
summer jobs. Look through the sources described in this chapter and prepare
a list of employers to whom you will submit your résumé and cover letter.
1. Write About It For each job, prepare a résumé and cover letter. Next,
work with a partner to role-play an interview. Interview each other using
the résumés and cover letters as a basis.
2. Think Critically How will you change your résumé and cover letter to
emphasize your specific skills?
Career Information Updates Forecasts about careers with the
greatest potential can help you narrow your choices.
Log On Go to finance07.glencoe.com for a link to a Web site for
nationwide career information developed by the U.S. Department of
Labor. Click on Résumé Tutorial to find directions about what to include in
your résumé. Answer the following questions:
1. What are most employers looking for when they read your résumé?
2. What can you do to make your résumé stand out from other résumés?
Newsclip: Career Edge Students who develop strong job-search
skills have a career advantage. They develop clear career direction. They also
O N L I N E
communicate and promote their competitive edge to employers.
Log On Go to finance07.glencoe.com and open Chapter 2. Learn
more about career strategies. Write a paragraph about how you can
boost your chances of getting hired.
finance07.glencoe.com Chapter 2 Finances and Career Planning 55
Chapter 2 Review & Activities
FIND YOUR
PERSONALITY TRAITS
Learning more about your own personality will help you choose
the best career for you. Read the characteristics below that describe
people’s personalities. On a separate piece of paper, write down the
five traits that best describe you, then answer the question that follows the list
of characteristics.
Personality Traits
outgoing ambitious patient
studious kind thoughtful
neat strong intelligent
quiet trustworthy respectful
playful warm happy
energetic persistent spontaneous
serious organized worried
easygoing rebellious sensitive
caring stubborn sociable
loyal responsible creative
confident fair talkative
cheerful calm inquisitive
dependable brave funny
generous helpful athletic
shy imaginative competitive
Activity
Keeping in mind the five traits that best describe your personality, what kind of work do
you think would suit you? For example, if you are persistent, outgoing, assertive, energetic,
and confident you might enjoy working in sales. If you are inquisitive, creative, imaginative,
inquisitive, and intelligent you might enjoy a career in writing. List the jobs or careers that
you think fit best with your personality.
56 Unit 1 Planning Personal Finances
Chapter 2 Review & Activities
Your Financial Portfolio
Applying for a Job
Mark Cortez was interested in working at his neighborhood grocery store as a clerk. He
wanted to work part-time after school and on weekends to earn money for his personal
expenses. He filled out the application at the store and was called back for an interview.
Mark interviewed with the store manager and got the job.
Complete
Before you interview for APPLICATION FOR EMPLOYMENT
SUPERIOR MARKETS
a job, you will probably have
to fill out an application. Take DIRECTIONS: Please use a pen and print.
Answer all sections completely and accurately.
time to practice “the art” of NAME SOCIAL SECURITY NUMBER
LAST FIRST MIDDLE
completing application forms. Cortez Mark A. 0___3___2___– ___
X ___
X – ___
X ___
X ___
X ___
X
Always fill out a job applica- HOME ADDRESS
NUMBER STREET CITY STATE ZIP
tion as neatly and accurately 134 North Avenue Indianapolis IN 46268
as possible. Write “N/A” in TELEPHONE # ALTERNATE #
any blank for which an answer (317) 555-2492
is not required. N/A means POSITION APPLIED FOR SPECIFY DAYS AND HOURS AVAILABLE PAY DESIRED
“Not Applicable” and tells the Clerk evenings and weekends negotiable
employer that you saw the EDUCATION
question, but it does not apply MIDDLE
NAME AND ADDRESS OF SCHOOL
Valley Middle School
COURSE DATE LEFT
SCHOOL Indianapolis, IN 46266 N/A June 6, 20--
to you. Fill out the application HIGH Northwest High School
SCHOOL Indianapolis, IN 46244 N/A N/A
on a separate sheet of paper, VOCATIONAL
SCHOOL N/A N/A N/A
being sure to fill it out com- COLLEGE OR
N/A N/A N/A
UNIVERSITY
pletely. Use a pencil before OTHER N/A N/A N/A
you complete the application
LAST EMPLOYMENT
in ink, or use a rough copy. NAME OF COMPANY ADDRESS SUPERVISOR JOB PAY
1217 Sheldon Ave
Were there any questions that Cameron’s Business Supply Indianapolis, IN 46244 Jill Lambert Clerk $6.50/hr
you could not answer? If so, DATE BEGAN DATE LEFT REASON FOR LEAVING
June 20-- September 20-- Summer position only
list those questions and see if
Additional qualifications applicant has to offer for consideration. These may include job-related interests, experiences, or volunteer activities.
you can find answers to them Volunteer one night a week to help deliver meals-on-wheels, on weight-lifting team,
___________________________________________________________________________________________________
elsewhere. and run track at school.
___________________________________________________________________________________________________
___________________________________________________________________________________________________
___________________________________________________________________________________________________
Analyze
The facts set forth on my application are true and complete.
What would a neatly pre- October 8, 20-- Mark A. Cortez Mark A. Cortez
DATE _____________________________________________ SIGNATURE ________________________________________
pared application tell a pros-
pective employer about you?
Chapter 2 Finances and Career Planning 57
3
CHAPTER
Money Management
Strategy
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 3.1
• Discuss the relationship
between opportunity costs and
money management.
• Explain the benefits of
keeping financial records and
documents.
• Describe a system to maintain
personal financial documents.
Section 3.2
• Describe a personal balance
sheet and cash flow statement.
• Develop a personal balance
sheet and cash flow statement.
Section 3.3
• Identify the steps of creating a
personal budget.
• Discuss the advantage of
increasing your savings.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
58
In the Real World . . .
S usan Finn and Farrah Shah are good friends and high
school classmates. They both work similar hours at a bank after
school. However, their financial situations and outlooks are very different.
Susan puts a certain amount of her paycheck in savings; she saves the rest in cer-
tificates of deposit, which pay higher interest. She does not buy many new clothes
but hopes to buy a used car. In contrast, Farrah spends her money on concerts or
sporting events every weekend and eats out frequently. She realizes that she is
not building up savings but figures she might as well have fun now.
Most people’s money management habits fall between those of
Susan and Farrah.
As You Read Consider whether you would handle
your money like Susan or Farrah.
Money When You
ASK Need It
Q: Do I need an emergency fund even though I
work part time, live at home, and have no bills?
A: There is no guarantee that your job will always be there for you. If you become
sick or injured, you may have to take time off from work. Even if you have disability
insurance, it may pay only a fraction of what you earn. If you own a car, you may
have unexpected repair bills. Emergency funds are for those unexpected things.
Ask Yourself How much of your monthly income do you think you should
put into your emergency fund?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com Chapter 3 Money Management Strategy 59
Section 3.1
#.#
Focus on
Reading
Organizing Financial
Records
Read to Learn Opportunity Costs and
• How to discuss the rela-
tionship between oppor- Money Management
tunity costs and money How do opportunity costs affect managing
management. your money?
• How to explain the ben-
efits of keeping financial Every time you make a decision, you choose one thing and reject
records and documents. another. This is true no matter how major or minor the decision may
• How to describe a sys- be. Perhaps you decide to go to the movies instead of reading a book
tem to maintain personal for your English homework assignment. On a Saturday afternoon,
financial documents. you may choose to play with the neighbor’s dog instead of watching
television or playing with your Xbox. Every decision you make repre-
Main Idea sents a trade-off, or opportunity cost.
Organizing your personal Trade-offs are especially common when it comes to making deci-
financial records can help
sions about money management. Money management is planning
you make informed deci-
sions about your spending. how to get the most from your money. Good money management
can help you keep track of where your money goes so that you can
Key Terms make it go farther. In order to manage your money well, you prob-
• money management ably consider financial trade-offs. For example, you may consider
• safe-deposit box whether you should spend your paycheck on clothes or put some of
it in the bank to earn interest. You might also wonder if you should
shop around for a CD or MP3 player at a lower price or if doing that
is a waste of time.
Trade-offs can be very hard to resolve because you might think
Before of good reasons for making either choice. In the first example, the
You Read first option would increase the amount you can spend now. However,
depositing some money would contribute to your long-term finan-
PREDICT cial security. In the second example, you might be able to save some
Do you think it is necessary money by checking prices at other stores downtown or at a differ-
to keep organized copies of ent mall, but you would also be using up something you can never
your financial records? Why replace—your time.
or why not? How can you be sure of making the right decisions when you
are faced with tough opportunity costs? You may never be sure, but
you can become a better judge of your options. Consider the fac-
tors that influence your decision making by compiling a mental list
of your options. Then consider how those options fit your values,
your current financial situation, and your goal of effective money
management.
60 Unit 1 Planning Personal Finances
By considering your values, your goals, and the state of your
bank account, you can make better spending decisions. For example, As You
if your goal is to save as much money as you can for college, then you Read
might borrow a book from a library rather than buy it from a book- RELATE
store. On the other hand, if your goal is to put aside only a certain
amount of your paycheck each month, you might be able to buy the Have you ever wondered
what happened to a sum
book with the money you have left.
of money you had? Explain
the circumstances.
Benefits of Organizing Your
Financial Documents
Why is it important to have a system to organize
your financial documents?
The first step in effective money management is to organize your
personal financial documents. The category of “personal financial
documents” includes a variety of materials, such as bank statements
and paycheck stubs. (The receipt for the shirt you bought is also a
document.) These documents tell you how much money you have.
Personal financial documents also include records that are not
directly related to your day-to-day use of money. Automobile owner-
ship titles, birth certificates, and tax forms are personal financial docu-
HALF OFF Some people
ments. Together, these records present a clear picture of your finances.
like to wait until an item they
Creating an organized system for handling your personal finan-
want goes on sale before they
cial documents has several advantages. Most obviously, a system helps
buy it. When might this be a
you quickly find any document you may need in a hurry. Organizing
wise money management strat-
your documents also helps you:
egy? When might it make more
• Plan and measure your financial progress. sense to go ahead and buy the
• Handle routine money matters, such as paying bills on time. item, even if it is not on sale?
• Determine how much money you will have
now and in the future.
• Make effective decisions about how to
save money.
Where to Keep Your
Financial Documents
Why should you keep your financial
documents in a specific place?
You can keep your financial documents in
different places—in a home file, in a safe-deposit
box, or on a computer. See Figure 3.1 on page 62
for a list of the types of financial documents you
might keep in these places. To organize your doc-
uments as effectively as possible, you may want
to use all three. Each method has advantages and
disadvantages, depending on the types of docu-
ments being kept.
Chapter 3 Money Management Strategy 61
&IGURE 7HERE TO +EEP 9OUR &INANCIAL 2ECORDS
(OME &ILE
0ERSONAL AND %MPLOYMENT 2ECORDS 3OCIAL
3ECURITY NUMBER EMPLOYEE BENEFIT INFORMATION
CURRENT RÏSUMÏ
-ONEY -ANAGEMENT 2ECORDS CURRENT BUDGET
BALANCE SHEET CASH FLOW STATEMENT LIST OF
FINANCIAL GOALS COPIES OF DOCUMENTS IN
SAFE DEPOSIT BOX
&INANCIAL 3ERVICES 2ECORDS CHECKBOOK CANCELED
CHECKS BANK STATEMENTS LOCATION AND NUMBER
OF SAFE DEPOSIT BOX
4AX 2ECORDS 7 FORMS PAYCHECK STUBS
COPIES OF INCOME TAX RETURNS
#ONSUMER 2ECORDS RECEIPTS FOR MAJOR 3AFE $EPOSIT "OX
PURCHASES AUTOMOBILE SERVICE AND REPAIR "IRTH CERTIFICATES MORTGAGE LOAN PAPERS TITLE
RECORDS OWNERS MANUALS FOR CARS AND MAJOR DEEDS COPY OF WILL CERTIFICATES OF DEPOSIT
APPLIANCES WARRANTIES CHECKING AND SAVINGS ACCOUNT NUMBERS
(OUSING 2ECORDS LEASE IF RENTING PROPERTY TAX AUTOMOBILE TITLES INSURANCE POLICY NUMBERS
RECORDS HOME REPAIR AND IMPROVEMENT RECEIPTS VALUABLE COLLECTIBLES
)NSURANCE 2ECORDS ORIGINAL INSURANCE POLICIES LIST
OF INSURANCE PREMIUM AMOUNTS AND DUE DATES
MEDICAL INFORMATION SUCH AS HEALTH HISTORY
PRESCRIPTION DRUG INFORMATION
)NVESTMENT 2ECORDS RECORDS OF STOCK BOND
AND MUTUAL FUND PURCHASES AND SALES LIST OF
INVESTMENT CERTIFICATE NUMBERS BROKERAGE
STATEMENTS DIVIDEND RECORDS
%STATE 0LANNING AND 2ETIREMENT 2ECORDS WILL
PENSION PLAN INFORMATION )2! STATEMENTS
3OCIAL 3ECURITY INFORMATION
(OME #OMPUTER
#URRENT AND PAST BUDGETS SUMMARIES OF
CHECKS WRITTEN AND OTHER BANKING
TRANSACTIONS TAX RECORDS RÏSUMÏ
3AFE AND 3OUND ! HOME FILE SAFE DEPOSIT BOX OR PERSONAL COMPUTER WILL ENABLE YOU TO
ORGANIZE YOUR FINANCIAL DOCUMENTS
.AME AT LEAST THREE PERSONAL FINANCIAL DOCUMENTS THAT YOU MIGHT
STORE IN A HOME FILE
62 Unit 1 Planning Personal Finances
Home Files As You
A home file is one place to keep financial documents. This type Read
of file is simple to set up and does not take up much space. You can QUESTION
use a file drawer, several folders, or even a cardboard box. Whatever
method you use, your home file should be simple so that you have Why might it be necessary
to have easy access to auto
quick access to your documents.
repair records, bank state-
You may already have the beginnings of a home filing system. ments, and receipts for
For example, you may have been keeping a savings account pass- purchases such as clothes
book in the back of a bureau drawer since you were ten years old, or video games?
or maybe you have an accordion file folder where you store all your
receipts. To make good use of a home filing system, sort through all
your personal financial records and arrange them according to the
type of each document. Next, label all folders or boxes. Train your-
self to file your receipts and other financial papers as soon as possible
after receiving them.
What types of financial documents should you keep in a home
file? If you have a checking account, keep your bank statements so
that you can determine how much money you have in your account
or verify your checkbook against the statements. However, do not
keep hard-to-replace documents, such as a car title or paperwork
related to a mortgage loan, in a home file. A cardboard box does not
protect against fire, water, or theft.
Safe-Deposit Boxes
You should keep important documents such as car titles and
mortgage loan papers locked away in a safe-deposit box—a small,
secure storage compartment that you can rent in a bank, usually for
$100 a year or less. Other items commonly kept in safe-deposit boxes
include rental agreements, birth certificates, adoption papers, a list of
insurance policies, stock certificates, and valuable collectibles, such
TechByte
Net Worth Calculator
as coins or stamps.
Your net worth is the dif-
Safe-deposit boxes are usually kept in a locked, fireproof room ference between your
that is accessible only while the bank is open for business. Each box assets (the things you
has two individual locks. You, the holder of the box, have one key; own that have value) and
the bank keeps the other key. The box can be opened only when both your liabilities (short-term
keys are used together. and long-term debts you
are working to pay off).
Safe-deposit boxes offer more security for your valuables than
Figuring out your net
your home file because at a bank loss from fire and other disasters is worth from time to time
extremely rare. Moreover, the financial institution that owns the box will help you evaluate the
usually (though not always) has insurance to cover such losses. Nev- progress you are mak-
ertheless, it is probably a wise idea to keep copies at home of all the ing toward your financial
financial records in your safe-deposit box. goals.
As an alternative, some people use home fire-safe boxes that Calculate your
lock. These “safes” are an inexpensive way to protect against loss due net worth through
finance07.glencoe.com.
to fire but not due to theft.
finance07.glencoe.com Chapter 3 Money Management Strategy 63
Home Computers
Rental agreements and canceled checks cannot be stored on a
home computer. However, if you have a personal computer, it can be
a great place to keep certain types of financial records. It is also a good
tool to use for planning your financial future.
You can use a software program specifically designed to keep a
running summary of checks you have written. You enter any checks,
and the program automatically calculates the new balance in your
account. Some programs also facilitate payments online. By tracking
your monthly spending on a computer, you can see at a glance how
much money you are spending, and you can easily compare your
expenses from one month to the next. You can also generate personal
financial documents and statements from the information you have
organized by using software.
Section 3.1 Assessment
QUICK CHECK Write About It Write a list of some
1. How will organizing your financial docu- places Maritza might store the agree-
ments help you manage your money? ment to ensure her claim to the deposit.
2. What steps would you take to create a
SOLVE MONEY PROBLEMS
home filing system?
3. What are the advantages of using a safe- 6. Financial Documents Martin is sit-
deposit box to store your personal financial ting in his bedroom surrounded by doz-
documents? ens of papers—gas receipts for his car, a
checkbook, a couple of unopened and
THINK CRITICALLY unpaid bills, paycheck stubs from his work
4. List three examples of money-related at a day-care center, and much more. He
opportunity costs you have faced in the wants to organize his financial documents
last two months. Write a sentence explain- in a shoebox, but he is completely over-
ing what decision you made for each one whelmed by the amount of paper.
and why. Analyze Help Martin prioritize this
job. Give him some suggestions about
USE COMMUNICATION SKILLS breaking it down into parts, starting with
5. Organizing Financial Records To be- the most important tasks. For example, tell
come a member of an Internet DVD library, Martin to begin by categorizing his docu-
Maritza has to put down a deposit of $100, ments by the type of each document.
using her credit card. When and if Maritza
chooses to discontinue her membership,
the library will refund her deposit only if
she has returned all her rented DVDs, has
paid the annual membership fee, and has
presented her membership agreement.
64 Unit 1 Planning Personal Finances
Section 3.2
Personal Financial Focus on
Reading
Statements
Read to Learn
• How to describe a
Personal Balance Sheet personal balance sheet
How can a personal balance sheet help you and cash flow statement.
find out your current worth? • How to develop a
personal balance sheet
Most of the documents mentioned in the previous section are and cash flow statement.
issued by banks, federal and state governments, and businesses.
However, such documents reveal only part of your financial picture. Main Idea
For a complete look at your financial situation, you should create A personal balance sheet
a personal balance sheet and a cash flow statement. These reports and cash flow statement
are known as personal financial statements. A personal financial can help you to analyze
your financial situation.
statement is a document that provides information about an indi-
vidual’s current financial position and presents a summary of income
and spending.
Key Terms
• personal financial
Personal financial statements can help you:
statement
• Determine what you own and what you owe. • personal balance sheet
• net worth
• Measure your progress toward your financial goals.
• assets
• Track your financial activities. • wealth
• Organize information that you can use when you file your tax • liquid assets
return or apply for credit. • real estate
• market value
To evaluate your financial situation, you first need to create a • liabilities
balance sheet. A personal balance sheet, also called a net worth • insolvency
statement, is a financial statement that lists items of value owned, • cash flow
• income
debts owed, and a person’s net worth. Your net worth is the differ-
• take-home pay
ence between the amount that you own and the debts that you owe. • discretionary income
Net worth is a measure of your current financial position. To create • surplus
a personal balance sheet, follow these steps. Figure 3.2 on page 66 • deficit
shows an example of a personal balance sheet.
STEP 1: Determine Your Assets Before
Assets are any items of value that an individual or company
You Read
owns, including cash, property, personal possessions, and invest- PREDICT
ments. To determine your assets, you need to consider four categories
What information do you
of wealth. Wealth is an abundance of valuable material possessions
think might be on a cash
or resources. The categories include: liquid assets, real estate, personal flow statement?
possessions, and investment assets.
Chapter 3 Money Management Strategy 65
&IGURE ! 0ERSONAL "ALANCE 3HEET
Melinda and Carroll Durbin
Personal Balance Sheet as of October 31, 20--
!SSETS
,IQUID !SSETS
#HECKING ACCOUNT BALANCE
3AVINGS ACCOUNT BALANCE
4OTAL LIQUID ASSETS
2EAL %STATE
-ARKET VALUE OF HOUSE
0ERSONAL 0OSSESSIONS
-ARKET VALUE OF CAR
&URNITURE AND APPLIANCES
%LECTRONIC EQUIPMENT
#OLLECTIBLES
4OTAL PERSONAL POSSESSIONS
)NVESTMENT !SSETS
2ETIREMENT ACCOUNTS
3TOCK INVESTMENTS
4OTAL INVESTMENT ASSETS
4OTAL !SSETS
,IABILITIES
#URRENT ,IABILITIES
-EDICAL BILLS
#REDIT CARD BALANCES
4OTAL CURRENT LIABILITIES
,ONG 4ERM ,IABILITIES
-ORTGAGE
3TUDENT LOAN
#AR LOAN
4OTAL LONG TERM LIABILITIES
4OTAL ,IABILITIES
.ET 7ORTH ASSETS MINUS LIABILITIES
4RUE OR &ALSE 4HE $URBINS PERSONAL BALANCE SHEET INDICATES THAT THEY HAVE A POSITIVE
NET WORTH OF
$OES THIS NET WORTH FIGURE REFLECT THEIR TRUE FINANCIAL SITUATION
%XPLAIN YOUR ANSWER
66 Unit 1 Planning Personal Finances
Liquid Assets The first category is called liquid assets. Liquid assets
are cash and items that can be quickly converted to cash. The money
in your savings and checking accounts is a liquid asset. For example,
if Bharat has $500 in his savings account and $35 in cash, his liquid
assets are worth $535 ($500 + $35 = $535). This money is immediately
available for Bharat to spend. He may be able to convert other assets
into cash, but the process is not quite as easy or as fast.
Real Estate The second category of wealth is real estate, land and
any structures that are on it, such as a house or any other building
that a person or family owns. The amount recorded on the real estate
portion of your balance sheet is the property’s market value, or the PLAY TIME Many people
price at which property would sell. Suppose that the Louis family owns save favorite toys or other
a house and a cottage with market values at $135,000 and $84,000, items from childhood. Which
respectively. They would list the sum of those figures—$219,000— items do you have that might be
under the heading “Real Estate” on their balance sheet. valuable? How can you find out?
Personal Possessions Personal
possessions—cars and any other
valuable belongings that are not
real estate—make up the third
category. For example, Joyce might
choose to list her new $800 elec-
tric guitar, her television, her skis,
and several pieces of fine jewelry.
Note that the emphasis is on “valu-
able”; old clothes and used CDs do
not count.
You may list personal posses-
sions on the balance sheet at their
original cost, but you will get a bet-
ter idea of your financial situation
by recording their current market
value. For example, Joyce’s televi-
sion is worth less now than it was
when she purchased it five years
ago. In contrast, collectible items,
such as old baseball cards and comic
books, may increase in value over
time. Although determining current
values for some items may be diffi-
cult, doing so will give you a more
accurate picture of your net worth.
You may have to look up comparable
items in newspaper classified ads or
visit thrift stores. You can also check
Web sites where people buy and sell
such items.
Chapter 3 Money Management Strategy 67
GO FIGURE FINANCIAL MATH
NET WORTH Janine’s net worth is $2,300.
Synopsis: Calculating your net worth will help you
get an accurate measure of your current YOU FIGURE
financial situation. You own a bike that is worth $250, a watch
that is worth $60, and a stereo that is worth
Example: What is Janine’s net worth if her assets
$400. You owe your older brother $70 for
are worth $3,000 and her liabilities total $700?
some concert tickets he bought for youyou,and
and
Formula: Assets ⫺ Liabilities ⫽ Net Worth you have
owe $120 to a department store. Whatto
monthly school fees that amount is
Solution: $3,000 ⫺ $700 ⫽ $2,300 $120.
your netWhat is your net worth?
worth?
Investment Assets The fourth category of wealth is investment
assets. Investment assets include retirement accounts and securities
such as stocks and bonds. Set aside such assets for long-term financial
needs, such as paying for college, buying a house, or retirement.
STEP 2: Determine Your Liabilities
When you prepare a personal balance sheet, you must also record
your liabilities, or the debts that you owe. Suppose that Marlene
borrows $200 from her mother to buy a new printer for her computer.
She would record the printer as an asset, but she would also have to
record $200 as a liability on her personal balance sheet.
Current Liabilities Current liabilities are short-term debts that
have to be paid within one year. Most medical bills, cash loans, and
taxes fall under this heading.
Long-Term Liabilities Long-term liabilities are debts that do not
have to be fully repaid for at least a year. Car loans, student loans, and
mortgage loans are examples of long-term liabilities. Note that the term
“liabilities” includes only money that you will owe for longer than a
month. For example, a telephone bill does not qualify as a liability.
STEP 3: Calculate Your Net Worth
Once you know the amounts of your assets and liabilities, you
As You can calculate your net worth. To determine your net worth, subtract
Read your liabilities from your assets; the difference is your net worth.
It is important to understand the meaning of net worth. If the
RELATE Romano family has a net worth of $62,300, that does not mean they
Using the formula in the have $62,300 to spend. Much of their wealth may be in stocks, real
Go Figure box, calculate estate, and personal possessions, which cannot be easily converted
your net worth. to cash. Net worth is only an indication of your general financial
situation.
68 Unit 1 Planning Personal Finances
Although you may have a high net worth, you can still have
trouble paying your bills. This is especially true when most of your
assets are not liquid and you do not have enough cash to meet
your expenses. That can happen if you purchase a more expen-
sive car than you can afford or spend all of your savings to buy a
house.
If you are unable to pay all your debts, you may experience
insolvency. Insolvency is a financial state that occurs if liabilities
are greater than assets. Suppose that Brad owes $4,000 and that his
assets–—a ten-year-old car and an old computer–—are worth $1,800.
Even if Brad sold all his assets and put his whole $1,500 paycheck
toward paying his debts, he would still be insolvent.
STEP 4: Evaluate Your Financial Situation
You can use a balance sheet to track your financial progress.
Update your balance sheet, or make a new one, every few months to
chart changes over time. Is your net worth increasing? Good! Keep
doing what you are doing to make that happen. Is it decreasing or
just holding steady? Then you might make changes. As a rule, you
can increase your net worth by increasing your savings, increasing
your investments, reducing your expenses, and/or reducing your
debts.
Careers in Finance
CREDIT ANALYST
FINANCIAL ADVISOR Elaine Hawkins
AXA Financial, Inc.
Elaine has always been good at coming up with solutions to difficult or complicated problems, so
handling finances comes naturally to her. In her capacity as a financial advisor, Elaine visits with a
wide variety of clients and helps them understand their financial needs. She also helps them create a
plan for reaching their goals through financial planning, investment services, and risk management.
At a time when people are unsure of the soundness of Social Security and may be financially unpre-
pared for retirement, Elaine is able to provide them with options and comfort. Elaine gains work
through word of mouth and enjoys building and assisting a network of friends and acquaintances.
SKILLS: Finance, math, communication, business, and problem-solving skills
PERSONAL TRAITS: Entrepreneurial, social, tactful, and goal oriented
EDUCATION: Bachelor’s degree or higher in law, accounting, banking, or management;
certification as a Certified Financial Planner or Chartered Financial Consultant
ANALYZE What are some financial goals that a financial advisor could help you reach?
To learn more about career paths for financial advisors, visit finance07.glencoe.com.
finance07.glencoe.com Chapter 3 Money Management Strategy 69
As You Cash Flow Statement: Income
Read Versus Expenses
QUESTION What kind of information do you get from creating
a cash flow statement?
What is the difference
between net worth and The money that actually goes into and out of your wallet and
cash flow? bank accounts is called cash flow. It is divided into two parts: cash
inflow and cash outflow. Cash inflow is the money you receive, or
your income. That may include a paycheck from a job, an allowance
from your parents, or interest earned in your savings account. Cash
outflow includes all of the money you spend.
A cash flow statement is simply a summary of your cash flow dur-
ing a particular period, usually a month or a year. This summary gives
you important information and feedback on your income and spend-
ing patterns. To create a cash flow statement, such as the one shown in
Figure 3.3, follow these steps:
1. Record your income.
2. Record your expenses.
3. Determine your net cash flow.
Figure 3.3 Cash Flow Statement
Amy Grossman Cash Flow Statement for Month Ending July 31, 20--
Income (Cash Inflow)
Take-home pay $450
Allowance 100
Savings account interest 12
Total income $562
Expenses (Cash Outflow)
Fixed expenses $ 80
(cable TV, train commuter tickets, etc.)
Variable expenses 320
(recreation, clothing, take-out food)
Total expenses $400
Net Cash Flow $162
Money Supply Amy’s cash flow statement indicates that her net cash flow is $162.
How might she increase her net cash flow?
70 Unit 1 Planning Personal Finances
STEP 1: Record Your Income
List all of your sources of income during a given month, and
record the amounts as your cash inflow. Make sure that you record the
exact amount. Most paychecks include various deductions for federal One Life to Plan
and state taxes. These taxes are withheld from the total amount of Learn about different
money you have earned, or your gross pay. Your take-home pay, or kinds of investments that
net pay, is the amount of income left after taxes and other deductions a financial planner would
suggest for a young per-
are taken out of your gross pay. For example, Joshua earns $1,000 a
son planning for college
month, but he does not receive the entire amount. After taxes, his and then beginning a
take-home pay is $700. Your take-home pay plus your interest earn- career.
ings on investments and savings is your cash inflow.
To continue with
Some financial experts evaluate the strength of a person’s income
Task 4 of your
by measuring discretionary income—the money left over after WebQuest project, visit
paying for the essentials, such as food, clothing, shelter, transporta- finance07.glencoe.com.
tion, and medication. You can spend this amount at your discretion,
or according to your wants. The higher your discretionary income,
the better off you are.
STEP 2: Record Your Expenses
Expenses can be fixed or variable. Fixed expenses are those that
are more or less the same each month. Cable television charges, rent,
and bus fare for commuting to work or school are all examples of
fixed expenses. Variable expenses may change from month to month.
Food and clothing are variable expenses. During some months you
may need to buy new sweaters and pants, but during other months,
you may not buy any clothing. Electricity, medical costs, and recre-
ation are also examples of variable expenses. The total of your fixed
and variable expenses is your cash outflow.
GO FIGURE FINANCIAL MATH
NET CASH FLOW Jason has a positive net cash flow of $150.
Synopsis: Computing your net cash flow will help
you determine your financial health. YOU FIGURE
Example: What is Jason’s net cash flow if his You work 12 hours a week, 3 weeks a month,
income for the month is $1,500 and his expenses at a part-time job after school. You get $8 an
add up to $1,350? hour. You pay $40 a month for gas, $60 a
month for entertainment (CDs, movies, etc.),
Formula: Income ⫺ Expenses ⫽ Net Cash Flow
and $25 a month toward paying off your new
Solution: $1,500 ⫺ $1,350 ⫽ $150. skis. What is your net cash flow?
finance07.glencoe.com Chapter 3 Money Management Strategy 71
STEP 3: Determine Your Net Cash Flow
You can determine your net cash flow by subtracting your
expenses from your income.
Because Jason’s net cash flow is positive, he has a surplus—extra
money that can be spent or saved, depending on a person’s financial
goals and values. A cash surplus can be placed in an emergency fund
savings account for unexpected expenses or to pay living costs if you
do not receive a salary. You might also place cash surplus in savings
and investment plans.
If Jason’s net cash flow were negative, however, he would have
a deficit. A deficit is the financial situation that occurs when more
money is spent than is earned or received.
A current and accurate cash flow statement can provide the
foundation for preparing and implementing your spending, savings,
and investment plans.
&IGURE %VALUATING 9OUR &INANCIAL 0ROGRESS
2ATIO #ALCULATION %XAMPLE -EANING
$EBT RATIO ,IABILITIES DIVIDED x x #OMPARES YOUR LIABILITIES TO YOUR
BY NET WORTH NET WORTH ! LOW DEBT RATIO IS
DESIRABLE
,IQUIDITY RATIO ,IQUID ASSETS x x )NDICATES NUMBER OF MONTHS YOU
DIVIDED BY WOULD BE ABLE TO PAY YOUR LIVING
MONTHLY EXPENSES EXPENSES IN CASE OF A FINANCIAL
EMERGENCY SUCH AS THE LOSS OF
YOUR JOB 4HE HIGHER THE LIQUIDITY
RATIO THE BETTER
$EBT PAYMENTS -ONTHLY CREDIT x h x )NDICATES HOW MUCH OF A PERSONS
RATIO PAYMENTS DIVIDED EARNINGS GOES TO PAY DEBTS EXCLU
BY TAKE HOME PAY DING A HOME MORTGAGE -OST
FINANCIAL EXPERTS RECOMMEND A
DEBT PAYMENTS RATIO OF LESS THAN
PERCENT
3AVINGS RATIO !MOUNT SAVED EACH x h x -OST FINANCIAL EXPERTS
MONTH DIVIDED BY RECOMMEND A SAVINGS RATIO OF
GROSS MONTHLY AT LEAST PERCENT
INCOME
%XPERT !DVICE 9OU CAN CHECK YOUR FINANCIAL PROGRESS BY FIGURING DIFFERENT RATIOS
3UPPOSE THAT YOU EARNED GROSS MONTHLY INCOME AND YOU
WERE PAID TWICE A MONTH 7HAT WOULD BE YOUR SAVINGS RATIO IF
YOU SAVED APPROXIMATELY FROM EACH PAYCHECK 7OULD YOU BE
SAVING ENOUGH
72 Unit 1 Planning Personal Finances
Your Financial Position
How do you calculate your net worth by using
personal financial statements?
When your net cash flow changes, so does your net worth. Every
time you create a deficit by spending more than you earn, your net
worth decreases. To make up for the deficit, you can either borrow
money (increasing your liabilities) or draw from your savings (decreas-
ing your assets). In either case, your net worth declines.
On the other hand, if you end a month with a surplus, your
net worth will probably go up. You can choose to save the money,
adding to your assets, or you can use it to pay off previous debts and
reduce your liabilities. Whichever path you select, your net worth
will increase. As a general rule, if you have a surplus cash flow, your
net worth increases; if you have a deficit, your net worth decreases.
However, net worth does not give you a completely accurate pic-
ture of your finances. You can use your balance sheet and cash flow
statement to determine your financial situation in other ways as well.
See Figure 3.4 for details.
Section 3.2 Assessment
QUICK CHECK Calculate What was Tameka’s
1. How do you calculate your net worth when net cash flow during the month of
preparing a balance sheet? January? Be sure to indicate whether she
2. How should you record your income on a had a surplus or a deficit.
cash flow statement?
SOLVE MONEY PROBLEMS
3. If your personal financial statements indi-
cate that you have a deficit, what might you 6. Spending Wisely Larry’s personal bal-
do to change your financial situation? ance sheet shows $1,200 in credit card
debts; a savings account of $550; and per-
THINK CRITICALLY sonal property amounting to $3,700 in rare
4. List the three most valuable items that you stamps. Recently he was promoted at his
own that would fall into the category of part-time job. Because of that and because
personal possessions. he made an effort to reduce his expenses,
he had a positive cash flow of $600 last
USE MATH SKILLS month. He asks what you think he should
5. Finding the Net Tameka’s income for do with the surplus cash.
the month of January was $2,375. Her fixed Present Evaluate Larry’s possible
expenses during that same month were choices and come up with a specific
$750, and her variable expenses totaled plan of action for his use of the surplus.
$1,750.
Chapter 3 Money Management Strategy 73
Section 3.3
Focus on
Reading
Budgeting for
Financial Goals
Read to Learn
• How to identify the steps Preparing a Practical Budget
of creating a personal What is so important about having a budget?
budget.
A budget is a plan for using money to meet wants and needs.
• How to discuss the
advantage of increasing Having a budget is necessary for successful financial planning. By
your savings. using a budget, you will learn how to live within your income and
how to spend your money wisely. You will also develop good money
Main Idea management skills that will help you reach your financial goals.
Learn to budget and
achieve financial goals by STEP 1: Set Your Financial Goals
increasing your savings.
As discussed in Chapter 1, your financial goals are the things
Key Terms you want to accomplish with your money. What you do with your
• budget money today will affect your ability to achieve your financial goals in
• consumer price index the future. To meet those financial goals, you will need to plan your
(CPI) savings, your spending, and your investments.
• budget variance How should you set your financial goals? That depends on
your lifestyle, your values, and your hopes for the future. The type
of job you choose will determine your income and your ability to
save to reach your financial goals. For example, perhaps you would
Before like to get a pilot’s license after you graduate from college. When
You Read setting your financial goals, you will need to take into account the
cost of the lessons and the amount of time it will take to obtain the
PREDICT license.
What is your definition of a It is important to make your financial goals as specific as pos-
budget, and what are the sible. Having a definite time frame can also help you achieve your
advantages of using one? goals. You can separate your goals into short-term, intermediate, and
long-term goals.
STEP 2: Estimate Your Income
When you have set your goals, you can begin working on a bud-
get that is practical for you. Start by recording your estimated income
for the next month. Include all sources of income that you know you
will be receiving, such as your take-home pay and income on invest-
ments and savings. Do not include money you may or may not get,
such as bonuses and gifts.
74 Unit 1 Planning Personal Finances
Estimating income is easier in some cases than in others. For
example, because Ryan always works 12 hours each week, he gets
paid the same amount every month. In contrast, Rachel works irreg-
ular hours at two part-time jobs. During some weeks, she earns only
$75, but there are weeks when her earnings are more. Rachel should HISTORY
estimate her income based on her best guess about what will hap- By 1865, approximately
pen in the coming month. She might make her estimate a little one-third of all circulating
lower than she thinks it will actually be. That will help her avoid currency was counterfeit.
overspending. As a result, the Depart-
ment of the Treasury
In another example, in Figure 3.5 on page 76, the Thompsons
established the United
have estimated that their income for next month will be $3,550. States Secret Service in an
Estimate your income and record that amount, using a similar effort to control counter-
budget form. Remember that a budget should always be a written feiting. Just as it is impor-
document. tant that the government
manages the distribution
of currency and tracks
STEP 3: Budget for Unexpected Expenses down counterfeiters, it is
important that you prop-
The Thompsons have decided to put aside a little money each
erly manage your money.
month for unexpected expenses and savings to reach their financial Why is setting financial
goals. Every month they place $100 in an emergency fund. One of goals such an essential
their financial goals is to save three to six months’ worth of living part of good money
expenses in case someone in the family becomes unemployed, needs management?
medical attention, or encounters some other financial problem. They
keep their emergency fund in a separate savings account that will
earn interest.
The Thompsons are also trying to meet three other financial
goals, some short-term, others long-term. They deposit money in
their vacation fund each month, hoping that they will soon have
enough to take a trip to Jamaica. They also have a college fund for
their young children and an investment fund to buy stocks. They put
$150 into these other special savings accounts each month, bringing
their total monthly savings to $250.
STEP 4: Budget for Fixed Expenses
The Thompsons then list all their monthly expenses. They start
by listing their fixed expenses, or those that do not change from
month to month. That includes their mortgage, automobile and stu-
dent loan payments, and insurance premiums. Their budgeted total
for fixed payments totals $1,200.
As You
STEP 5: Budget for Variable Expenses Read
Planning for variable expenses—those that vary from month to RELATE
month—is not as easy as budgeting for fixed expenses. Such items as
Do you think you should
medical costs are often unexpected. Heating and cooling costs can have an emergency fund?
vary with the season. You should make your best guesses based on How large do you think
costs from previous months. When in doubt, guess high. The Thomp- your fund should be?
sons budgeted $2,100 for these variable expenses.
Chapter 3 Money Management Strategy 75
&IGURE 4HE -ONTHLY "UDGET
Step 1:
Set Financial &INANCIAL 'OALS 0AY OFF CAR LOAN SAVE FOR COLLEGE TAKE VACATION TRIP AND
Goals INCREASE INVESTMENTS
Step 6:
Record What You Spend
"UDGETED !CTUAL
!MOUNTS !MOUNTS 6ARIANCE
Step 2:
)NCOME
Estimate
Your Income 3ALARY AND INTEREST INCOME
?????? n
??????
/UTFLOWS
5NEXPECTED %XPENSES AND 3AVINGS
Step 3: %MERGENCY FUND SAVINGS
?????? n
??????
Budget for
?????? n
??????
6ACATION SAVINGS
Unexpected n
??????
#OLLEGE SAVINGS ??????
Expenses and n
)NVESTMENT SAVINGS
??????
?????? ??????
Savings
4OTAL SAVINGS
?????? n
??????
&IXED %XPENSES
-ORTGAGE
?????? n
??????
Step 4: n
!UTOMOBILE LOAN
?????? ??????
Budget for
3TUDENT LOAN
?????? n
??????
Fixed Expenses
)NSURANCE PREMIUMS
??????
?????? n
??????
4OTAL FIXED EXPENSES
?????? n
??????
6ARIABLE %XPENSES
&OOD
??????
??????
#LOTHING
?????? n
??????
Step 5: 5TILITIES
?????? n
??????
Budget for %NTERTAINMENT
??????
??????
Variable
?????? n
??????
-EDICAL
Expenses n
4RANSPORTATION ?????? ??????
0ERSONAL ALLOWANCES
??????
??????
??????
4OTAL VARIABLE EXPENSES
??????
??????
4OTAL OUTFLOW
??????
______
??????
______
??????
______
Step 7:
Review Spending and Saving Patterns
+EEPING 4RACK 9OU CAN USE THIS SAMPLE MONTHLY BUDGET FORM TO KEEP TRACK OF YOUR OWN
INCOME AND EXPENSES SO YOU CAN MANAGE YOUR FINANCES AND REACH GOALS
)N THIS SAMPLE HOW MIGHT THE 4HOMPSONS BUDGET BE AFFECTED IF
THEY HAD TO BUY A SECOND AUTOMOBILE
76 Unit 1 Planning Personal Finances
How can you determine reasonable expense levels? Financial
experts publish guidelines that tell what percentage of income should
go for various expenses. The U.S. Department of Labor produces the
consumer price index (CPI), which is a measure of the changes Have Fun for Less
in prices for commonly purchased goods and services in the United 1. Rent movie videos
States. Comparing the CPI to your actual budget can indicate when or DVDs or go to
you are spending too much on various items. A third source of infor- a matinee with
friends.
mation is your friends and relatives. If you eat out more often than
your friends do or buy more clothes than your siblings buy, your bud- 2. Call a museum;
many offer free
get may be in trouble. admission one day
a month.
STEP 6: Record What You Spend 3. Check with your
local parks for free
Your budget is prepared, but your work is still incomplete. music concerts.
You must begin to keep track of your actual income and expenses. 4. Volunteer as an
Remember, many budgeted items are only guesses. Your old car usher at a theater
may continue to run through the month. However, maybe it will to see plays and
break down next week and need $400 worth of repairs. To find out concerts for free.
how practical your budget is, you will need to keep track of your 5. Look in your news-
expenses during an entire month and then revise your budget if paper’s calendar
necessary. section for free
events.
In Figure 3.5, the Thompsons have used a second column to
record the actual amounts they spent. Some of their expenses were
what they had expected, and some were not. Your spending will not
always work out as planned. The budget variance is the differ-
ence between the budgeted amount and the actual amount that you
spend. This figure can be either a surplus or a deficit. It is a surplus if
you spend less money than you had expected, and it is a deficit if you
spend more. Budget variances can also occur in the income category.
Earning more than you anticipated creates a surplus, whereas earning
less results in a deficit.
Although the Thompsons have no budget variance on the
income side, they have a surplus in their expense section. They spent
$50 less than they had expected they would spend on entertainment.
However, they spent more than they had budgeted in the other vari-
able expense categories, creating a deficit in those categories. The
overall result was a total monthly deficit of $75.
STEP 7: Review Spending and
Saving Patterns As You
Budgeting is a continual process. You may need to review your Read
budget each month and consider making changes based on the nature
QUESTION
of your expenses.
Prepare a written monthly
Reviewing Financial Progress If you fall behind on bill payments,
budget according to Steps
or if you are left with a lot of money at the end of the month, you may 1 to 7. How well does your
need to revise your budget. Even if your budget generally seems to be budget match your finan-
on target, it is a good idea to prepare an occasional budget summary cial goals?
to review your progress. (See Figure 3.6 on page 78.)
Chapter 3 Money Management Strategy 77
Figure 3.6 A Budget Summary
You can prepare an annual budget
summary to compare your actual
spending with the amounts that
you have budgeted. Completing
an annual budget summary will be
vital to both successful short-term
money management and long-
term financial security.
1 Create your own
monthly budget
document.
2
Record what you spend in each
category of your budget during a
period of several months.
3 Highlight areas where your
spending consistently goes
over your budget. Also high-
light areas where you have
spent less than you budgeted.
This will help you identify the
changes you need to make in
your budget.
78 Unit 1 Planning Personal Finances
Revising Goals and Adjusting Your Budget If you always
have deficits, ask yourself where you can cut your expenses. Review
your spending patterns carefully to see where the shortfalls occur.
Could you rent videos instead of going to the movie theater every week?
Could you take a bag lunch to school instead of buying cafeteria food?
Perhaps you do not really need a car to get around. Doing without it might
sometimes be inconvenient, but it certainly would be cheaper.
To decide which expenses to cut, you might take another look
at your financial goals. Which purchases fit into your overall plan for
the future? The answer can help you in deciding what to cut. How
quickly are you progressing toward your objectives? Are your goals
changing or outdated? It may be necessary to revise your goals to
meet your needs.
How to Budget Successfully
How can you plan a good budget?
Simply preparing a budget will not solve your financial prob-
lems, nor will keeping track of every expense down to the last penny.
You have to follow a practical spending plan to make it work.
Money management experts agree that a budget should have
several important characteristics:
1. A good budget is carefully planned. Your estimates
cannot be wild guesses, and your spending categories must
cover all expenses.
2. A good budget is practical. If your first full-time job
pays you $1,500 a month, do not expect to buy an expensive
sports car soon.
3. A good budget is flexible. As you experience changes in
your life—marriage, children, or retirement—you will need
to adapt your budget accordingly. You will also encounter
unexpected expenses and unexpected shifts in income. Your
budget should be easy to revise when life changes such as
these occur.
4. A good budget must be written and easily accessible.
Use a notebook, folder, or computer to store your budget. Do
Put on
not try to keep the information in your head or on loose scraps
of paper. The odds are you will forget or lose the information. Your
Financial
Ways to Increase Your Savings Planner’s
Why is it important to have a savings plan? Cap
Increasing your savings is the key to establishing a sound finan- Your client has just started
cial future. The more you save, the better you will be able to handle his first full-time job and
needs to revise his budget to
unexpected emergencies and the sooner you will be able to meet your
reflect the new income. What
financial goals. If you save large amounts, it may be possible for you expense categories will you
to retire comfortably and to send your children to college. Best of all, suggest to change?
money that is saved earns interest income.
Chapter 3 Money Management Strategy 79
However, learning to save is not easy. Many people are tempted
to buy whatever they want, whenever they want it. Moreover, when
income is low, saving anything at all can be especially hard. From
1996 to 2001, Americans saved an average of only 31 cents for every
ten dollars they earned. Fortunately, you can improve your savings
rate by using several savings strategies.
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis-
tics, information, and news, and analyzes this data for
3EOUL
international businesses, governments, and individuals
to help them guide their financial decisions.
SOUTH KOREA
In the last half-century, South Korea has grown
into one of the world’s leading high-tech economies.
This success is due in large part to the Korean peo-
ples’ willingness to spend great amounts of time and
money on education. Fierce competition to attend DATABYTES
the country’s best colleges and universities has devel-
oped. As a result, there is an extremely high demand Capital Seoul
for private tutoring, “cram schools,” pre-testing ser- Population 47,939,000
vices for college entrance exams, and educational Languages Korean, English
sites on the Internet. Children as young as two can Currency South Korean won
receive 20 minutes of weekly instruction in Korean, Gross Domestic
English, and math. This type of extra schooling does Product (GDP) $855.3 billion (2003 est.)
not come cheap. In a single year, Koreans pay more
GDP per capita $17,700
than $25 billion for after-school instruction. Parents
may spend as much as $36,000 on each child per Industry: Electronics, automobile production,
year, as Koreans compete for a position in the global chemicals, shipbuilding, steel, and textiles
landscape. Agriculture: Rice, root crops, barley, vegetables, cattle,
and fish
Exports: Electronic products, machinery and
equipment, motor vehicles, steel, ships, and textiles
Natural Resources: Coal, tungsten, graphite, and
molybdenum
Think Globally
Why do you think education has been such an
important part in South Korea’s growth into a high-
tech economic leader?
80 Unit 1 Planning Personal Finances
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: A Personal Balance Sheet Your Motive: A balance sheet shows
A personal balance sheet contains the your financial health at a given point in
following information: time. Updating your personal balance
sheet from time to time will help you
• Your assets with a value for each
keep track of your financial situation.
• Your liabilities with a value for each
• Amount of your net worth
Tanisha Brigg’s Personal Balance Sheet
Assets Amount
Cash/Checking & Savings $3,000
Securities (stocks, bonds, etc.) 15,000
Real estate/home 125,000
Other real estate 0
Automobiles 18,000
Personal property 23,000
Personal loans 5,000
Insurance cash values 15,000
Total Assets $204,000
Liabilities
Loans $ 3,500
Credit card debt 6,500
Current monthly bills 2,500
Mortgage 145,000
Unpaid taxes 4,500
Other debt 2,300
Total Liabilities $164,300
NET WORTH $39,700
Key Points: A balance sheet lists the items Find the Solutions
of value that you own, the debts that you 1. What are Tanisha’s assets?
owe, and your net worth. Personal financial 2. What are Tanisha’s liabilities?
statements such as a personal balance sheet 3. According to the balance sheet, what is
can help you determine what you own and Tanisha’s current net worth?
4. Why might a bank be interested in a
what you owe; measure your progress toward
person’s net worth?
your financial goals; track your financial
5. How do you figure net worth?
activities; and organize information for
taxes and credit applications.
Chapter 3 Money Management Strategy 81
SAVE Bringing your lunch
to school or work is one way
to spend less money than
you would by eating out.
On an average day, how much
money do you spend on food?
How might you save in this area?
Pay Yourself First
Common One method you can adopt is to set aside a fixed amount as
CENTS savings before you sit down to pay your bills. For example, Tyronne
considers his savings as a fixed expense. He writes himself a check for
$75 before he pays his bills; then he sends the check for immediate
Pay or Save?
deposit into his savings account. As an alternative to writing a check
Be a smart consumer and
pay off your credit card each month, many banks will automatically deduct a certain amount
bills before you put money from your checking account each month and deposit that in your
away in a savings account. savings account. Tyronne has set a specific dollar amount, but you
The interest rate charged can also set aside a percentage of your monthly income.
on credit cards is usually
higher than the interest
you can earn from your Payroll Savings
savings account. How do
you determine the interest Your employer may offer a similar option called a payroll savings
rate on your credit card? deduction. A payroll savings deduction is a portion of your earnings
that is automatically taken out of your paycheck and put into your
savings or retirement account.
82 Unit 1 Planning Personal Finances
For example, Teresa has authorized her employer to deduct $50
from each paycheck. Although that arrangement reduces her take-
After You
home pay to $750, she knows she is on her way to meeting her finan-
Read
cial goals. REACT
With the information
Spending Less to Save provided in this chapter,
would you be able to cre-
A third way to save is to start small. Make an effort to spend less
ate a budget and stick to
each day. If you read a magazine in the library rather than buying it it? Why or why not?
in a store, count out the purchase price of the magazine and place
it in a jar. If you go to the $4.50 matinee movie instead of the $7.75
evening show, pat yourself on the back and pay the jar the $3.25
difference. Before long you will have enough cash to start a savings
account or make a substantial deposit into an existing one.
How you save, though, is less important than the action of sav-
ing. The earlier you start, the better. Even small amounts of savings
can grow quickly and help you reach your financial goals.
Section 3.3 Assessment
QUICK CHECK Write About It Write a paragraph
1. What are some practical ways to budget for persuading Tara that cutting some of
variable expenses? her expenses is not only possible but is also
2. If you continually experience budget defi- necessary if she wants to meet her financial
cits, how can you decide which expenses goals.
to cut?
SOLVE MONEY PROBLEMS
3. What are three methods you might use to
increase your savings? 6. Budgets Hiroko earns $2,000 a month.
Her monthly expenses are about $1,850,
THINK CRITICALLY leaving $150 for savings. She now has
4. List three of your variable expenses. $1,000 in her emergency savings account
Estimate the amounts for each of and another $300 in an account for a new
these expenses for one month. computer. Hiroko has been offered a job
that will pay her an extra $200 a month,
USE COMMUNICATION SKILLS but she will need to buy a car to travel to
5. No Cuts! Tara complains that she can- the new job.
not seem to get ahead financially. Every Analyze What financial factors
time she receives a paycheck, it seems to should Hiroko consider as she decides
disappear. She also points out that all her whether to accept the job?
expenses, such as her phone bill, car pay-
ment, and subscriptions to several maga-
zines, are absolutely necessary.
Chapter 3 Money Management Strategy 83
Chapter 3 Review & Activities
CHAPTER SUMMARY
• There are opportunity costs, or trade- • On a personal balance sheet, list the
offs, in all decisions. When you make value of all your assets, along with all
a decision about how to manage your your liabilities. On a personal cash flow
money, you remove the option to use statement, record your income and
the money in a different way. expenses. Then subtract your expenses
• Organizing your financial documents from your income to determine your
makes it easier to plan and measure net cash flow.
progress, handle routine money • To create a budget: (1) Set financial
matters, know how much money is goals; (2) estimate your income; 3)
available, and make effective decisions. budget for unexpected expenses and
• You can organize financial documents savings; 4) budget for fixed expenses;
in home files, a safe-deposit box, and (5) budget for variable expenses; (6)
on a computer. record what you spend; and (7) review
• A personal balance sheet helps deter- your spending and saving patterns.
mine your net worth, so you can man- • Savings are the key to a sound financial
age your money to meet your financial future. Savings enable you to handle
goals. A personal cash flow statement unexpected emergencies.
helps determine the amount of cash you
receive and how you spend it.
Communicating Key Terms
Your best friend has asked you to explain how much he needs to save from each paycheck to
buy a digital camera that costs $350. Use 8 to 12 of the terms below to write an explanation.
• money management • liquid assets • discretionary income
• safe-deposit box • real estate • surplus
• personal financial • market value • deficit
statement • liabilities • budget
• personal balance sheet • insolvency • consumer price index (CPI)
• net worth • cash flow • budget variance
• assets • income
• wealth • take-home pay
Reviewing Key Concepts
1. List at least three examples from your own experience of opportunity costs.
2. Explain the benefits of keeping and organizing financial records and documents.
3. Identify documents to store in home files, safe-deposit boxes, or on a computer.
4. Describe what you learn from a balance sheet and personal cash flow statement.
5. List the steps in preparing a personal balance sheet and a personal cash flow statement.
6. Identify the steps in preparing a personal budget.
7. Explain how you can use your budget to identify ways to increase your savings.
84 Unit 1 Planning Personal Finances
Chapter 3 Review & Activities
Social Studies Many people have difficulty saving money for a variety
of reasons. Research some typical roadblocks to saving money.
Write About It Write a paragraph explaining at least three reasons and
how you would counsel them if they asked you for help.
Saving for a Club Trip The school Spanish Club is sponsoring a trip
to Mexico that will cost $1,000 per student. Your parents will contribute
$300, but you need to save the remaining $700 over the next four months.
You currently work seven hours a week babysitting for $10 per hour. The
following are your monthly expenses:
Variable Expenses (clothes, CDs, movie tickets, etc.) $180
Fixed Expenses (school fees, bus pass) $65
1. Calculate your total monthly earnings and expenses.
2. Compute by using spreadsheet software to calculate how much you need
to earn and/or reduce your expenses to meet your goal.
Connect with Mathematics You want to save $2,000 for college
by working over the summer. You can find a job that will pay you for 40
hours per week at regular rates plus an average of 10 hours per week at
overtime rates at 1.5 times. You can work for 10 weeks. You figure that you
need $150 per week to pay miscellaneous variable expenses.
1. Calculate How much will you need to earn per hour to save at least
$2,000 in addition to meeting your weekly expenses?
2. Think Critically Is $150 in weekly expenses a realistic estimate? What
are you not including?
How Much Is Enough? You have started a job at an annual salary of
$32,000. Your take-home pay is about 2/3 of your gross salary.
Log On Use an Internet search engine to find Web sites that discuss
what proportion of your salary you should spend on fixed expenses.
Answer the following questions:
1. What percentage of your take-home pay should be fixed expenses?
2. What percentage of your take-home pay should be discretionary income?
Newsclip: Ways to Save Best-selling personal finance authors
advise finding ways to save by cutting small luxuries and saving money from
O N L I N E
summer jobs.
Log On Go to finance07.glencoe.com and open Chapter 3. Read
the article. Then make a record of expenses. Ask yourself: What are
your spending and saving habits?
finance07.glencoe.com Chapter 3 Money Management Strategy 85
Chapter 3 Review & Activities
MONEY MANAGEMENT QUIZ
Imagine you were living on your own. How would you handle
your money? On a separate sheet of paper, take this money
management quiz.
1. I would create a budget for my income and expenses.
a. Always
b. Sometimes
c. Never
2. I would pay the rent or mortgage payment and utility bills on time.
a. Always
b. Sometimes
c. Never
3. I would keep three months of my living expenses in reserve for emergencies.
a. Always
b. Sometimes
c. Never
4. I would save 10 percent of my take-home pay.
a. Always
b. Sometimes
c. Never
5. I would set money aside for large expenses.
a. Always
b. Sometimes
c. Never
6. I would save to buy what I want.
a. Always
b. Sometimes
c. Never
7. I would use credit only when I have money to cover the charge.
a. Always
b. Sometimes
c. Never
8. I would balance my checkbook every month.
a. Always
b. Sometimes
c. Never
How did you score? Give yourself 2 points for each “Always,” 1 point for each “Sometimes,”
and 0 points for each “Never.”
If you scored 12–16, you are practicing good money management skills.
If you scored 6–11, with a little more effort you could improve your money management skills.
If you scored 0–5, it is time to start developing money management skills.
86 Unit 1 Planning Personal Finances
Chapter 3 Review & Activities
Your Financial Portfolio
What Is Your Net Worth?
Roberto plans to go to Europe next summer with the school band. He probably will
be able to save enough money by working all year at his part-time job. However, he is
prepared to sell some of his possessions if he needs to, so he made a list of his assets
and liabilities to determine his net worth.
Roberto’s Balance Sheet as of December 31, 20--
Liquid Assets
Checking account balance $150
Savings accounts 635
Total liquid assets $785
Personal Possessions
Market value of automobile $2,300
Stereo, TV, and video equipment 1,600
Computer 1,350
Watch 330
Total personal possessions $5,580
Investment Assets
Savings bonds $ 600
Total investment assets 600
Total Assets $6,965
Liabilities
Balance due on car loan $1,527
Total Liabilities $1,527
Net Worth $5,438
Calculate
Determine your net worth. In your workbook or on a separate sheet of paper,
list your assets, personal possessions, and liabilities (what you owe). Are you surprised
that your net worth is as much (or as little) as it is? How much would you like your net
worth to be in ten years? When you retire?
Chapter 3 Money Management Strategy 87
#
4
CHAPTER
Chapter Title
Consumer
Purchasing and
Protection
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 4.1
• Determine the factors that
influence buying decisions.
• Explain a research-based
approach to buying goods and
services.
• Identify strategies for making
wise buying decisions.
Section 4.2
• Identify ways to solve consumer
problems.
• Describe the legal alternatives
for consumers.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
88
In the Real World . . .
FT or more
ext here
than a year, Carla Jackson has been saving money
for a down payment to buy a car. Now that she has enough, she
is not sure what to do. Used cars sold by private owners are the most af-
fordable, but Carla would like to have a warranty. While auto dealers offer
financing, they do not sell the model that she wants. Everyone seems to have a
different opinion about where to buy a car, and Carla is unsure about what to
believe. In addition, when she decides where to buy the car, Carla is faced with
other dilemmas: How much money should she put down? If the car ends up
being a “lemon,” how can she protect her investment?
As You Read Consider the safest strategy for a consumer
who is making a major purchase and what protection
he or she can expect.
Comparison Shopping
ASK Q: I would like to purchase a new stereo. Is it
really that important for me to comparison shop?
A: Prices and quality can be very different from one store to another. Particularly
with expensive items, it is worthwhile to compare prices on similar items to see if
one store has a lower price than the others. If you write down the manufacturer and
style information, you can do a lot of this “legwork” by phone or by looking at store
advertisements or by doing research on the Internet.
Ask Yourself What is the benefit of comparison shopping?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com Chapter 4 Consumer Purchasing and Protection 89
Section 4.1
Focus on
Reading
Consumer
Purchasing
Read to Learn
• How to determine the
factors that influence
Factors That Influence
buying decisions. Buying Decisions
• How to explain a
What influences you to make a purchase?
research-based approach
to buying goods and You may enjoy shopping and do it often, or you might go to the
services. mall only if you need to buy something. In either case, wise buying
• How to identify strategies decisions will help you get the most out of the products you buy now
for making wise buying
and will enable you to meet your long-term financial goals. To get the
decisions.
most for your money, you need to recognize the factors that affect
your buying habits. Figure 4.1 shows some of the economic, social,
Main Idea
and personal factors that influence the purchases you make.
Understanding the factors
that influence your buy- The following example shows several of these factors at work.
ing decisions will help you Jessica is thinking about buying a new backpack. Economic factors
get the best value for your will play an important role in her decision. She will be more likely to
money. spend her money on a backpack that is well made but not too expen-
sive and can be repaired easily if it rips. Social factors may also affect
Key Terms Jessica’s choice. She may be more likely to buy a certain brand if it is
• down payment in style and if she could use it for her hobby, painting. In addition,
• cooperative personal factors may be at work. Jessica will have to determine how
• impulse buying
much of her income she can spend on the backpack.
• open dating
• unit pricing
• rebate Trade-Offs and Buying Decisions
• warranty
• service contract To make the most of your buying power, consider trade-offs.
Suppose that you buy a sound system with a credit card instead of
waiting until you have saved enough money to pay cash for it. You
get the pleasure of having the sound system now. However, you may
Before pay a higher price in the long run because of fees and interest the
You Read credit card company charges for use of the card.
Perhaps you choose a jacket because it is the cheapest one avail-
PREDICT able. Within a few days, you may discover that it is poorly made or
How could learning about difficult to repair. You may save time by ordering a sweater from a
consumer purchasing catalog or online. However, if you decide that you do not want it, you
benefit you now and in may have to pay postage to return it to the mail-order company. You
the future?
might not get your money back for the initial shipping and handling
charges. Keep in mind that buying decisions always involve trade-
offs, so you will be prepared to make wise choices.
90 Unit 1 Planning Personal Finances
Researching Consumer As You
Purchases Read
How do you research a product you want to buy? RELATE
By taking time to do research and evaluating products you What are the economic,
want to buy, you can get more value for your money. By following a social, and personal factors
research-based approach to buying goods and services, you can buy that would influence you
if you were going to buy
a high-priced item, such as a treadmill or a gym membership, more
a car?
intelligently. In addition, you will gain useful practice in making ordi-
nary purchasing decisions about low-cost items, such as toothpaste. A
research-based approach to buying has four phases:
1. Before you shop
2. Weighing alternatives
3. Making the purchase
4. After the purchase
PHASE 1: Before You Shop
Before you can begin to construct the walls of a house, you need
to lay its foundation. In the same way, before you begin to shop, you
need to do some background work. A good start to successful shop-
ping involves three steps: identifying your needs, gathering informa-
tion, and becoming aware of the marketplace. Completing these steps
will enable you to get what you really want.
&IGURE )NFLUENCES ON #ONSUMER "UYING $ECISIONS
%CONOMIC &ACTORS 3OCIAL &ACTORS 0ERSONAL &ACTORS
s 0RICES s ,IFESTYLE s 'ENDER
s )NTEREST RATES s )NTERESTS s !GE
s 0RODUCT QUALITY s (OBBIES s /CCUPATION
s 3UPPLY AND DEMAND s &RIENDS s )NCOME
s #ONVENIENCE s #ULTURE s %DUCATION
s 0RODUCT SAFETY s !DVERTISEMENTS s &AMILY SIZE
s "RAND NAME s -EDIA MAGAZINES RADIO s 'EOGRAPHIC REGION
s -AINTENANCE COSTS TELEVISION NEWSPAPERS s %THNIC BACKGROUND
s 7ARRANTY s 2ELIGION
-AKING A $IFFERENCE %CONOMIC SOCIAL AND PERSONAL FACTORS INFLUENCE CONSUMER BUYING DECISIONS
(OW MIGHT A FAMILYS SIZE AND INCOME AFFECT THE TYPE OF HOUSE
THE FAMILY BUYS
Chapter 4 Consumer Purchasing and Protection 91
Identify Your Needs Suppose that your VeryKool jeans are worn
out, and you would like to buy a new pair. You think that your
problem is a “need for a new pair of VeryKool jeans,” when the actual
problem is a “need for new jeans.” Some people always buy Brand A
when Brand B sells for the same price. They may not even consider
Brand C, which is cheaper than either A or B, and which also serves
their needs. If you define your needs clearly, you will be more likely
to make the best buying decisions.
Gather Information For example, suppose that Sarah loses her
watch on a white-water rafting trip. She might be able to borrow a
watch from a friend for a day or two, but eventually she will need to
buy a new watch. To begin her research, she should gather information
on the different models and prices of watches.
Information for buying decisions usually falls into three cate-
gories: costs, options, and consequences. Sarah might ask questions
related to cost, such as “What do watches cost at different stores?”
Her options will depend on the brands that the manufacturers pro-
duce and on where those brands are available. Sarah will also have to
consider consequences—how the purchase will affect her budget.
&IGURE 3OURCES OF #ONSUMER )NFORMATION
2
You can gather information to help
with purchasing decisions from a number
of different sources. Make sure they are
reliable, complete, relevant, and impartial. Ads and packaging can tell you a lot about
a product, so be sure to read the labels.
1 People you know
might be able to
provide insight on
a product’s perfor-
mance, quality, and
average price.
92 Unit 1 Planning Personal Finances
Some people do not spend enough time gathering and evaluating
information. Others do so much research that they become confused
and frustrated. Simple, routine purchases probably do not require
much more research than your own experience can provide. For more
expensive items, ask people you know for recommendations.
Other resources include product advertising and labeling, media
sources, consumer publications, such as Consumer Reports, govern-
ment agencies, or the Internet. Figure 4.2 illustrates some of these
resources. As you research and gather information, take notes on what
you learn. Having a written record of the information you collect can
be helpful in making comparisons later.
Be Aware of the Marketplace Knowledge is power. Research
provides sources for the item you want to buy. In addition, you
will be able to identify the brands and features from which you can
choose, average prices for an item, and where you can obtain reliable
information about similar products. Also, familiarize yourself with
some common myths about sales, returns, and credits in Figure 4.3
on page 94.
3 Reports issued by the media and
independent testing organizations on
the quality of products and services
are usually valuable, easily available,
and inexpensive. 4 Web sites for companies, magazines, newspapers,
and government agencies have product information
and shopping suggestions.
© 2005 Amazon.com, Inc.
All Rights Reserved.
Chapter 4 Consumer Purchasing and Protection 93
&IGURE #OMMON #ONSUMER -YTHS
4HE .ATIONAL !SSOCIATION OF #ONSUMER !GENCY !DMINISTRATORS RECENTLY IDENTIFIED A LIST OF COMMON
CONSUMER MYTHS 4HESE INCLUDE
h) CAN RETURN MY CAR WITHIN THREE DAYS OF PURCHASEv
7HILE MANY PEOPLE WOULD SAY THAT THIS STATEMENT IS
TRUE THERE IS NO SUCH
TIME PERIOD
h)T SAYS RIGHT HERE THAT )VE
WON IT MUST BE TRUEv &AKE
PRIZE NOTIFICATIONS CONTINUE TO
BECOME MORE CONVINCING 3OME
CONSUMERS ACTUALLY GO TO
COMPANY OFFICES TO TRY TO
PICK UP THEIR PRIZES
h)F ) LOSE MY CREDIT CARDS )M LIABLE FOR
PURCHASESv &EDERAL LAWS LIMIT CHARGES
ON LOST OR STOLEN CARDS TO -OST MAJOR
CREDIT CARD COMPANIES WILL NOT EVEN CHARGE
YOU THE IF YOU MAKE A REASONABLE EFFORT
TO NOTIFY THE COMPANY QUICKLY OF LOST
OR STOLEN CARDS
h!N AUTO LEASE IS JUST LIKE A RENTAL IF ) HAVE PROBLEMS
WITH THE CAR OR PROBLEMS PAYING ) CAN JUST BRING
IT BACKv -OST LEASES REQUIRE PAYMENTS FOR THE
DURATION OF THE CONTRACT %ARLY TERMINATION OF THE
CONTRACT CAN OFTEN RESULT IN VARIOUS ADDITIONAL CHARGES
h9OU CANT REPOSSESS MY CAR ITS ON PRIVATE
PROPERTYv 7HILE STATE LAWS VARY THE GENERAL RULE
IS THAT REPOSSESSION CANNOT OCCUR IF IT INVOLVES FORCE
OR ENTRY INTO A DWELLING (OWEVER VEHICLES IN
DRIVEWAYS AND UNLOCKED GARAGES ARE USUALLY
FAIR GAME
3OURCE h4EN 4OP #ONSUMER ,AW @5RBAN -YTHS v .ATIONAL !SSOCIATION OF #ONSUMER !GENCY !DMINISTRATORS 4WO
"RENTWOOD #OMMONS 3UITE /LD (ICKORY "LVD 4. OR 3!9 .!#!! 7EB SITE
WWWNACAANET
&ACT OR &ICTION 4HERE ARE SOME TYPICAL MYTHS THAT CONSUMERS BELIEVE ABOUT SALES RETURNS AND CREDIT
(OW DO SUCH MYTHS AFFECT YOU AS A CONSUMER
94 Unit 1 Planning Personal Finances
PHASE 2: Weighing the Alternatives
Every consumer decision may be approached in several effec-
tive ways. Instead of buying an item, for example, you might decide Shopping for
to rent it, borrow it, or do without it. You also have alternatives to Clothes
spending cash for a product. You might take advantage of special 1. Look at the sale
deals that allow you to delay payment, or you might choose to pay items first.
with a credit card. 2. Choose clothes
that you can mix
Identify What Is Important to You As you evaluate alternatives, and match or
decide which characteristics of the product—such as features, wear over several
performance, or design—are important to you. As you research the seasons.
available brands, you will recognize the characteristics that most 3. Shop at outlet
closely match your needs. You can judge a potential purchase by malls and discount
considering the following factors: stores, from sale
catalogs, and on
• Your personal values the Internet.
• Available time for research 4. Wait for end-of-
• Amount of money you have to spend season clearance
• Convenience of buying the item immediately sales.
• Pros and cons of a particular brand 5. Buy only items you
are sure you will
For example, as Sarah considers the selection of watches in a wear.
department store, she decides that a light-up dial and an alarm are
two features that she would use. In terms of performance, she prefers
a model that can withstand rugged outdoor activities. She wants a
watch that has big numbers and a stainless steel wristband.
Compare Prices The price of an item is an important consideration.
Prices can vary for all types of products. For example, Sarah’s watch
may cost as little as $15 or as much as $500. Differences in price may
be related to quality, but price does not always equal quality. When the
quality and quantity are basically the same for an item such as aspirin,
sugar, or salt, the lowest-priced item is probably the wisest choice.
When prices and quality vary, you have two options. If you can
afford all choices, you can buy the highest-quality item. If you cannot
afford all choices, you should consider buying the item that gives you
the best value per dollar.
Do Comparison Shopping Comparison shopping means you
compare prices and features of similar items at different stores. Many
people consider comparison shopping a waste of time. However, it
can be very useful under certain circumstances:
• You are buying complex or expensive items, such as a
computer or a mountain bike.
• You are buying items you purchase often, such as shampoo
or school supplies.
• You are using the Internet, print advertisements, or
mail-order catalogs.
• Different sellers are offering different prices and services.
• Product quality or price varies greatly.
Chapter 4 Consumer Purchasing and Protection 95
BEST BUYS Timing your
purchases to get the best
buys is not limited to clothes.
Why do you think that Septem-
ber, October, and November are
the best months to buy apples?
PHASE 3: Making the Purchase
After you have completed the research and evaluation process,
some other activities and decisions may be appropriate. These include
negotiating the price (if possible), deciding whether to use credit or
cash, and determining the real price of the product.
Negotiate the Price Certain purchases, such as real estate or cars,
may involve price negotiation. To negotiate, research information
about the product and the buying situation. Be sure that you are
dealing with the person, such as the owner or store manager, who
has authority to give you a lower price or additional features.
Decide on Credit or Cash When making a purchase, you usually
have two options—pay credit or cash. You need to consider the costs
and benefits of each one.
Credit is an arrangement to buy something now and pay for it
later. It is a type of loan. To repay the loan, you make monthly pay-
ments that often include additional fees or interest. The advantage of
One Life to Plan paying cash is that you do not have to pay these extra fees or make
Learn about personal continuing payments. However, because the cash is no longer in your
inventories and how you bank account, you lose the opportunity to earn interest on it. In addi-
can use them to match tion, the money is no longer available for emergencies.
yourself to the right job,
Before deciding to use credit, evaluate its costs, such as interest
which will be part of your
financial plan. rates and fees. These costs will differ depending on various factors:
To continue with • Source of the loan (e.g., parents, bank, or credit card company)
Task 3 of your • Type of credit account
WebQuest project, visit • Payment period
finance07.glencoe.com. • Amount of down payment—a portion of the total cost of an
item that must be paid at the time of purchase
96 Unit 1 Planning Personal Finances finance07.glencoe.com
Know the Real Price Sometimes you may discover that what
appears to be a bargain is not such a good deal after extra costs are
added to the price. Stores may charge you a fee for installation or
delivery. Find out exactly what the purchase price includes and get all
costs and conditions in writing.
PHASE 4: After the Purchase
After making a purchase, you may have other costs or tasks. A
car, for example, will require additional maintenance and ownership
costs, such as gasoline and insurance. You may have to learn how to
operate it correctly to improve its performance and to avoid major
repairs. If your car requires repair service, you should follow a process
similar to the one you used when you bought the car—investigate,
evaluate, and negotiate a variety of servicing options.
In some cases, you may be dissatisfied with a purchase and want
to return or replace it. When that happens, you need to know how to
handle your complaints effectively. The next section of this chapter
explains how to resolve consumer complaints.
Remember that the purchasing process is an ongoing activity.
You should rethink and reevaluate your decisions. The information
that you gather before you shop, along with your previous buying
experiences, will help you make deci-
sions in the future. Also, be sure to con-
sider changes in your needs, lifestyle,
values, goals, and financial resources.
Smart Buying
Strategies
How can you make an
informed purchase decision?
People have a variety of buying
styles. For example, Gordon looks for
ways to save on the brands he buys reg-
ularly. Anita and Roger buy the lowest-
priced brands or look for bargains.
SMART SHOPPING To get the best
buys, do research about products and
do comparison shopping. What is
comparison shopping?
Chapter 4 Consumer Purchasing and Protection 97
Whatever your style, several strategies can help you get the most
value for your dollar—timing of purchases, store selection, brand
comparison, information research, price comparison, and warranty
evaluation.
Timing Purchases
You are more likely to find a bargain at certain times of the year.
Stores traditionally offer reduced prices for seasonal clothing, such
as swimsuits, overcoats, and other items, about midway through a
particular season. You can also find reduced prices at back-to-school
sales, spring sales, and other special sales. Timing your purchases to
take advantage of sales can result in big savings.
The law of supply and demand can also affect the timing of pur-
chases. For example, if you wait a few months before buying a popular
new CD or DVD, the price may be lower than it was when it first came
out because the demand for the item has decreased. When businesses
want to reduce the supply of a product, they have clearance sales.
&IGURE 4YPES OF 2ETAILERS
"ENEFITS ,IMITATIONS
4RADITIONAL 3TORES
$EPARTMENT STORES s 7IDE VARIETY OF PRODUCTS s 0OSSIBLE INEXPERIENCE OR LIMITED
GROUPED BY DEPARTMENT KNOWLEDGE OF SALES STAFF
3PECIALTY STORES s 7IDE SELECTION OF A SPECIFIC s 0RICES GENERALLY HIGHER LOCATION
PRODUCT LINE KNOWLEDGEABLE AND SHOPPING HOURS MAY NOT
SALES STAFF BE CONVENIENT
$ISCOUNT STORES s #ONVENIENT PARKING LOW s 3ELF SERVICE FORMAT MINIMAL
PRICES ASSISTANCE FROM SALES STAFF
#ONTEMPORARY 2ETAILERS
#ONVENIENCE STORES s #ONVENIENT LOCATION LONG s 0RICES GENERALLY HIGHER THAN THOSE
HOURS FAST SERVICE OF OTHER TYPES OF RETAIL OUTLETS
&ACTORY OUTLET s "RAND NAME ITEMS LOW PRICES s -AY OFFER ONLY hSECONDSv OR
hIRREGULARSv FEW SERVICES RETURNS
MAY NOT BE ALLOWED
(YPERMARKET s &ULL SUPERMARKET COMBINED s #LERKS NOT LIKELY TO OFFER SPECIALIZED
WITH GENERAL MERCHANDISE SERVICE OR PRODUCT INFORMATION
DISCOUNT STORE
7AREHOUSE 3UPERSTORE s ,ARGE QUANTITIES OF ITEMS AT s -AY REQUIRE MEMBERSHIP FEE
DISCOUNT PRICES LIMITED SERVICES INVENTORY ITEMS
MAY VARY
3HOP !ROUND #ONSUMERS HAVE A CHOICE OF MANY DIFFERENT TYPES OF STORES EACH OF WHICH HAS
PROS AND CONS
(OW CAN COMPETITION AMONG STORES BENEFIT CONSUMERS
98 Unit 1 Planning Personal Finances
Store Selection Put on
The quality and variety of goods as well as the price at a store Your
may influence your decision to shop there. Store selection may affect Financial
the value of the products you purchase. You may also choose a retail
Planner’s
store because of its hours, location, reputation, policies, and services
such as parking and delivery. Figure 4.4 provides an overview of the Cap
major types of retailers—businesses that sell directly to consumers. Many people prefer the
Over the years, several alternatives to store shopping have convenience of doing their
emerged. One alternative is the cooperative, a nonprofit organization shopping online. If you were
owned and operated by its members for the purpose of saving money advising a client about buy-
on the purchase of goods and services. Because a cooperative buys large ing a car, what would you say
are some trade-offs of buying
amounts of goods, it can lower prices for its members. The main draw-
online?
back to cooperatives is that they offer few customer services.
Another alternative to store shopping is direct selling, which
includes mail order, TV home shopping, and online shopping. An
advantage of these types of shopping is the convenience of not hav-
ing to leave home. Online shopping sometimes offers lower prices,
and you may find excellent product information on the Internet. The
possible disadvantages of online direct selling are paying for shipping
and handling, and difficulty in returning purchases.
Brand Comparison
Most items are sold under a number of well-known
brand names that identify the products and their manufac-
turers. National-brand products are widely advertised and
available in many stores. Although they are usually more
expensive than non-brand products, national brands usually
offer consistent quality or value for your money.
A store-brand, or generic, product is usually sold by
one chain of stores and carries the name of that chain on
its label. Examples of these products include paper, canned
goods, and dairy foods. Because store-brand products are
often made by the same companies that make national-
brand products, their quality is good. However, because they
do not carry a brand-name label, they are less expensive.
When you compare brands, remember to consider price
and quality. Plan what you are going to buy before you shop
and take a list of what you need. Displays may attract your
attention and lead to impulse buying, which is purchasing
items on the spur of the moment. Impulse buying may be fun,
but it can cost you more. Also, you may buy products that you
do not really need.
HONEST BRANDING Some food labels claim that the
product is considered “low in fat” or “light.” Foods must
meet government criteria to be labeled with such terms.
Why do you think this type of regulation is necessary?
Chapter 4 Consumer Purchasing and Protection 99
Label Information Research
Labels on product packages typically include a great deal of
Common advertising. However, federal laws also require labels to present fac-
CENTS tual information. For example, food labels must indicate the com-
mon name of the product, the name and address of the manufacturer
Impulse Buying or distributor, the net weight of the product, and a list of the ingredi-
Too much impulse buying ents in decreasing order of weight.
can ruin a budget. When In addition, labels on almost all processed foods must have nutri-
you are tempted to buy tional information, such as the number of calories in one serving and the
clothes, cool sneakers, specific amounts of nutrients and food substances in the product. Some
CDs, or anything else that
foods are advertised as being “low in fat” or “light,” “low in sodium,” or
you really do not need,
give yourself a two-day “high in fiber.” Foods must meet government criteria to be labeled with
cool-down period. If you such terms. Manufacturers can include health claims on product pack-
decide you really want it, ages only if they have scientific evidence to support the claims.
you can go back to the To help consumers determine the freshness of some foods, manu-
store and buy it. However, facturers print dates on the labels. Open dating is a labeling method
chances are that most
that indicates the freshness, or shelf life, of a perishable product, such
things will not seem as
necessary a few days later. as milk or bread. Labels indicate open dating with phrases such as
How would you plan your “Use before May 25, 2008” or “Not to be sold after October 8.”
budget to allow for some Product labels for appliances, such as refrigerators and washing
impulse buying? machines, include information about operating costs, which identify
the most energy-efficient models.
Price Comparison
Unit pricing is the use of a standard unit of measurement to
compare the prices of packages that are different sizes. For example,
Claudia went to the drugstore to buy a bottle of mouthwash and
noticed that her favorite brand comes in two sizes at different prices.
The best way for her to determine which one is the better buy is to
use unit pricing. Most grocery stores and drugstores display the unit
pricing information for the products they sell. If a store does not pro-
vide this information, you can calculate the unit price by dividing
the price of the item by the unit of measurement (weight, volume,
or quantity). For example, an 8-ounce can of frozen orange juice that
costs $1.60 has a unit price of 20 cents per ounce.
When you know how to calculate the unit price, you can com-
pare the unit prices for various sizes, brands, and stores. Keep in mind
that the package with the lowest unit price may not be the best buy
for your situation. For example, a 10-pound bag of potatoes might
have the lowest unit price; but if you do not eat potatoes often, they
may spoil before you can use them.
Two common ways to save money are to take advantage of dis-
count coupons and manufacturers’ rebates. By using discount cou-
pons, you save money on products at the time you purchase them.
A rebate is a partial refund of the price of a product. To obtain a
rebate, you usually have to submit a form, the original receipt, and
the package’s UPC symbol, or bar code.
100 Unit 1 Planning Personal Finances
GO FIGURE FINANCIAL MATH
UNIT PRICING $3.39
⫽ $0.21/oz.
16 oz.
Synopsis: Knowing the unit price of an item can
help you determine the best buy. The 16-ounce size is the better buy at 21 cents per
ounce.
Example: The brand of peppermint mouthwash
that Claudia likes is offered in two sizes, 12 ounces
for $2.89 and 16 ounces for $3.39. Which is the
better buy? YOU FIGURE
You are considering buying soft drinks for your
Formula: Total Price
⫽ Unit Price sister’s birthday party. The market is offering a
Unit of Measurement
six-pack of 12-ounces for $2.99 and a liter bottle
Solution: $2.89 for $1.29. Which is the better buy? (Hint: One
⫽ $0.24/oz.
12 oz. liter equals 33.8 ounces.)
When comparing prices, the following guidelines can be very
helpful:
• More convenience (location, hours, sales staff) usually means
higher prices.
• Ready-to-use products (frozen prepared dinners, preassembled
toys) usually have higher prices.
• Large packages are usually the best buy; use unit pricing to
compare brands, sizes, and stores.
• Buying items “on sale” may not always mean that you save
money; the sale price at one store may be higher than the
regular price at another store.
Warranty Evaluation
Many products come with a guarantee of quality called a war-
ranty. A warranty is a written guarantee from the manufacturer or
distributor that states the conditions under which the product can be
returned, replaced, or repaired. Federal law requires sellers of products
that cost more than $15 (and that have a warranty) to make the war-
ranty available to customers before purchase. The warranty is often
printed directly on the package.
Types of Warranties Warranties are divided into two basic types:
implied and express. Implied warranties are unwritten guarantees that
cover certain aspects of a product or its use. An implied warranty of
merchantability guarantees that a product is fit for its intended use.
For example, a toaster will toast bread, or a CD player will play CDs.
Chapter 4 Consumer Purchasing and Protection 101
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: A Warranty Your Motive: Before making a purchase,
A warranty for a product contains the you should read the product’s warranty to
following information: understand exactly what protections the
• Name of the seller or manufacturer manufacturer offers you. A warranty is an
• Name of product assurance from the seller to the buyer that a
• Terms of the warranty product will perform as promised, or it will
• Instructions for how to get service be replaced or repaired.
FREE FLOW® ONE-YEAR LIMITED WARRANTY
FREE FLOW® plumbing fixture, faucets, and fittings are warranted to be free of defects in material and
workmanship for one year from date of installation.
Free Flow will, at its election, repair, replace, or make appropriate adjustments where Free Flow
inspection discloses any such defects occurring in normal usage within one year after installation. Free Flow
is not responsible for removal or installation costs.
To obtain warranty service, contact Free Flow either through your dealer, plumbing contractor, home
center or e-tailer, or by writing to Free Flow, Attn: Customer Service Department, 2525 Highland Drive,
Glenview, WI 53044, USA.
IMPLIED WARRANTIES INCLUDING THAT OF MERCHANTABILITY AND FITNESS FOR A
PARTICULAR PURPOSE ARE EXPRESSLY LIMITED IN DURATION TO THE DURATION
OF THIS WARRANTY. FREE FLOW DISCLAIMS ANY LIABILITY FOR SPECIAL, INCIDENTAL,
OR CONSEQUENTIAL DAMAGES. Some states/provinces do not allow limitations on how long an
implied warranty lasts, or the exclusion or limitation of special, incidental, or consequential damages so
these limitations and exclusions may not apply to you. This warranty gives you specific legal rights.
You may also have other rights, which vary from state/province to state/province.
This is our exclusive written warranty.
Notes:
1. There may be variation in color fidelity between catalog images and actual plumbing fixtures.
2. Free Flow reserves the right to make changes in product characteristics, packaging, or availability at any
time without notice.
Copyright © 2006.
Key Points: A warranty usually covers Find the Solutions
defects in materials and workmanship, and 1. For how many years are Free Flow fixtures
promises that the product will work properly covered by this warranty?
under normal circumstances. It does not 2. If you purchased a Free Flow faucet in
usually cover defects that occur due to the November of 2006 and installed it in August
user’s carelessness or inappropriate use of of 2007, when would the warranty expire?
the product. It also explains how a buyer can 3. What will Free Flow do if a product is defective?
resolve any problems. 4. Who is responsible for the cost of removing a
defective faucet and replacing it?
5. If a faucet is replaced under this warranty,
will it be the same model faucet?
102 Unit 1 Planning Personal Finances
Express warranties, which are usually written, come in two forms.
A full warranty states that a defective product will be fixed or replaced at
As You
no charge during a reasonable amount of time. A limited warranty covers Read
only certain aspects of the product, such as parts. This type may also QUESTION
require the buyer to pay a portion of the shipping or repair charges.
When you buy a product, you may be offered a service contract, What research should you
do if you are considering
which is a separately purchased agreement by the manufacturer or dis-
buying a used car with a
tributor to cover the costs of repairing the item. Service contracts are limited warranty? What do
sometimes called extended warranties, but they are not really warran- you need to consider if a
ties. You have to pay extra to obtain a service contract. Such contracts service contract is offered?
are generally offered on large, expensive items, such as cars and home
appliances. Sometimes service contracts are not worth the cost.
Smart shoppers know when to buy, where to buy, what to buy, how
much to pay, and how to make sure that the products they buy will per-
form as advertised. In the next section, you will learn some additional
rules for smart shoppers: how to resolve consumer complaints and how
to use the law to ensure that your rights as a consumer are protected.
Section 4.1 Assessment
QUICK CHECK The store stocks food similar to the one she
1. What are three economic factors that influ- buys at the animal hospital, but it is not
ence what people buy? organic. The store sells 25-pound bags for
2. Suppose that you are considering buying a $59.55 and 50-pound bags for $99.50.
pair of in-line skates. What steps might you Calculate Using the formula for
take before you shop and as you weigh your unit pricing, calculate the best buy
alternatives? among the three different-sized bags of cat
3. What are at least five strategies followed by food. Would the lowest-priced cat food be
smart shoppers. the best choice? Why or why not?
THINK CRITICALLY SOLVE MONEY PROBLEMS
4. Create a scenario in which someone is con- 6. Getting the Best Buy Marta loves shop-
sidering a purchase. Discuss the economic, ping for holiday gifts for her friends and
social, and personal factors that will affect family. This year she started looking for gifts
this buying decision. early, in June. She hopes that the extra time
will allow her to find the perfect gift for
USE MATH SKILLS everyone on her shopping list. By shopping
5. Cat Food Costs Gilda would do anything early, she might get some good buys.
for Luna, her 11-year-old cat. Until recently,
Write About It Using the infor-
she had been paying an animal hospital
mation in the section on smart buy-
$22.50 every two weeks for a 10-pound
ing strategies, explain how Marta can shop
bag of vitamin-enriched organic cat food
wisely to make the best choices for gifts and
designed for older cats. On Wednesday,
get good bargains.
Gilda called a local pet store.
Chapter 4 Consumer Purchasing and Protection 103
Section 4.2
Focus on
Reading
Resolving Consumer
Complaints
Read to Learn
• How to identify ways
to solve consumer Sources of Consumer Complaints
problems. What are some examples of consumer complaints?
• How to describe the
legal alternatives for When you purchase a product, you do not expect to have any
consumers. problems with it, especially if you have done research and considered
the alternatives. Unfortunately, every purchase involves some degree
Main Idea of risk.
Various methods can solve Most customer dissatisfaction results from products that are
consumer problems. Legal defective or of poor quality. Consumers also complain about unex-
alternatives are available to pected costs, deceptive pricing, and unsatisfactory repair service.
consumers. Another source of consumer complaints is fraud—dishonest busi-
ness practices that are meant to deceive, trick, or gain an unfair
Key Terms advantage.
• fraud
• mediation
• arbitration
• small claims court
• class-action suit
• legal aid society
Before
You Read
PREDICT
What would you do if you
received a bill for an item
you did not buy?
BUYER BEWARE Many advertisements appeal to the emotions of
consumers. How might this ad influence someone to buy the product?
104 Unit 1 Planning Personal Finances
Common Types of Fraud
Every year millions of consumers become victims of unethical
people who use dishonest business practices to trick or cheat buyers.
Experts estimate that fraud costs consumers tens of billions of dollars
annually.
As a consumer, you must be aware of various types of fraud. Tele-
phone and mail scams may offer you phony free prizes, travel packages,
work-at-home schemes, and investment opportunities. Fraudulent
diet products and other remedies attract consumers with phrases
such as “scientific breakthrough” or “miraculous cure.” The best way
to protect yourself from consumer fraud is to recognize it before you
become a victim—and to report it if you see it happening.
Resolving Differences
Between Buyers and Sellers
What is the best way to resolve a dispute over goods
or services?
BACK TO THE STORE
If you are dissatisfied with a product or service and decide to If you have a problem
make a complaint, remember to document the process. Keep a file of with a product and want
receipts, names of people you talk to, dates of attempted repairs, copies to resolve it, remember to
of letters you write, and any fees that you have had to pay. Resolving document each step you
complaints with a business can be handled in five different ways. take. What types of records
should you keep?
Chapter 4 Consumer Purchasing and Protection 105
As You Return to the Place of Purchase
Read Most consumers can resolve their complaints at the original
RELATE place of purchase. Most businesses care about having a reputation for
honesty and fairness and will usually do what is necessary to settle
Have you ever been dis- reasonable complaints. Remember to bring sales receipts and other
satisfied with a purchase? relevant information. Also, keep calm and avoid yelling or threaten-
What did you do?
ing the salespeople or managers. Explain the problem as clearly as
possible, and ask them to help you resolve it.
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis- 1UITO
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals
to help them guide their financial decisions.
ECUADOR
In 2000, Ecuador became the first country in
Latin America to adopt U.S. currency and discon-
tinue using its own—a practice called dollarization.
Although most nations have their own money, dol- DATABYTES
larization in Ecuador’s case was a last-ditch effort to
save the country’s collapsing economy. It was hoped Capital Quito
that trading Ecuadorian money for the American dol-
Population 12,558,000
lar would improve the country’s financial situation. It
Languages Spanish and Quechua
has—but to greater and lesser degrees. For example,
the exchange has low- Currency U.S. dollar
ered inflation but has Gross Domestic
spurred wage increases Product (GDP) $45.4 billion (2003 est.)
only slightly. (Ecuador’s GDP per capita $3,200
minimum wage has Industry: petroleum, food processing, textiles, and
grown from $50 to $120 metal work
a month.) For now dol-
Agriculture: bananas, coffee, cacao, rice; cattle;
larization has set up a
balsa wood; and fish
stable economic foun-
Exports: petroleum, bananas, shrimp, coffee, and cacao
dation for growth. It
was “a life raft,” sums Natural Resources: petroleum, fish, and timber
up one Ecuadorian
economist. “We didn’t Think Globally
have many options.” Do you think consumers in Ecuador can resolve
purchase complaints as suggested in this chapter?
Why or why not?
106 Unit 1 Planning Personal Finances
Contact Company Headquarters
If you cannot resolve your problem at the local store or business,
contact the company’s headquarters. Sending a complaint letter such
as the one shown in Figure 4.5 can be effective. To find a company’s
address, check the Consumer’s Resource Handbook. Your library may
have other useful references as well. Company Web sites are also good
sources. If you would rather talk to someone in the company’s cus-
tomer service department but do not know the telephone number,
call 1-800-555-1212, the information number. Your library may also
carry a directory of toll-free numbers. Some companies print their
toll-free customer-service numbers on their packages.
&IGURE 3AMPLE #OMPLAINT ,ETTER
9OUR .AME .OTE +EEP COPIES OF YOUR LETTER AND ALL
9OUR !DDRESS RELATED DOCUMENTS AND INFORMATION
9OUR #ITY 3TATE :)0 #ODE
$ATE
!PPROPRIATE 0ERSON
#OMPANY .AME
$ESCRIBE YOUR PURCHASE 3TREET !DDRESS
#ITY 3TATE :)0 #ODE
!PPROPRIATE .AME
$EAR ??????????????????????????
3TATE PROBLEM ,AST WEEK ) PURCHASED OR HAD REPAIRED A NAME OF PRODUCT WITH MODEL NUMBER OR SERVICE
PERFORMED ) MADE THIS PURCHASE AT LOCATION AND OTHER IMPORTANT DETAILS OF THE TRANSACTION
5NFORTUNATELY YOUR PRODUCT OR SERVICE HAS NOT PERFORMED SATISFACTORILY OR THE SERVICE WAS
INADEQUATE BECAUSE ???????????????? 4HEREFORE TO SOLVE THE PROBLEM ) WOULD APPRECIATE
'IVE HISTORY OF
YOUR HERE STATE THE SPECIFIC ACTION YOU WANT %NCLOSED ARE COPIES COPIES./4 ORIGINALS
PROBLEM OF MY RECORDS RECEIPTS GUARANTEES WARRANTIES CANCELLED CHECKS CONTRACTS MODEL AND SERIAL
NUMBERS AND ANY OTHER DOCUMENTS
) AM LOOKING FORWARD TO YOUR REPLY AND RESOLUTION OF MY PROBLEM AND WILL WAIT THREE WEEKS
3TATE REASONABLE BEFORE SEEKING THIRD PARTY ASSISTANCE #ONTACT ME AT THE ABOVE ADDRESS OR BY PHONE AT HOME
TIME FOR ACTION AND OFFICE NUMBERS HERE
3INCERELY YOURS
9OUR .AME
%NCLOSURE
3OURCE #ONSUMERS 2ESOURCE (ANDBOOK REPRINTED BY PERMISSION OF $IANA 0UBLISHING #O #OLLINGDALE 0!
)N 7RITING 3ENDING A LETTER TO A COMPANYS HEADQUARTERS CAN PRODUCE RESULTS WHEN YOU
WANT TO RESOLVE A CONSUMER COMPLAINT
7HEN SHOULD YOU TAKE THIS STEP TO RESOLVE A PROBLEM
Chapter 4 Consumer Purchasing and Protection 107
Consumer Agency Assistance
If the company is not providing the answers you seek, get help
from various consumer, business, and government organizations.
These groups include national organizations that deal with issues
LANGUAGE ARTS such as nutrition and automobile safety. Local organizations also
In 2003, the U.S. Better handle complaints, do surveys, and provide legal assistance.
Business Bureau system Among the best-known consumer agencies is the Better Busi-
handled over 773,000
ness Bureau, a network of offices around the country sponsored by
written consumer com-
plaints. Some of the prod- local business organizations. These bureaus deal with complaints
ucts and businesses that against local merchants. However, the merchants are under no
had the highest number obligation to respond to those complaints. Therefore, the bureaus
of complaints against are most useful before you buy a product. They can tell you about
them included automo- the experiences other consumers have had with a certain store or
bile dealers and cellular
company.
phone dealers. If you have
a complaint, you should Government Agencies A large network of local, state, and federal
always approach the com-
government agencies is also available. These agencies handle all
pany first. With a partner,
prepare a script you could types of problems, from false advertising to illegal business activities.
use when approaching One federal agency is the Food and Drug Administration, which
a company with a com- sets safety standards for food, drugs, chemicals, cosmetics, and
plaint. Rehearse your script household and medical devices. The Consumer Product Safety Com-
together and then present it mission, another federal agency, helps protect consumers against
to the class.
unsafe products. If you do not know which consumer protection
agency to choose, contact your U.S. representative locally or in
Washington, D.C.
Dispute Resolution
Dispute resolution programs offer other ways to settle disagree-
ments about a product. Working out a complaint may involve
mediation—the attempt by a neutral third party to resolve a conflict
between a customer and a business through discussion and negotia-
tion. However, a decision made in mediation is not legally binding.
Sometimes manufacturers and industry organizations use the arbitra-
tion process to resolve consumer complaints. Arbitration is a process
whereby a conflict between a customer and a business is resolved by
an impartial third party whose decision is legally binding.
Settling a dispute through one of these methods can be quicker,
less expensive, and less stressful than going to court. Sources for dis-
pute resolution programs in your area include:
• Local or state consumer protection agencies
• State attorney general’s office
• Small claims courts
• Better Business Bureau
• trade associations
• local bar associations.
If these dispute resolution methods do not produce the results
you want, you may choose to take legal action.
108 Unit 1 Planning Personal Finances
Legal Options for Consumers As You
What are your legal rights? Read
First, try to settle your dispute by going to the place of business, QUESTION
contacting the company’s headquarters, or getting help from a con-
What are the alternative
sumer agency. However, if you are still unhappy with the outcome,
measures available to con-
your final alternative is the legal system. sumers before they resort
to the legal system?
Small Claims Court
Every state has a court system to settle minor disagreements. A
small claims court is a court that deals with legal disputes that
involve amounts below a certain limit. The amount varies from state
to state, ranging from about $500 to $10,000. Cases usually do not
involve juries or lawyers, so the cost of this type of legal action is rela-
tively low. The decision of the judge is final.
When you present your case, you should be calm and polite and
stick to the point. Submit your own evidence, such as receipts, con-
tracts, and photographs. You may use witnesses who can testify on
your behalf and support your claim. The process takes a few weeks.
Careers in Finance
CREDIT
RETAILANALYST
SALES Jamie Jefferson
ASSOCIATE Patagonia
Before Jamie worked at Patagonia, she was a frequent customer. As a participant of outdoor sports,
Jamie was happy to land a sales associate position at a Patagonia store, a company that specializes in
outdoor gear. She appreciates being surrounded by merchandise that she actually uses. She enjoys
working with others and tending to customers who share similar interests. Jamie also finds value in
working with a company that shares her enthusiasm for the environment. Patagonia employees are
expected to educate themselves about environmental campaigns, and the workplace recycles all
paper, glass, and plastic items. Retail sales associates often work for stores that reflect their interests.
SKILLS: Sales, communication, cooperation
PERSONAL TRAITS: Positive, neat, detail-oriented, shares company’s vision for outdoor activities
and responsibilities, able to lift heavy objects and stand for long periods
of time
EDUCATION: High school diploma or equivalent, sales experience
ANALYZE How do you think a company such as Patagonia trains employees to respond to
customer complaints?
To learn more about career paths for retail sales associates, visit finance07.glencoe.com.
finance07.glencoe.com Chapter 4 Consumer Purchasing and Protection 109
FORMAL COMPLAINTS To resolve a consumer complaint, some-
times you must take your case to small claims court. How is a small
claims court different from a trial court?
Class-Action Suits
Sometimes many people have the same complaint. For example,
several people may have been injured by a defective product or over-
charged by a utility company. Such a group may qualify for a class-
TechByte
Lawyering Up If you
action suit. A class-action suit is a legal action on behalf of all the
people who have suffered the same injustice. These people are called
have not been able to a “class” and are represented by one lawyer or a group of lawyers
resolve a consumer com- working together.
plaint by talking with the If a situation qualifies for a class-action suit, all parties must be
company’s customer ser- notified of the suit. An individual may decide to file a separate law-
vice representative, you
suit instead. If the court rules in favor of the class action, the money
can take some legal steps
on your own without the awarded is divided among the claimants or put into public funds.
help of a lawyer. But if
you still cannot resolve Other Legal Alternatives
the issue, you may need
to search for a lawyer to If you do not want to go to small claims court or join in a class-
help you. action suit, you may seek the services of a lawyer. Get a referral for
List two things you a lawyer from someone you know. You can also find the names of
can do to resolve lawyers in newspapers, in the yellow pages of the phone book, or
a complaint. Then list by calling a local branch of the American Bar Association (ABA), a
steps for finding a good professional organization of lawyers. It is important to make sure that
lawyer after reading
the lawyer you choose has experience in handling your type of case.
information through
finance07.glencoe.com. You should also ask about fees and payment policies. Lawyers can be
expensive. You may decide that your problem is not worth the time
and expense.
110 Unit 1 Planning Personal Finances finance07.glencoe.com
If the cost of lawyers and other legal services is too high for you,
you may seek help from a legal aid society, a network of commu-
After You
nity law offices that provide free or low-cost legal assistance. Sup-
Read
ported by public funds, these offices provide a variety of legal services. REACT
Not everyone is eligible for help from a legal aid society. Your income
must fall below a certain amount to qualify, which varies from state What legal remedies are
available for settling con-
to state.
sumer disputes?
If you do not qualify to use the legal aid society, and hiring a
private attorney is out of your budget, you might visit a legal clinic.
In many cases, such businesses can offer basic assistance with advice
and filing paperwork. In addition, some private attorneys offer their
services at reduced rates and work part time in legal clinics.
Many tools are available to protect your rights. However, they
will not be valuable, unless you use them. You will have fewer con-
sumer problems if you do business only with companies that have
good reputations. You should avoid signing contracts and other doc-
uments you do not understand, and watch out for offers that seem
too good to be true.
Section 4.2 Assessment
QUICK CHECK Discuss With your classmates,
1. What are some typical consumer complaints? brainstorm various types of fraud.
2. What are five methods of resolving con- Discuss ways to avoid becoming a victim
sumer complaints? of fraud.
3. What are some of the advantages and dis-
SOLVE MONEY PROBLEMS
advantages of taking a consumer dispute to
small claims court? 6. Resolving Consumer Complaints
Eduardo and Ana recently bought a new
THINK CRITICALLY dining room table that they saw adver-
4. Write a brief paragraph describing a product tised on a furniture manufacturer’s Web
or service with which you were dissatisfied, site. When the table arrived and they
and explain what the problem was. Did you opened the box, they discovered long, deep
complain? If so, what specific steps did you scratches on the top of the table. The manu-
take, and what was the outcome? facturer is located thousands of miles from
where they live. The box had no directions
USE COMMUNICATION SKILLS about how they could return the product.
5. Too Good to Be True? You recently Write About It Describe the
received a letter offering a four-day vaca- steps Eduardo and Ana should take
tion trip to Hawaii for only $350. The price to resolve their situation and get either a
includes transportation, a hotel room, and refund or a new table.
meals. To reserve a space, you must send
$175. The offer sounds too good to be true,
and you suspect that it is fraudulent.
Chapter 4 Consumer Purchasing and Protection 111
Chapter 4
# Review & Activities
CHAPTER SUMMARY
• Buying decisions are influenced by • Make buying decisions by using
several factors: economic factors, such the following strategies: time your
as prices, brand names, quality, and purchases, select stores, compare
maintenance costs; social factors, such brands, check labels, compare prices,
as lifestyle and culture; and personal and evaluate warranties.
factors, such as age, occupation, and • To solve consumer problems, return
family size. to the place of purchase, contact the
• A research-based approach to buying company that manufactured the
involves identifying needs, gathering disputed product, obtain help from a
information, becoming aware of the consumer agency or dispute resolution
marketplace, weighing alternatives, and program, or initiate legal action.
making the purchase. The purchase • Legal alternatives available to
may involve negotiation, plus you will consumers include lawsuits in small
need to determine whether to pay cash claims court, joining in a class-action
or use credit. suit, hiring a lawyer, and obtaining
assistance from a legal aid society.
Communicating Key Terms
A neighbor who has just moved to the United States is buying several large appliances. He
is having some difficulty understanding some of the advertising information on the products.
Write simple explanations of eight of the terms below that you think he may be having trouble
understanding.
• down payment • service contract
• cooperative • fraud
• impulse buying • mediation
• open dating • arbitration
• unit pricing • small claims court
• rebate • class-action suit
• warranty • legal aid society
Reviewing Key Concepts
1. List the economic, social, and personal factors that influence a decision to buy an article of
clothing.
2. Describe the research-based steps for buying a personal computer.
3. Explain why some of the strategies for making wise purchases may be more important than
others, depending on the item being purchased.
4. Identify methods to resolve consumer complaints.
5. Describe the advantages and disadvantages of small claims court and joining a class-action suit.
112 Unit 1 Planning Personal Finances
Chapter 4 Review & Activities
Language Arts Many consumers are attracted to name brands because
they are recognized through advertising. However, generic or store brands
have become popular alternatives.
Write About It Write a paragraph explaining three reasons for buying a
brand-name product and three reasons for buying a store brand instead.
Back to School You have $130 to spend at August “back-to-school”
sales. The tennis shoes you really want cost $105 plus 7 percent sales tax.
Online, the shoes cost $95.99, with 11 percent shipping charges but no sales
tax. Based on experience, you think the shoes’ price will be one-third less by
mid-October.
1. Calculate (a) How much will the shoes cost in October? Compare that
total price to the current store and online prices. (b) What trade-offs
do you incur by waiting to buy the shoes? (c) How do those trade-offs
compare to having more money now for other purchases?
2. Compute by using spreadsheet software the total costs of the shoes in
stores now, online now, and in stores in October.
Connect with Social Studies In late 2004, a pain medication
called Vioxx was removed voluntarily from the market by its manufacturer,
Merck, Inc., due to a risk of heart-related problems. Merck lost a great deal of
income and its stock price went down significantly.
Research Use library and Internet sources to find out about Merck’s
voluntary removal of Vioxx and the potential for class-action lawsuits
against the company. Investigate the Federal Food and Drug Act and other
laws aimed at protecting citizens and summarize your findings
Shopping Online Many people limit their online purchases to books,
CDs, and airplane tickets. Based on this chapter, explain why you would or
would not buy the following items online:
Log On Use an Internet search engine to find Web sites selling the
items listed:
1. Expensive tennis shoes 4. Flowers for your mother
2. An iPod 5. The latest CD from your favorite band
3. A dress or suit for the prom 6. Four CDs from your favorite bands
Newsclip: Continuous Shopping Consumer spending has been
on the rise since 2001. Despite unemployment rates, higher oil prices, and
O N L I N E
terrorist threats, Americans continue to shop.
Log On Go to finance07.glencoe.com and open Chapter 4. List
reasons consumers continue to spend. Ask your teenage friends what
they buy and want. Make a list.
finance07.glencoe.com Chapter 4 Consumer Purchasing and Protection 113
Chapter 4 Review & Activities
ARE YOU A SMART SHOPPER?
With so many places to shop and a wide variety of products to buy, it
takes skill and practice to get the most from your money. On a separate
sheet of paper, test your shopping know-how.
1. When I want something, I
a. go to the nearest store that has it and buy it. (1 point)
b. locate where I can buy it at the lowest cost today and buy it. (2 points)
c. wait for the item to go on sale. (3 points)
2. I like to
a. buy what looks good to me at the time. (1 point)
b. look at consumer guides to help me choose the best buy. (2 points)
c. compare all the brands and decide which offers the most value. (3 points)
3. When buying an item in the drugstore, I
a. always buy name brands. (1 point)
b. always buy generic brands. (2 points)
c. calculate the best price per weight or unit and buy accordingly. (3 points)
4. When shopping for clothes, I
a. buy what strikes my fancy. (1 point)
b. only buy what’s on sale. (2 points)
c. only buy what I know I will wear. (3 points)
5. I use coupons whenever I can.
a. Never (1 point)
b. Sometimes (2 points)
c. Always (3 points)
6. When eating out, I
a. order what I want, regardless of cost. (1 point)
b. sometimes am more concerned about cost but sometimes order expensive dishes.
(2 points)
c. always look at prices and order accordingly. (3 points)
7. Whenever I can, I borrow books and DVDs from the library.
a. Never (1 point)
b. Sometimes (2 points)
c. Always (3 points)
8. When buying CDs or DVDs, I
a. get what I want as soon as it comes out. (1 point)
b. try to wait for a sale but get what I want if I really want it. (2 points)
c. wait for a sale. (3 points)
If you scored:
21–24: You are a smart shopper. However, be sure you treat yourself occasionally.
16–20: You sometimes make choices that cost more, but you are usually aware of them.
Less than 16: Try to practice a few more smart shopping skills and see how much you save.
114 Unit 1 Planning Personal Finances
Chapter46Review
Chapter Review&&Activities
Activities
Your Financial Portfolio
Your Budget
David wants a $2,500 laptop computer. At his part-time job at Computer Warehouse,
he earns $7 an hour and works an average of 16 hours a week. For ten weeks in the
summer, he works 40 hours a week. He also makes money on the side by setting up
and troubleshooting computers. By keeping track of his expenses, he has figured his
monthly budget.
If David sticks to his budget, in a year’s time he can save $3,630 ($302.50 ⫻ 12 ⫽
$3,630). That would be more than enough to buy the computer he wants.
Average Monthly Income
Income:
Monthly take-home pay from Computer Warehouse $502.50
Income from setting up and troubleshooting computers 50.00
Other income 20.00
Total Income $572.50
Average Monthly Expenses
Expenses:
Fixed Expenses
Online services $ 20.00
Car loan and insurance 135.00
Variable Expenses
Entertainment and personal 90.00
Gifts and contributions 25.00
Total Expenses $270.00
(Total Income ⫺ Total Expenses ⫽ Savings)
($572.50 ⫺ 270.00 ⫽ $302.50)
David can save $302.50 a month.
Calculate
What is your budget? A budget can help you see where you are spending your
money and assist you in determining how long it will take to save for a special purchase.
In your workbook or on a separate sheet of paper, calculate your income and expenses
for one month. How much can you save in one month? What is the cost of your desired
purchase? How long will it take you to save for what you want?
Chapter 4 Consumer Purchasing and Protection 115
# LAB
Unit 1
Titlea Financial Life!
Get
Setting Up a Procedures
Career Plan STEP A The Process
In order to develop a career
plan, you must set goals, understand your abili-
Overview ties and interests, and conduct research. By fol-
Carrie Houston will be graduating from lowing this process, you will have a head start
high school this year. She is facing many impor- into your future. In addition, you will be able to
tant decisions—from developing her personal share what you have learned with Carrie or your
financial goals to planning her career strategy. friends.
She is interested in fashion design and computer 1. Develop five to seven financial goals. You
graphics and has been taking related classes. should have at least one short-term goal,
When you make decisions, you are taking one intermediate goal, and one long-term
control of your life. You can shape your future in goal. Your selected career will help you meet
ways that are important to you. To make sound your goals.
decisions, you should identify your goals and 2. Take an aptitude test and/or interest inven-
understand the ways in which your personal val- tory. You can find these in your school’s
ues and life situations will influence your choices. guidance office or career center, or on the
If you are prepared to make decisions—rather than Internet.
leave your future to chance or allow others to tell 3. Research a career that interests you. Make
you what to do—you will be able to achieve per- sure that you find out about the educational
sonal satisfaction and financial security. requirements, skills needed, pay range,
Develop a process to help plan your own duties and responsibilities, opportunities for
career; then share it with Carrie so that she can advancement, and future trends in the field.
plan her future career. 4. Conduct an informational interview with
someone who is working in your area of
interest to gather practical information, or
arrange to “job shadow” someone in your
Resources & Tools selected field. (To job shadow means to fol-
• Career center/guidance office at school low a person on the job for a day to learn
• Career-development book about a particular career.)
• Crayons, markers, colored pencils 5. Obtain catalogs from colleges or other post-
• Internet secondary institutions where training is
• Portfolio (ring binder or file folder) offered in the field you are researching. Try
• Poster board to locate at least one institution in your
• Presentation software (optional) community, one in your state, and one out
• Public or school library of state.
• Word-processing software 6. Using a word-processing program, create
templates for a résumé and cover letter.
116 Unit 1 Planning Personal Finances
STEP B Create Your Portfolio
As you work through the STEP C Presentation
One of the most important
process, save the results so that you can refer, skills that employers look for in a good
review, and refine. Divide your portfolio into six employee is the ability to communicate. This
sections. Label the sections: (1) Goals, (2) Tests, is a skill that you can develop in class through
(3) Career Research, (4) Live Work, (5) Educa- oral presentations.
tion, and (6) Résumé.
1. Read a book on career development. Exam-
1. Using a word-processing program, type your ples include:
goals in a large font (16–18 point). These • What Color Is Your Parachute? by Richard
will be your guiding principles. Place them Nelson Bolles
in Section 1. • Who Moved My Cheese? by Spencer
2. Place the results of your aptitude test or Johnson
interest inventory in Section 2. • Job Interviews for Dummies by Joyce Lain
3. Type a two- or three-page (double-spaced) Kennedy
career report based on your research, and • Cool Careers for Dummies by Marty
place it in Section 3. Nemko, Paul Edwards, and Sarah Edwards
4. Write about your informational interview or • I Could Do Anything If I Only Knew What It
job shadowing experience. Include pictures, Was by Barbara Sher with Barbara Smith
brochures, or other materials that you might
have received. Place these items in Section 4. 2. Using either presentation software or poster
5. Place the catalogs that you collect in board with markers, crayons, or colored
Section 5. pencils, create a five-minute presentation
6. Place the templates that you create in that summarizes the book.
Section 6. 3. Include your opinion of the book, stating
whether you would recommend it to Carrie.
117
Unit 2
Banking
and
Credit
Internet
Project
Your Own Home
Buying your first home takes a lot of planning and
preparation. In this project, you will write a plan
designed to help you to purchase your first home
when you are an adult. Since you have several years
to accomplish this goal, you have time to save some
money for a down payment, establish a good credit
rating, choose a home, apply for a mortgage, and
negotiate a price.
Log on to finance07.glencoe.com. Begin
by reading Task 1. Then continue on your
WebQuest as you study Unit 2.
Section 5.1 6.2 7.3
Page 135 170 223
118 finance07.glencoe.com
FINANCE FILE
Consumer Debt: The
Deeper the Hole, the
Better for Business
When is bad debt good business?
Public collection agencies that special-
ize in the purchase of unpaid credit-card
obligations and other bills are expected to
get a lift as the consumer starts to show
signs of overload.
Consumers have borrowed a bundle
in recent years—over $2 trillion in credit
card and auto debt, according to the Fed-
eral Reserve. Add mortgages and the figure
jumps to nearly $10 trillion. The average
U.S. household is deeper in the hole than
it was four years ago, carrying debt of
about $9,200, up from $7,200.
Since household income isn’t keep-
ing pace with debt growth, more consum-
ers are getting close to the edge. Credit
card charge-offs, or the bad debt that
banks write off the books, were expected
to hit a record $65 billion in 2004, up
from $57.3 billion in 2003, according to
the Nilson Report. Such debts will increase
to $2.8 trillion by 2010.
Ultimately, collection companies
make their money from bad-debt port-
folios by working out reasonable solu-
tions with borrowers. Zaro [CEO of
Cavalry Investments] says: “If you don’t
help them, you don’t help yourself.”
—By Mara Der Hovanesian
Write About It How do you
think consumers can reduce
their credit debt?
Log On To read the complete
BusinessWeek article and do the
BusinessWeek Extension activity to
help you learn more about handling
credit and avoiding debt, go to
finance07.glencoe.com.
finance07.glencoe.com 119
5
CHAPTER
Banking
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 5.1
• Identify types of financial
services.
• Describe the various types of
financial institutions.
Section 5.2
• Compare the costs and benefits
of different savings plans.
• Explain features of different
savings plans.
• Compare the costs and benefits
of different types of checking
accounts.
• Explain how to use a checking
account effectively.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
120
In the Real World . . .
W hen Lynn Podesta was hired for her first job, she de-
cided to open a bank account. She went to local branches and picked up
brochures that explained interest rates, fees for services, locations of ATMs, and
online services. Lynn was surprised to find out that each bank had different benefits
and costs. Some banks charged for ATM usage and teller services. She also found a
bank that offered a free checking account if her paychecks were deposited directly.
Lynn felt that it was important to start an account. Using a debit card would
allow her to shop without carrying cash, and having an account would help
her establish credit. Getting to know banking would not be too diffi-
cult, and she would have advantages.
As You Read Consider how you can use basic banking
services to your advantage.
Savings Account
ASK Q: I make only $75 a week at my part-time job and
use most of it for movies, food, and CDs. Because I
make so little, do I really need to put my money in a bank?
A: Since you have a small amount of money to take care of, you may not need a
bank. However, $75 a week is a large sum to spend on entertainment. You should
open a savings account and try to save at least $10 a week. After three months you
would have $130, and after a year you would have more than $500.
Ask Yourself Why is it a good idea to start a savings account now?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com 121
Section 5.1
Focus on
Reading
Financial Services
and Institutions
Read to Learn
• How to identify types of
financial services. How to Manage Your Cash
• How to describe the What are your cash needs?
various types of financial
institutions. Banking in America began in 1791, soon after the United States
declared independence. Congress established the nation’s first cen-
Main Idea tral bank with eight branches. Today, with more than 11,000 banks,
Understanding the features 2,000 savings and loan associations, and 12,000 credit unions in the
of financial services and United States, you have a wide array of financial services from which
institutions will help you to choose. A trip to the bank may be a visit to an automated teller
choose options that best machine (ATM) in the mall or a quick look at your savings account bal-
meet your needs. ance on the Internet. Your choice of financial services will depend on
your daily cash needs and your savings goals. (See Figure 5.1.)
Key Terms
• direct deposit
• automated teller Daily Cash Needs
machine (ATM)
Your daily cash needs may include buying lunch, going to the
• debit card
• point-of-sale transaction movies with friends, filling the car with gasoline, or paying for other
• commercial bank routine activities. Of course, you can carry cash, or currency—bills
• savings and loan and coins—to pay for these items. You can also use a credit card or go
association (S&L) to an ATM, also known as a cash machine.
• credit union As you decide which method to use for your everyday cash
needs, consider the pros and cons of each one. For example, ATMs
may charge a fee for each use. If you pay a $1 fee each time you take
out cash, say, twice a week, you will spend $104 on fees each year.
Before In addition to your short-term cash needs, you need to consider
You Read your long-term financial goals. Resist the temptation to overspend
PREDICT and avoid buying on impulse or overusing credit cards. Try not to dip
into your savings to pay current bills. Put extra money you have to
What might be the differ- work for you—in a savings account or an investment plan.
ences between commercial
banks, savings and loans,
and credit unions? Sources of Quick Cash
Regardless of how well you plan, you may sometimes need more
cash than you have available. You have two options: Use your sav-
ings or borrow the money. Remember that either choice requires a
trade-off. Although you will have immediate access to the funds you
need, long-term financial goals—such as paying for college, buying a
car, or starting a business—may be delayed.
122 Unit 2 Banking and Credit
Types of Financial Services
Which financial services would benefit you?
In order to stay competitive in today’s marketplace, banks and
other financial institutions have expanded the range of services that
they offer. These services can be divided into three main categories:
• Savings
• Payment services
• Borrowing
Savings
Safe storage of funds for future use is a basic need for everyone.
Money that is going to be left in a financial institution for months
or years is called a time deposit. Some examples of time deposit funds
include money that you keep in any type of savings account and cer-
tificates of deposit or CDs. Having a savings acount is essential for
any personal finance plan.
&IGURE &INANCIAL 3ERVICES
&INANCIAL 3ERVICES FOR 3HORT 4ERM .EEDS
s $AILY PURCHASES
s ,IVING EXPENSES
s %MERGENCY FUND
$AILY #ASH .EEDS 3AVINGS #HECKING #REDIT #ARDS
s #HECK CASHING s 2EGULAR SAVINGS ACCOUNT s 2EGULAR CHECKING
s !UTOMATED TELLER s -ONEY MARKET ACCOUNT ACCOUNT
MACHINES !4-S s /NLINE PAYMENTS
s 0REPAID CARDS s !UTOMATIC
PREAUTHORIZED
PAYMENTS
s 0AYMENT BY PHONE
s #ASHIERS CHECKS
s -ONEY ORDERS
&INANCIAL 3ERVICES FOR ,ONG 4ERM .EEDS
s -AJOR PURCHASES
s ,ONG TERM FINANCIAL SECURITY
3AVINGS #REDIT 3ERVICES )NVESTMENT 3ERVICES /THER 3ERVICES
s #ERTIFICATES OF DEPOSIT s #ASH LOANS FOR CARS s -UTUAL FUNDS s 4AX PREPARATION
#$S EDUCATION s &INANCIAL ADVICE s )NSURANCE
s 53 3AVINGS "ONDS s (OME LOANS s "UDGETING
0LANNING !HEAD 9OU MAY THINK THAT YOU NEED ONLY CASH AND CHECKING SERVICES AT THIS TIME IN
YOUR LIFE
7HY WOULD IT BE A GOOD IDEA TO SAVE A SMALL AMOUNT REGULARLY
Chapter 5 Banking 123
Careers in Finance
CREDIT
BANKANALYST
TELLER Brandon Lewis
American Bank and Trust
Brandon has always been good at handling money. Brandon’s job is to process customer
transactions in a timely, accurate manner according to established policies and procedures.
His tasks may include tending to checking and savings accounts, ATM/debit cards, telephone
and Internet banking, bill payment, certificates of deposit, IRAs, safe deposit, discount broker-
age, credit cards, and merchant processing. A bank teller is expected to uphold the positive
image of his or her bank by providing the best possible customer service in a responsible and
professional manner.
SKILLS: Communication, problem-solving, decision-making, retail sales, and cash-
handling skills, as well as proficiency with office machines
PERSONAL TRAITS: Personable, courteous, outgoing, team oriented, and able to remain calm
under pressure
EDUCATION: High school diploma or equivalent; associate degree or higher degree
ANALYZE Why would a bank teller’s job require selling skills? Provide examples.
To learn more about career paths for bank tellers, visit finance07.glencoe.com.
Payment Services
Transferring money from a personal account to businesses or
individuals for payments is a basic function of day-to-day financial
activity at a bank. The most commonly used payment service is a
checking account. Money that you place in a checking account is
called a demand deposit because you can withdraw the money at any
time, or on demand.
Borrowing
Most people use credit at some time during their lives. If you
need to borrow money, financial institutions offer many options. You
can borrow money for a short term by using a credit card or taking
out a personal cash loan. If you need to borrow for a longer term, say,
for the purpose of buying a house or car, you may apply for a mort-
gage or auto loan. Chapter 6 discusses the types and costs of credit.
Other Financial Services
Financial institutions may also offer a variety of services, such
as insurance protection; stock, bond, and mutual fund investment
accounts; income tax assistance; and financial planning services.
124 Unit 2 Banking and Credit finance07.glencoe.com
Electronic Banking Services As You
How can you use electronic banking services? Read
When Jeff’s older brother was in high school, he had to get to RELATE
his bank by 3 P.M. on Friday, or he would have to wait until 9 A.M. on
Would you use electronic
Monday to cash his paycheck. Today Jeff’s bank is open for longer
banking services? Why or
periods on weekdays as well as on Saturdays. For more convenience, why not?
Jeff can use the bank’s electronic services 24 hours a day. He can
check the status of his account or make a transaction from an ATM,
by telephone, or online. Other online services allow customers to get
up-to-date account information with personal financial management
software to view details about a home loan or a line of credit and to
check the amount of interest paid.
Security is the number one issue for online customers. The way
䊲 CASH AT HAND Follow
to ensure online security is to use a security code, or password, and a
simple rules of ATM eti-
customer identification name or number.
quette when using this
banking convenience. If
Direct Deposit you are in line, stand at
Many businesses offer their employees direct deposit, an auto- least a few feet away from
matic deposit of net pay to an employee’s designated bank account. the person who is using the
Instead of a paper paycheck, employees receive a printed statement machine. When you are at
that lists deductions and information about their earnings. Direct the machine, protect the
deposit saves time, money, and effort—and offers a safe way to trans- screen as you enter your PIN
fer funds. and other information. Why
are these practices important?
Chapter 5 Banking 125
Automatic Payments
Utility companies, lenders, and other businesses allow custom-
ers to use an automatic payment system. With your authorization,
your bank will withdraw the amount of your monthly payment or
bill from your bank account. Make sure you have enough money in
your account for the payment. Arrange your payments according to
when you receive your paycheck. Check your bank statements each
month to make sure the payments were made correctly.
Automated Teller Machines (ATMs)
A cash machine, or automated teller machine (ATM), is a
computer terminal that allows a withdrawal of cash from an account.
You can also make deposits and transfer money from one account to
another. ATMs are located in banks, shopping malls, grocery stores,
and even sports arenas.
To use an ATM for banking, you must apply for a card from your
financial institution. This card is called a debit card, which is a cash
card that allows you to withdraw money or pay for purchases from
your checking or savings account.
The card also allows you to access
the machine for other purposes.
Some financial institutions may
charge a small fee for the use of
the card. Unlike a credit card, a
䊳 PLASTIC PAYMENT Debit
debit card enables you to spend
cards are convenient, cashless only the money that you have in
ways to make purchases. What your account.
might be one drawback of using a When you use your debit
debit card? card, the ATM computer will ask
you to enter your personal iden-
tification number (PIN). Never
give this number to any business
or individual, or for online trans-
actions. Memorize it and keep
a written record in a safe place.
Never keep your PIN with your
debit card. If your card is lost or
stolen along with your PIN, any-
one could withdraw money from
your account.
ATM Fees The fees that some
financial institutions charge for
the convenience of using an
ATM can add up over time. You
may feel that the benefit is worth
the cost. However, you might
consider these suggestions:
126 Unit 2 Banking and Credit
• Compare ATM fees before opening an account. Get a list of fees
in writing.
• Use your bank’s ATM machines to avoid the additional fees
that other banks charge when you use their machines.
TechByte
Paperless Banking
• Consider using traveler’s checks, credit cards, personal checks, In October 2004, the
and prepaid cash cards when you are away from home. Check Clearing for the
21st Century Act took
effect. Known as Check
Lost Debit Cards If you lose your debit card, or if it is stolen,
21, this law made check
notify your bank immediately. Most card issuers will not hold you processing and clearing
responsible for stolen funds. Check with your card issuer. However, easier for financial institu-
some institutions require you to notify them within two days of tions. Now, if you write a
losing your card. If you wait longer, you may be held responsible check to pay for an item,
for up to $500 for its unauthorized use for up to 60 days. Beyond you may never see that
check again. Instead, you
that time, your liability may be unlimited.
may receive a copy of the
check from your bank.
Plastic Payments Write a paragraph
comparing the
Although cash and checks are very common methods of paying old system of clearing
for goods and services, various access cards are also available. checks with the new sys-
tem after reading more
Point-of-Sale Transactions A point-of-sale transaction is information through
a purchase by a debit card of a good or service at a retail store, a finance07.glencoe.com.
restaurant, or elsewhere. Financial institutions offer two types of
cards for these transactions—online and offline. An online card
works like an ATM card. You have to use your PIN to authorize the
payment, and the money is transferred from your account instantly.
Charges made with an offline card do not require a PIN, and the
funds to cover the payment are deducted from your account within
a day or two.
Stored-Value Cards Prepaid cards that you can use for bus
or subway fares, school lunches, long-distance phone calls, or
library fees are popular. Some of these cards, such as phone cards,
are disposable. Others, called stored-value cards, are reloadable or
rechargeable, which means that money can be added to the card.
Electronic Cash Some companies are working to develop elec-
tronic money. They plan to create electronic versions of all existing
payment systems—paper money, coins, credit cards, and checks.
The day may come when you will not handle currency at all.
Opportunity Costs of
Financial Services
What are the trade-offs when you choose
financial services?
When you are making decisions about saving and spending, try
to find a balance between your short-term needs and your future finan-
cial security. Also, consider the opportunity costs, or trade-offs, of each
choice you make as you select financial services. Ask several questions.
finance07.glencoe.com Chapter 5 Banking 127
• Is a higher interest rate on a certificate of deposit worth
giving up liquidity, which is the ability to easily convert your
resources into cash without a loss in value?
• Would you trade the convenience of getting cash from the
ATM near your office for lower ATM fees?
• Is it worth opening a checking account that has no fees—but
does not earn interest––if you have to keep a minimum balance
of $500?
Remember to consider the value of your time in addition to the
money you are saving. Reevaluate your choices occasionally. You may
find a new financial institution that offers you more of the services
you need or offers less expensive services.
Types of Financial Institutions
What are the differences between
financial institutions?
After you have identified the services you want, you can choose
from among many types of financial institutions. You may select an
institution that offers a wide range of services or one that special-
izes in certain services. Figure 5.2 provides some tips for selecting a
financial institution. Many institutions provide the option of cyber-
banking, or banking via the Internet. Some banks operate exclusively
on the Internet.
Figure 5.2 Selecting a Financial Institution
1
When you are ready to choose Stop by the bank. Pick up
a financial institution, plan so brochures about the bank’s
that you will have the services services. While there, speak to
you need and will not have to a customer service representa-
pay for those you will not use. tive about the bank’s services.
Do your banking homework.
128 Unit 2 Banking and Credit
2 Take the brochures home. Study them
and discuss the features with your parents.
Federal Deposit Insurance Corporation
When you consider a financial institution consider its safety
record. During the Great Depression of the 1930s, many banks failed.
The people and businesses that had made deposits in these institu-
tions lost their money. In 1933, the federal government created the
Federal Deposit Insurance Corporation (FDIC) to protect deposits in
banks. The FDIC insures each account in a federally chartered bank
up to $100,000 per account. The FDIC also administers the Savings
Association Insurance Fund (SAIF) for savings and loan associations.
Like the FDIC, the SAIF insures deposits up to $100,000. All federally
chartered banks must participate in the FDIC program. Banks that are
not federally chartered may choose to enroll in the program.
Deposit Institutions
Most people use deposit-type institutions to handle their bank-
ing needs. These institutions include commercial banks, savings and
loan associations, mutual savings banks, and credit unions.
Commercial Banks A commercial bank is a for-profit institution
that offers a full range of financial services, including checking, savings,
and lending. Commercial banks serve individuals and businesses. These
banks are authorized to conduct business through a charter, or license,
granted by either the federal government or a state government.
3
Go online. Get complete information on
the institution’s benefits, fees, and charges.
4 Open your accounts. Use checking and
savings accounts to start managing your
money.
Chapter 5 Banking 129
Savings and Loan Associations
A savings and loan association
(S&L) is a financial institution
that traditionally specialized in
savings accounts and mortgage
loans but now offers many of the
same services as commercial banks.
Services include checking accounts,
business loans, and investment
services. S&Ls have either a federal
or a state charter.
Mutual Savings Banks Mutual
savings banks specialize in savings
accounts and mortgage loans. Some
offer personal and automobile loans
as well. The interest rates on loans
from a mutual savings bank may be
lower than those that a commercial
䊱 CONVENIENCE Many bank charges. In addition, mutual savings banks sometimes pay a higher
people use commercial interest rate on savings accounts.
banks because these banks
Credit Unions A credit union is a nonprofit financial institu-
offer a full range of financial
tion that is owned by its members and organized for their benefit.
services. What might be some
Traditionally, its members have some common bond, such as mem-
benefits of using a large com-
bership in a labor union, college alumni association, or employment
mercial bank?
by the same company. Most credit unions offer a full range of
services, including checking accounts, loans, credit cards, ATMs, and
investment services. Credit union fees and loan rates may be lower
than those at commercial banks.
Non-Deposit Institutions
Financial services are also available at institutions such as life
insurance companies, investment companies, finance companies,
and mortgage companies.
Life Insurance Companies Though the main purpose of life
insurance companies is to provide financial security for dependents,
many insurance policies also contain savings and investment features.
In addition, some insurance companies offer retirement planning
services. You will learn more about life insurance in Chapter 14.
Investment Companies These firms combine your money with
funds from other investors in order to buy stocks, bonds, and other
securities. The investment company then manages these combined
investments, which are called mutual funds. Chapter 10 discusses
more about mutual funds.
Finance Companies Finance companies make higher-interest
loans to consumers and small businesses that cannot borrow else-
where because they have below-average credit ratings.
130 Unit 2 Banking and Credit
Mortgage Companies Mortgage companies specialize in loans for
the purchase of homes. Chapter 7 discusses the finances of housing.
As You
Read
Comparing Financial QUESTION
Institutions Under what circumstances
might you be better off
What should you know to choose a with each of these institu-
financial institution? tions: a commercial bank,
a savings and loan asso-
When you compare banks and other financial institutions, you ciation, a mutual savings
should ask these questions to help choose the best one: bank, or a credit union?
• Where can you get the highest rate of interest on your savings?
• Where can you obtain a checking account with low (or no) fees?
• Will you be able to borrow money from the institution—with a
credit card or another type of loan—when you need it?
• Do you need an institution that offers free financial advice?
• Is the institution FDIC- or SAIF-insured?
• Does the institution have convenient locations?
• Does it have online banking services?
• Does it have any special banking services that you might need?
Section 5.1 Assessment
QUICK CHECK Calculate What is Margaret’s annual
1. What are three main categories of services expense for the use of this ATM?
offered by financial institutions?
SOLVE MONEY PROBLEMS
2. What are the types of electronic banking
services that are available? 6. Choosing a Financial Institution
3. Which institutions fall under the category Dakota is thinking about changing banks. He
of deposit institutions? Which are classified has a part-time job at a supermarket. Some-
as non-deposit institutions? times he works late hours, and he would like
the convenience of being able to make depos-
THINK CRITICALLY its and withdrawals at any time. He needs
4. Name some financial services you use now. cash for food and gas, and he writes only
How might your needs for services change two checks a month—to his music CD club
in the next five years? account and to his credit card company. Soon
he will need to take out a loan to buy a car. He
USE MATH SKILLS also wants to put aside some money to pay for
5. Wise Use of ATMs Margaret uses an technical school.
ATM three times a week. It is not her bank’s Write About It Help Dakota select
machine, but it is convenient to the store the type of financial institution that
where she works. For every transaction, offers the features that would be most use-
Margaret pays a fee of $1.50. ful to him and write a list for him.
Chapter 5 Banking 131
Section 5.2
Focus on
Reading
Savings Plans and
Payment Methods
Read to Learn
• How to compare the
costs and benefits of Types of Savings Plans
different savings plans. What are some savings program options?
• How to explain features
of different savings plans. To achieve your financial goals, you will need a savings program.
Various types of savings programs include regular savings accounts,
• How to compare the
costs and benefits of certificates of deposit, money market accounts, and U.S. Savings
different types of check- Bonds. (See Figure 5.3.)
ing accounts.
• How to use a checking Regular Savings Accounts
account effectively.
Regular savings accounts, traditionally called passbook accounts,
Main Idea are ideal if you plan to make frequent deposits and withdrawals.
Recognizing the types of They require little or no minimum balance and allow you to with-
savings plans and payment draw money on demand. The trade-off for this convenience is that
methods that financial insti- the interest you earn will be low compared with other savings
tutions offer can help you plans.
use money wisely.
You may receive a passbook that records deposits and withdraw-
als, but typically, you will get a monthly or quarterly statement in the
Key Terms
mail. Commercial banks, savings and loan associations, and other
• certificate of deposit (CD)
• money market account financial institutions offer regular savings accounts. At credit unions
• rate of return they may be called share accounts.
• compounding
• annual percentage yield
(APY)
Certificates of Deposit
• overdraft protection A certificate of deposit (CD) is a savings alternative in which
• stop-payment order money is left on deposit for a stated period of time to earn a spe-
• endorsement
cific rate of return. This period of time is called the term. The date
• bank reconciliation
when the money becomes available to you is called the maturity date.
This savings plan is a relatively low-risk way to invest your money. It
offers a higher interest rate than a regular savings account pays, but
Before you will have to accept a few trade-offs.
You Read To earn the higher interest rate paid by CDs, you must accept
three key limitations. First, you may have to leave your money on
PREDICT deposit for one month to five or more years. Second, you probably
What is the difference will pay a penalty if you take the money out before the maturity
between a CD and a date. Third, financial institutions require that you deposit a mini-
money market account? mum amount to buy a certificate of deposit. This amount is usually
larger than the balance a regular savings account requires.
132 Unit 2 Banking and Credit
CD Investment Strategies Here are some tips for investing in CDs:
• Find out where you can get the best rate. You can put your
savings in a bank anywhere in the United States. You can
use the Internet to find out what rates banks offer all over
the country.
• Consider the economy as you decide what maturity date to
choose. You may want to buy a long-term CD if interest rates
are relatively high. Then, if interest rates go down because of
changes in the economy, your money will continue to earn
the higher rate.
• Never let a financial institution “roll over” a CD. For example,
if your one-year CD matures, and you do nothing, the bank
will redeposit that money in another one-year CD. You may
decide to roll over, however, if you know that you will get the
best rate possible.
• Consider when you will need the money. If you plan to use the
money in two years to help pay for college, then buy a CD with
a term of two years or less.
• If you have enough funds to have several accounts, you might
consider creating a CD portfolio, which includes CDs that
mature at different times. For example, you could have $1,000
in a three-month CD, $1,000 in a six-month CD, and $1,000
in a one-year CD. This way, you would be able to withdraw
money at different times and still get better interest rates than
you would with a passbook savings account.
&IGURE 3AVINGS !LTERNATIVES
4YPE OF !CCOUNT "ENEFITS $RAWBACKS
2EGULAR SAVINGS s ,OW MINIMUM BALANCE s ,OW RATE OF RETURN
ACCOUNTS s %ASE OF WITHDRAWAL
s )NSURED
#ERTIFICATES OF s 'UARANTEED RATE OF RETURN FOR s 0OSSIBLE PENALTY FOR EARLY WITHDRAWAL
DEPOSIT #$S TIME OF #$ s -INIMUM DEPOSIT
s )NSURED
-ONEY MARKET s 'OOD RATE OF RETURN s -INIMUM BALANCE
ACCOUNTS s 3OME CHECK WRITING s .O INTEREST AND POSSIBLE SERVICE
s )NSURED CHARGE IF BELOW A CERTAIN BALANCE
53 3AVINGS s ,OW MINIMUM DEPOSIT s ,OWER RATE OF RETURN WHEN CASHED IN
"ONDS s 'UARANTEED BY THE GOVERNMENT BEFORE BOND REACHES MATURITY DATE
s &REE FROM STATE AND LOCAL TAXES
3O -ANY #HOICES %ACH TYPE OF SAVINGS PLAN HAS PROS AND CONS THAT YOU SHOULD CONSIDER
7HICH TYPES WOULD BE BEST FOR A PERSON WHO WANTS TO
SAVE FREQUENTLY BUT WITH SMALL AMOUNTS
Chapter 5 Banking 133
Money Market Accounts
A money market account is a savings account that requires
a minimum balance and earns interest that varies from month to
month. The rates float, or go up and down, as market rates change.
Although the interest rate of a money market account is usually higher
than that of a regular savings account, a money market account also
requires a higher minimum balance, typically $1,000. You may have
to pay a penalty if your balance goes below the minimum amount.
You can write a limited number of checks to make large payments or
to transfer money to other accounts. The FDIC insures money market
accounts up to $100,000.
U.S. Savings Bonds
Another savings option is purchasing a U.S. Savings Bond (also
called a Patriot Bond). For example, when Meagan graduated high
school in 2005, her aunt gave her a U.S. Savings Bond as a gift. Her
aunt paid $250 for the bond, but it has a face value of $500. This
means that if Meagan keeps the bond long enough until the des-
ignated maturity date, it will eventually earn enough interest to be
worth $500 or even more.
䊱 MEETING GOALS Most people save for many years to go to college. Why might certificates
of deposit and U.S. Savings Bonds be good investments for someone who is saving for a long-term
goal such as college?
134 Unit 2 Banking and Credit
You can purchase Series EE Savings Bonds from the federal gov-
ernment in amounts that range from $25 to $5,000 (face values of
$50 to $10,000, respectively). The government limits total purchases
per year to $15,000 ($30,000 face value) per person. You may buy
savings bonds from banks or through the governments’ Web site. The Your Own Home
Federal Reserve sends bond certificates within 15 business days. Learn about saving for a
The maturity date, or the date a bond reaches its face value, down payment on your
first home and how to
depends on the date it was bought and the interest rate the bond is
choose a bank that fits
earning. For some bonds, the rate changes every six months. Because your needs.
interest rates vary, no official maturity date exists for Series EE Sav-
To continue with
ings Bonds. Bonds purchased after April 1997 and cashed after less
Task 2 of your
than five years are subject to a three-month penalty—that is, you will WebQuest project,visit
not receive any interest for the last three months before you cash it. finance07.glencoe.com.
For example, if you cash a bond after 18 months, you receive only 15
months’ worth of interest.
A Series EE Savings Bond continues to earn interest for 30 years if
you do not cash it in. The longer you hold it, the more it is worth. Its
value may be more than the face value if it is held past maturity.
Meagan kept her bond for ten years. In 2004, she decided to
cash it in to help her make a down payment on a condominium.
She found out that it was worth a little more than $450. Your bond’s
worth will depend on current interest rates and on the month and
year in which the bond was issued.
Taxes on Savings Bonds The interest you earn on Series EE
Bonds is exempt from, or free of, state and local taxes. You do not
pay federal taxes on the interest earnings until you cash in the bond.
Once a Series EE Bond has reached maturity, you can choose to defer
federal taxes further by exchanging it for a Series HH Bond. Low- and
middle-income families who use the money from redeemed Series EE
Bonds to pay for higher education pay no taxes on the interest.
Evaluating Savings Plans
How should you evaluate a savings plan?
Your selection of a savings plan will be influenced by several fac-
tors. You should consider the rate of return, inflation, tax consider-
ations, liquidity, restrictions, and fees.
Rate of Return
Earnings on savings can be measured by the rate of return, or yield.
The rate of return is the percentage of increase in the value of your
savings from earned interest. For example, when Emisha put the $75
she earned from babysitting on New Year’s Eve into a regular savings
account last year, she earned $3 in interest. Therefore, her rate of return
was 4 percent. To calculate the rate of return, she divided the total inter-
est by the amount of her deposit ($3 ÷ $75 = .04 or 4 percent).
finance07.glencoe.com Chapter 5 Banking 135
Compounding The yield on your savings will usually be greater
As You than the stated interest rate. Compounding is the process in which
Read interest is earned on both the principal—the original amount you
RELATE deposited—and on any previously earned interest. It is a multistep
process for computing interest. First, the interest on the principal is
Do you currently have a computed. That interest is added to the principal. The next time interest
savings account? Do you
know if your interest is com-
is computed, the new, larger balance is used. Compounding may take
pounded daily, monthly, or place every year, every quarter, every month, or even every day.
annually? What difference How much interest would your account earn in one year if the
does it make? interest were compounded monthly? To make this calculation, first
multiply the principal by the annual interest rate. Divide that fig-
ure by 12, the number of months in a year. This is the interest you
would earn after the first month. To calculate the interest earned for
the second month, add any interest earned in the first month to the
principal. Then take that amount and multiply it by the annual inter-
est rate. Next divide that number by 12. This is your interest earned
in the second month. After you have repeated this calculation for all
12 months, add the monthly interest totals. The sum of the monthly
interest amounts is the interest your account would earn in one year
if the interest were compounded monthly.
GO FIGURE FINANCIAL MATH
INTEREST COMPOUNDED Solution: Month Calculation
MONTHLY 1 ($100.00 ⫻ 4%) ⫼ 12 ⫽ $0.33
2 ($100.33 ⫻ 4%) ⫼ 12 ⫽ $0.33
Synopsis: Savings accounts that pay interest
3 ($100.66 ⫻ 4%) ⫼ 12 ⫽ $0.34
monthly can end up earning more interest than an
4 ($101.00 ⫻ 4%) ⫼ 12 ⫽ $0.34
account that pays once a year.
5 ($101.34 ⫻ 4%) ⫼ 12 ⫽ $0.34
Example: You deposit $100 in a savings account. 6 ($101.68 ⫻ 4%) ⫼ 12 ⫽ $0.34
The bank is paying you 4 percent annually, which is 7 ($102.02 ⫻ 4%) ⫼ 12 ⫽ $0.34
compounded monthly. How much interest will you 8 ($102.36 ⫻ 4%) ⫼ 12 ⫽ $0.34
earn for the year? 9 ($102.70 ⫻ 4%) ⫼ 12 ⫽ $0.34
Formula: Find the interest earned for the first 10 ($103.04 ⫻ 4%) ⫼ 12 ⫽ $0.34
month: 11 ($103.38 ⫻ 4%) ⫼ 12 ⫽ $0.34
12 ($103.72 ⫻ 4%) ⫼ 12 ⫽ $0.35
A. Principal ⫻ Annual At the end of the year, you will have $104.07
Interest Rate Interest Earned for
⫽ ($100.00 ⫹ $4.07 ⫽ $104.07). You earned $4.07 in
12 First Month
compounded interest for the year.
B. (Principal + Previously
Earned Interest ) ⫻
Interest Earned for YOU FIGURE
Annual Interest Rate
⫽ a Given Month How much interest would this account earn if
12
interest was paid once for the whole year?
136 Unit 2 Banking and Credit
GO FIGURE FINANCIAL MATH
RATE OF RETURN Solution: $4.07
⫽ 0.0407 ⫽ 4.07%
$100
Synopsis: A compounded rate of return (percent-
age) is more than the stated year’s rate. Your rate of return is 4.07 percent.
Example: You deposit $100 in a savings account.
The bank is paying you 4 percent annually, com-
pounded monthly. After one year, the account has
earned $4.07 in interest. What would your rate of YOU FIGURE
return be for one year? What would be your rate of return for one
Formula: Total Interest Earned year if the account earned $5.14 in interest
⫽ Rate of Return
Original Deposit on a deposit of $100?
The more frequently your balance is compounded, the greater
your yield, or rate of return, will be. For example, if you deposited
$100 in an account with a 4 percent annual interest rate that is
compounded annually (once a year), after one year you will earn
$4 ($100 ⫻ .04 or 4% ⫽ $4). Your rate of return is 4 percent. If you
put that same $100 in an account that is compounded monthly
at an annual interest rate of 4 percent, your rate of return will be
higher.
Remember, your rate of return is the total interest earned divided
by the amount of your original deposit. The difference may not seem
like much, but compounding can have a great impact on large amounts
of money that are held in savings accounts for long periods.
Truth in Savings According to the Truth in Savings law (Federal
Reserve Regulation DD), financial institutions have to inform you of
the following information:
• Fees on deposit accounts
• Interest rate
• Annual percentage yield (APY)
• Terms and conditions of the savings plan
The annual percentage yield (APY) is the amount of inter-
est that a $100 deposit would earn, after compounding, for one year.
The interest is based on the annual stated interest rate and the fre-
quency of compounding for a 365-day period. In the previous Go
Figure example, the APY is 4.07 percent. The higher the APY is, the
better the return. The APY helps you determine the amount you can
expect to earn on your money. Because the APY is stated as a percent-
age and as an annual rate, it you can compare savings plans that have
different rates and compounding frequencies.
Chapter 5 Banking 137
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: A Checking Account Your Motive: You need to keep track
Bank Statement of deductions and deposits in your
A checking account bank statement check register as you write checks and
contains the following information: deposit money. The monthly statement
• Balance, or amount, in the account at is the bank’s record of that activity. It is
the beginning of a time period important that your records and the bank’s
• Deposits made to the account records are the same so your account will
• Deductions made from the account not get overdrawn.
• Ending balance at the end of the time
period
3-)4(6),,% "!.+ .! 4OM *ONES
&IRST 3TREET
3MITHVILLE &LORIDA
!##/5.4 35--!29 3TATEMENT $ATE
"ALANCE FORWARDED FROM
#HECKS
)NTEREST ADDED
%NDING BALANCE
%,%#42/.)# #2%$)43
$ATE $ESCRIPTION
).4%2%34 0!)$
#(%#+3 !.$ /4(%2 $%")43 $!),9 "!,!.#% 35--!29
$ATE #HECK !MOUNT $ATE "ALANCE
Key Points: If there is a difference between Find the Solutions
your records and the bank’s records, you need 1. What time period does this statement cover?
to resolve the problem with your bank. If the 2. From this statement, what do you think is
bank thinks you have less money than you the meaning of the word credits?
do, your checks may “bounce,” or be rejected 3. From this statement, what do you think is
the meaning of the word debits?
and go unpaid, causing the bank to charge you
4. On 02/10/05, the balance in this account
penalty fees.
changed. Why?
5. There is a line on this statement that reads
“Checks 6,310.00.” What does this mean?
138 Unit 2 Banking and Credit
Inflation Put on
You should compare the rate of interest you earn on your sav- Your
ings with the rate of inflation. If you open a savings account that Financial
offers 3 percent interest, and the inflation rate rises to 6 percent, your
Planner’s
money will lose value and buying power. Usually, however, the inter-
est rates offered on savings accounts increase if the rate of inflation Cap
increases. The biggest problem with inflation occurs if you are locked A previously unknown rela-
into a lower interest rate for a long period. tive has died and left your
friend $50,000. Would you
recommend that she open a
Tax Considerations checking account, a savings
Like inflation, taxes reduce the interest earned on savings. For account, or another type of
example, Karim was glad to find a savings account that would pay account? Why or why not?
5 percent interest. However, he was not happy when he filled out his
tax return and had to pay taxes on that interest. He decided to look into
tax-exempt and tax-deferred savings plans for some of his money.
Liquidity
Check the savings plans you are considering to determine whether
they charge a penalty or pay a lower rate of interest if you withdraw
your funds early. If you need to be able to withdraw your money eas-
ily, put your money in a liquid account—even if it earns lower inter-
est. On the other hand, if you are saving for long-term goals, a high
interest rate is more important than liquidity.
Restrictions and Fees
Be aware of any restrictions on savings plans, such as a delay between
the time when interest is earned and when it is actually paid into your
account. Also check for fees for making deposits and withdrawals. Find
out about any service charges you may have to pay if your balance drops
below a certain amount, or if you do not use your account for a certain
period. These fees and service charges can add up.
Types of Checking Accounts
What are the different kinds of checking accounts?
Checking accounts can be divided into three main categories:
regular, activity, and interest-earning accounts.
Regular Checking Accounts
Regular checking accounts usually do not require a minimum
balance. However, if the account does require a minimum balance,
and your account drops below that amount, you will have to pay a
monthly service charge. A $10 charge every month can take a bite
out of your funds. Some institutions will waive a service charge if you
keep a certain balance in your savings account.
Chapter 5 Banking 139
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis-
tics, information, and news, and analyzes this data for
"ERN
international businesses, governments, and individuals
to help them guide their financial decisions.
SWITZERLAND
Say “Switzerland,” and people often think of rich
chocolate, cozy alpine villages, and cuckoo clocks. Swit-
zerland also boasts its most famous industry—banking.
Once called the crossroads of Europe, the country of
DATABYTES
Switzerland has been one of the world’s most impor-
tant financial centers for centuries. Its Capital Bern
government’s neutrality during times of war and the
Population 7,341,000
skill of its bankers attract depositors by the millions.
Above all, clients—from the ordinary to the rich— Languages German, French, Italian, and
appreciate the banks’ Romanisch
secrecy. Numbers, Currency Swiss franc
not names, iden- Gross Domestic
tify each customer. Product (GDP) $239.8 billion (2003 est.)
“Serious money is GDP per capita $32,800
safe and private in a Industry: Banking, machinery, chemicals, watches,
Swiss bank in Swit- textiles, and precision instruments
zerland,” promises
Agriculture: Grains, fruits and vegetables, and meat
one ad. However, a
new Swiss federal law Exports: Machinery, chemicals, metals, watches, and
now prohibits com- agricultural products
plete secrecy. Depos- Natural Resources: Hydropower potential, timber,
its of questionable or and salt
criminal origin must Think Globally
be reported to the If you were planning to open a checking or savings
authorities. account in Switzerland or the United States what
three types of accounts would you consider?
Activity Accounts
If you write only a few checks each month and are unable to
maintain a minimum balance, this type of checking account may
be right for you. The financial institution will charge a fee for each
check you write and sometimes a fee for each deposit. In addition,
a monthly service fee will be charged. However, you do not need to
maintain a minimum balance.
140 Unit 2 Banking and Credit
Interest-Earning Checking Accounts
Interest-earning checking accounts are a combination of check-
ing and savings accounts. These accounts pay interest if you maintain
a minimum balance. If your account balance goes below the limit,
you may not earn any interest, and you may also have to pay a ser- HISTORY
vice charge. In response to financial
hardship caused by the
Great Depression, the
Evaluating Checking Accounts Emergency Banking Act
of 1933 called for a four-
What factors should you consider when choosing day bank holiday during
a checking account? which time all banks were
assessed by federal inspec-
How do you decide which type of checking account will meet
tors. Within those four
your needs? You will need to weigh several factors: restrictions, fees days, roughly two-thirds
and charges, interest, and special services. of the nation’s banks were
declared financially secure
and were reopened,
Restrictions restoring Americans’ faith
The most common restriction is the requirement that you keep a in banking institutions.
Research the Great Depres-
minimum balance. Other restrictions may include the number of trans-
sion and write a short para-
actions allowed and the number of checks you may write in a month. graph explaining why you
think the Emergency Bank-
ing Act helped restore faith
Fees and Charges in banking institutions.
You may pay a monthly service charge as well as fees for check
printing, overdrafts, and stop-payment orders.
Interest
Interest rates, frequency of compounding, and the way in which
interest is calculated all affect an interest-bearing checking account.
Special Services
Checking account services include ATMs and banking by tele-
phone and online. As a checking account customer, you may also
receive overdraft protection—an automatic loan made to an
account if the balance will not cover checks written. The institution
will charge interest on that loan, but the amount may be less than
the fee for overdrawing your account. Your bank may also offer an
overdraft protection service that transfers money from your savings
to your checking account.
The Check Clearing for the 21st Century Act, or “Check 21,”
took effect as of October 28, 2004. The Act allows banks to dispense
with original paper checks. Banks can now transmit electronic images
of checks through the check-clearing process. If you want to receive
your cancelled paper check, the bank will provide a substitute check,
such as a printout of an electronic image, for a fee.
Chapter 5 Banking 141
Using a Checking Account
How do you open and use a checking account?
Finding the Best After you select the type of checking account that best fits your
Savings Account needs, you need to know how to use it effectively.
1. Shop around to
find the bank that
offers the highest Opening a Checking Account
interest rates.
Before you open a checking account, decide whether you want
2. Ask if you must
deposit a minimum an individual or joint account. An individual account has one owner;
amount. a joint account has two or more. Personal joint accounts are usually
3. Find out if the “or” accounts, which means that only one of the owners needs to
bank pays less on sign a check. You sign a signature card at the bank so that your signa-
small accounts. ture on a check can be verified.
4. Ask the bank how
often it credits Writing Checks
interest to your
account. Before you write a check, write the date, the number of the check,
5. Ask if you will the name of the party who will receive the payment, and the exact
receive simple amount in your check register. A check register is a small booklet that
interest or com- you use to record activity in your account. You receive it with your
pound interest.
supply of blank checks. Record all checks that you write, deposits, ATM
withdrawals, debit card charges, interest earned (if any), any fees, and
other transactions. Be sure to keep a current balance of the money you
have by deducting from or adding to your balance the amount of any
check transaction. Figure 5.4 shows a sample check register.
&IGURE #HECK 2EGISTER
&%% "!,!.#%
.5-"%2 $!4% $%3#2)04)/. /& 42!.3!#4)/. 0!9-%.4$%")4 )& !.9 $%0/3)4#2%$)4
#PC¤T4FSWJDF4UBUJPO
PJMDIBOHF
$VUMFS&OUFSQSJTFT
NBHB[JOFTVCTDSJQUJPO
.PUPS7FIJDMFT%FQBSUNFOU
SFOFXBM
+BDL¤T.VTJD
HJGU
+EEPING 4RACK 4HIS SAMPLE CHECK REGISTER SHOWS HOW TO KEEP TRACK OF CHECKS AS YOU
WRITE THEM
7HAT OTHER AMOUNTS SHOULD YOU RECORD IN YOUR CHECK REGISTER
142 Unit 2 Banking and Credit
&IGURE 3AMPLE 0ERSONAL #HECK
Printed name and address of depositor 0AYEE $ATE #HECK NUMBER !MOUNT
!MOUNT
+%..%4( "5#+,%9
IN WORDS
#!2, $2)6%
7%34/6%2 /2
.AME OF 1 +VMZ 2 0
FINANCIAL 0!9 4/ 4(%
/2$%2 /&
2 #PC¤T4FSWJDF4UBUJPO 3$
INSTITUTION
DRAWEE 4 5XFOUZGJWFBOE $/,,!23
!MERICAN .ATIONAL "ANK
2EASON 7ESTOVER /REGON
-%-/
6 PJMDIBOHF 5 ,FOOFUI#VDLMFZ
Magnetic ink
characters
"ANK ROUTING NUMBER $EPOSITORS ACCOUNT NUMBER #HECK NUMBER 9OUR SIGNATURE
0ERSONAL #HECK .EVER WRITE A CHECK IN PENCIL AND ALWAYS WRITE LEGIBLY
7HY DO YOU HAVE TO WRITE THE AMOUNT IN WORDS AND
IN NUMERALS
Figure 5.5 illustrates the correct way to write a check. Follow
these steps when you write a check:
1. Write the current date.
2. Write the name of the party (payee) who will receive the
check.
3. Record the amount of the payment in numerals.
4. Write the amount in words.
5. Sign the check in the same way you signed your signature
card at the bank.
6. Make a note of the reason for the payment. This is a
good place to record an account number if the payment
is for a credit card or service, such as electricity or cable
television.
If you make a mistake when writing a check, do not erase the
error. Write a new check, tear up the old check, and write the word
Void in your check register. If the mistake is small, you may be able to
correct the check and write your initials next to the correction.
If a check is lost or stolen, or if you want to take back your pay-
ment for a business transaction, you may ask the bank to issue a stop-
payment order. A stop-payment order is a request that a bank or
other financial institution not cash a particular check. Fees for this
service can range from $10 to $20 or more.
Chapter 5 Banking 143
Making Deposits
Common To add money to your checking account, fill out a deposit
CENTS ticket. Tickets usually include room to list four or five checks and any
amount of cash that you are depositing. Endorse, or sign, the back of
each check you want to deposit. The endorsement is the signature
Money Toss
Empty the change from of the payee, the party to whom the check has been written.
your pocket or wallet There are also different ways to endorse a check. A blank endorse-
every night and throw it ment is the most simple. You or the check holder signs the back of
into a jar. At the end of the check. A restrictive endorsement requires the check holder’s signa-
each month, deposit all ture and a restriction on how the paper may be used by the bank.
your “throwaway” money
The most common expression used is “For deposit only.” This is an
in your savings or check-
ing account account. That instruction that restricts the bank to applying the check amount to
loose change can really the holder’s account. A special endorsement allows you to transfer a
add up. What type of bank check to an organization or another person. When you endorse the
account would be best for check, you write the words pay to the order of, followed by the name
your loose change? Why? of the organization or person, and then you sign your name.
Here are some tips to follow when endorsing a check:
• Do not endorse a check until you are ready to cash or deposit it.
• Write your signature on the back of the check at the top left end.
• Sign your name exactly as it appears on the front of the check.
• Use a pen so that your signature cannot be erased.
• If depositing a check by mail, write “For deposit only” above
your signature.
Check Clearing
Check clearing is a system that ensures that the money you
deposited in the account is available for withdrawal. For example,
if you deposit a check for $50 into your account, your bank usually
holds that $50 until it clears with the bank on which it was drawn.
During this time you cannot withdraw that money. By law, institu-
tions are limited to holding funds from checks drawn on local banks
to no more than two business days, and from checks drawn on non-
local banks to no more than five business days. Check-clearing rules
vary by bank, so ask your bank about its rules.
Keeping Track of a Checking Account
Each month your bank will send you a statement that shows
your checking account activity for the month.
Your bank statement will list:
• Deposits
• Checks you have written (charged against your account)
• ATM withdrawals
• Debit card charges (identified by the business or organization
to whom you made the payment)
• Interest earned
• Fees
144 Unit 2 Banking and Credit
Reconciliation The balance reported on the bank statement may
be different from the balance in your check register. You might have
written checks that have not yet cleared your bank, or maybe you
deposited money into your account after the bank prepared your
statement.
To determine your true balance, you can fill out a bank reconcili-
ation form. A bank reconciliation is a report that accounts for the
differences between the bank statement and a checkbook balance.
This process is called balancing your checkbook. To balance, or recon-
cile, your account, follow several steps (a simplified version of a rec-
onciliation form is shown in Figure 5.6).
&IGURE "ANK !CCOUNT 2ECONCILIATION
V !MERICAN .ATIONAL "ANK
7%34/6%2 /2%'/.
+ENNETH "UCKLEY
#ARL $RIVE
7ESTOVER /2 !CCOUNT .UMBER
3TATEMENT $ATE
&$)#
"ALANCE $EPOSITS /THER #REDITS #HECKS /THER $EBITS "ALANCE
,AST 3TATEMENT .O !MOUNT .O !MOUNT 4HIS 3TATEMENT
#HECKS $EPOSITS
$ESCRIPTION /THER $EBITS /THER #REDITS $ATE "ALANCE
"ALANCE &ORWARD
$EPOSIT
#HECK
#HECK
#HECK
$EPOSIT
#HECK
#HECK
0,%!3% %8!-).% 9/52 34!4%-%.4 !4 /.#% )& ./ %22/2 )3 2%0/24%$ ). $!93 4(% !##/5.4 7),, "%
#/.3)$%2%$ #/22%#4 !.$ 6/5#(%23 '%.5).% !,, )4%-3 !2% #2%$)4%$ 35"*%#4 4/ &).!, 0!9-%.4
"!.+ 2%#/.#),)!4)/. &/2-
0,%!3% %8!-).% 9/52 34!4%-%.4 !4 /.#%
#(%#+3 /5434!.$).'
!.9 $)3#2%0!.#9 3(/5,$ "% 2%0/24%$ 4/
4(% "!.+ )--%$)!4%,9 .UMBER !MOUNT
)N YOUR CHECKBOOK RECORD ANY TRANSACTIONS APPEARING
ON THIS STATEMENT BUT NOT YET LISTED
,IST ANY CHECKS STILL OUTSTANDING IN THE SPACE PROVIDED
TO THE RIGHT
%NTER THE BALANCE SHOWN ON THIS
STATEMENT HERE
%NTER DEPOSITS RECORDED IN YOUR
CHECKBOOK BUT NOT SHOWN ON THIS
STATEMENT
4OTAL LINES AND AND ENTER HERE
%NTER TOTAL CHECKS OUTSTANDING HERE
3UBTRACT LINE FROM LINE 4HIS
ADJUSTED BANK BALANCE SHOULD
AGREE WITH YOUR CHECKBOOK BALANCE 4/4!,
"ALANCING 9OUR #HECKBOOK 4HE ADJUSTED BANK BALANCE SHOULD AGREE WITH YOUR CHECKBOOK REGISTER
7HY SHOULD YOU RECONCILE YOUR CHECKING ACCOUNT WITH EACH
NEW STATEMENT
Chapter 5 Banking 145
1. Compare the checks you have written during the month
As You with those that are listed on the bank statement as paid, or
Read cleared. List all outstanding checks—checks you wrote but
QUESTION have not cleared. Subtract the total amount of outstanding
checks from the balance on the bank statement.
When you receive your
2. Determine whether any recent deposits are not on the bank
checking account bank
statement each month, statement. If so, add the amounts of those deposits to the
what items might be on it bank statement balance.
that you do not show in 3. Subtract fees and charges listed on the statement from your
your account register? Why checkbook balance.
is it important to enter 4. Add interest earned to your checkbook balance.
these each month on your
account register? Then compare the balance in your check register and the adjusted
bank balance on the reconciliation form. They should be the same.
If the balances do not match, check your math, and make sure all
checks and deposits are entered in your check register and on the
statement. If there is a bank error, report it.
Other Payment Methods
You may make payments by other methods besides using a per-
sonal check. A certified check is a personal check with a guaranteed
payment. The financial institution deducts the amount from your
account when it certifies the check. You can also purchase a cashier’s
check or money order from a financial institution. You pay the amount
of the check or money order plus a fee. Travelers checks allow you to
obtain cash in a country’s currency when you are away from home.
䊳 TRAVELING MONEY
Travelers checks are one
option for students who need
to carry money while travel-
ing in foreign countries. Most
banks, hotels, and stores will
accept this currency. Why are
travelers checks preferred over
regular cash when traveling?
146 Unit 2 Banking and Credit
You sign each check once when you purchase the checks and a sec-
ond time when you cash them. If you lose a check or it is stolen, it After You
can be replaced with proof of purchase. Prepaid travelers cards allow Read
travelers to get local currency from ATMs throughout the world. REACT
What is a bank reconcilia-
Financial Institutions tion? Why is it important?
and Your Money
How Do Banks Make Money?
The amount of deposits held by a bank affects its ability to loan
money. Banks make money by making loans. The amount of money
that banks can lend is affected by the reserve requirement set by the
Federal Reserve. The reserve requirement is 3 percent to 10 percent
of a bank’s total deposits, including your deposit. For example, when
a bank gets a deposit of $100, the bank can then lend out $90. That
$90 goes back into the economy, paying for goods or services, and
may end up deposited in another bank. That bank can then lend out
$81 of that $90 deposit, and that $81 goes into the economy to pay
for goods or services, and is then deposited into another bank that
proceeds to lend out a percentage of it. Thus, banking your money
benefits you as well as others in the economic system.
Section 5.2 Assessment
QUICK CHECK Present a Poster Choose one or
1. What are some of the costs and benefits of a more features of savings or checking
certificate of deposit? accounts and create a poster advertising
2. What factors can you use to evaluate a sav- those features in a way that will inform peo-
ings plan? ple and invite them to become customers.
3. What are regular, activity, and interest-
SOLVE MONEY PROBLEMS
earning checking accounts?
6. Checking Account Choices Matthew
THINK CRITICALLY Delarosa has just moved to a new town and
4. Why do you think a law was passed to is about to open a checking account. He
standardize the ways in which financial pays for all his monthly expenses—rent,
institutions inform consumers of the terms phone, car payment, credit card bills, dry
and conditions of savings plans? cleaning, and insurance—by check.
Write About It With a partner,
USE COMMUNICATION SKILLS examine the features of the different
5. The Banking Business Banks advertise types of checking accounts and write a para-
to attract customers. graph to help Matthew decide which type
would be best for him.
Chapter 5 Banking 147
Chapter 5 Review & Activities
CHAPTER SUMMARY
Money market accounts and U.S.
• The three primary types of financial Savings Bonds are less liquid than bank
services are savings; payment services; savings accounts, but may provide
and borrowing. greater returns.
• Commercial banks, savings and loan • To evaluate a savings plan, look
associations, mutual savings banks, at its features, such as its rate of
and credit unions are financial return compared with inflation,
institutions that accept secure deposits tax considerations, liquidity, and
and provide transfer and lending restrictions and fees.
services. Life insurance companies • Regular, activity, and interest-earning
and investment companies accept are the three categories of checking
customers’ funds, provide financial accounts. Some of these require
security for dependents, and invest and minimum balances and/or fees for
manage funds. Finance companies and transactions. Some pay interest on
mortgage companies offer loans. deposits.
• Bank savings plans offer the lowest • To use a checking account, write checks
interest rates with the greatest liquidity. carefully, endorse checks you deposit,
Higher interest rates are available on and reconcile your checkbook against
certificates of deposit (CDs); money bank statements.
must be on deposit for a specified time.
Communicating Key Terms
Write the copy for a promotional brochure for a commercial bank, explaining what the bank
offers its customers. Use at least eight of the terms below in your brochure copy.
• direct deposit • savings and loan • compounding
• automated teller association (S&L) • annual percentage yield
machine (ATM) • credit union (APY)
• debit card • certificate of deposit • overdraft protection
• point-of-sale transaction (CD) • stop-payment order
• commercial bank • money market account • endorsement
• rate of return • bank reconciliation
Reviewing Key Concepts
1. Explain two advantages and two disadvantages of online banking.
2. Identify the services offered by the different financial institutions.
3. Explain why a large, nationally chartered bank may be the safest place to deposit your money.
4. Discuss how you benefit when interest is compounded monthly as opposed to annually.
5. Explain the circumstances under which a person should choose a regular checking account,
activity checking account, or interest-bearing checking account.
6. List the steps to take to use a checking account effectively.
148 Unit 2 Banking and Credit
Chapter 5 Review & Activities
Economics Explain at least three ways to reduce ATM fees charged to
your account. Also describe the trade-offs involved in each action.
Write About It Create a list with your explanations.
Checking Account Minimum Balances Bank X offers a
checking account with a minimum balance of $300, but does not charge fees
nor give interest. Bank Y’s minimum balance is $50, but it charges a fee of
$25 if you have more than 35 transactions per month, including deposits.
Both banks pay 2 percent interest on regular savings accounts and 3 percent
on certificates of deposit with terms of 24 months.
1. Describe (a) Someone for whom Bank A’s offer is the best deal. (b)
Someone for whom Bank B’s offer is the best deal.
2. Compute by using spreadsheet software bank statements that compare
returns from Bank A and Bank B for the people profiled.
Connect with Business and Government Check 21 is a federal
law that lets banks handle more checks electronically, which should make
check processing faster, more efficient, and less expensive. Before Check 21
became effective in late 2004, banks physically moved paper checks from
one bank to another. If you used to receive your cancelled checks after they
cleared your bank, you now receive a picture of the front and back of your
checks instead.
1. Research Use library and online sources to find out more about Check 21.
2. Think Critically Who do you think benefits the most from this
change? The least?
Banking Online Many banks offer online banking, but it does not
appeal to everyone.
Log On Go to the Web site of a bank that you or your family uses
and find out if it offers Internet banking. Answer the following
questions:
1. How can you be sure the site is secure?
2. What transactions can you perform with an online account?
Newsclip: Teen Savings Banks offer many savings options to
teenagers. A teen can open a savings/passbook account or a CD (certificate of
O N L I N E
deposit).
Log On Go to finance07.glencoe.com and open Chapter 5. Read
about the different types of available savings options. Then answer
this question: When is it the right time to save, and what types of savings
accounts are available?
finance07.glencoe.com Chapter 5 Banking 149
Chapter 5 Review & Activities
BASIC BANKING QUIZ
How much do you know about basic bank services and terms? Take
this quiz before you read the chapter and retake it after studying the
chapter to see how much you have learned. Write your answers on a
separate sheet of paper.
1. A bank CD is a __________ .
a. cash deposit c. certificate of deposit
b. compact disc d. compact deposit
2. To borrow money from the bank, you need to ask for a __________ .
a. loan c. safe-deposit box
b. money market account d. transfer
3. You can store valuables in the bank’s vault if you have __________ .
a. permission c. a safe-deposit box
b. a money market account d. an ATM card
4. You keep money in a bank account to __________ .
a. keep it safe c. learn financial responsibility
b. earn interest d. all of the above
5. The total amount of money in your bank account is called __________ .
a. the statement c. the balance
b. the interest d. peanuts
6. The amount of money your bank account earns depends on the __________ .
a. type of account you have c. interest rate
b. balance in your account d. all of the above
7. When you make a purchase and have the funds taken directly from your checking
account, you use a __________ .
a. credit card c. debit card
b. note from your mother d. driver’s license
8. To set up a savings plan that requires a low minimum balance and allows you to with-
draw funds at any time, you would __________ .
a. buy a CD c. put the money under your mattress
b. buy a U.S. Savings Bond d. open a savings account
150 Unit 2 Banking and Credit
Chapter 5 Review & Activities
Your Financial Portfolio
Comparison Shopping for Banking Services
Sean is ready to open some bank accounts and is looking for the bank that best suits his
needs. He is deciding between the local bank and the credit union where he works.
Sean’s Savings Search
Name of Institution Kensington Bank Acme
Credit Union
Savings
Annual interest rate 1.8% 2.5%
Minimum balance required $100 none
Certificate of Deposit (CD) interest rate for
6 months 5.20% 5.40%
Checking
Monthly service charge $8.50 $6.00
Minimum balance for
“free” checking $3,000 $1,000
Fees for ATM Free no ATMs
Cost of checks $10.00 $8.75
Overdraft protection yes none
Banking hours Mon.–Sat. 9–6, Mon.–Fri. 9–6,
Closed Sun. Closed Sat. and Sun.
Sean decided to open a checking account at the bank because he needs the con-
venience of using the ATM. He opened a savings account at the credit union because it
pays higher interest. When he has enough money, he will also purchase a CD at the credit
union.
Compare
In your workbook or on a separate sheet of paper, list the banking services that are
important to you. Then call or visit several banks in your area and compare services, costs,
and interest rates that are available to you. What services are most important to you? Which
bank would you choose? Explain why.
Chapter 5 Banking 151
6
CHAPTER
Consumer Credit
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 6.1
• Explain the meaning of
consumer credit.
• Differentiate between closed-
end credit and open-end credit.
Section 6.2
• Name the five C’s of credit.
• Identify factors to consider when
choosing a loan or credit card.
• Explain how to build and
protect your credit rating.
Section 6.3
• Discuss how to protect yourself
from fraud and identity theft.
Section 6.4
• Identify ways to manage debt
problems.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
152 Unit 2 Banking and Credit
In the Real World . . .
W hen Jillian graduated high school and went to a local
college in Atlanta, she received an offer for a credit card and applied
for it. She was excited when she made her first charge for a new outfit. After
purchasing more clothes on credit, she reached her card limit. So she applied
for two more credit cards, each with an annual interest rate of 21 percent. Then
she began to charge groceries and furniture because it was easier than paying
cash. Jillian continued to use credit but did not notice her balances until they
grew to $9,500. Then she realized it would take years to pay them off and
knew she needed to learn more about handling credit.
As You Read Consider ways Jillian could manage her credit
more effectively.
Credit Payments
ASK Q: My brother is going to college and has three
credit cards with balances totaling $5,000. He is
having trouble paying the minimum monthly payments. What should I tell him?
A: He needs a plan to pay down these debts. Have him contact the credit card
companies and tell them that he wants to pay the debt and maintain good credit.
They may accept payments of interest only for a few months while he finds ways to
increase his income or cut spending.
Ask Yourself Why would communicating with a debtor (the credit card
company) benefit someone who is behind in payments?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com Chapter66
Chapter ConsumerCredit
Consumer Credit 153
Section 6.1
Focus on
Reading
What Is Consumer
Credit?
Read to Learn
• How to explain the
meaning of consumer Using Consumer Credit Wisely
credit. Why is having good credit important?
• How to differentiate
between closed-end When you borrow money or charge an item to a credit card, you
credit and open-end are using credit. Credit is an arrangement to receive cash, goods, or
credit. services now and pay for them in the future. Consumer credit is
the use of credit for personal needs. It is also an indicator of consumer
Main Idea spending and demand. A common form of consumer credit is a credit
There are advantages to card account issued by a financial institution. Merchants may also pro-
using consumer credit if vide financing for products that they sell. Banks may directly finance
you use it correctly.
purchases through loans and mortgages. A financial institution, mer-
Key Terms chant, or individual can be a creditor—an entity that lends money.
• credit Good credit is valuable. Having the ability to borrow funds allows us to
• consumer credit buy things we would otherwise have to save for years to afford: homes,
• creditor cars, or a college education. Credit is an important financial tool, but it
• closed-end credit can also be dangerous, leading people into debt beyond their ability to
• open-end credit repay. That is why using credit wisely is a valuable financial skill.
• line of credit
Today consumer credit is a major force in the American economy,
• grace period
• finance charge and the use of credit is a basic factor in personal and family financial
planning (see Figure 6.1). Sometimes using credit is necessary, and
it can be an advantage. However, paying for an item through credit
also involves responsibility and risks.
Before
You Read
Credit Uses and Misuses
PREDICT When is it appropriate to use credit?
What is your definition of You can probably think of many good reasons for using credit. For
credit?
example, maybe you can buy something on credit now for less money
than it will cost to pay in cash later. If you live in an area that lacks good
public transportation, you may need a vehicle to travel. But when is it
appropriate to use credit? If you cannot afford a high monthly payment,
it probably is not a good idea to borrow money to buy an expensive
sports car when all you need is simple and reliable transportation.
Using credit may increase the amount of money you can spend
now, but the cost of credit decreases the amount of money you will
have in the future. That is because you will be paying back the money
you borrowed along with any charges for borrowing that money.
154 Unit 2 Banking and Credit
&IGURE #ONSUMER )NSTALLMENT #REDIT
"ILLIONS OF $OLLARS
3OURCE 3TATISTICAL !BSTRACT OF THE 5NITED 3TATES '
#OLOSSAL #REDIT %CONOMISTS RECOGNIZE CONSUMER CREDIT AS A MAJOR FORCE IN THE 53 ECONOMY
7HAT IS ONE DISADVANTAGE OF USING CREDIT
Factors to Consider
Before Using Credit
What should you know before using credit?
Imagine you want to finance—give or get money for—a used
As You
vehicle. Before you decide to finance a major purchase by using
Read
credit, consider: RELATE
• Do you have the cash you need for the down payment? Did you ever use credit to
• Do you want to use your savings instead of credit? buy something you could
• Can you afford the item? not afford?
• Could you use the credit in some better way?
• Could you put off buying the item for a while?
• What are the costs of using credit?
When you buy something on credit, you also agree to pay the fee
that a creditor adds to the purchase price. For example, if you do not
pay your credit card bill in full every month, you will be charged interest
on the amount that you have not paid. Interest is the price that is paid
for the use of another’s money. It can be a periodic charge for the use
of credit. Think carefully before you decide to use credit. Make sure the
benefits of making the purchase now outweigh the costs of credit.
Chapter 6 Consumer Credit 155
THINK FIRST Everyone
likes to have nice things,
but using credit unwisely
can lead to problems. What
should you consider before
using credit?
Advantages of Credit
The main advantage of using consumer credit is that it lets you
enjoy goods and services now, perhaps when your funds are low, and
pay for them later. Credit cards allow you to combine several pur-
chases, making just one monthly payment.
If you are making hotel reservations, renting a car, or shopping
by phone or online, you will probably need a credit card. Using credit
gives you a record of your expenses. Shopping and traveling without
carrying a lot of cash is safer.
Finally, if you use credit wisely, other lenders will view you as a
responsible person.
Disadvantages of Credit
As You
Always remember that credit costs money. Perhaps the greatest
Read
disadvantage of using credit is the temptation to buy more than you
QUESTION can afford. Using credit to buy goods or services you cannot afford
can lead to serious trouble. If you fail to repay a loan, or a credit card
Why is it important to pro-
tect your good reputation balance, you can lose your good credit reputation. You may also lose
as a borrower? some of your income and property, which may be taken from you in
order to repay your debts.
Using credit does not increase your total purchasing power, nor
does it mean that you have more money. It just allows you buy things
now for which you must pay later. If your income does not increase,
you may have difficulty paying your bills. Therefore, you should
always approach credit with caution and avoid using it for more than
your budget allows.
156 Unit 2 Banking and Credit
Types of Credit
Why will you need more than one type of credit?
There are two basic types of consumer credit: closed-end credit
and open-end credit. You may use both types during your lifetime
because each has advantages and disadvantages.
Closed-End Credit
Closed-end credit is credit as a one-time loan that you will pay
back over a specified period of time in payments of equal amounts.
Closed-end credit is used for a specific purpose and involves a definite
amount of money.
A mortgage—a long-term loan extended to someone who buys
property—is a common use of closed-end credit. Vehicle loans and
installment loans for purchasing furniture or large appliances are
also examples of closed-end credit. These types of loans usually carry
lower interest rates than open-end credit carries.
For example, when the Petersons were ready to move out of their
apartment, they decided to buy a three-bedroom house and apply
for a mortgage from a bank. They signed a written agreement that
indicated how much their monthly payments would be, how many
payments they would make, and the cost of the credit over the life of Get a Good
the loan. The bank will hold the title to the house until the Petersons Credit Rating
have completed their payments. 1. Open a savings
Suppose that you want to buy a sofa and loveseat to furnish your account and make
living room. You might apply for an installment loan from a furniture regular deposits.
2. Apply for a
company. You would sign a contract promising to repay the balance,
department store
plus interest, in equal installments over a specified period. or gasoline credit
card and use it
Open-End Credit responsibly.
3. Pay all loans and
What does open-end credit mean? Open-end credit is credit credit card bills on
as a loan with a certain limit on the amount of money you can bor- time.
row for a variety of goods and services. A line of credit is the maxi- 4. Open a checking
mum amount of money a creditor will allow a credit user to borrow. account and do
not bounce checks.
Department store credit cards and bank credit cards, such as Visa or
5. Never let anyone
MasterCard, are examples of open-end credit. After a credit card com- use your credit
pany has approved your application for credit and you have received card.
the card, you can use it to make as many purchases as you wish, as
long as you do not exceed your line of credit. You are then billed peri-
odically for at least partial payment of the total amount you owe.
Sources of Consumer Credit
What are some sources of consumer credit?
Many sources of consumer credit are available, including com-
mercial banks and credit unions. Figure 6.2 summarizes the major
sources of consumer credit. Study and compare the differences to deter-
mine which source might best meet your needs and requirements.
Chapter 6 Consumer Credit 157
&IGURE 3OURCES OF #ONSUMER #REDIT
Credit Source Type of Loan Lending Policies
Commercial Banks Single-payment loan • Seek customers with established credit history
Personal installment loans • Often require collateral or security
Passbook loans • Prefer to deal in large loans, such as vehicle,
Check-credit loans home improvement, and home modernization,
Credit card loans with the exception of credit card and check-
Second mortgages credit plans
• Determine repayment schedules according to
the purpose of the loan
• Vary credit rates according to the type of credit,
time period, customer’s credit history, and the
security offered
• May require several days to process a new credit
application
Consumer Finance Personal installment loans • Often lend to consumers without established
Companies Second mortgages credit history
• Often make unsecured loans
• Often vary rates according to the size of the
loan balance
• Offer a variety of repayment schedules
• Make a higher percentage of small loans than
other lenders
• Maximum loan size limited by law
• Process applications quickly, frequently on the
same day the application is made
Credit Unions Personal installment loans • Lend to members only
Share draft-credit plans • Make unsecured loans
Credit card loans • May require collateral or cosigner for loans
Second mortgages over a specified amount
• May require payroll deductions to pay
off loan
• May submit large loan applications to a
committee of members for approval
• Offer a variety of repayment schedules
Life Insurance Single-payment or partial • Lend on cash value of life insurance policy
Companies payment loans • No date or penalty on repayment
• Deduct amount owed from the value of the
policy benefit if death or other maturity
occurs before repayment
Federal Savings Banks Personal installment loans • Will lend to all creditworthy individuals
(Savings and Loan (generally permitted by • Often require collateral
Associations) state-chartered savings • Loan rates vary depending on size of loan, length
associations) of payment, and security involved
Home improvement loans
Education loans
Savings account loans
Second mortgages
3EEKING #USTOMERS #ONSUMER CREDIT IS AVAILABLE FROM SEVERAL TYPES OF SOURCES
7HICH SOURCES SEEM TO OFFER THE WIDEST VARIETY OF LOANS
158 Unit 2 Banking and Credit
Loans
A loan is borrowed money with an agreement to repay it with
interest within a certain amount of time. If you were considering tak-
ing out a loan, your immediate thought might be to go to your local
bank. However, you might want to explore some other options first.
Inexpensive Loans Parents or other family members are often the
source of the least expensive loans—loans with low interest. They
may charge only the interest they would have earned on the money
if they had deposited it in a savings account. They may even give you
a loan without interest. Be aware, however, that loans can complicate
family relationships.
Medium-Priced Loans Often you can obtain medium-priced
loans—loans with moderate interest—from commercial banks, savings
and loan associations, and credit unions. Borrowing from credit
unions has several advantages. Credit unions provide personalized
service, and they are usually willing to be patient with borrowers who
can provide good reasons for late or missed payments. As you learned
in Chapter 5, you must be a member of a credit union in order to get
a loan from one.
Expensive Loans The easiest loans to obtain are also the QUICK CASH Using a
most expensive. Finance companies and retail stores that lend to debit card can be a con-
consumers will frequently charge high interest rates, ranging from venient way to get cash any
12 to 25 percent. Banks also lend money to their credit card holders time you need it. How is a
through cash advances—loans that are billed to the customer’s credit debit card different from a
card account. Most cards charge higher interest for a cash advance and credit card?
charge interest from the day the cash advance is made.
As a result, it is much more expensive to take out a cash
advance than to charge a purchase to a credit card.
Home Equity Loans A home equity loan is a loan
based on your home equity—the difference between the
current market value of your home and the amount you
still owe on the mortgage. Unlike interest on most other
types of credit, the interest you pay on a home equity loan
is tax-deductible. Use these loans only for major items
such as education, home improvements, or medical bills.
If you miss payments on a home equity loan, the lender
can take your home. For more information about home
equity loans, see Chapters 7 and 17.
Credit Cards
Credit cards are extremely popular. The average card-
holder has more than nine credit cards, including bank,
retail, gasoline, and telephone cards. Cardholders who
pay off their balances in full each month are often known
as convenience users. Cardholders who do not pay off
their balances every month are known as borrowers.
Chapter 6 Consumer Credit 159
Most credit card companies offer a grace period, a time period
during which no finance charges will be added to your account. A
finance charge is the total dollar amount you pay to use credit.
Generally, if you pay your balance before the due date stated on your
monthly bill, you do not have to pay a finance charge. Borrowers
who carry balances beyond the grace period pay finance charges.
The cost of a credit card depends on the type of credit card you
have and the terms set forth by the lender. As a cardholder, you may
have to pay interest or other finance charges. Some credit card com-
panies charge cardholders an annual fee, usually about $20. How-
ever, many companies have eliminated annual fees. If you are looking
for a credit card, be sure to shop around for one with no annual fee.
Figure 6.3 gives some other helpful hints for choosing a credit card.
&IGURE #HOOSING AND 5SING A #REDIT #ARD
When you choose a credit card, it pays to shop around. Follow these suggestions to find the card
that best meets your needs and to use it wisely:
1. Department stores and gasoline companies are 8. If your card offers a grace period, take advantage
good places to obtain your first credit card. of it by paying off your balance in full each month.
2. Bank credit cards are offered through banks and With a grace period of 25 days, you actually get a
savings and loan associations. Annual fees and free loan when you pay bills in full each month.
finance charges vary widely, so shop around. 9. If you have a bad credit history and have trouble
3. If you plan on paying off your balance every getting a credit card, look for a savings institution
month, look for a card that has a grace period that will give you a secured credit card. With this
and carries no annual fee or a low annual fee.You type of card, your line of credit depends on how
might have a higher interest rate, but you plan to much money you keep in a savings account that
pay little or no interest anyway. you open at the same time.
4. Watch out for creditors that offer low or no 10. Travel and entertainment cards often charge
annual fees but instead charge a transaction fee higher annual fees than most credit cards. Usually,
every time you use the card. you must make payment in full within 30 days of
5. If you plan to carry a balance, look for a card receiving your bill, or no further purchases will
with a low monthly finance charge. Be sure be approved on the account.
that you understand how the finance charge is 11. Be aware that debit cards are not credit cards
calculated. but simply a substitute for a check or cash. The
6. To avoid delays that may result in finance charges, amount of the sale is subtracted from your
follow the card issuer’s instructions as to where, checking account.
how, and when to make bill payments. 12. Think twice before you make a telephone call
7. Beware of offers of easy credit. No one can guar- to a 900 number to request a credit card.You
antee to get you credit. will pay from $2 to $50 for the 900 call and may
never receive a credit card.
3OURCES !MERICAN )NSTITUTE OF #ERTIFIED 0UBLIC !CCOUNTANTS 53 /FFICE OF #ONSUMER !FFAIRS &EDERAL 4RADE #OMMISSION
#RITICAL 4HINKING "EFORE YOU ENTER THE WORLD OF CREDIT YOU NEED TO UNDERSTAND THE VARIOUS OPTIONS
THAT ARE AVAILABLE TO YOU
7HICH OF THESE FACTORS WOULD BE MOST IMPORTANT IN YOUR CHOICE
OF A CREDIT CARD
160 Unit 2 Banking and Credit
Debit Cards Do not confuse credit cards with debit cards. A debit
card allows you to electronically subtract money from your savings or
checking account to pay for goods or services. A credit card extends
credit and delays payment. Debit cards are most commonly used at
TechByte
Smart Cards The first
automated teller machines (ATMs). They are also used to purchase basic credit card was the
goods in stores and to make other types of payments. BankAmericard, issued by
Bank of America in 1958.
Smart Cards Some lenders offer a credit card called a smart card. A Today a variety of cards
smart card is a plastic card equipped with a computer chip that can are available, including
store 500 times as much data as a normal credit card. Smart cards can smart cards, which com-
bine a credit card, driv-
store a variety of information. A smart card, for example, can be used to
er’s license, healthcare
buy an airline ticket, store it digitally, and track frequent flyer miles. ID, medical history, and
other features.
Travel and Entertainment (T&E) Cards Travel and Enter-
tainment (T&E) cards are really not credit cards because the balance List other features
is due in full each month. However, most people think of T&E cards— of smart cards
by reading more
such as American Express cards—as credit cards because users do not
information through
pay for goods or services when they purchase them. finance07.glencoe.com.
Section 6.1 Assessment
QUICK CHECK Write About It What is your view
1. What are two advantages and two disadvan- on the issue of using credit? Do you
tages of using credit? plan to obtain a credit card? Would you
2. What is the difference between closed-end prefer to pay cash? Write a short essay that
credit and open-end credit? explains the role of credit cards and loans in
3. What is an example of an inexpensive loan, your philosophy of money management.
a medium-priced loan, and an expensive
SOLVE MONEY PROBLEMS
loan?
6. Evaluating Credit Garrett, a high
THINK CRITICALLY school senior, wanted to get his girlfriend
4. Review Figure 6.3 on page 160. How might a special birthday gift. A local electronics
you select a card that best meets your needs? store had one-day special discounts on ste-
reos, with no payments required until after
USE MATH SKILLS six months. With income from his part-
5. Cash or Charge? The use of credit in the time job, Garrett felt that he could incor-
United States is widespread. Nevertheless, porate the expense into his budget. His
some people use credit cards and take out mother and sister tried to discourage him
loans only in an emergency. Their philoso- from buying the stereo.
phy is that if they do not have cash to pay Analyze What should Garrett
for something, they should not take on a do in this situation? Explain your
debt. Other people believe credit is neces- reasoning.
sary for everyday living.
finance07.glencoe.com Chapter 6 Consumer Credit 161
Section 6.2
Focus on
Reading
The Costs and
Methods of
Read to Learn
• How to name the five C’s
Obtaining Credit
of credit.
• How to identify factors to
consider when choosing Can You Afford a Loan?
a loan or credit card.
What is a loan?
• How to explain how to
build and protect your A loan is money that you borrow and must repay. Loans cost
credit rating. money to the borrower in the form of interest. Taking out a loan can
be a substantial financial burden. Before you take out a loan, you
Main Idea need to be sure that you can afford it. Will you be able to meet all
You should consider the your usual expenses plus the monthly loan payments you will have
costs of credit and your to make? You can answer this question in several ways.
own credit standing when
One way is to add up all your basic monthly expenses and then
applying for credit.
subtract the total from your take-home pay. If the difference is not
Key Terms enough to make a monthly loan payment and still have a little left
over, you cannot afford the loan.
• net income
• annual percentage rate A second way is to consider what you might give up to make the
(APR) monthly loan payment. For example, perhaps you are putting some
• collateral of your monthly income into a savings account. Would you be willing
• simple interest to use that money to make loan payments instead? If not, would you
• minimum monthly consider cutting back on unnecessary but fun activities, such as going
payment
to movies or eating out? Are you prepared to make this trade-off?
• credit rating
Although you cannot measure your credit capacity exactly, you
can use the debt payments-to-income ratio formula to decide whether
you can safely take on the responsibility of credit.
Before
You Read Debt Payments-to-Income Ratio
PREDICT The debt payments-to-income ratio is the percentage of debt you
have in relation to your net income. Net income is the income you
What is your definition of
receive (take-home pay, allowance, gifts, and interest). Experts suggest
credit?
PREDICT that you spend no more than 20 percent of your net income on debt
payments. For example, if your net income is $1,000 per month, your
monthly debt payments should total no more than $200. Monthly
debt payments include credit card and loan payments. You can cal-
culate your debt payments-to-income ratio by dividing your total
monthly debt payments (not including housing payments) by your
monthly net income.
162 Unit 2 Banking and Credit
GO FIGURE FINANCIAL MATH
DEBT PAYMENTS-TO-INCOME Formula: Monthly Debt Payments
⫽
RATIO (DPR) Monthly Net Income
Synopsis: Computing your monthly net income Debt Payments-to-Income Ratio (DPR)
will help you calculate how much to spend on debt
Solution: $180
payments. Your debt payments-to-income ratio ⫽ 0.15 ⫽ 15%
$1,200
(DPR) will also determine your monthly budget.
Example: Suppose that your monthly net income is
$1,200. Your monthly debt payments include your YOU FIGURE
student loan payment and a gas credit card, and
they total $180. What is your debt payments-to- What is your debt payments-to-income ratio if
income ratio? your debt payments total $342 and your net
income is $1,000 per month?
Twenty percent is the most you should spend on debt payments,
but 15 percent is much better. The higher figure does not take into
account emergency expenses, and it is based on an average family’s
average expenses. If you are a young adult who is just beginning to
experiment with credit, play it safe and stay below the 20 percent
limit.
The Cost of Credit
What does it cost to apply for credit?
If you are thinking of taking out a loan or applying for a credit Put on
card, your first step should be to figure out how much the loan will Your
cost you and whether you can afford it. Then you should shop for the Financial
best credit terms. Two key factors will be the finance charge and the
annual percentage rate (APR).
Planner’s
Cap
The Finance Charge and the If you were a financial plan-
Annual Percentage Rate (APR) ner, what is the first thing
you would say to a client
The finance charge is the total dollar amount you pay to use who was in serious credit
credit. In most cases, you will have to pay finance charges to a credi- card debt?
tor on any unpaid balance.
The finance charge is calculated using the annual percentage
rate. The annual percentage rate (APR) is the cost of credit on a
yearly basis, expressed as a percentage. For example, an APR of 18 per-
cent means that you pay $18 per year on each $100 you owe. Every
organization that extends credit of any kind must state the true APR
that it charges its customers. This makes it easy to compare the cost of
credit at several businesses or among several different credit cards.
Chapter 6 Consumer Credit 163
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis-
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals
*ERUSALEM
to help them guide their financial decisions.
ISRAEL
Israel’s economy operates on borrowed money
from institutions such as the World Bank and the
International Monetary Exchange or from foreign
nations. However, because of ongoing political con- DATABYTES
flicts and an economic slump, the country’s credit
rating dropped. When countries or individuals carry
Capital Jerusalem
excessive debt, lenders view them as credit risks.
However, tight security and an upbeat global mar- Population 6,707,000
ket set the stage for Israel’s financial recovery. Israeli Languages Hebrew, Arabic, and English
exports grew by 20 percent. Incentives such as tax- Currency new Israeli shekel
free “holidays” encouraged the development of new Gross Domestic
companies. Even Product (GDP) $120.6 billion
tourism has grown. GDP per capita $19,700
In fact, the coun-
Industry: High-technology projects, wood and paper
try made its biggest
products, potash and phosphates, and food
economic gain in
2004. One news head- Agriculture: Citrus, vegetables, cotton, and beef
line described the Exports: machinery and equipment, software, cut
country and its turn- diamonds, agricultural products, and chemicals
around: “Israel: A Natural Resources: Copper, phosphates, bromide,
Bunch of Blooms in potash, and clay
the Desert.”
Think Globally
Would you invest in an international stock from Israel?
Why or why not?
To determine the total amount of finance charges that you will
pay on $100 borrowed, look at Figure 6.4. Find the APR at the top
of the chart and the number of payments at the left side of the chart.
The point at which they meet is the total amount you will pay in
finance charges for each $100 borrowed.
For example, find the column showing an APR of 8 percent. Fol-
low it down until it meets the row showing 24 monthly payments.
You will see that if you borrow $100 at an APR of 8 percent for two
years (24 months), you will pay $8.55 in finance charges. Under the
Truth in Lending Act, the creditor must inform you, in writing and
before you sign any agreement, of the finance charge and the APR.
164 Unit 2 Banking and Credit
&IGURE !NNUAL 0ERCENTAGE 2ATE 4ABLE FOR -ONTHLY 0AYMENTS
Annual Percentage Rate—APR (Finance Charge per $100 Borrowed)
Number of Monthly Payments 7.0% 7.5% 8.0% 8.5% 9.0%
6 $2.05 $2.20 $ 2.35 $ 2.49 $ 2.64
12 $3.83 $4.11 $ 4.39 $ 4.66 $ 4.94
18 $5.63 $6.04 $ 6.45 $ 6.86 $ 7.28
24 $7.45 $8.00 $ 8.55 $ 9.09 $ 9.64
30 $9.30 $9.98 $10.66 $11.35 $12.04
&INDING THE )F YOU BORROW MONEY AND DO NOT PAY IT BACK RIGHT AWAY YOU WILL PROBABLY HAVE TO
&INANCE #HARGE PAY A FINANCE CHARGE
7HAT IS THE FINANCE CHARGE THAT YOU WOULD PAY IF YOU BORROWED
FOR MONTHS AT AN !02 OF PERCENT
Tackling the Trade-Offs
When you select your financing, you will have to make trade-
offs. You will have to choose among various features, including the
length of the loan, the size of monthly payments, and the interest
rate. Here are some of the major trade-offs you should consider.
Term Versus Interest Costs Many people choose longer-term
financing because they want smaller monthly payments. However,
the longer the term (the period of time) of a loan at a given interest
rate, the greater the amount you will pay in interest charges. Compare
the following credit arrangements on a $6,000 loan:
Term of Monthly Total Finance Total
APR Loan Payment Charge Cost
Creditor A 14% 3 years $205.07 $1,382.52 $7,382.52
Creditor B 14% 4 years 163.96 1,870.08 7,870.08
How do these choices compare? The answer depends partly on
what you need. The lower-cost loan is available from Creditor A. If
you are looking for lower monthly payments, you could repay the
loan over a longer period of time. However, you would have to pay
more in total costs. A loan from Creditor B provides smaller monthly
payments but adds about $488 to your total finance charge.
Lender Risk Versus Interest Rate You may prefer financing that
requires a minimum down payment, a portion of the total cost of an
item that is required at the time of purchase. Another option is to take
out a loan that features low fixed payments with a large final payment.
Keep in mind that the lender’s goal is to minimize risk, or make sure
that you pay back the loan in full. Consumers who want these types of
features have to accept the trade-off of a more expensive loan.
Chapter 6 Consumer Credit 165
GO FIGURE FINANCIAL MATH
SIMPLE INTEREST ON A LOAN formula below to help compute Janelle’s loan
interest.
Synopsis: Simple interest, compounded annually, is
a percentage of the amount borrowed. The amount Formula: Principal ⫻ Interest Rate ⫻ Amount of
borrowed is called principal. Compound interest may Time ⫽ Simple Interest
be computed daily, monthly, or yearly. Solution: $1,000 ⫻ .05 or 5% ⫻ 1 ⫽ $50 interest
Example: Janelle’s cousin agreed to lend her $1,000
to purchase a used laptop computer. She has agreed
YOU FIGURE
to charge only 5 percent simple interest, and Janelle
has agreed to repay the loan at the end of one year. You just bought a used car for $3,500 from your
How much interest will she pay for the year? Use the aunt. She agreed to let you make payments for
3 years with simple interest at 6 percent. How
much interest will you pay?
To reduce lender risk and increase your chance of getting a loan
at a lower interest rate, consider the following options:
• Variable Interest Rate A variable interest rate is based on
changing rates in the banking system. This means that the
interest rate you pay on your loan will vary from time to time.
If you have a loan with a variable interest rate and overall
interest rates rise, the rate on your loan is adjusted accordingly.
Therefore, the lender may offer you a lower beginning interest
rate than you would have with a fixed-rate loan.
• A Secured Loan You will probably receive a lower interest
rate on your loan if you pledge collateral. Collateral is a form
of security to help guarantee that the creditor will be repaid.
It indicates that if you lost your source of income, you could
repay your loan with the collateral, such as your savings, or
by selling some of your property. If you do not pay back the
loan, the lender may have the legal right to take whatever you
pledged as collateral.
• Up-Front Cash Many lenders believe that you have a higher
stake in repaying a loan if you make a large down payment.
Thus, you may have a better chance of getting the other loan
features you want.
• A Shorter Term The shorter the period of time (or term)
for which you borrow, the smaller the chance that something
will prevent you from repaying your loan. This lowers the
risk to the lender. Therefore, you may be able to borrow at a
lower interest rate if you accept a shorter-term loan, but your
monthly payments will be higher.
166 Unit 2 Banking and Credit
Careers in Finance
CREDIT
CREDITANALYST
ANALYST Michelle Molyneux
3Com Corporation
Before joining 3Com Corporation, a global company specializing in computer networks, Michelle
worked for a credit department at a bank where she evaluated business loans. She explains that a
credit analyst considers a company’s credit by evaluating financial statements, company statistics,
and its managers. Credit analysts evaluate the worthiness of corporate customers, credit risk, and
then set credit lines. They also advise whether to extend credit to a company.
SKILLS: Time-management, accounting, judgment, investigative, analytical,
communication, some foreign language, and interpersonal skills
PERSONAL TRAITS: Curiosity, a desire to know the big picture, and an international perspective
EDUCATION: High school diploma or equivalent; bachelor’s degree in accounting or
finance
ANALYZE People can get into debt by mistaking needs and wants. List your needs, such as
clothing and food. Then list your wants, such as luxury items or recreation. Describe how a credit
analyst might rate your credit worthiness, based on your needs and wants.
To learn more about career paths for credit analysts visit finance07.glencoe.com.
Calculating the Cost of Credit
To assess your trade-offs, you can also compare loans and credit
cards by calculating the interest to find the cost of credit. The most
common method of calculating interest is the simple interest formula.
Other methods, such as simple interest on the declining balance and
add-on interest, are variations of this formula.
Simple Interest Simple interest is the interest computed only
on the principal, the amount that you borrow. It is based on three
factors: the principal, the interest rate, and the amount of time for As You
which the principal is borrowed. To calculate the simple interest on a Read
loan, multiply the principal by the interest rate and by the amount of
RELATE
time (in years) for which the money is borrowed. (See the Go Figure
box on page 166.) Why should you pay more
than the monthly mini-
Simple Interest on the Declining Balance When a simple mum balance on a credit
interest loan is paid back in more than one payment, the method of card debt?
computing interest is known as the declining balance method. You
pay interest only on the amount of principal that you have not yet
repaid. The more often you make payments, the lower the interest
you will pay. Most credit unions use this method.
finance07.glencoe.com Chapter 6 Consumer Credit 167
Add-On Interest With the add-on interest method, interest is
calculated on the full amount of the original principal, no matter
how often you make payments. When you pay off the loan with one
payment, this method produces the same APR as the simple interest
method. However, if you pay in installments, your actual rate of
interest will be higher than the stated rate. Interest payments on this
type of loan do not decrease as the loan is repaid. The longer you take
to repay the loan, the more interest you will pay.
Cost of Open-End Credit The Truth in Lending Act requires that
open-end creditors inform consumers as to how the finance charge
and the APR will affect their costs. For example, they must explain
how they calculate the finance charge. They must also inform you
when finance charges on your credit account begin to accrue so that
you know how much time you have to pay your bills before a finance
charge is added.
Cost of Credit and Expected Inflation Inflation reduces the
buying power of money. Each percentage point increase in inflation
means a decrease of about 1 percent in the quantity of goods and
services you can buy with the same amount of money. Because of
this, lenders incorporate the expected rate of inflation when deciding
how much interest to charge.
Remember the earlier example in which Damon borrowed
$1,000 from his aunt at the bargain rate of 5 percent for one year?
If the inflation rate was 4 percent that year, his aunt’s actual rate of
return on the loan would have been only about 1 percent (5 per-
cent stated interest minus 4 percent inflation rate). A professional
lender that wanted to receive 5 percent interest on Damon’s loan
might have charged him 9 percent interest (5 percent interest plus
4 percent—anticipated inflation rate).
The Minimum Monthly Payment Trap On credit card bills and
for other forms of credit, the minimum monthly payment is the
smallest amount you can pay and remain a borrower in good standing.
Lenders often encourage you to make the minimum payment because
it will then take you longer to pay off the loan. However, if you are
paying only the minimum amount on your monthly statement, you
need to plan your budget more carefully. The longer it takes for you
to pay off a bill, the more interest you pay. The finance charges you
pay on an item could end up being more than the item is worth.
For example, suppose that Natasha is buying new books for col-
lege. She spends $500 on textbooks, using a credit card that charges
19.8 percent interest per year, and she makes only the minimum
monthly payment of $21.67. Based on that payment amount, it
will take Natasha approximately two and one-half years to pay off
the loan. Interest charges of $150 will be added to the cost of her
purchase.
168 Unit 2 Banking and Credit
Applying for Credit
Why does a lender need to know about your credit
history to extend credit? Common
When you are ready to apply for a loan or a credit card, you CENTS
should understand the factors that determine whether a lender will
extend credit to you. One Is Enough
When you turn 18, you
may start receiving appli-
The Five C’s of Credit cations for credit cards.
Be a smart consumer and
When a lender extends credit to consumers, it takes for granted
compare interest rates,
that some people will be unable or unwilling to pay their debts. There- annual fees, and any other
fore, lenders establish policies for determining who will receive credit. fees. Decide which credit
Most lenders build such policies around the “five C’s of credit”: char- card best suits your needs
acter, capacity, capital, collateral, and credit history. and apply for that one.
Toss any other applications
Character: Will You Repay the Loan? Creditors want to know you get into the trash.
what kind of person to whom they will be lending money. They Why should you get the
want to know that you are trustworthy and stable. They may ask best (or lowest) interest rate
for personal or professional references, and they may check to see for a credit card?
whether you have a history of trouble with the law. Some questions a
lender might ask to determine your character are:
• Have you used credit before?
• How long have you lived at your present address?
• How long have you held your current job?
Capacity: Can You Repay the Loan? Your income and the debts
you already have will affect your ability to pay additional debts. If you
already have a large amount of debt in proportion to your income,
lenders probably will not extend more credit to you.
LOOK BEFORE YOU LEAP
Before taking out a loan,
you should sit down and
figure out your finances.
What is perhaps the most
important point you should
consider?
Chapter 6 Consumer Credit 169
A creditor may ask several questions about your income and
expenses:
• What is your job, and how much is your salary?
• Do you have other sources of income?
• What are your current debts?
Capital: What Are Your Assets and Net Worth? You may recall
from Chapter 3 that assets are any items of value that you own, including
Your Own Home
cash, property, personal possessions, and investments. Your capital is the
Learn how to estab-
lish and maintain good amount of your assets that exceed your liabilities, or the debts you owe.
credit so you can get a Lenders want to be sure that you have enough capital to pay back a loan.
mortgage when the time That way, if you lost your source of income, you could repay your loan
comes to buy your first from your savings or by selling some of your assets. A lender might ask:
home.
• What are your assets?
To continue with • What are your liabilities?
Task 3 of your
WebQuest project, visit Collateral: What If You Do Not Repay the Loan? Creditors
finance07.glencoe.com. look at what kinds of property or savings you already have, because
these can be offered as collateral to secure the loan. If you fail to repay
the loan, the creditor may take whatever you pledged as collateral. A
creditor might ask:
• What assets do you have to secure the loan (a vehicle, your
home, or furniture)?
• Do you have any other assets (bonds or savings)?
Credit History: What Is Your Credit History? Lenders will
review your credit history to find out whether you have used credit
responsibly in the past. They will probably obtain a copy of your
credit report from a credit bureau. Some questions a creditor might
ask about your credit history are:
• Do you pay your bills on time?
• Have you ever filed for bankruptcy?
The information gathered from your application and the credit
bureau establishes your credit rating.
As You A credit rating is a measure of a person’s ability and willing-
Read ness to make credit payments on time. The factors that determine a
person’s credit rating are income, current debt, information about
QUESTION character, and how debts have been repaid in the past. If you always
make your payments on time, you will probably have an excellent
Why does a lender need
to know about your credit
credit rating. If not, your credit rating will be poor, and a lender prob-
history to extend credit? ably will not extend credit to you. A good credit rating is a valuable
asset that you should protect.
Creditors use different combinations of the five C’s to reach
their decisions. Some creditors set unusually high standards, and
others simply do not offer certain types of loans. Creditors also use
various rating systems. Some rely strictly on their own instincts and
experience. Others use a credit scoring or statistical system to predict
whether an applicant is a good credit risk. When you apply for a loan,
the lender is likely to evaluate your application by asking questions
such as those included in the checklist in Figure 6.5 on page 172.
170 Unit 2 Banking and Credit finance07.glencoe.com
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: A Credit Card Your Motive: Understanding how to read
Statement your credit card statement is important
A credit card statement lists this so you can track where you spend your
information: money each month. You can also verify
• Payments made that the transactions on the statement are
• New balance accurate.
• Your available credit
• Transactions for the month
• Minimum payment due
CREDIT CARD STATEMENT
Statement Date
Previous Payments New New 02/03/––
Credit Line
Balance and Credits Charges Balance
Payment Date
$100 $100 $40.60 $40.60 $5,000
02/28/––
FOR CUSTOMER SERVICE CALL OR WRITE 1-800-555-4553 P.O. BOX 23 SIOUX FALLS, SD
SEND PAYMENTS TO: BANKCENTER P.O. BOX 6575 GOLDEN, NEVADA 88777
Cash Advance Limit Available Credit Line Available Cash Line*
6593-5800-0086-1905
$500 $4,900 $500
Sale Post Reference
Date Date Number Type of Activity Location Amount
01/05 01/07 24036215006661 Daisy Market Clover, IL 4.30
01/08 01/10 24692165008000 Chloe’s Coffee Fielding, CT 2.30
01/13 01/13 74046585013013 PAYMENT RECEIVED--THANK YOU 100.00
01/18 01/20 24036215019664 Real Music Clover, IL 15.50
02/02 02/03 242753050337531 Books ‘n’ News Montclair, MO 13.90
02/01 02/03 242753950329000 Nick’s Candy Montclair, MO 4.60
DAYS IN BILLING PERIOD: 40
Purchases Cash Advance Payment Due: 20.00
Balance Subject to Interest Charge > 0.00 .00 Amount Over Credit Limit: .00
Periodic Rate > .0000% .0000% Amount Past Due .00
ANNUAL PERCENTAGE RATE > 0.00% 0.00% MINIMUM AMOUNT DUE: 20.00
Key Points: A credit card statement is sent Find the Solutions
to you each month. It lists all the purchases 1. How many charges or transactions were
you have made using your credit card and completed on this statement?
the amount of each purchase. It also lists the 2. How much more can you charge on the
payments you made during the month. In credit card?
3. What is the new balance listed on the
addition, it indicates how much money you
statement?
can still borrow from the credit card.
4. What is the minimum payment to be paid?
5. What is the due date of the next payment?
Chapter 6 Consumer Credit 171
&IGURE #REDIT !PPLICATION )NFORMATION
• Amount of loan requested • Present salary • Savings account number,
institution, and branch
• Proposed use of the loan • Number and ages of • Name of nearest relative not
dependents living with you
• Your name and birth date • Other income and sources of • Relative’s address and tele-
other income phone number
• Social Security and driver’s • Have you ever received credit • Your marital status
license numbers from us?
• Present and previous street • If so, when and at which office?
addresses
• Present and previous employers • Checking account number,
and their addresses institution, and branch
7HO !RE 9OU ! POTENTIAL LENDER WILL REQUIRE YOU TO ANSWER A NUMBER OF SPECIFIC QUESTIONS ON A
CREDIT APPLICATION
7HY DO YOU THINK THAT A CREDITOR WOULD WANT TO KNOW THE NAMES
AND ADDRESSES OF YOUR PRESENT AND PREVIOUS EMPLOYERS
Credit and Equal Opportunity
You should also know what factors a lender cannot consider,
according to the law. The Equal Credit Opportunity Act (ECOA) gives
all credit applicants the same basic rights. It states that a lender may
not use race, nationality, age, sex, marital status, and certain other
factors to discriminate against you.
Age The Equal Credit Opportunity Act (ECOA) is very specific
about how a person’s age may be used as a factor in credit decisions.
A creditor may request that you state your age on an application, but
if you are old enough to sign a legal contract (usually 18 or 21 years
old, depending on state law), a creditor may not turn you down or
decrease your credit because of your age. Creditors may not close your
credit account because you reach a certain age or retire.
Public Assistance You may not be denied credit because you re-
ceive Social Security or public assistance. However, certain information
related to this source of income can be considered in determining
your creditworthiness.
Housing Loans The ECOA also covers applications for mortgages
or home improvement loans. In particular, it bans discrimination
against you based on the race or nationality of the people in the
neighborhood where you live or want to buy your home, a practice
that is called redlining.
172 Unit 2 Banking and Credit
What If Your Application Is Denied?
If your credit application is denied, the ECOA gives you the right
to know the reasons. If the denial is based on a credit report from a
credit bureau, you are entitled to know what specific information in
the report led to the denial. After you receive this information, you
can contact the credit bureau and ask for a copy of your credit report.
The bureau cannot charge a fee for this service as long as you ask to
see your files within 60 days of notification that your credit applica-
tion has been denied. You are entitled to ask the bureau to investigate
any inaccurate or incomplete information and correct its records.
(See Figure 6.6.)
&IGURE 7HAT )F 9OU !RE $ENIED #REDIT
9OU RECEIVE WRITTEN NOTIFICATION THAT CREDIT
HAS BEEN DENIED AND THE REASONS FOR DENIAL
#HECK YOUR CREDIT AT THE CREDIT BUREAU
9OU BELIEVE THE REASONS 9OU ARE NOT SURE IF THE REASONS 9OU BELIEVE THE REASONS FOR
FOR DENIAL ARE VALID FOR DENIAL ARE VALID OR INVALID CREDIT DENIAL ARE INVALID
AND THE CREDITOR HAS
DISCRIMINATED AGAINST YOU
!SK THE CREDITOR TO CLARIFY
THE REASONS FOR DENIAL
.OTIFY THE FEDERAL (IRE A PRIVATE ATTORNEY TO FILE
ENFORCEMENT AGENCY WHOSE SUIT AGAINST THE CREDITOR
NAME YOU WERE GIVEN
)F THE COURT FINDS
4HE FEDERAL ENFORCEMENT DISCRIMINATION THE CREDITOR
AGENCY WILL INVESTIGATE AND MUST PAY YOU ACTUAL DAMAGES
REPORT BACK TO YOU PLUS PUNITIVE DAMAGES
!SK THE CREDITOR IF YOU !PPLY TO ANOTHER CREDITOR 4AKE STEPS TO IMPROVE YOUR
CAN PROVIDE ADDITIONAL WHOSE STANDARDS MAY CREDITWORTHINESS IE INCREASE
INFORMATION OR ARRANGE BE DIFFERENT INCOME REDUCE SPENDING PAY
ALTERNATIVE CREDIT TERMS BILLS ON TIME AND REAPPLY
3OURCE &EDERAL 2ESERVE "ANK OF -INNEAPOLIS
2IGHT THE 7RONG 4HE LAW REQUIRES CREDIT CARD COMPANIES TO CORRECT INACCURATE OR INCOMPLETE
INFORMATION IN YOUR CREDIT REPORT
7HY IS IT BEST TO REQUEST CHANGES OF INCORRECT INFORMATION BY LETTER
RATHER THAN BY PHONE
Chapter 6 Consumer Credit 173
Your Credit Report
Why is your credit report important?
When you apply for a loan, the lender will review your credit
HISTORY history closely. The record of your complete credit history is called
The first credit card, a your credit report, or credit file. Your credit records are collected and
travel and entertainment maintained by credit bureaus. Most lenders rely heavily on credit
card, was issued in 1950 reports when they consider loan applications. Figure 6.7 provides
by Diners Club. Card hold- information on building and protecting your credit history.
ers could charge meals in
27 restaurants in New York
City. Eight years later, the
first bank credit card was Credit Bureaus
issued. By 1965, about 5 A credit bureau is an agency that collects information on how
million credit cards were in
promptly people and businesses pay their bills. The three major credit
circulation. Fast forward to
2004, and U.S. consumers bureaus are Experian, Trans Union, and Equifax. Each of these bureaus
held more than 1.8 billion maintains more than 200 million credit files on individuals, based
credit cards. Credit cards on information they receive from lenders. Several thousand smaller
make buying easier—but credit bureaus also collect credit information about consumers. These
give less incentive to save. firms make money by selling the information they collect to creditors
Do you think that credit
who are considering loan applications.
cards have caused people
to have more debt? Explain Credit bureaus get their information from banks, finance compa-
why or why not in two nies, stores, credit card companies, and other lenders. These sources
sentences. regularly transmit information about the types of credit they extend
to customers, the amounts and terms of the loans, and the customers’
payment habits. Credit bureaus also collect some information from
other sources, such as court records.
Your Credit File
A typical credit bureau file contains your name, address, Social
Security number, and birth date as well as other information:
• Your employer, position, and income
• Your previous address
• Your previous employer
• Your spouse’s name, Social Security number, employer, and
income
• Homeowner or renter status
• Checks returned for insufficient funds
In addition, your credit file contains detailed credit information.
Each time you use credit to make a purchase or take out a loan of any
kind, a credit bureau is informed of your account number and the
date, amount, terms, and type of credit.
Your file is updated regularly to show how many payments you
have made, how many payments were late or missed, and how much
you owe. Any lawsuits or judgments against you may appear as well.
Federal law protects your rights if the information in your credit file
is incorrect.
174 Unit 2 Banking and Credit
&IGURE 7AYS TO "UILD AND 0ROTECT 9OUR #REDIT
✓ /PEN A CHECKING OR SAVINGS ACCOUNT OR BOTH
✓ !PPLY FOR A LOCAL DEPARTMENT STORE CREDIT CARD
✓ 4AKE OUT A SMALL LOAN FROM YOUR BANK
✓ -AKE PAYMENTS ON TIME
"E AWARE THAT A CREDITOR MUST "E AWARE THAT A CREDITOR CANNOT
%VALUATE ALL APPLICANTS ON THE SAME BASIS 2EFUSE YOU INDIVIDUAL CREDIT IN YOUR OWN NAME IF
#ONSIDER INCOME FROM PART TIME EMPLOYMENT YOUR ARE CREDITWORTHY
#ONSIDER THE PAYMENT HISTORY OF ALL JOINT ACCOUNTS IF 2EQUIRE YOUR SPOUSE TO COSIGN A LOAN !NY CREDIT
THIS ACCURATELY REFLECTS YOUR CREDIT HISTORY WORTHY PERSON CAN BE YOUR COSIGNER IF ONE IS REQUIRED
$ISREGARD INFORMATION ON ACCOUNTS IF YOU CAN PROVE !SK ABOUT YOUR FAMILY PLANS OR ASSUME THAT YOUR
THAT IT DOES NOT AFFECT YOUR ABILITY OR WILLINGNESS TO INCOME WILL BE INTERRUPTED TO HAVE CHILDREN
REPAY #ONSIDER WHETHER YOU HAVE A TELEPHONE LISTING IN
YOUR NAME
3OURCE 2EPRINTED BY PERMISSION OF THE &EDERAL 2ESERVE "ANK OF -INNEAPOLIS
&IRM &OUNDATION )F YOU WANT A GOOD CREDIT RATING YOU MUST USE CREDIT WISELY
7HY IS IT A GOOD IDEA TO APPLY FOR A LOCAL DEPARTMENT CREDIT CARD
OR A SMALL LOAN FROM YOUR BANK
Fair Credit Reporting
Fair and accurate credit reporting is vital to both creditors and
consumers. In 1971, the U.S. Congress enacted the Fair Credit Report-
ing Act, which regulates the use of credit reports. This law requires
the deletion of out-of-date information and gives consumers access to
their files as well as the right to correct any misinformation that the
files may include. The act also places limits on who can obtain your
credit report.
Who Can Obtain a Credit Report?
Your credit report may be issued only to properly identified per-
sons for approved purposes. It may be supplied in response to a court
order or by your own written request. A credit report may also be pro-
vided for use in connection with a credit transaction, underwriting
of insurance, or some other legitimate business need. Friends, neigh-
bors, and other individuals cannot be given access to credit informa-
tion about you. In fact, if they even request such information, they
may be subject to a fine, imprisonment, or both.
The credit bureaus contend that current laws protect a con-
sumer’s privacy, but many consumer organizations believe that any-
one with a personal computer and a modem can easily access credit
bureau files.
You may obtain a copy of your credit report free of charge if you
have been denied credit. Current law also allows anyone using credit
to obtain one free credit report per year.
Chapter 6 Consumer Credit 175
EQUAL PLAYING FIELD
Part of the American dream
is to own a home. What fed-
Time Limits on Unfavorable Data
eral law ensures that all appli- Most of the information in your credit file may be reported for
cants for mortgages or home only seven years. However, if you have declared personal bankruptcy,
improvement loans will be that fact may be reported for ten years. A credit reporting agency can-
treated equally? not disclose information in your credit file that is more than seven
or ten years old unless you are being reviewed for a credit application
of $75,000 or more, or unless you apply to purchase life insurance of
$150,000 or more.
Incorrect Information
Credit bureaus are required to follow reasonable procedures
to make sure that the information in their files is correct. Mistakes
can and do occur, however. If you think that a credit bureau may
be reporting incorrect data from your file, contact the bureau to
dispute the information. The credit bureau must check its records
and change or remove the incorrect items. If you challenge the
accuracy of an item on your credit report, the bureau must remove
the item unless the lender can verify that the information is
accurate.
If you are denied credit, insurance, employment, or rental hous-
ing based on the information in a credit report, you can get a free
copy of your report. Request it within 60 days of the denial.
176 Unit 2 Banking and Credit
Legal Action
You have a legal right to sue a credit bureau or creditor that has
caused you harm by not following the rules established by the Fair
Credit Reporting Act. If the agency or the user is found guilty, the
consumer may be awarded actual damages, court costs, and attor-
neys’ fees. In the case of willful noncompliance, punitive damages
in the form of money may also be awarded by the court. The action
must be brought within two years of the occurrence or within two
years after the discovery of material and willful misrepresentation of
the information.
An unauthorized person who obtains a credit report under false
pretences may be fined up to $5,000, imprisoned for one year, or
both. The same penalties apply to anyone who willfully provides
credit information to someone not authorized to receive it.
Section 6.2 Assessment
QUICK CHECK Calculate Help Kim make her
1. What are some ways to determine decision by calculating her debt
whether you can afford a loan? payments-to-income ratio with and with-
2. What are the five C’s of credit? out the college loan. (Remember the
3. What are at least three steps you can take 20 percent rule.)
to maintain a good credit rating?
SOLVE MONEY PROBLEMS
THINK CRITICALLY 6. Equal Credit Opportunity Act
4. Summarize ways you can lower lender risk Eleanor Davis is a single woman. Although
to increase your chances of getting a loan she has a good income and uses credit
at a lower interest rate? wisely, she has been denied a loan to buy
a house and does not know why. She
USE MATH SKILLS believes that she may have been discrimi-
5. Debt Payments-to-Income Ratio nated against or that there may be some
Kim Lee is trying to decide whether she incorrect information on her credit report.
can afford a loan she needs so she can Write About It Using the infor-
go to chiropractic school. Right now, mation in this section on apply-
Kim lives at home and works in a shoe ing for credit, discuss Eleanor’s rights
store earning a gross income of $820 per and options for finding out why she was
month. Kim also pays $95 on several denied credit.
credit card debts each month. The loan
she needs for chiropractic school will cost
her an additional $120 per month.
Chapter 6 Consumer Credit 177
Section 6.3
Focus on
Reading
Protecting Your
Credit
Read to Learn
• How to protect yourself Billing Errors and Disputes
from fraud and identity What can you do to correct billing errors?
theft.
Have you ever received a bill for something you did not buy?
Main Idea Have you ever made a payment that was not credited to your account?
If so, you are not alone. You may be a responsible consumer who pays
You must take action to
protect your credit if you bills promptly and manages personal finances carefully. Even so, mis-
discover billing errors, have takes can happen. If you want to protect your credit rating, your time,
purchase disputes, or expe- and your money, you need to know how to correct mistakes that may
rience identity theft. pop up in your credit dealings.
What can you do to dispute billing errors? Follow these steps
Key Term if you think that a bill is wrong or want more information about it.
• cosigning
First, notify your creditor in writing, and include any information
that might support your case. (A telephone call is not sufficient and
will not protect your rights.) Then pay the portion of the bill that is
not in question.
Before Your creditor must acknowledge your letter within 30 days. Then
You Read within two billing periods (but not longer than 90 days), the credi-
PREDICT tor must either adjust your account or tell you why the bill is correct.
If the creditor made a mistake, you do not have to pay any finance
How could you protect you
credit?
charges on the disputed amount. If no mistake is found, the credi-
tor must promptly send you an explanation of the situation and a
statement of what you owe, including any finance charges that accu-
mulated and any minimum payments you missed while you were
questioning the bill.
Protecting Your Credit Rating
According to law, a creditor may not threaten your credit rating
or do anything to damage your credit reputation while you are nego-
tiating a billing dispute. In addition, the creditor may not take any
action to collect the amount in question until your complaint has
been answered.
Defective Goods and Services
According to the Fair Credit Billing Act, if you purchase a defec-
tive item and the store will not accept a return, you may tell your
credit card company to stop payment because you made a sincere
attempt to resolve the problem.
178 Unit 2 Banking and Credit
PLAYING FAIR Suppose that you buy something with your credit
card, and it turns out to be defective. If you try to get your money back and
the store refuses your request, what might you do?
Credit and Stolen Identity
How can someone steal your identity?
Imagine yourself saying: “I don’t remember charging those
items. I’ve never been in that store.” Maybe you never charged those
goods and services, but someone else did—someone who used your
name and personal information to commit fraud. When impostors
use your personal information for their own purposes, they are com-
mitting a crime, sometimes called “identity theft.”
You may not even know that your identity has been stolen until
you notice that something is wrong: You may get bills for a credit
card account you never opened, or you may see charges to your
account for things that you did not purchase. In addition, a thief may
access your bank account and withdraw your money using your ATM
information.
If you think that your identity has been stolen and that someone
is using it to charge purchases or obtain credit in some other way, you
can take action. See Figure 6.8 on page 181 for information on what
to do if your identity is stolen.
Chapter 6 Consumer Credit 179
Protecting Your Credit
from Theft or Loss
What should you do when you realize your credit has
been stolen?
Some thieves will pick through your trash in the hope of coming
across your personal information. You can prevent this from happen-
ing by tearing or shredding any papers that contain personal infor-
mation before you throw them out.
If you believe that an identity thief has accessed your bank
accounts, close the accounts immediately. If your checks have been
stolen or misused, stop payment on them. If your debit card has been
lost or stolen, cancel it and get another with a new Personal Identifi-
cation Number (PIN). You may also need to close your account and
open a new one as a precaution.
Lost credit cards are a key element in credit card fraud. To pro-
tect your card, you should take the following actions:
• Be sure that your card is returned to you after you make a
purchase. Unreturned cards can sometimes find their way into
the wrong hands.
• Keep a record of your credit card number. You should keep this
record separate from your card.
Notify the credit card company immediately if your card is lost
or stolen. Under the Consumer Credit Protection Act, the maximum
amount that you must pay if someone uses your card illegally is $50.
If you manage to inform the company before the card is used ille-
gally, you have no obligation to pay at all. However, many credit card
companies do not require the cardholder to pay even the maximum
amount if the card is used.
Keeping Track of Your Credit
A big problem with credit or identity theft is that you may not
know your credit has been stolen until you notice that something
is wrong. As discussed in Section 6.2, you might get bills for a credit
card account you never opened. Your credit report may include debts
you never knew you had; a billing cycle may pass without you receiv-
ing a statement; or you may see charges on your bills for which you
did not sign or did not authorize.
Steps to Protect Other Accounts If you believe an identity thief
has accessed your bank accounts, checking account, or ATM card, close
those accounts immediately. When you open new accounts, insist on
password-only access. If your checks have been stolen or misused,
stop payment on them. If your ATM card has been lost, stolen, or
otherwise compromised, cancel the card and get another one with
a new PIN. Stay alert to new instances of identity theft. Notify the
company or creditor immediately, and follow up in writing.
180 Unit 2 Banking and Credit
Figure 6.8 Dealing With Stolen Identity
)F SOMEONE HAS STOLEN YOUR
IDENTITY THE &EDERAL 4RADE
#OMMISSION RECOMMENDS
THAT YOU TAKE THREE ACTIONS
IMMEDIATELY
1 Contact the Credit Bureaus
Tell them to flag your file with a
fraud or security alert, including a
statement that creditors should
call you for permission before
they open any new accounts in
your name.
2Contact the Creditors
Contact the creditors for any
accounts that have been
tampered with or opened
fraudulently. Follow up in writing.
3
File a Police Report Keep a
copy of the police report in case
your creditors need proof of
the crime. If you are still having
identity problems, stay alert to
new instances of identity theft.
You can also contact the Privacy
Rights Clearinghouse.
Chapter 6 Consumer Credit 181
Government Agency Protection If you continue to experience
identity-theft problems after taking these steps, contact the Privacy
Rights Clearinghouse of the Federal Trade Commission (FTC), which
provides information on how to network with other victims.
The U.S. Secret Service has jurisdiction over financial fraud cases.
Although the service generally investigates cases that involve sub-
stantial monetary loss, your information may provide evidence of a
larger pattern of fraud that requires its attention.
The Social Security Administration may issue you a new Social
Security number if you are still having difficulties after trying to resolve
problems resulting from identity theft. Unfortunately, however, there
is no guarantee that a new number will resolve the problem.
The Federal Trade Commission cannot resolve individual prob-
lems for consumers, but it can act against a company if it sees a pat-
tern of possible law violations. You can file a complaint with the FTC
through a toll-free consumer help line; by mail; or at its Web site,
using the online complaint from.
As You Protecting Your Credit
Read Information on the Internet
RELATE The Internet is becoming almost as important to daily life as
the telephone and television. Increasing numbers of consumers use
Do you, your friends, or the Internet for financial activities, such as investing, banking, and
family members shop
shopping.
online? How do you or
they make sure all trans- When you make purchases online, make sure that your trans-
actions are secure? actions are secure, that your personal information is protected, and
that your “fraud sensors” are sharpened. Although you cannot con-
trol fraud or deception on the Internet, you can take steps to recog-
nize it, avoid it, and report it. Here’s how:
• Use a secure browser.
• Keep records of your online transactions.
• Review your monthly bank and credit card statements.
• Read the privacy and security policies of Web sites you visit.
• Keep your personal information private.
• Never give your password to anyone online.
• Do not download files sent to you by strangers.
Cosigning a Loan
Why would someone ask a friend or relative to cosign
a loan?
If a friend or relative ever asks you to cosign a loan, think twice.
Cosigning a loan means that you agree to be responsible for the
loan payments if the other person fails to make them. When you
cosign, you are taking a chance that a professional lender will not
take. The lender would not require a cosigner if the borrower were
considered a good risk.
182 Unit 2 Banking and Credit
If you cosign a loan and the borrower does not pay the debt, you
may have to pay up to the full amount of the debt as well as any late
fees or collection costs. The creditor can even collect the debt from
you without first trying to collect from the borrower. The creditor can
use the same collection methods against you that can be used against
the borrower. If the debt is not repaid, that fact will appear on your
credit record.
Complaining About
Consumer Credit
When should you complain about a lender?
If you believe that a lender is not following the consumer credit
protection laws, first try to solve the problem directly with the lender.
If that fails, then you should use more formal complaint procedures.
This section describes how to file a complaint with the federal agen-
cies that administer consumer credit protection laws.
Consumer Credit Protection Laws
If you have a particular problem with a bank in connection with
any of the consumer credit protection laws, you can get advice and
help from the Federal Reserve System. You do not need to have an
account at the bank to file a complaint. You may also take legal action
against a creditor. If you decide to file a lawsuit, you should be aware
of the various consumer credit protection laws described below.
Truth in Lending and Consumer Leasing Acts If a creditor
fails to disclose information as required under the Truth in Lending As You
Act or the Consumer Leasing Act, or gives inaccurate information, Read
you can sue for any money loss you suffer. You can also sue a creditor QUESTION
that does not follow rules regarding credit cards. In addition, the
Truth in Lending Act and the Consumer Leasing Act permit class- What is the Truth in
action lawsuits. A class-action suit is a legal action on behalf of all of Lending Act?
the people who have suffered the same injustice.
Equal Credit Opportunity Act (ECOA) If you think that you
can prove that a creditor has discriminated against you for any
reason prohibited by the ECOA, you may sue for actual damages plus
punitive damages—a payment used to punish the creditor who has
violated the law—up to $10,000.
Fair Credit Opportunity Act A creditor that fails to follow the
rules that apply to correcting any billing errors will automatically
give up the amount owed on the item in question and any finance
charges on it, up to a combined total of $50. This is true even if the
bill was correct. You may also sue for actual damages plus twice the
amount of any finance charges.
Chapter 6 Consumer Credit 183
&IGURE &EDERAL !GENCIES THAT %NFORCE #ONSUMER #REDIT ,AWS
)F YOU THINK YOUVE BEEN DISCRIMINATED AGAINST BY 9OU MAY FILE A COMPLAINT WITH THE FOLLOWING AGENCY
! RETAILER NONBANK CREDIT CARD ISSUER CONSUMER FINANCE #ONSUMER 2ESPONSE #ENTER
COMPANY STATE CHARTERED CREDIT UNION OR BANK AND &EDERAL 4RADE #OMMISSION &4#
NONINSURED SAVINGS AND LOAN INSTITUTION 7ASHINGTON $#
! NATIONAL BANK #OMPTROLLER OF THE #URRENCY
#OMPLIANCE -ANAGEMENT -AIL 3TOP n
7ASHINGTON $#
! &EDERAL 2ESERVE MEMBER BANK "OARD OF 'OVERNORS OF THE &EDERAL 2ESERVE 3YSTEM
$IRECTOR $IVISION OF #ONSUMER AND #OMMUNITY !FFAIRS
7ASHINGTON $#
/THER INSURED BANKS &EDERAL $EPOSIT )NSURANCE #ORPORATION
#ONSUMER !FFAIRS $IVISION
7ASHINGTON $#
)NSURED SAVINGS AND LOAN INSTITUTIONS AND FEDERALLY /FFICE OF 4HRIFT 3UPERVISION
CHARTERED STATE BANKS #ONSUMER !FFAIRS 0ROGRAM
7ASHINGTON $#
4HE &(! MORTGAGE PROGRAM (OUSING AND 5RBAN $EVELOPMENT (5$
$EPARTMENT OF (EALTH %DUCATION AND 7ELFARE
7ASHINGTON $#
! FEDERAL CREDIT UNION .ATIONAL #REDIT 5NION !DMINISTRATION
#ONSUMER !FFAIRS $IVISION
7ASHINGTON $#
0ROTECTING 9OUR 2IGHTS 4HE LAW GIVES YOU CERTAIN RIGHTS AS A CONSUMER OF CREDIT
7HAT TYPES OF COMPLAINTS ABOUT A CREDITOR MIGHT YOU REPORT TO
THESE GOVERNMENT AGENCIES
Fair Credit Reporting Act You may sue any credit bureau or
creditor that violates the rules regarding access to your credit records
or that fails to correct errors in your credit file. You are entitled to
actual damages plus any punitive damages the court allows if the
violation is proven to have been intentional.
Consumer Credit Reporting Reform Act The Consumer Credit
Reporting Reform Act of 1997 places the burden of proof for accurate
credit information on the credit bureau rather than on you. Under this
law, the creditor must prove that disputed information is accurate. If
a creditor or the credit bureau verifies incorrect data, you can sue for
damages.
The Federal Reserve System has set up a separate office, the Divi-
sion of Consumer and Community Affairs, in Washington to handle
consumer complaints. This division also writes regulations to carry
out the consumer credit laws, enforces these laws, and helps banks
comply with these laws.
184 Unit 2 Banking and Credit
Your Rights Under Consumer Credit Laws
If you believe that you have been refused credit because of dis-
crimination, you can take one or more of the following steps:
1. Complain to the creditor. Let the creditor know that you are
aware of the law.
2. File a complaint with the government. You can report any vio-
lations to the appropriate government enforcement agency, as
shown in Figure 6.9.
3. If all else fails, sue the creditor. You have the right to bring a case
in a federal district court. If you win, you can receive actual dam-
ages and punitive damages of up to $10,000. You can also recover
reasonable attorneys’ fees and court costs.
Section 6.3 Assessment
QUICK CHECK Write About It Write a letter to
1. What should you do if you think that a bill your friend explaining why you have
is wrong or want more information about decided not to cosign her loan. In the letter,
it? How should your creditor respond to point out what the consequences to you
your attempt to resolve the situation? will be if she is unable to repay the loan.
2. How can you protect yourself against credit
SOLVE MONEY PROBLEMS
card theft or loss?
3. How does the Fair Credit Reporting Act 6. Putting a Stop to Fraud Joel went to
protect you? the ATM the other day to withdraw some
cash. When he checked his receipt, he
THINK CRITICALLY noticed that the balance on his savings
4. Recall the suggestions for protecting your account was $500 less than it should have
credit information on the Internet. Predict been. After discussing the matter with a
the problems that could result from not customer service representative at his bank,
following the guidelines. he realized that someone else had gained
access to his account number and Personal
USE COMMUNICATION SKILLS Identification Number (PIN).
5. Cosigning a Loan Suppose that a close Role-Play Using what you have
friend has asked you to cosign a loan she learned about protecting yourself from
needs to start up a children’s clothing store. fraud, explain to Joel the steps he should
You would like to help if you can. However, take to stop any further damage from being
your friend is currently unemployed, and done. Partner with another student to role-
you are concerned that she will not be able play the conversation.
to repay the loan. After much thought, you
decide not to cosign the loan.
Chapter 6 Consumer Credit 185
Section 6.4
Focus on
Reading
Managing Your
Debts
Read to Learn
• How to identify ways to
manage debt problems. Signs of Debt Problems
How do you know when you are getting in
Main Idea financial trouble?
If you experience the warn- Carl Reynolds is in his early 20s. A recent college graduate, he
ing signs of debt problems,
there are several options
has a steady job and earns an annual income of $40,000. With the
available to manage your latest model sports car parked in the driveway of his new home, it
finances. would appear that Carl has the ideal life.
However, Carl is deeply in debt. He is drowning in a sea of bills.
Key Term Almost all of his income is tied up in debt payments. The bank has
• bankruptcy already begun foreclosure proceedings on his home, and several
stores have court orders to repossess practically all of his new furni-
ture and electronic gadgets. His current car payment is overdue, and
he is behind in payments on all of his credit cards. If he does not
Before come up with a plan of action, he will lose everything.
You Read Carl’s situation is all too common. Some people who seem to be
wealthy are just barely keeping their heads above water financially.
PREDICT
They may lack self-discipline and do not control their impulses. They
What corrective steps use poor judgment or fail to accept responsibility for managing their
would you take if you were money. Carl and others like him are not necessarily bad people. They
experiencing the debt simply have not thought about their long-term financial goals.
troubles listed here?
The Warning Signs
There are some warning signs of being in financial trouble. If
you are experiencing two or more of these warning signs, it is time
for you to rethink your priorities.
• You make only the minimum monthly payment on credit cards.
• You are having trouble making even the minimum monthly
payment on your credit card bills.
• The total balance on your credit cards increases every month.
• You miss loan payments or often pay late.
• You use savings to pay for necessities such as food and utilities.
• You receive second or third payment due notices from creditors.
• You borrow money to pay off old debts.
• You exceed the credit limits on your credit cards.
• You have been denied credit because of a bad credit report.
186 Unit 2 Banking and Credit
LIVING IT UP Some
people use credit to finance
Debt Collection Practices a comfortable lifestyle. How
might this approach create
Are debt collection practices regulated by laws?
problems in the future?
When people are in debt and getting behind in payments, they
may worry about debt collection agencies. Creditors will often turn
their bad debts over to such companies. However, a federal agency
protects certain legal rights of debtors in their dealings with these
types of agencies.
The Federal Trade Commission enforces the Fair Debt Collection
Practices Act (FDCPA). This act prohibits certain practices by debt col-
lectors—businesses that collect debts for creditors. The act does not
erase the legitimate debts that consumers owe, but it does control
the ways in which debt collection agencies do business and deal with
consumers in debt.
Financial Counseling Services
What are sources of financial counseling?
If you are having trouble paying your bills and need help, you
have several options. You can contact your creditors and try to work
out an adjusted repayment plan. In addition, you can contact a non-
profit financial counseling program, such as the Consumer Credit
Counseling Service, which operates nationwide.
Chapter 6 Consumer Credit 187
Consumer Credit Counseling Service
The Consumer Credit Counseling Service (CCCS) is a nonprofit
organization affiliated with the National Foundation for Consumer
Credit (NFCC). Local branches of the CCCS provide debt counseling
services for families and individuals with serious financial problems.
The CCCS is not a charity, a lending institution, or a government
agency. CCCS counseling is usually free. However, when the organi-
zation supervises a debt repayment plan, it sometimes charges a small
fee to help pay administrative costs.
According to the NFCC, millions of consumers contact CCCS
offices each year for help with their personal financial problems. To
find an office near you, check the white pages of your local telephone
directory under Consumer Credit Counseling Service, or call 1-800-
388-CCCS. All information is kept confidential.
Credit counselors know that most individuals who are over-
whelmed with debt are basically honest people who want to clear
up their unmanageable indebtedness, the condition of being deeply
in debt. Too often, such problems arise from a lack of planning or a
miscalculation of earnings. The CCCS is concerned with preventing
problems as much as it is with solving them. As a result, its activities
are divided into two parts:
• Aiding families with serious debt problems by helping them
manage their money better and setting up a realistic budget
• Helping people prevent indebtedness by teaching them the
importance of budget planning, educating them about the
pitfalls of unwise credit buying, and encouraging credit insti-
tutions to withhold credit from people who cannot afford it
Other Counseling Services
In addition to the CCCS, universities, credit unions, military
bases, and state and federal housing authorities sometimes provide
nonprofit credit counseling services. These organizations usually
charge little to nothing for their assistance. You can also check with
your bank or local consumer protection office to see whether it has a
listing of reputable financial counseling services.
Declaring Personal Bankruptcy
Why do people declare personal bankruptcy?
What if an individual suffers from an extreme case of debt prob-
lems? Is there any relief? As a last resort, an individual can declare
bankruptcy. Bankruptcy is a legal process in which some or all of
the assets of a debtor are distributed among the creditors because
the debtor is unable to pay his or her debts. Bankruptcy may also
include a plan for the debtor to repay creditors on an installment
basis. Declaring bankruptcy is a last resort because it severely dam-
ages your credit rating.
188 Unit 2 Banking and Credit
Prakrit Singh illustrates the new face of bankruptcy. A 43-year-
old freelance photographer from California, she was never in serious As You
financial trouble until she began running up big medical costs. She Read
reached for her credit cards to pay the bills. Because Prakrit did not
have health insurance, her debt quickly mounted and soon reached
RELATE
$17,000—too much to pay off with her $25,000-a-year income. Her What might cause you
solution was to declare personal bankruptcy and enjoy the immedi- or someone you know
ate freedom it would bring from creditors’ demands. to declare personal
In 1994, the U.S. Senate passed a bill that reduced the time and bankruptcy?
cost of bankruptcy proceedings. The bill strengthened creditor rights
and enabled more individuals to get through bankruptcy proceed-
ings without selling their assets. Today legislators have enacted new
tougher bankruptcy law reforms that are intended to end perceived
abuses of the current bankruptcy system.
&IGURE 53 "ANKRUPTCIES n
4OTAL 0ERSONAL "ANKRUPTCIES
4HOUSANDS
3OURCE !DMINISTRATIVE /FFICE OF THE 5NITED 3TATES #OURTS -AY
"ANKRUPTCY "OOM 4HE TOTAL NUMBER OF PERSONAL BANKRUPTCIES HAS RISEN SHARPLY IN THE LAST
FEW DECADES
7HY DO YOU THINK THE NUMBER OF PERSONAL BANKRUPTCIES IN THE
5NITED 3TATES WAS RELATIVELY LOW IN THE EARLY S AS COMPARED
TO THE LATE S
Chapter 6 Consumer Credit 189
As You The U.S. Bankruptcy Act of 1978
Read Figure 6.10 on page 189 illustrates the rate of personal bank-
QUESTION ruptcy in the United States. The vast majority of bankruptcies in the
United States, like Prakrit Singh’s, are filed under a part of the U.S.
How would filing for bank- bankruptcy code known as Chapter 7. You have two choices in declar-
ruptcy negatively impact a ing personal bankruptcy:
person’s future?
• Chapter 7 (a straight bankruptcy)
• Chapter 13 (a wage-earner plan bankruptcy)
Both choices are undesirable, and neither should be considered
an easy way to get out of debt.
Chapter 7 Bankruptcy In a Chapter 7 bankruptcy, an individual
is required to draw up a petition listing his or her assets and liabilities.
A person who files for relief under the bankruptcy code is called a
debtor. The debtor submits the petition to a U.S. district court and
pays a filing fee.
Chapter 7 is a straight bankruptcy in which many, but not all,
debts are forgiven. Most of the debtor’s assets are sold to pay off credi-
tors. Certain assets, however, receive some protection. Among the
assets usually protected are Social Security payments, unemployment
compensation, and the net value of your home, vehicle, household
goods and appliances, tools used in your work, and books.
The release from debt does not affect alimony, child support,
certain taxes, fines, certain debts arising from educational loans, or
debts that you fail to disclose properly to the bankruptcy court. Fur-
thermore, debts arising from fraud, driving while intoxicated, or cer-
tain other acts or crimes may also be excluded.
Chapter 13 Bankruptcy In a Chapter 13 bankruptcy, a debtor
with a regular income proposes a plan to the court for using future
earnings or assets to eliminate his or her debts over a specific period
of time. In such a bankruptcy, the debtor normally keeps all or most
of his or her property.
During the period when the plan is in effect, which can be as
long as five years, the debtor makes regular payments to a Chapter 13
trustee, or representative appointed by the court, who then distrib-
utes the money to the creditors. Under certain circumstances, the
bankruptcy court may approve a plan that permits the debtor to keep
all of his or her property even though he or she repays less than the
full amount of the debts.
Using a Lawyer
Choosing a bankruptcy lawyer may be difficult. Some of the
least reputable lawyers make easy money by handling hundreds of
bankruptcy cases without considering individual needs. Recommen-
dations from friends, family, or employee assistance programs are
most useful.
190 Unit 2 Banking and Credit
Effects of Bankruptcy After You
People have varying experiences in obtaining credit after they Read
file for bankruptcy. Some find the process more difficult, whereas REACT
others find it easier because they have removed the burden of prior
debts or because creditors know that they cannot file another bank- What would be the best
ruptcy case for a certain period of time. Obtaining credit may be eas- way to avoid credit prob-
lems and bankruptcy?
ier for people who file a Chapter 13 bankruptcy and repay some of
their debts than for those who file a Chapter 7 bankruptcy and make
no effort to repay any of their debts. Bankruptcy reports are kept on
file in credit bureaus for ten years, a fact that is likely to make getting
credit more difficult during that time. Therefore, you should take the
extreme step of declaring bankruptcy only when you have no other
options. Of course, the best way to solve your financial problems is to
avoid them by maintaining good credit.
Section 6.4 Assessment
QUICK CHECK SOLVE MONEY PROBLEMS
1. What are some of the warning signs of debt 6. Making Financial Decisions Deanne is
problems? a customer service representative for a pop-
2. What consumer credit counseling services ular fitness club. Her income is modest, but
are available? that does not stop her from satisfying her
3. What are the differences between declaring most important desire—to travel. Deanne
Chapter 7 and Chapter 13 bankruptcy? takes two vacations a year, and she has been
all over the world. She has paid for most of
THINK CRITICALLY her trips to faraway places with her credit
4. Consider your own financial situation and card. However, when she received the bills
determine whether any of the warning for her last trip to India, reality hit hard.
signs of debt problems might apply to you Her monthly debt payments are actually
or to someone you know. Analyze what you greater than her monthly net income.
might do to correct them or how you might
Write About It According to what
advise someone else.
you have learned in this section, what
USE MATH SKILLS can Deanne do to solve her problem? Con-
sider the options she might have, and write
5. Declaring Bankruptcy Unfortunately,
a plan.
bankruptcy has increased.
Calculate Using the graph in
Figure 6.10 on page 189, determine
the percent increase of total personal
bankruptcies from 1990 to 2003. Do you
think this figure will rise? Why?
Chapter 6 Consumer Credit 191
Chapter 6 Review & Activities
CHAPTER SUMMARY
• Consumer credit is the use of credit • To build and protect good credit,
for personal needs. Credit is an pay your bills and loans promptly
arrangement to receive cash, goods, or and manage your personal finances
services now and to pay for them later. carefully. Also, correct mistakes related
• Closed-end credit is credit as a one-time to your credit bills and credit reports.
loan that you pay back over a specified Dispute billing errors in writing and
period of time in payments of equal pay amounts that are not in question.
amounts. Open-end credit is credit as • If your credit or identity has been
a loan with a limit on the amount of stolen, contact all your credit card
money that you borrow for goods and companies; close and open new
services. bank accounts; and change all PINs.
• The five C’s of credit include character, Notify law enforcement agencies and
capacity, capital, collateral, and credit credit bureaus. If purchasing online,
history. Creditors use the five C’s to never share your PINs, Social Security
determine who will receive credit. numbers, or passwords.
• When choosing a loan or credit card, • Manage debt problems by contacting
consider factors such as length of the creditors and/or debt counseling
loan, amount of monthly payments, services. Bankruptcy is a last resort.
and interest rate.
Communicating Key Terms
Imagine you are applying for a loan to buy a new car. In a paragraph, write a conversation you
would have with a loan officer while applying for the loan, using at least ten key terms:
• credit • grace period • simple interest
• consumer credit • finance charge • minimum monthly
• creditor • net income payment
• closed-end credit • annual percentage rate • credit rating
• open-end credit (APR) • cosigning
• line of credit • collateral • bankruptcy
Reviewing Key Concepts
1. Explain the concept of consumer credit.
2. Differentiate between open-end credit and closed-end credit.
3. Identify the five C’s of credit using a graphic organizer. Then rate yourself.
4. Discuss the factors to consider when choosing a loan or credit card.
5. Identify ways you can build a good credit rating.
6. Discuss the steps you should take if your identity is stolen.
7. Explain the role of consumer counseling services.
192 Unit 2 Banking and Credit
Chapter 6 Review & Activities
Language Arts You have just received a telephone bill for $225. Usually
your bill is about $35 a month. You read it closely and discover two long-
distance calls to Japan at $100 and $92, both of which you did not make.
Write About It Write a brief letter to the phone company explaining why
you should not be charged.
Billing Errors Miguel read his credit card statement and discovered
that a store charged him twice for the same item. His total bill was $658.22:
Lane Electronics 207.33
Brewster Cable TV 127.45
Lane Electronics 207.33
Empress Wok 38.87
Office Supplies, Inc. 77.24
1. Calculate how much Miguel should subtract from his bill and calculate
his actual balance.
2. Compute by using spreadsheet software to show what Miguel’s bill will
be next month if he pays $25 this month with 18 percent interest.
Connect With Ethics Your credit score determines whether you
receive credit and at what interest rate. The credit-score scale runs from 300
to 850. Most people in the United States have scores between 600 and 800.
1. Research Use an Internet search engine to find information on credit
scores.
2. Think Critically Explain why credit scoring may increase fairness in
getting credit. Explain why it may be unfair.
Student Loans Many students finance their college educations with
their own earnings, savings, family help, grants, scholarships—and loans.
Log On Use an Internet search engine to find out about student
loans. Check the colleges that interest you. Click on their Financial Aid
links. Answer the following questions:
1. What is the interest rate for a government student loan and how long can
you take to repay a student loan?
2. How could this monthly payment affect your debt payments-to-income
ratio?
Newsclip: Student Credit Cards Many credit companies offer
credit cards to students 18 years and over. As a result, many students have
O N L I N E
heavy debts. Debt advisers say students should have a low maximum limit.
Log On Go to finance07.glencoe.com and open Chapter 6. Learn
more about managing credit, and then write a list of ways to avoid
credit card debt.
finance07.glencoe.com Chapter 6 Consumer Credit 193
Chapter 6 Review & Activities
YOUR CREDIT PROFILE
Do you know how to use credit wisely? On a
separate sheet of paper write the letter that best
describes your answer to the following questions.
1. I pay any bills I have when they are due _____.
a. always
b. most of the time
c. sometimes
2. If I need more money for my expenses, I borrow it _____.
a. never
b. sometimes
c. often
3. If I want to see a copy of my credit report, I can contact _____.
a. a credit reporting agency
b. a bank
c. the principal of my school
4. If I default (do not repay) on a loan, it will stay on my credit report for _____.
a. 7 years
b. 2 years
c. 6 months
5. If I have serious credit problems, I should _____.
a. contact my creditors to explain the problem
b. contact only the most persistent creditors
c. not contact my creditors and hope they will forget about me
6. I can begin building a good rating by _____.
a. opening a savings account and making regular monthly deposits.
b. paying most of my bills on time
c. opening a checking account and bouncing checks
Scoring: Give yourself 3 points for each “a,” 2 points for each “b,” and 1 point for each “c.”
Add up the number of points.
If you scored 6–9 points, you might want to take a closer look at how credit works before you
get over your head in debt.
If you scored 10–13 points, you are off to a good start, but be sure you know the pitfalls of
opening a credit account.
Source: How to Be Credit Smart (Washington, D.C., Consumer Education Foundation, 1994).
194 Unit 2 Banking and Credit
Chapter 6 Review & Activities
Your Financial Portfolio
Credit Cards:
Getting the Best Deal
Melanie’s parents want to give her a credit card she could use for emergencies. They
made it clear that if she could eat it, wear it, or listen to it, it was not an emergency.
They asked Melanie to do the homework to find the best deal. She called the bank
where she has a savings account and another neighborhood bank and asked about the
following credit card information.
Melanie’s Credit Card Comparison
Credit Card Company Peabody Bank Imperial Bank
Phone number 800/555-1274 800/555-9201
Annual percentage rate (APR) 19.9% 10.9%
Introductory rate 2.9% on transferred balances 5% for first 6 months
Annual fee $50 none
Grace period 18 days 25 days
Cash advance fee 19.8% 19.9%
Late payment fee $25 $29
Credit limit for new customers based on income based on income
Travel accident insurance $150,000 $10,000
Other travel-related services airline miles; lost luggage insurance; lost luggage insurance;
emergency travel services emergency travel services
Protection if the cards are yes yes
lost or stolen
Melanie chose the credit card with Imperial Bank because there was no annual fee,
and the APR was lower. She did not think she would spend enough to make Peabody
Bank’s offer of airline miles useful. Melanie was surprised at the high penalty for late
payments, so she made a mental note to be sure to make her payment on time.
If you wanted a credit card, which company would you choose? Explain why.
Would you be influenced by the offer of airline miles?
Research
On a separate sheet of paper, research two credit card companies. List their fees
and any advantages they offer.
Chapter 6 Consumer Credit 195
7
CHAPTER
The Finances
of Housing
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 7.1
• Evaluate various housing
alternatives.
Section 7.2
• Assess the advantages and
disadvantages of renting.
• Identify the costs of renting.
Section 7.3
• Identify the advantages and
disadvantages of owning a
residence.
• Explain how to evaluate a
property.
• Discuss the financing involved in
purchasing a home.
• Describe a plan for selling a
home.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
196
In the Real World . . .
C harles and Susan James have been renting an apart-
ment and saving money to buy property in Chicago. Finally, they have
enough for a down payment. Both are excited about moving to the Windy
City. However, they have different ideas about what type of housing to get.
Susan likes the idea of buying a house that needs to be fixed up. By purchasing an
older house that requires repairs and improvements, they could afford a larger prop-
erty for less money. Susan thinks they can renovate a house on their own. However,
Charles does not like the idea of having to do yard work, much less major home
improvements. Charles thinks it is a better idea to buy a townhouse and
let property managers handle the maintenance and upkeep.
As You Read Consider the factors that go into
making a housing decision.
Housing Options
ASK Q: My older sister loves her new job and has decided
that she would like to work for her company at least
five years. Is this a good time for her to buy a house, or should she continue renting?
A: A home can be an excellent investment, but your sister will need to take some things
into consideration before she makes this decision. For example, she will need to assess her
finances to determine if she can afford to buy a house. She must also consider whether she
wants to spend time maintaining a house; if not, it may be best for her to continue renting.
Ask Yourself What could be some advantages of owning a house?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com Chapter 7 The Finances of Housing 197
Section 7.1
Focus on
Reading
Housing Options
Read to Learn
Your Lifestyle and
• How to evaluate various Choice of Housing
housing alternatives. How does your lifestyle affect your
choice of housing?
Main Idea
Finances play an important role in housing decisions. Whether
Knowing about housing
options will help you spend you are renting a small apartment in a city or buying a house in
your money wisely now the country, you will have to consider your financial situation. You
and in the future. can use your budget and the other personal financial statements dis-
cussed in Chapter 3 to determine how much you should spend for
Key Term housing.
• mobility One major factor you will need to consider when making hous-
ing decisions is your lifestyle, which is the way you choose to spend
your time and money. For example, when looking at your housing
choices, you might consider if you like hosting big family gatherings.
If so, you would probably want a large living room or family room.
Figure 7.1 lists types of housing for people in different life situa-
tions. Your lifestyle will determine several housing decisions:
• How close to work you want to live
• How long you plan to stay in one place
• How much privacy you would like to have
Before
You Read Opportunity Costs of
PREDICT Housing Choices
What are some opportunity costs to consider
Do you plan to own or rent when purchasing a home?
a residence? Explain your
choice. A housing decision requires many trade-offs, or opportunity
costs. For example, buying a handyman’s special—a home that is
priced lower because it needs repairs and improvements—may allow
you to purchase a larger property for less money, but it also means
that you will have to work on the house. Renting an apartment may
give you more mobility, which is the ability to move easily from
place to place. However, you will give up the tax advantages that
homeowners enjoy. When you make choices about housing, you
cannot look at only the benefits. You also have to consider what you
will be giving up in terms of time, effort, or money.
198 Unit 2 Banking and Credit
&IGURE (OUSING FOR $IFFERENT ,IFE 3ITUATIONS
,IFE 3ITUATION 0OSSIBLE 4YPES OF (OUSING
9OUNG SINGLE s 2ENT AN APARTMENT OR HOUSE BECAUSE MOBILITY IS IMPORTANT AND FINANCES ARE LOW
s "UY A SMALL HOME FOR TAX ADVANTAGES AND POSSIBLE INCREASE IN VALUE
3INGLE PARENT s 2ENT AN APARTMENT OR HOUSE BECAUSE TIME FOR MAINTENANCE IS AT A PREMIUM
PLAYMATES FOR CHILDREN MAY BE NEARBY AND FINANCES ARE LOW
s "UY A HOME TO BUILD LONG TERM FINANCIAL SECURITY
9OUNG COUPLE s 2ENT AN APARTMENT OR HOUSE BECAUSE MOBILITY IS IMPORTANT AND FINANCES ARE LOW
NO CHILDREN s "UY A HOME TO BUILD LONG TERM FINANCIAL SECURITY
#OUPLE WITH CHILDREN s 2ENT AN APARTMENT OR HOUSE BECAUSE TIME FOR MAINTENANCE IS AT A PREMIUM AND
PLAYMATES FOR CHILDREN MAY BE NEARBY
s "UY A HOUSE TO BUILD LONG TERM FINANCIAL SECURITY AND TO PROVIDE MORE SPACE
AND PRIVACY
2ETIRED PERSON s 2ENT AN APARTMENT OR HOUSE TO MEET FINANCIAL SOCIAL AND PHYSICAL NEEDS
s "UY A HOME THAT NEEDS LITTLE MAINTENANCE OFFERS CONVENIENCE AND PROVIDES
DIFFERENT SERVICES
2ENT OR "UY $IFFERENT LIFE SITUATIONS WILL REQUIRE DIFFERENT HOUSING CHOICES
7HAT MIGHT BE A WISE HOUSING CHOICE FOR A SINGLE PARENT %XPLAIN
YOUR REASONING
Renting versus Buying As You
Why would you rent a home if you could buy one? Read
One of the most basic considerations about housing is whether RELATE
to rent or buy. Your decision will depend on your lifestyle and on
What opportunity costs are
financial factors.
you willing to pay to obtain
Renting is a good choice for young adults who are beginning the home you would like?
their careers. It also appeals to people who want or need mobility.
Renting is also a good choice for people who do not want to devote
time or money to maintenance. Because renting is often—though not
always—cheaper than owning a home, it appeals to people whose
funds are limited.
In contrast, owning property also has advantages. It is a wise
choice for people who want a certain amount of stability in their
lives. Buying a home also gives the owner privacy and some freedoms
that may not be available to a renter. For example, you may not be
allowed to have pets or large parties in an apartment, but you can do
so in a house that you own. While ownership can be costly—at least
in the short run—it offers financial benefits, such as tax advantages.
In addition, the value of a house may increase, making the purchase
of a home a good long-term investment. See Figure 7.2 on page 200
for more information about renting and buying.
Chapter 7 The Finances of Housing 199
&IGURE %VALUATING (OUSING !LTERNATIVES
!DVANTAGES $ISADVANTAGES
2ENTING AN !PARTMENT s EASY TO MOVE s NO TAX ADVANTAGE
s LOW MAINTENANCE RESPONSIBILITY s LIMITATIONS ON ACTIVITIES
s LOW FINANCIAL COMMITMENT s LESS PRIVACY
2ENTING A (OUSE s EASY TO MOVE s HIGHER UTILITY EXPENSES
s LOW MAINTENANCE RESPONSIBILITY s SOME LIMITATIONS ON ACTIVITIES
s LOW FINANCIAL COMMITMENT s NO TAX ADVANTAGE
s MORE SPACE
/WNING A (OUSE s PRIDE OF OWNERSHIP s FINANCIAL COMMITMENT
s PLENTY OF SPACE s HIGH LIVING EXPENSES
s TAX BENEFITS s LIMITED MOBILITY
/WNING A #ONDOMINIUM s PRIDE OF OWNERSHIP s FINANCIAL COMMITMENT
s FEWER MAINTENANCE COSTS OR s LESS PRIVACY THAN IN A HOUSE
RESPONSIBILITIES THAN A HOUSE s NEED TO GET ALONG WITH OTHERS
s TAX BENEFITS s TYPICALLY SMALL AND LIMITED SPACE
s ACCESS TO RECREATION s MAY BE HARD TO SELL
AND BUSINESSES
/WNING A -OBILE (OME s LESS EXPENSIVE THAN OTHER s MAY BE HARD TO SELL
OWNERSHIP OPTIONS s POSSIBLE POOR CONSTRUCTION QUALITY
/N THE /THER (AND #HOOSING A TYPE OF HOUSING IS A DECISION THAT INVOLVES MANY TRADE OFFS
&IND THE THREE ADVANTAGES OR DISADVANTAGES ON THIS LIST THAT SEEM
MOST IMPORTANT TO YOU NOW
Housing Information Sources
Where can you research housing options?
Housing information is plentiful and often free. You can begin
researching on your own, using a variety of sources:
• Libraries—The public library will probably have books and
other basic resources on the subject.
• Newspapers—You can find articles on renting, buying, and
other housing topics in the real estate section of a newspaper.
• Internet—The Internet can provide home buying tips, the
latest mortgage rates, and information on available housing in
your area and in other parts of the United States.
200 Unit 2 Banking and Credit
• Friends and Family—Friends and family can also be good
sources of information on housing. They can share some of As You
their own housing choices. Read
• Real Estate Agents—You might seek the services of an QUESTION
experienced real estate agent who is familiar with the local
housing market. What are some sources of
housing information?
• Government Agencies—You can also write to government
agencies, such as the U.S. Department of Housing and Urban
Development (HUD).
Any combination of these sources will provide the information
you need to make wise housing decisions, whether you decide to rent
or buy your home.
Section 7.1 Assessment
QUICK CHECK Present Review the classified section
1. What should you consider when you evalu- of your local newspaper. Choose sev-
ate available housing alternatives? eral houses and apartments for Manny and
2. When would buying a residence be a better Karen that are about the same size and for
choice than renting one? rent, and prepare a chart that compares the
3. What are at least three sources of housing prices, locations, and features of each option.
information? Display it in class.
THINK CRITICALLY SOLVE MONEY PROBLEMS
4. Write a short paragraph explaining the 6. Housing and Lifestyle Your cousin
probable housing needs of a family that Lavani, who is 25 years old and single, tells
consists of two working adults and three you that she is thinking of buying a house.
school-age children. Decide whether this She has been at her job for eight months
family should rent or buy, and explain why and loves it so far, but she has not made
you think so. many friends yet. The house she is looking
at is 10 miles from her workplace. Lavani
USE COMMUNICATION SKILLS says that the house needs a new roof, and
5. Housing Options Your uncle Manny’s the basement sometimes floods, but other-
company has transferred him to your area, wise it is in good shape. She thinks that she
and he and his wife, Karen, will be moving will be able to afford it when she gets her
within the next two months. Because Man- first raise.
ny’s work requires fairly frequent moves, he Analyze Help Lavani determine the
and Karen are not interested in purchasing opportunity costs of this potential pur-
a home at this time. Manny and Karen are chase. Would buying the house be a good
both busy with their jobs, so they have little decision for Lavani? Explain your answer.
time to research a place to live. You have
offered to do some background work
to get them started.
Chapter 7 The Finances of Housing 201
Section 7.2
Focus on
Reading
Renting a Residence
Read to Learn
Selecting a Rental Unit
What should you know before signing a lease?
• How to assess the advan-
tages and disadvantages Are you interested in a “3-bdrm apt., a/c, w/w carpet, pvt back
of renting. ent, $800 + utils, ref reqd”? This is not a secret code. It is just a short
• How to identify the costs way of describing an apartment for rent listed in the classified ads
of renting.
of a newspaper. Decoded, the message reads: “Three-bedroom apart-
ment for rent. It has air conditioning, wall-to-wall carpeting, and a
Main Idea private back entrance. The rent is $800, and the renter must also pay
Knowing more about the
for utilities. The renter must provide references.” The ability to read
advantages, disadvantages,
and costs of renting will and understand such ads is one of the skills you will need if you are
help you make the right going to look for some type of rental housing.
choice. When you rent the place where you live, you become a tenant—
a person who pays for the right to live in a residence owned by some-
Key Terms one else. Your landlord is the person who owns the property that
• tenant is rented. You should consider the differences in the size, cost, and
• landlord location of rental units when making a selection.
• lease
• security deposit
• renters insurance Size and Cost
Most people who rent live in apartments. These units may be
located in a two-story house, in a high-rise building, or in an apart-
ment complex. An apartment building contains a number of separate
Before
living units that can range in size from one room (an efficiency or
You Read
studio) to three-bedroom or larger units.
PREDICT
How would you begin a
search for an apartment? HAMILTON TWP—2 bdrm 1 bath, off str SIERRAS—2 bdrm 1 bath, beautiful view,
prkg. quiet nghborhd. Use of cellar. $800 mo. quiet nghborhd. $700 mo. 612-999-7647.
602-989-7767. AUSTIN—Close to stores. 1 bdrm. apt.,
PRINCETON—Close to campus. Pvt 1st wood flr., lndry. & prkg. No smkg/pets.
flr, 1 bdrm. apt., wood flr., Indry. & prkg. No $825/mo + 1st and last. Avail 10/2 or 11/2.
smkg/pets. $925/mo + utils. Avail 7/1 or 8/1. 788-997-8211.
1 yr lse. 616-433-8756. UPSTATE—Affordable rental. Spacious
TRENTON—Historic dist. Attractive apt. apt. Refinished wood floor, 2 large bdrm,
Refinished wood fire, 1 large bdrm, lg liv lg kit, din rm, bsmnt storage. $950/mo.
rm, lg kit, yard. $850/mo. 677-547-6400. 565-989-5466.
䊱 MEET THE PRESS Newspaper ads are one way to find out about avail-
able rental units. What information is usually included in an ad for a rental unit?
202 Unit 2 Banking and Credit
If a unit features a patio and a bit of lawn, it may be called a
garden apartment. Some apartments are located in complexes with on-
site conveniences such as swimming pools, tennis courts, and laun-
dry facilities.
A family or individual who needs more space than an apart-
ment provides may prefer to rent a house. The trade-off for the extra
space is usually higher rent. A single person with very few possessions
might choose to rent a private room in a house. He or she may have
to share common areas, such as the kitchen and bathroom.
Sources of Information
To find a rental unit, you can check the classified section of
the local newspaper. Friends and coworkers are good sources of sug-
gestions, too. You can also check with real estate and rental offices.
Figure 7.3 describes what to look for when selecting an apartment.
&IGURE 3ELECTING AN !PARTMENT
,OCATION &INANCES "UILDING ,AYOUT AND &ACILITIES
s .EAR SCHOOL OR WORK s !MOUNT OF MONTHLY RENT s #ONDITION OF BUILDING s 3IZE AND CONDITION OF UNIT
s .EAR PLACE OF WORSHIP s !MOUNT OF SECURITY AND GROUNDS s 4YPE AND CONTROLS OF
s .EAR SHOPPING DEPOSIT s 0ARKING FACILITIES HEATING AND COOLING
s .EAR PUBLIC s #OST OF UTILITIES s 2ECREATION ON PREMISES SYSTEMS
TRANSPORTATION s ,ENGTH OF LEASE s 3ECURITY SYSTEM s 0LUMBING AND WATER
s .EAR RECREATION PARKS s #ONDITION OF HALLWAYS PRESSURE
AND MUSEUMS STAIRS AND ELEVATORS s 4YPE AND CONDITION OF
s !CCESS TO MAILBOXES APPLIANCES
s #ONDITION OF DOORS LOCKS
WINDOWS CLOSETS AND
FLOORS
/N 9OUR /WN -ANY CONSIDERATIONS GO INTO RENTING AN APARTMENT
7HICH OF THE FOUR BROAD CATEGORIES ABOVE WOULD BE MOST
IMPORTANT TO YOU RIGHT NOW
Chapter 7 The Finances of Housing 203
䊳 ON THE MOVE Many
people like to rent because
it allows them to move eas-
ily to different places. What
types of individuals might find
such mobility most attractive?
As You Advantages of Renting
Read What are some of the advantages of renting?
RELATE The three main advantages of renting over buying a home are
greater mobility, fewer responsibilities, and lower initial costs.
How would you begin a
search for an apartment?
Mobility and Fewer Responsibilities
For many people, the appeal of renting is the mobility it offers.
If you want to move, you can usually notify your landlord 30 days
before you plan to leave, and he or she can find a new tenant. If you
are offered a job in another town, you can move quickly and simply.
This is also an advantage for growing families who need more space.
If your landlord increases your rent beyond the amount you have
budgeted, or if you decide that you want to live in a different commu-
nity, making a change will be fairly easy if you rent an apartment.
Tenants do not have many of the responsibilities that home-
owners have. Making major repairs and maintaining the property are
the landlord’s concern. Tenants do not have to worry about property
taxes or property insurance. Of course, they must pay the rent and
any utility bills on time, and keep their homes clean.
Low Initial Costs
A third advantage to renting is cost. Buying a house typically
requires many thousands of dollars for the down payment and other
costs. In contrast, you usually pay the equivalent of only one or two
months’ rent to move into a rental unit.
204 Unit 2 Banking and Credit
Disadvantages of Renting
What are some of the disadvantages of renting? TechByte
Virtual Tour Software
Renting is a good option for many people, but it has some disad-
vantages. Renting offers few financial benefits, and it can contribute Online virtual tours are
making selling a home
to a more restrictive lifestyle. In addition, renting may involve vari-
easier than ever. Virtual
ous legal issues for tenants. tour software allows you
to create, with a digital
Financial and Lifestyle Restrictions camera, rotating, 360-
degree photographs
Although it has lower initial costs, renting may actually be that show all the features
more expensive than owning property in some cases. Certain finan- of a home. Virtual tours
can be uploaded to Web
cial benefits are available to homeowners but not to tenants. Home-
sites or distributed to
owners, for example, are eligible for various tax deductions. They potential buyers on CDs.
also benefit as the value of their property increases. Over time,
See example tours,
homeowners pay back the money they borrowed to buy their home, list the features and
eventually eliminating their monthly housing payments after many build into a virtual tour,
years. Tenants, on the other hand, must continue to pay housing and download some free
costs each month for as long as they continue to rent. They are also software to create a virtual
subject to rent increases. tour of your home through
Tenants must accept certain limitations regarding their activi- finance07.glencoe.com.
ties in the places they rent. For example, you might not be allowed
to paint your walls without first getting permission from your land-
lord. Homeowners have more freedom to do what they want on
their own property.
Legal Issues
If you decide to rent, you will probably have to sign a lease, a
legal document that defines the conditions of the rental agreement
between the tenant and the landlord (see Figure 7.4 on page 206
for an example of a lease).
Never sign a lease without making sure that you understand and
agree with what it says. Pay special attention to the amount and due
date of the monthly rent and the length of the rental period. Also,
check to see whether you have the right to sublet the property if you
want to move out before the lease expires. To sublet is to have a per-
son other than the original tenant take over the rental unit and pay-
ments for the remaining term of the lease. If you disagree with any
of the terms of the lease, discuss those issues with the landlord before
you sign the lease—not afterward. Sometimes landlords are willing to
negotiate changes to the document.
A lease is designed to protect the rights of both the landlord and
the tenant. The tenant is usually protected from rent increases dur-
ing the lease term. In most states, the tenant cannot be locked out or
forced to move without a court hearing. However, the lease gives the
landlord the right to take legal action against a tenant who does not
pay his or her rent or who damages the property.
finance07.glencoe.com Chapter 7 The Finances of Housing 205
&IGURE ! 4YPICAL ,EASE !GREEMENT
$ESCRIPTION OF THE PROPERTY , / Ê, /Ê"Ê*,"* ,/9
INCLUDING ITS ADDRESS /Ê{Ç{{Ê " Ê-/, /]Ê -/Ê/,"9]Ê7- " - ÊÊxΣÓä
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DAMAGE OR FOR MOVING OUT OF
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206 Unit 2 Banking and Credit
The Cost of Renting
What are the factors affecting the cost
of renting besides basic rent? Common
Several factors affect and determine the price of renting a home: CENTS
location, living space, utilities, security deposit, and insurance.
On Your Own
Sharing an apartment
Location or a house with a room-
The amount of your monthly rent will depend on the location, mate is a great way to cut
costs and can be fun. It is
or neighborhood, in which you choose to live (see Figure 7.5). You
a good idea to have a trial
may decide that you are willing to live near the freeway if it costs less period to make sure you
than living elsewhere. However, you may be willing to pay more for get along before making a
an apartment that is close to a park or work. long-term commitment.
Why do you think sharing
an apartment or a house
Living Space will help you cut costs?
The price of a rental unit will also depend on the amount of
living space that you require. The least expensive choice might be
a private room in a house, but you have to be willing to share com-
mon areas. Apartments, which are more expensive, often feature one
to four bedrooms. Your most costly option might be to rent a town-
house or single-family house. You might consider living with one or
more roommates to share expenses.
&IGURE &INDING AND ,IVING IN 2ENTAL (OUSING
3TEP 4HE 3EARCH 3TEP "EFORE 3IGNING A ,EASE
s #HOOSE A LOCATION AND A PRICE THAT FITS s "E SURE THAT YOU UNDERSTAND AND AGREE
YOUR NEEDS WITH ALL ASPECTS OF THE LEASE
s #OMPARE COSTS AND FEATURES AMONG s .OTE THE CONDITION OF THE RENTAL UNIT IN
POSSIBLE RENTAL UNITS WRITING HAVE THE UNITS OWNER SIGN IT
s 4ALK TO PEOPLE WHO LIVE IN THE APARTMENT
COMPLEX OR THE NEIGHBORHOOD WHERE THE
UNITS ARE LOCATED
3TEP ,IVING IN 2ENTAL 0ROPERTY 3TEP !T THE %ND OF THE ,EASE
s .OTIFY THE OWNER OF ANY NECESSARY s ,EAVE THE UNIT IN GOOD CONDITION
REPAIRS s 4ELL YOUR LANDLORD WHERE TO SEND YOUR
s 2ESPECT THE RIGHTS OF NEIGHBORS REFUNDED SECURITY DEPOSIT
s /BTAIN RENTERS INSURANCE TO PROTECT PERSONAL s !SK THAT ANY DEDUCTIONS FROM YOUR
BELONGINGS DEPOSIT BE EXPLAINED IN WRITING
3EEING %YE TO %YE 2ENTING INVOLVES MORE THAN JUST FINDING A DESIRABLE APARTMENT
(OW DO THESE STEPS PROTECT THE RIGHTS OF BOTH TENANT
AND LANDLORD
Chapter 7 The Finances of Housing 207
As You
Utilities
Read You may also have to pay for utilities, such as electricity, gas,
water, and trash. Before you sign a lease, be sure to ask your landlord
QUESTION
if the rent payment includes any utilities.
What factors affect the cost
of renting?
Security Deposits
When you sign a lease, you may have to pay a security deposit,
an amount of money paid to the owner of the property by a tenant
to guard against any financial loss or damage that the tenant might
cause. Security deposits usually equal one or two months’ rent.
When you move out, your landlord must return the security
deposit, minus any charges for damage you may have caused or for
any unpaid rent. Most states require landlords to return the secu-
rity deposit within one month. In California, however, it must be
returned within three weeks.
Renters Insurance
Another expense is renters insurance, a type of insurance that
covers the loss of a tenant’s personal property as a result of damage or
theft. Many tenants neglect to buy renters insurance, wrongly assuming
that their possessions are covered by their landlord’s insurance. Most
tenants who buy it find the cost worth the peace of mind it brings.
Section 7.2 Assessment
QUICK CHECK The monthly rent on the house is $900.
1. What are the three main advantages of Utilities will be $300 a month. Raji and Jon
renting a residence? have agreed to split all costs evenly.
2. What are the disadvantages of renting a Calculate How much would the
residence. move save or cost Raji each month
3. What are the costs of renting a residence? and over the course of a year?
THINK CRITICALLY SOLVE MONEY PROBLEMS
4. Explain which types of apartments would 6. Lease Terms Jaycee is a college student
best suit two friends who plan to become who has a small apartment for which she
roommates. pays $450 a month in rent. The lease she
signed in August specified that no pets were
USE MATH SKILLS allowed. However, while visiting her parents
5. Sharing Costs Raji is currently paying over winter break, Jaycee found a stray cat,
$675 a month to rent a one-bedroom apart- and she would like to keep it.
ment. The cost of all utilities is included
Analyze What options does Jaycee
in the rent. However, he is thinking about
have? Consider all possibilities and
renting a house with his friend Jon.
rank them from most to least desirable.
208 Unit 2 Banking and Credit
Section 7.3
Buying and Selling Focus on
Reading
a Home
Read to Learn
• How to identify the
The Home-Buying Process advantages and dis-
How do you buy a home? advantages of owning
a residence.
Many people dream of owning a home. Buying a home, however,
• How to explain how to
is a huge financial commitment. It will probably be the most costly evaluate a property.
purchase you will ever make. There are a number of steps that you • How to discuss the
will need to take to purchase a home. You will need to determine your financing involved in
home ownership needs, find and evaluate a property to purchase, price purchasing a home.
the property, obtain financing, and close the transaction. • How to describe a plan
for selling a home.
STEP 1: Determine Your Home Main Idea
Ownership Needs Understanding the pro-
cesses involved with
What are some of the benefits and drawbacks
homeownership is neces-
of owning a home? sary when you buy or sell
To make an informed decision about whether to buy a home, a home.
you will need to consider the benefits and drawbacks of ownership.
You will also need to consider the types of homes that are available
Key Terms
and how much you can afford to spend. • equity
• escrow account
• private mortgage
Owning Your Residence: Benefits insurance (PMI)
• mortgage
While renters may be attracted to the idea of mobility, home- • points
owners may enjoy a sense of stability and permanence. Home own- • amortization
ership also allows individual expression. You have more freedom to • fixed-rate mortgage
decorate and change your own home and to have pets. Many people • adjustable-rate
mortgage (ARM)
find this type of flexibility very appealing.
• home equity loan
As a homeowner, you will also gain financial benefits. You can • refinance
deduct the interest charges on your loan payments from your fed- • closing
eral income taxes each year. Your property taxes are also deductible. • title insurance
Moreover, the value of many homes rises steadily. Therefore, home- • deed
owners can usually sell their homes for a profit, depending on their • appraisal
equity, which is the value of the home less the amount still owed
on the money borrowed to purchase it. In addition, once the bor-
rowed money is paid off, homeowners have no further payments to
make other than property taxes, homeowners insurance, and main-
tenance costs.
Chapter 7 The Finances of Housing 209
䊳 FREEDOM OF
EXPRESSION For many peo-
ple, one of the most appeal-
ing advantages of home &IGURE ! 4YPICAL ,EASE !GREEMENT
ownership is the ability to
decorate or remodel freely.
Can you think of any situations $ESCRIPTION OF THE PROPERTY , /
in which homeowners are not INCLUDING ITS ADDRESS /Ê{Ç{{Ê "
completely free to change the
look of their homes?
.AMES OF OWNERS AND TENANTS *>ÀÌiÃÊÊ>}ÀiiiÌÊ>ÀiÊ >
>ÃÊÀiÌi`ÊÌ iÊÃiV`ÊvÀÊ
ÀÊ iÀÊiÊ«iÀîÊÕÃiÊÞ
$ATES DURING WHICH THE
/ iÊÌiÀÊvÊÌ ÃÊ>}ÀiiiÌÊ
LEASE IS VALID Ü V ÊÌiÊ>Ì iÀÊÃÝ
/ iÊÀiÌÊÜÊLiÊfÈxäÊ«iÀÊ
!MOUNT OF THE i >vÊÌ Ã½ÊÀiÌ]ÊvÀÊ>
i`ÊÕÌÊÃÕV ÊÌiÊÌ >ÌÊÌ i
SECURITY DEPOSIT
Û>V>ÌiÊÌ iÊ«ÀiÃiðÊ/ iÊÃiV
Li ÀiÌÕÀi` Ì Ì i Ìi>Ì]
Before Owning Your Residence: Drawbacks
You Read
Of course, buying a home does not guarantee happiness. Home
PREDICT ownership can involve financial risk. Saving money for a down pay-
ment to buy a home is very difficult for many people. Moreover, the
If you plan to own a house
one day, how do you think tax deductions may not make up for high loan payments. Property val-
you begin the process? ues do not always go up; in some cases, they may even decline.
A second drawback is limited mobility. A homeowner who
wants to move must either sell his or her property or arrange to rent
it to tenants. These processes can be slow and may result in finan-
cial loss.
Owning a home can involve high expenses. Homeowners must
pay for all maintenance and repairs, such as fixing a leaky roof, clean-
ing out a flooded basement, putting up new wallpaper, and replac-
ing or repairing broken appliances. The cost of taking good care of
a home can be quite high, even if homeowners do most of the work
themselves.
Types of Housing
Homes come in all shapes and sizes, providing housing alterna-
tives for a range of budgets and lifestyles.
Single-Family Dwellings The most popular type of housing in
the United States is the single-family house. A single-family house
usually stands on a separate lot with a lawn and some outdoor living
space. The home is not attached to any other buildings. Because a
single-family dwelling provides the most privacy of any type of
housing, it is often the most expensive.
210 Unit 2 Banking and Credit
Multiunit Dwellings This category of housing includes duplexes
and townhouses. A duplex is a single building divided into living
spaces for two families—or two units. A building divided into three
units is a triplex. A townhouse is one of many single-family units
attached to other units. For these types of housing, each unit has its
own outside entrance.
Condominiums A condominium is one of a group of apartments
or townhouses that people own instead of rent. Condominium
owners pay a monthly fee to cover the cost of maintenance, repairs,
improvements, and insurance for the building and its common
spaces. The unit owners form a condominium association, which
manages the housing complex. Common spaces, such as hallways,
lawns, elevators, and recreational areas, belong to the association, not
to individual owners.
Cooperative Housing Cooperative housing is another apartment-
style living arrangement in which a building that contains a number
of units is owned by a nonprofit organization. Members of the
organization do not actually own the property. Members pay a
monthly fee which covers their rent and the operating expenses of
the organization.
Prefabricated Homes Prefabricated houses are manufactured
and partially assembled at a factory. The pieces are then transported to
a building site and put together there. Prefabricated homes are often
cheaper than other single-family houses because the mass production of
their pieces and partial assembly at the factory help keep costs down.
䊴 OPTIONS TO BUY
Attractively designed pre-
fabricated homes are a less
costly alternative for hous-
ing. Who might be interested
in purchasing these homes?
Why?
Chapter 7 The Finances of Housing 211
Mobile Homes Another type of manufactured home is known as a
mobile home. Most mobile homes are not truly mobile because they are
rarely moved from their original sites. Mobile homes are fully assembled
Furnishing Your in factories. They contain many of the features of larger houses, such
First Apartment as fully equipped kitchens, bathrooms, and even fireplaces. Some
1. Buy large items mobile-home owners purchase the land on which their houses are
such as sofas and located. Spaces can also be rented in mobile-home parks where access
tables at thrift
to community recreation facilities is often included.
shops.
Compared with other housing choices, mobile homes are rela-
2. Shop for items
such as kitchen- tively inexpensive. However, they are not as well constructed or as
ware at discount safe as many other types of housing, and they usually do not increase
stores. in value at the same rate as single-family houses do.
3. Browse garage or
moving sales to Affordability and Your Needs
find great buys.
4. Ask friends and Selecting a type of dwelling is only one part of determining your
relatives if they home ownership needs. You will also need to consider the price of a
want to get rid of home, its size, and its quality.
household items
they do not use. Price and Down Payment To determine how much you can
5. Be creative: Make afford to spend on a home, you will need to examine your income,
curtains from your savings, and your current living expenses. Can you afford to
colorful sheets. make a large down payment when you buy a home? A down payment
is a portion of the total cost of an item that is required at the time of
purchase. You will need to make monthly payments on a loan, pay
property taxes, and buy homeowners insurance. The exact amounts
will depend on interest rates and local economic conditions. Is
your income enough to cover these costs as well as other current
expenses?
Before you look for the home of your dreams, it is smart to know
exactly what you can afford to pay. To determine how much you can
afford to spend on a home and if you will be approved for a loan, talk
to a loan officer at a mortgage company or other financial institution.
Many companies and banks will prequalify loan applicants so that
prospective home buyers will know in advance if they can get a mort-
gage loan. This service is usually provided without charge.
Size and Quality Ideally, the home you buy will be big enough
for your needs and will be in good condition. If you are a first-time
buyer, though, you may not be able to get everything you want.
Trading Up Most financial experts recommend buying what you
can afford, even if you have to sacrifice the size and features you
would love to have. As you advance in your career and your income
increases, you may be able to “trade up” and purchase a home with
some extra comforts. For example, eight years ago, Kanya bought a
condominium that had only a tiny garden and one small bathroom.
Last week she sold it, made a profit, and moved into a larger house,
where she will be able to plant a vegetable and flower garden and
enjoy the convenience of two full baths.
212 Unit 2 Banking and Credit
STEP 2: Find and Evaluate
a Property to Purchase
Why is the location of your home important?
When you know what type of residence you would prefer and
what you can afford, you will be able to start searching for a property
to purchase.
Selecting a Location
The location of your home is very important. Ask yourself if you
would rather live in a city, in the suburbs, or in a small-town or coun-
try setting. Perhaps you want a neighborhood with parks and trails
that accommodate cyclists and runners. If you commute to work by
bus, you will have to make sure that your house is close to the bus
lines. The distance between home and work, the quality of the local
school system, your interests and lifestyle, and other factors all help
determine where you will want to live.
Careers in Finance
CREDIT ANALYSTAGENT
REAL ESTATE Carlos Garza
RealTime Real Estate, Inc.
Carlos has always had a knack for putting people at ease. This ability has proven very useful in
his job as a real estate sales agent. Carlos is also very good at handling the complicated proce-
dures involved in selling real estate. He sees his job as being a matchmaker between buyers and
sellers.He works well with both sides, advising sellers on how to make homes more appealing
to potential buyers and advising buyers on the suitability and value of the homes they visit. As
a real estate agent, he relishes the challenge of making his clients happy and the satisfaction of
closing a deal.
SKILLS: Sales, marketing, administration, time-management, communication,
negotiation, math, and legal skills
PERSONAL TRAITS: Personable, highly disciplined, persistent, trustworthy, and self-starting
EDUCATION: High school diploma or equivalent; training through a real estate company
or organization; and state license
ANALYZE If you were looking for a home to buy, what qualities, in addition to trustworthiness,
would you look for in a real estate agent?
To learn more about career paths for real estate agents, visit finance07.glencoe.com.
finance07.glencoe.com Chapter 7 The Finances of Housing 213
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: Calculating a
Mortgage Payment
A worksheet to calculate an affordable
mortgage payment contains the following
information:
• Your monthly income
• Your monthly expenses
• Difference between your
.AME ,E"RON
monthly income and expenses
-ONTHLY )NCOME CASH FLOW
Your Motive: You may not 7AGES AND SALARY
)NVESTMENT INCOME
realize all of the expenses you
/THER INCOME
incur each month. Therefore, 4OTAL -ONTHLY )NCOME
when considering purchasing -ONTHLY %XPENSES
'ROCERIES
a home, you must carefully
#AR PAYMENTS
calculate your cash flow to be sure #AR MAINTENANCE
you are not overestimating your 'ASOLINE
#LOTHING
ability to pay for expenses.
3TUDENT LOAN PAYMENTS
-EDICAL EXPENSES NOT COVERED BY INSURANCE
!UTOMATIC DEPOSIT SAVINGS ACCOUNT
2ETIREMENT ACCOUNT
#REDIT CARD PAYMENTS
)NSURANCE PAYMENTS CAR LIFE HEALTH ETC
)NCOME TAXES INCLUDING 3OCIAL 3ECURITY
2ESTAURANTS
#HARITABLE CONTRIBUTIONS
6ACATIONS
%NTERTAINMENT
/THER EXPENSES
4OTAL -ONTHLY %XPENSES
!FFORDABLE -ORTGAGE 0AYMENT
-ONTHLY )NCOME n %XPENSES
Key Points: A mortgage payment for a Find the Solutions
house is usually the single largest monthly 1. What are some other possible expenses?
expense you will incur. It is important 2. Why are income taxes monthly expenses?
that you are able to pay it each month. By 3. Does LeBron have enough money to cover
determining your monthly income and monthly mortgage payments and closing
and other costs?
expenses, you will be able to calculate how
4. Should LeBron spend all of the money he
much you can afford to pay each month
has left after paying his monthly expenses
for a mortgage.
on a mortgage payment?
5. What expenses would you be willing to cut
if your mortgage payment was $1,500 per
month? Why?
214 Unit 2 Banking and Credit
Local Zoning Laws Some communities have strict zoning laws,
which are regulations that limit how property in a given area can
be used. The existence of such laws may also affect your housing
decisions. William wanted to live in an all-residential area, so he
bought a duplex in a neighborhood where local zoning laws ban
any commercial construction of stores or business buildings. In
contrast, Alicia bought a condominium in a much less restrictive
community because she wanted to be able to walk to nearby
restaurants and businesses.
Hiring a Real Estate Agent
Real estate agents are people who arrange the sale and purchase
of homes as well as other buildings and land. They are good sources
As You
of information about the location, availability, prices, and quality of
Read
homes. Potential home buyers often use real estate agents to help RELATE
them find housing. The agents can also negotiate the purchase price
between buyer and seller. They help buyers arrange financing for the How would you go about
finding a real estate agent
purchase, and they can recommend lawyers, insurance agents, and who suits you?
home inspectors to serve the buyers’ needs.
Real estate services are usually free to the buyer. The agents may
represent the sellers, who pay them a commission of 3 to 6 percent
when the property is sold. Some real estate agents also represent buyers.
In this case, the agent may be paid by either the buyer or the seller.
Conducting a Home Inspection
Before you make a final decision to buy property, it is impor-
tant to get an evaluation of the house and land by a qualified home
inspector. (See Figure 7.6 on page 216.) When Josh Samuels called
in a home inspector to check the house he wanted to buy, the inspec-
tor found cracks in the foundation, an overloaded electrical system,
and problems with the water quality. Josh still wanted the house,
and he was able to negotiate a lower price because he had the inspec-
tor’s report. A home inspection costs money, but it can save you from
problems and unplanned expenses in the future.
Some states, cities, and lenders require inspection documents.
The mortgage company will usually conduct an appraisal to determine
the fair market value of the property. An appraisal is not a detailed
inspection. It is an estimation of the value of the property usually in
comparison with other similar properties that have recently sold in the
particular area.
STEP 3: Price the Property
What price should you offer to pay?
After you have checked out the property as thoroughly as pos-
sible, it is time to consider making an offer to the current owner. This
is usually done through a real estate agent, unless the owner is acting
as his or her own agent.
Chapter 7 The Finances of Housing 215
Figure 7.6 Conducting a Home Inspection
Taking steps to evaluate a home before
you buy it may save you unplanned
expenses and disappointments later.
1 The Exterior The buyer
does a “walk-through”
of the neighborhood to
check the condition of
streets and sidewalks. It is
also important to check
the exterior features of
the home.
2
The Interior The buyer
looks at the interior design
of the home to be sure that
it will meet his or her needs.
3
Professional Home Inspection The buyer
hires a home inspector who checks the
exterior: windows, foundation, chimney, and
!PPLE 0IE (OME )NSPECTION 3ERVICE
-ANITOWOC !VENUE roof. The home inspector will also look at the
7OODLAND (ILLS #! interior construction: wiring, plumbing, heating
)NSPECTION .O )NSPECTOR -ICHELLE #ABALU system, walls, and floors.
#LIENT 0EGGIE 4HOMPSON
)NSPECTION $ATE !DDRESS 'LADE 2D
#ARLSBAD #!
4HE HOUSE IS A SINGLE FAMILY DWELLING ONE
STORY STRUCTURE BUILT ON A FLAT LOT
%STIMATED AGE IS APPROXIMATELY TO YEARS
OLD 7EATHER AT TIME OF INSPECTION WAS SUNNY
%84%2)/2
$RIVEWAY #ONCRETE WITH CRACKS NOTED
7ALKS #ONCRETE AND BRICK
WITH CRACKS NOTED -ISSING BRICKS NOTED
&ENCE'ATES 7OOD AND CHAIN LINKS
$ETACHED WOOD FENCE NOTED
3IDING 3TUCCO AND WOOD WITH CRACKS NOTED
4RIM 7OOD
7INDOW &RAMES -ETAL AND WOOD
%LEC &IXTURES 3
'UTTERS$OWNSPOUTS 3
4
216
Inspection Report The buyer
reviews the home inspector’s
report to decide whether this is
the right home to buy.
Unit 2 Banking and Credit
Determining the Price of the Home
Every home that is for sale has a listing price—the price that the
owner is asking for it. That price is not necessarily the price you will
pay, however. You are free to make a lower offer. What should you
offer? Here are some questions to consider:
• How long has the home been on the market? If a home is on
the market for a while, the owner may accept a lower price.
• What have similar homes in the neighborhood sold for recently?
If a listing price is too high, you should offer less.
• How tight is the housing market? In a “seller’s market,” homes
are in high demand, and sellers can get the highest prices. In
a “buyer’s market,” there is an abundant supply of homes for
sale, and buyers can pay lower prices.
• Do the current owners need to sell in a hurry? If so, they may
be willing to accept less than they feel the home is worth.
• How well does the home meet your needs? If a home fits your
needs, you may be willing to pay more.
• How easily can you arrange financing? If interest rates are high,
your payment will be higher.
Negotiating the Purchase Price
Once you have decided on a reasonable amount to offer, the real
estate agent will communicate it to the seller, who may either accept
or reject it. If your offer is accepted, congratulations! You will soon
have a new home—and at a price you are willing to pay.
Sometimes the seller will not accept your offer if it is below the
listing price. In that case, you will have to make a second, higher
offer, or start looking for a different home. A seller may also make a
counteroffer in response to your bid. Making a counteroffer means
dropping the asking price. For example, Jian Wang offered $178,900 MATH
for a condominium that was listed at $186,000. The sellers rejected An average homeowner
his offer but made a counteroffer of $184,500. Jian thought that the stays in a home for about
price was still too high, so he submitted a bid of $182,000. They even- six years. With an 8 percent
tually settled on a purchase price of $183,000. mortgage, the homeowner
When the buyer and seller agree on a price, they must sign a will sell the home, still
owing over 90 percent of
purchase agreement, or purchase contract, that states their inten-
the mortgage. If this trend
tion to complete the sale. Most purchase contracts are conditional; continued, the homeowner
that is, they take effect only if certain other events occur. For exam- would never pay off a mort-
ple, the contract may be valid only if the buyers can obtain financ- gage in his or her lifetime.
ing, or only if they can sell their current home in a specified period Imagine you have purchased
of time. a house for $97,000, with
$9,700 down and a simple
At this point in the process, the buyer sometimes must pay
interest rate of 8 percent.
the seller a portion of the purchase price, called earnest money. This How long would it take to
money shows that the offer is serious. It is held in an escrow account pay off your mortgage if you
until the sale is completed. An escrow account is an account where paid $700 a month?
money is held in trust until it can be delivered to a designated party.
The earnest money is applied toward the down payment.
Chapter 7 The Finances of Housing 217
STEP 4: Obtain Financing
What are the costs involved in purchasing property?
After you have decided to purchase a specific home and have
agreed on a price, you will have to think about how you will pay for
your purchase. First, you will have to come up with money for the
down payment. Next, you will probably have to get a loan to help pay
for the remainder of the purchase price. Finally, you will be respon-
sible for fees and other expenses related to the settlement of the real
estate transaction.
Determining Amount of Down Payment
As a general rule, the greater the portion of the total purchase
price you can pay up front, the easier it will be to obtain a loan. Many
lenders suggest that you put 20 percent or more of the purchase price
as a down payment. For example, if the purchase price of the house
is $100,000, you would need to make a down payment of $20,000.
The most common sources of funds for down payments are personal
savings accounts, sales of investments or other assets, or gifts or loans
from relatives.
Private Mortgage Insurance Lenders might accept lower down
payments. However, if the down payment is less than 20 percent of
the purchase price, some lenders will require you to obtain private
mortgage insurance. Private mortgage insurance (PMI) is
a special policy that protects the lender in case the buyer cannot
make payments or cannot make them on time. Sometimes buyers
will pay the cost of PMI up front, and sometimes they will agree to
spread the cost over the life of the loan. When the borrower has
paid between 20 to 25 percent of the purchase price, the insurance
can be dropped.
Qualifying for a Mortgage
A mortgage is a long-term loan extended to someone who buys
property. The buyer borrows money from a bank, credit union, sav-
ings and loan association, or mortgage company, which pays the full
amount of the loan to the seller. In return, the buyer makes monthly
payments to the lender. These monthly payments are usually made
over a period of 15, 20, or 30 years. The home you buy serves as col-
As You lateral, a type of guarantee that the loan will be repaid. If you fail to
Read repay the mortgage or make regular payments, the lender can fore-
QUESTION close, or take possession of the property.
Lenders want to know how Financial Qualifications To take out a mortgage, you need to
much money you owe. meet certain criteria, just as you would to qualify for any other type
What other information do of loan. Lenders look at your income, your debts, and your savings
they look for? to decide whether you are a good risk. These figures are put into a
formula to determine how much you can afford to pay.
218 Unit 2 Banking and Credit
䊱 THE TEST Applying for a loan requires paperwork that will be examined by the lender to determine
your eligibility for the loan. Why is this process so important to the lender?
Interest Rate Factors The size of your mortgage will also depend
on the current interest rate. The higher the rate, the more you will need
to pay in interest each month. That means that less of your money
will be available to pay off the purchase price. When interest rates rise,
fewer people are able to afford the cost of an average-priced home. In
contrast, low rates increase the size of the loan that you can receive.
For example, Bernadette qualifies for a monthly mortgage pay-
ment of $700. If interest rates are 7 percent, she will be able to take
out a 30-year loan of $105,215. However, if interest rates increase to
12 percent, she will qualify for a 30-year loan of only $68,053. Both
of these loans will carry the same monthly payment of $700. The dif-
ferences can be quite surprising.
Paying Points
Different lenders may offer slightly different interest rates for
mortgages. In addition, when you compare the cost of doing busi-
ness with various lenders, you will have to consider other factors. If
you want a lower interest rate, you may have to pay a higher down
payment and points—extra charges that must be paid by the buyer
to the lender in order to get a lower interest rate. Each point equals
1 percent of the loan amount. For example, suppose that a bank offers
you a $100,000 mortgage with two points, or 2 percent. Since 2 per-
cent of $100,000 is $2,000, you will have to pay an extra $2,000 when
you get the loan to purchase your home.
Chapter 7 The Finances of Housing 219
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis-
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals
to help them guide their financial decisions. -ADRID
SPAIN
Each year thousands of people from Britain
make their way to Spain, seeking what their home-
land does not offer—affordable housing. The average
house in England costs more than 150,000 pounds
DATABYTES
(US $278,000). In comparison, a three-bedroom home
not far from the beautiful Spanish coast costs less
Capital Madrid
than 100,000 pounds (US $185,000). A roomy handy-
Population 41,334,000
man’s special can be found for under 20,000 pounds
(US $37,000). Many Languages Castilian Spanish, Catalan,
of the British house- Galician, and Basque
hunters may pur- Currency euro
chase a house to fit Gross Domestic
their pocketbooks, Product (GDP) $885.5 billion (2003 est.)
but there may be GDP per capita $22,000
other motivations Industry: Textiles and apparel, food and beverages,
as well. Some buy metal manufacturing, and chemicals
Spanish property
Agriculture: Grain, vegetables, olives, wine grapes,
as an investment,
beef, and fish
and then lease the
Exports: Machinery, motor vehicles, foodstuffs, and
homes to renters.
other consumer goods
Others simply prefer
the more stress-free Natural Resources: Coal, lignite, iron ore, and
life and agreeable uranium
climate of sunny
Think Globally
Spain.
Would you buy a home in another country? Why or
why not?
Comparing Points How does a high interest rate with no points
compare to a low interest rate with points? A lower interest rate results
in a lower monthly payment, but you pay more money up front.
If you keep your home for only a short time, you may lose money
with the lower rate because the monthly savings will not add up to
what you had to pay in points. If you keep the home for several years,
however, your monthly savings will eventually make up for what you
paid in points. As a rule, the longer you keep the home, the better off
you are when paying the points in exchange for a lower interest rate.
220 Unit 2 Banking and Credit
The Loan Application Process Put on
Most lenders charge home buyers a fee of between $100 and Your
$300 to apply for a mortgage, which is added into the loan amount. Financial
To apply, the buyer must fill out forms, giving details of his or her
income, employment, debts, and other information. The lender will
Planner’s
verify this information by obtaining a buyer’s credit report. Cap
After a careful examination of the buyer’s financial history and
A client has $27,000 in sav-
the size, location, and condition of the property, the lender decides to ings and an excellent credit
approve or deny the application. If it is approved, the purchase con- history. Assuming 20 percent
tract between seller and buyer becomes legally binding. down, what price should your
client pay for a house?
Types of Mortgages
How do the various types of mortgages differ?
For most people, a mortgage is the greatest financial obligation
of their lives. There are several types of mortgages. Depending on
the terms of the loan, a homeowner will have to make monthly pay-
ments for many years.
The monthly payments on a mortgage are set at a level that
allows amortization of the loan. Amortization is the reduction
of a loan balance through payments made over a period of time.
So the balance is reduced every time you make a payment. The
amount of your payment is applied first to the interest owed and
then to the principal, which is the original amount you borrowed.
In the first years of the loan, only a small part of each monthly
payment goes to reduce the principal. Most goes toward paying
off the interest. Near the end of the loan period, almost all of each
payment goes toward reducing the principal. By the end of the
loan period, both the interest and the principal will be completely
paid off.
It is possible to pay off a mortgage early. Paying a little extra
each month and applying that amount to the principal will save
interest charges over the long run. For example, paying $25 extra a
month on a 30-year, 10 percent mortgage of $75,000 will save more
than $34,000 in interest charges—and will repay the loan in about
25 years. Some lenders charge an extra fee for prepaying.
Fixed-Rate Mortgages
A fixed-rate mortgage, or conventional mortgage, is a mort-
gage with a fixed interest rate and a fixed schedule of payments.
A fixed rate is an interest rate that does not change. For example,
if the interest rate is 8.75 percent when the loan is granted, the
homeowner will continue to pay 8.75 percent throughout the life
of the loan, even if interest rates for new loans rise. Conventional
mortgages typically run for a period of 15, 20, or 30 years. They
offer peace of mind because monthly payments always remain the
same.
Chapter 7 The Finances of Housing 221
Adjustable-Rate Mortgages
Fixed-rate loans guarantee a particular interest rate for the life of
the loan. An adjustable-rate mortgage (ARM), also known as a
variable-payment mortgage, is a mortgage with an interest rate that
increases or decreases during the life of the loan. The rate changes accord-
ing to economic indicators, such as rates on U.S. Treasury securities, the
Federal Home Loan Bank Board’s mortgage rate index, or the lender’s
own cost-of-funds index. As a result, your loan payments may go up
or down.
Your rates will change according to the terms of your agreement
with the lender. Generally, if interest rates decline and stay low, an
ARM will save you substantial amounts of money. However, if rates
increase and stay high, an ARM may cost you a lot of money because
your monthly payment will go up.
Evaluating Adjustable-Rate Mortgages Consider several fac-
tors when you evaluate adjustable-rate mortgages:
1. Determine the frequency of and restrictions on allowed
changes in interest rates.
2. Consider the frequency of and restrictions on changes in the
monthly payment.
3. Find out what index the lender will use to set the mortgage
interest rate over the term of the loan.
Rate Caps Most adjustable-rate mortgages have a rate cap, which
limits the amount the interest rate can rise or fall. Rate caps generally
limit increases (or decreases) of the interest rate to one or two percentage
points in a year—or no more than five points over the life of the loan.
Some ARMs also carry payment caps, which limit the size of
monthly payments. That may seem like good protection for the
buyer, but it has drawbacks. When interest rates rise while monthly
payments remain the same, the payments will not cover the interest.
As a result, the loan balance increases, and payments may have to be
extended over a longer time.
Convertible ARMs Some lenders also offer convertible ARMs.
Convertible ARMs permit a borrower to convert, or change, an
adjustable-rate mortgage to a fixed-rate mortgage during a certain
period of time. If you decide to make the change, your interest rate
will be 0.25 to 0.50 percent higher than current rates for conventional
30-year mortgages. You will also have to pay a conversion fee, which
is usually $500 or less.
Government Financing Programs The Federal Housing
Administration (FHA) and the Veterans Administration (VA) help
home buyers obtain low-interest, low-down-payment loans. VA
loans are available to eligible veterans of the armed services. These
government agencies do not actually lend the money. Instead,
they help qualified buyers arrange for loans from regular lenders.
222 Unit 2 Banking and Credit
Typically, an agency guarantees repayment to the lender if the
borrower defaults, or is unable to make payments. As a result, many
government-guaranteed loans have lower interest rates. Although
extra insurance fees may be added on to these loans, government-
backed mortgages are a good deal for those who qualify for them.
Home Equity Loans
A second mortgage is also called a home equity loan, which is
a loan based on the difference between the current market value of a
home and the amount the borrower owes on the mortgage. To deter-
mine the amount of this type of loan, the financial institution will
find out the current market value of a home and how much equity is
in the property. Such loans can provide money for education, home
improvements, or other purposes. However, some states limit the
ways in which the money may be used.
Second mortgages are one source of extra cash for homeowners.
However, taking out additional loans can keep a homeowner con-
tinually in debt. Also, if the borrower cannot make the payments on
a second mortgage, the lender can take the home. For more informa-
tion on home equity loans, see Chapter 19.
Refinancing
Many homeowners need extra money or want to reduce their
monthly payments. These options are possible when they refinance,
which is obtaining a new mortgage to replace an existing one. For
example, Esther Aquino originally took out a fixed-rate mortgage at
11 percent interest, and then watched interest rates fall to 6 percent.
Fortunately, she was able to refinance her home, and take out a new
mortgage at the lower 6 percent interest rate. In Esther’s case, her
monthly payment decreased considerably.
Refinancing is not always a good choice. To refinance, a home-
owner usually pays extra fees, which may reduce any savings from a
small drop in interest rates. Moreover, refinancing may extend the
life of a loan. In general, refinancing is an advantage when the inter-
est rate drops two or more points below the current rate and when
the owner plans to stay in his or her present home for at least two or
more years. Your Own Home
Learn about different
kinds of mortgages and
STEP 5: Close the Transaction how to qualify for one.
What are closing costs? Then learn how to negoti-
ate the purchase of your
The final step in the home-buying process is the closing, a meet- first home.
ing of the seller, the buyer, and the lender of funds, or representatives To continue with
of each party, to complete the transaction. At the closing, documents Tasks 4 and 5 of your
are signed, last-minute details are settled, and money is paid. The WebQuest project, visit
seller and buyer must also pay a number of fees and charges, which finance07.glencoe.com.
are closing costs.
finance07.glencoe.com Chapter 7 The Finances of Housing 223
Closing Costs
Most closing costs involve the legal details related to purchas-
ing a home. For example, a title company researches the property to
make sure that no disputes exist over its ownership or that there are
no unpaid real estate taxes for the property. The title company also
offers title insurance, a type of insurance that protects the buyer
if problems with the title are found later.
Another typical closing cost is a fee for recording the deed,
which is the official document transferring ownership from seller
to buyer. Buyers also pay for private mortgage insurance, which pro-
tects the lender from any loss resulting from default on the loan. See
Figure 7.7 for a list of other common closing costs.
Escrow Account
After the closing, your lender might require that you deposit
money into an escrow account. The money, usually held by the lender,
is set aside to pay for taxes and insurance. The lender does not have
to worry whether the borrower is paying these obligations because the
money is available. See Figure 7.8 for a list of home-buying issues.
Taxes and Insurance Homeowners must pay property taxes and
homeowners insurance in addition to their mortgage payments.
In most states, property taxes generally cover the cost of public
services, such as police and fire protection, schools, and street repair.
Homeowners insurance protects the lender’s investment in case of
damage to the home from fire or other hazards.
&IGURE #LOSING #OSTS
#OST 2ANGE
)TEM "UYER 3ELLER
4ITLE SEARCH FEE n n
4ITLE INSURANCE n n
!TTORNEYS FEE n n
0ROPERTY SURVEY n n
!PPRAISAL FEE n n
2ECORDING FEES n n
#REDIT REPORT n n
4ERMITE INSPECTION n n
,ENDERS ORIGINATION FEE n OF LOAN n
2EAL ESTATE AGENTS COMMISSION n n OF PURCHASE PRICE
)NSURANCE TAXES AND INTEREST VARIES n
#OSTS !DD 5P #LOSING COSTS ADD TO THE EXPENSE OF BUYING A HOME
&OR A LOAN AMOUNT OF WITH IN INSURANCE TAXES AND
INTEREST WHAT COULD A BUYER PAY IN CLOSING COSTS BASED ON THE
FIGURES IN THIS CHART
224 Unit 2 Banking and Credit
&IGURE 4HE %LEMENTS OF "UYING A (OME
)T IS IMPORTANT TO CONSIDER THESE FACTORS WHEN MAKING A HOME PURCHASE
s ,OCATION #ONSIDER BOTH THE SURROUNDING COMMUNITY AND THE GEOGRAPHIC REGION 4HE SAME HOME MAY VARY
GREATLY IN COST DEPENDING ON WHERE IT IS LOCATED IN +ANSAS OR #ALIFORNIA ON A BUSY HIGHWAY OR A QUIET STREET
IN A LANDSCAPED SUBURB OR AN URBAN NEIGHBORHOOD
s $OWN 0AYMENT ! LARGE DOWN PAYMENT REDUCES YOUR MORTGAGE COSTS BUT HOW MUCH CAN YOU AFFORD TO PAY
UP FRONT
s -ORTGAGE 2ATES AND 0OINTS 9OU WILL HAVE TO CHOOSE BETWEEN A LOWER MORTGAGE RATE WITH POINTS AND A
HIGHER MORTGAGE RATE WITHOUT POINTS 9OU WILL ALSO NEED TO CONSIDER WHAT TYPE OF MORTGAGE TO ARRANGE 7HEN
YOU APPLY FOR THE LOAN BE PREPARED TO PROVIDE THE LENDER WITH COPIES OF YOUR FINANCIAL RECORDS AND OTHER
RELEVANT INFORMATION
s #LOSING #OSTS 3ETTLEMENT COSTS MAY RANGE ANYWHERE FROM TO PERCENT OF THE TOTAL AMOUNT YOU BORROW
4HAT IS IN ADDITION TO THE DOWN PAYMENT
s -ONTHLY 0AYMENTS 9OUR MONTHLY PAYMENT FOR INTEREST PRINCIPAL INSURANCE AND TAXES WILL BE AMONG YOUR
LARGEST MOST ENDURING EXPENSES "EWARE OF BUYING A HOME THAT COSTS MORE THAN YOU CAN AFFORD
s -AINTENANCE #OSTS (OMES REQUIRE A LOT OF REPAIR AND MAINTENANCE "E SURE TO SET ASIDE FUNDS FOR THESE
NECESSITIES
4HINK )T /VER "UYING A HOME IS A COMPLICATED PROCESS
7HAT ARE SOME POSSIBLE RESULTS OF NOT THINKING THROUGH ALL
THE ELEMENTS LISTED ABOVE
Selling a Home
What can an owner do to his or her home
to get the best selling price?
As your needs change, you may decide to sell your home. You will
have to get it ready for the market, set a price, and decide whether to
sell it on your own or get professional help from a real estate agent.
Preparing a Home for Selling
The nicer your home looks, the faster it will sell at the price
you want. Real estate salespeople recommend that homeowners
make needed repairs and paint worn exterior and interior areas
when preparing a home for selling. For example, Dora and Den-
nis Muldoon repainted several rooms, replaced some light fixtures,
and changed the living room carpet before they put their house
on the market. They kept the house as clean, neat, bright, and airy
as possible while prospective buyers were visiting. They also made
sure that the lawn was cut regularly and that their children did not
leave toys in the yard. Their work paid off: They sold their home
within a few months of listing their home.
Chapter 7 The Finances of Housing 225
䊳 LENDING A HAND
A real estate agent will
suggest to a seller ways to
improve the “curb appeal”
of a home, such as landscap-
ing, to attract buyers. What
is the biggest disadvantage of
using a real estate agent?
Determining the Selling Price
Setting a price on a home can be difficult. A price that is too
high may scare off potential buyers. Setting the price too low will
result in lost profit. Some sellers will pay for an appraisal—an esti-
mate of the current value of the property—and use that as a basis for
a listing price. If you ever sell a home, find out whether the current
market and demand for housing favors buyers or sellers. Then decide
how quickly you need to sell your home and evaluate any improve-
ments you have made to the property. Adding certain features—such
as a deck or an extra bathroom—can increase a home’s value.
Choosing a Real Estate Agent
Many sellers put the sale of their home into the hands of a
licensed real estate agent who is affiliated with an agency. There is a
wide choice of firms, from small local real estate agencies to nation-
ally known companies. When choosing an agent, pick someone who
knows your neighborhood and is eager to sell your home.
Real Estate Agent Services Real estate agents provide various
services. They can help determine a selling price, attract buyers,
show your home, and handle the financial aspects of the sale.
226 Unit 2 Banking and Credit
They are paid a commission, or fee, upon the sale of a home—
usually 5 to 7 percent of the purchase price.
After You
Read
Sale by Owner REACT
Each year about 10 percent of home sales are made directly by With the information pro-
homeowners without the help of real estate agents. Selling your home vided in this chapter, do
you feel that you could
yourself can save you thousands of dollars, but it will cost you time
make a wise decision about
and energy. Advertising the home will be up to you. Showing the whether to rent or buy a
home to prospective buyers will also be your responsibility. Be sure to home? Why or why not?
use the services of a lawyer or a title company to help you with the
contract, closing, and other legal matters.
Making Choices
Your housing decisions will be affected by many factors, includ-
ing your lifestyle and financial situation. By carefully reviewing
your options, making educated decisions, and following the appro-
priate processes, you will make the best housing choice to suit your
needs.
Section 7.3 Assessment
QUICK CHECK Write About It Write a paragraph
1. What are five steps that make up the pro- answering one of the questions.
cess of buying a home?
SOLVE MONEY PROBLEMS
2. What costs are associated with buying
a home? 6. Making an Offer After several weeks
3. What activities are associated with selling of searching for a new home, Renée has
a home? found a house that seems to be in good
shape and is located in a nice neighbor-
THINK CRITICALLY hood. The listing price is $125,000, which
4. State three reasons you should carefully is about $15,000 more than she wants to
inspect the property you plan to purchase. pay. She would like to make a lower bid,
but the housing market is tight, and she
USE COMMUNICATION SKILLS worries that someone else may buy the
5. Owner Obligations Imagine that you house at the listing price. Renée wonders
are a condominium owner attending a what she should do.
meeting of the condominium association. Analyze Working in a small
What should the association do about a group, brainstorm some ideas about
homeowner who leaves garbage in the hall- what factors Renée should consider in mak-
way? Should the association limit the use of ing a decision.
the pool and tennis courts to owners?
Chapter 7 The Finances of Housing 227
Chapter 7 Review & Activities
CHAPTER SUMMARY
• Renting tends to be less expensive Disadvantages include financial risk,
than buying and offers more flexibility. the possibility of value not increasing,
Home ownership offers stability, limited mobility, and high expenses.
financial benefits, and increased value • When evaluating property, walk
over time. through the neighborhood, check the
• Renting a residence has the advantages home exterior and interior, and get a
of mobility, few maintenance home inspection.
responsibilities, and relatively low • A down payment is needed to purchase
initial costs. Disadvantages include a home. Then a buyer must get a long-
rent increases, few tax benefits, and term loan, or mortgage, to pay for the
restricted activities. remaining purchase price. Closing costs
• The cost of renting is affected by the must also be paid.
neighborhood, space, monthly rent, • To sell a home, decide whether to use
security deposit, and renters insurance. a real estate agent, prepare the home,
• Advantages of owning a residence set a fair price, and keep the home neat
include stability, individual expression, and clean.
tax benefits, and increased value.
Communicating Key Terms
With a partner, role-play a real estate agent and a client discussing preparations for closing on
a house. Write a script of the conversation you would have, using most of the terms below.
• mobility • private mortgage • home equity loan
• tenant insurance (PMI) • refinance
• landlord • mortgage • closing
• lease • points • title insurance
• security deposit • amortization • deed
• renters insurance • fixed-rate mortgage • appraisal
• equity • adjustable-rate mortgage
• escrow account (ARM)
Reviewing Key Concepts
1. Evaluate the various housing alternatives that are available.
2. List the advantages and disadvantages of renting.
3. Identify the costs of renting.
4. List the advantages and disadvantages of owning a residence.
5. Explain how to evaluate a property.
6. Discuss the financing involved in purchasing a home.
7. Describe a plan for selling a home.
228 Unit 2 Banking and Credit
Chapter 7 Review & Activities
Language Arts Different life circumstances affect housing needs for
people at different stage of their lives.
Write About It Write a paragraph describing the housing needs of a
28-year-old married couple expecting a baby in six months, who have a
combined annual income of $62,000. Compare their needs with those of
a 23-year-old single person who is earning $36,000 a year.
Choosing Prices Imagine that you want to purchase a home and you
have narrowed your choice down to three different houses. The prices for the
houses are: House #1—$165,000; House #2—$151,000; House #3—$172,000.
1. Calculate the monthly mortgage payment for each home, assuming that
there will be a 10 percent down payment and a 30-year mortgage with a
simple interest rate of 5.2 percent.
2. Compute by going to the Web site of a real estate company or bank to
find current interest rates and monthly payments.
Connect with Math Today it is possible to buy a home without
making a down payment. This is called a 100 percent mortgage. It is
available to people with good credit scores and usually requires private
mortgage insurance and slightly higher interest on the overall loan.
1. Research Use an Internet search engine to find a financial institution
that offers 100 percent mortgages.
2. Think Critically For whom would a 100 percent mortgage be a
good deal?
Selling a Home Your neighbors are thinking of selling their
two-bedroom home in the suburbs and moving to a two-bedroom
condominium. Help them make this decision.
Log On Use an Internet search engine to find local real estate Web
sites. Answer these questions:
1. What is the average asking price of a two-bedroom home in your
neighborhood or nearby?
2. Based on the prices you find, would you advise a neighbor to sell this type
of home? Why or why not?
Newsclip: Low Interest Rates Home prices have been on the rise
since 2000, driven by low interest rates that make mortgages affordable.
O N L I N E
Log On Go to finance07.glencoe.com and open Chapter 7. Learn
more about the different types of mortgages available. How is buying a
home different today? Write a list of answers.
finance07.glencoe.com Chapter 7 The Finances of Housing 229
Chapter 7 Review & Activities
WHERE WOULD YOU LIKE
TO LIVE?
There are many factors that will help you decide where to live. These
factors may change over the next few years. As you look into your
housing options, you will need to consider your lifestyle, family situ-
ation, finances, and future plans. Here is a quick quiz to test your preferences. Write your
answers on a separate sheet of paper.
1. I do not care about having a yard.
True False
2. My income varies right now.
True False
3. I never want to own a house or a condominium.
True False
4. I need to be able to move at any time.
True False
5. I want to keep my expenses as low as possible.
True False
6. I do not want to be responsible for repairs and upkeep.
True False
7. I do not plan to have a family for a while.
True False
Scoring: The more “true” answers you have, the better it is for you to rent an apartment
and postpone house hunting until you are ready.
230 Unit 2 Banking and Credit
Chapter 7 Review & Activities
Your Financial Portfolio
Renting or Buying Your Home
Atul and Elena have saved enough money to buy a townhouse and have found one
they like, but they need to consider how much it will actually cost to live there. The
rent on their apartment is $700 a month ($8,400 a year), and the townhouse costs
$85,000. They will need to consider any additional costs.
Atul and Elena’s Dilemma
Rental Costs
Annual rent payments $8,400
Renters insurance 170
Total annual cost of renting $8,570
Buying Costs
Down payment (at 10%) 8,500
Annual mortgage payments 8,060
Property taxes (annual costs) 1,275
Mortgage insurance (annual premium) 536
Homeowners insurance (annual premium) 400
Estimated maintenance costs 850
Financial Benefits of Home Ownership
Less: Tax savings for mortgage interest –1,820
Less: Tax savings for property taxes –357
Total cost of buying first year $17,444
Less: one-time down payment –8,500
Estimated annual appreciation (4%)* –3,400
Total long-term annual cost of buying $5,544
*Nationwide average; actual appreciation varies by geographic area and economic conditions.
Atul and Elena compared the annual costs of renting ($8,570) and buying
($5,544) and decided that it would be a good investment to buy the townhouse.
Compare
On a separate sheet of paper, compare renting versus buying your place of resi-
dence. Check a newspaper for a rental price for a two-bedroom apartment and a sell-
ing price for a two-bedroom house. Use those figures to complete your comparison.
Chapter 7 The Finances of Housing 231
Unit 2 LAB
Get a Financial Life!
Home Ownership Procedures
Overview STEP A The Process
Carrie and David’s combined
income is $85,000 a year. Their banker told
Carrie Houston finished her associate in them that the most they should spend for a
arts science degree at the local community col- home is 2.5 times their annual income.
lege and is now working as a fashion designer
for Outside Box Designs. Last year she married 1. Determine the maximum amount that
David Lanier, a high school computer science Carrie and David should spend on their
teacher and basketball coach. Carrie and David future home.
have many decisions to make as a married cou- 2. Write a list of the features in the home. Then
ple. One of their goals is to purchase a home write a two-paragraph description of their
within the next two years. Recently, Carrie and future home and draw a picture of it.
David met with a real estate agent and a banker. 3. Using the newspaper, real estate magazines,
The real estate agent helped them think about or the Internet, find an ad or listing for a
the features and location they want for their home in their price range. You might look
future residence. The banker discussed mort- in different regions of the country to find
gages and budgeting with the young couple. different price ranges. Clip or print the ad
Both Carrie and David realize that they have a or listing.
lot of research and planning ahead of them. 4. Request an amortization table from a
local bank, or find one on the Inter-
net. Determine Carrie and David’s
monthly mortgage payment based on cur-
Resources & Tools rent interest rates.
5. Contact a homeowners insurance company
• Crayons, markers, colored pencils
and find out the cost of insuring the home.
• Internet (optional)
6. Contact companies that provide electric-
• Newspapers and real estate magazines
ity, gas, water, cable television, telephone,
• Portfolio (ring binder or file folder)
and trash pickup. Determine the installation
• Public or school library
fees, deposits, and monthly cost of each
• Spreadsheet software (optional)
service for the home.
• Word processor
7. Using newspapers, catalogs, garage sale ads,
the Internet, or other sources, furnish their
home for $15,000. Provide a picture or a
drawing of the items bought.
8. Prepare a budget for Carrie and David for
their first year as homeowners. If possible,
use a spreadsheet program.
232 Unit 2 Banking and Credit
STEP B Create Your Portfolio
As you work through the STEP C Technical Writing and
Reading
process, save the results so that you can refer, Many workplaces need employees who are
review, and refine. Use a ring binder or a file skilled in technical writing and reading. Tech-
folder to create a portfolio of your work. nical writing is the process of communicating
technical information in writing, clearly and
1. The title of the binder or folder should be
accurately. To practice technical writing, com-
“Home Ownership.” Decorate the front of
plete activity 1 or activity 2 (below). Activity 3
the binder or folder—and be creative.
will allow you to practice technical reading.
2. Organize the results of Step A (2–8) in your
binder or folder. If possible, use a word pro- 1. When Carrie and David are ready to pur-
cessor to ensure that your work is neat and chase their home, they will have to decide
easy to read. which lender to use to obtain a mortgage.
3. Read a magazine article on one of the fol- Write a technical paper (one or two pages)
lowing topics: (1) buying your first home, outlining the steps Carrie and David must
(2) making home repairs, (3) decorating a take to choose a mortgage.
home, or (4) landscaping a home. Present a 2. Carrie and David have decided to acquire a
summary of the article to the class. credit card. Write a technical paper (one or
two pages) outlining the steps Carrie and
David must take to choose a credit card.
3. Exchange technical writing papers with
another student. Read your classmate’s paper
and critique it for accuracy, completeness,
punctuation, and grammar. Return each
other’s papers.
233
Unit 3
#
Investing
Financial
Resources
Internet
Project
Nest Egg
Everyone wants to look forward to the future
with confidence. Knowing you can be financially
secure helps to build that confidence. Savings and
investments are keys to financial security. If you do
not have the resources right now to save and invest,
you can begin planning to start your nest egg. In
this project, you will find investment experts and
get their advice about how a young person can get
ready to save and invest.
Log on to finance07.glencoe.com. Begin
by reading Task 1. Then continue on your
WebQuest as you study Unit 3.
Section 1.2
8.1 2.2
9.3 10.4
3.2 11.1
4.1
Page 241
xx 286
xx 337
xx 358
xx
234 finance07.glencoe.com/careers
finance07.glencoe.com
FINANCE FILE
The Best Homes for
Rollover IRAs
When you go to work for an
employer, you are not just getting a job
but a retirement account as well. You
will be stuck with the 401(k) that is
offered, and you get no opportunity to
shop around for more attractive invest-
ment options or services.
But when you leave your job—for
another one or to retire—the situation
changes. Chances are you will want to
roll over the money in the 401(k) to
an IRA that will probably become the
most important source of your income
throughout retirement.
“Anyone who is shopping to move
a 401(k) should identify three or four
options, and do a thorough analysis so
they understand the fees,” Doland [a
financial advisor] recommends. One
cost is fees for services, such as open-
ing or closing an account, or account
maintenance.
When you retire, you’ll be mak-
ing regular withdrawals from your IRA,
so easy access to information and good
service may be more important than
before. Online account management
is a great tool for keeping track of bal-
ances and withdrawals.
—By Ellen Hoffman
Write About It Why might
having a 401(k) retirement
account be important to someone
who already has Social Security?
Log On To read the complete
BusinessWeek article and do
the BusinessWeek Extension activity
to help you learn more about IRAs
and other investment options, go to
finance07.glencoe.com.
finance07.glencoe.com 235
8
CHAPTER
Saving and
Investing
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 8.1
• Explain how to establish goals
for a savings or investment
program.
• Discuss ways to obtain funds for
investing.
• Identify the factors that affect
your investment choices.
Section 8.2
• Identify the main types of
savings and investment
alternatives.
• Explain the steps involved
in developing a personal
investment plan.
Section 8.3
• Describe your role in a personal
investment program.
• Identify sources of financial
information.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
236
In the Real World . . .
T
N ext
ellie
here
Magdaleno has been working as a part-time
florist. She opened a checking account for her regular expenses as
well as a savings account to earn interest. However, she earns only pennies
for each dollar she saves. So Nellie has been researching stocks, bonds, and
mutual funds. She has found investment plans that will earn her more interest
than a savings account. She is excited about finding a way to make her money
work for her and hopes to save enough to invest in real estate one day.
Different types of investments are suitable for different personalities,
situations, and stages of life.
As You Read Consider how your personality and goals will
affect your choices for investment and savings plans.
Investments
ASK Q: After paying my bills, I do not have much
money left over. I save any extra that I get. Since I do
not have a lot of money, why should I even consider investing?
A: If inflation increases at a higher rate than your savings account return, you can
lose purchasing power. To stay ahead of inflation and taxes, the money you set aside
for long-term goals will need to earn more than the rates usually paid on savings
accounts. Consider other investments that can earn a higher return.
Ask Yourself Besides investing some of your money, what are some other
things that you could do to help you reach your long-term financial goals?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com
nance07.glencoe.com/s+p Chapter 8 Saving and Investing 237
Section 8.1
Focus on
Reading
Preparing for
a Savings or
Read to Learn
• How to establish goals
Investment Program
for a savings or invest-
ment program.
• How to discuss ways Establishing Your Financial
to obtain funds for
investing. Goals
• How to identify the Why are financial goals important to your future?
factors that affect your
investment choices. When you think about the future, do you picture yourself own-
ing your own home, being the president of your own company, or
Main Idea retiring at age 50? You might want to travel or start a family. No
Laying a foundation for matter how much you may want to have something, you will not
your savings or investment acquire it if you cannot pay for it.
program will help ensure To gather the funds, you need to plan carefully—and have self-
that you meet your future discipline along the way. If you are saving or investing to meet a goal
financial goals. that will make you happy and financially secure, the sacrifices you
make will be worth it.
Key Terms A savings or investment plan starts with a specific, measurable
• emergency fund goal. For example, you may want to save $15,000 to make a down
• speculative investment
payment on a house five years after graduating from school. To reach
• dividends
• retained earnings that goal, a savings account provides safety but does not increase in
• investment liquidity value quickly. An investment may be safe or risky and increase in
value slowly or quickly—or it may lose value.
You might also decide that you should begin saving money in
an emergency fund—a savings account that you can access quickly
Before to pay for unexpected expenses or emergencies. For example, if you
You Read had to pay for an unexpected car repair or if you lost your job, you
could use the money you put away in your emergency fund.
PREDICT
Can you think of any rea- Your Goals and Values
sons to risk putting money
in investments instead of a Your goals should correspond with your values. At one extreme,
savings account? some people save or invest as much of each paycheck as possible.
The satisfaction they get from fulfilling long-term financial goals is
more important to them than spending a lot of money on something
temporary, such as a weekend trip. At the other extreme, some people
spend every cent they earn, and then run out of money before they
receive their next paycheck.
238 Unit 3 Investing Financial Resources
Outlining Goals
It is probably wise to take a middle-of-the-road approach. You
can spend money on some things you enjoy and still save enough
for a savings or investment program. As you will learn, even a small
amount of money saved or invested on a regular basis can add up to
a large amount over time.
As you outline your financial goals, ask yourself these questions:
• How do I want to spend my money?
• How much money do I need to satisfy my goals?
• How will I get the money?
• How long will it take to save the money?
• How much risk am I willing to take when I invest?
• What conditions in the economy or in my life could change
my investment goals?
• Are my goals reasonable, considering my circumstances or
future circumstances?
• Am I willing to make sacrifices to save?
• What will happen if I do not meet my goals?
Performing a Financial Check-Up
How can you assess the health of your finances?
Before you think about investing for the future, you must take
steps to be sure your personal finances are in good shape. Then you
will be ready to move ahead with your financial plan. See Figure 8.1
on page 240 for tips on how to perform your own financial check-up.
Money to Get Started
What are some sources of money to invest?
After you have set your goals and completed your financial
check-up, you are almost ready to start saving or investing. But first
you have to get the money. Here are a few ways to do that.
Pay Yourself First
People often save or invest money that is left over after they
have paid all their other expenses, from monthly bills to video games.
As you might guess, in many cases, nothing is left over. Here is a As You
better approach: Read
1. Include the amount you want to save in your monthly RELATE
expenses. Pay that amount first. Consider it as a bill that you
If you used the pay-yourself-
owe to yourself. first plan, how much would
2. Pay your monthly living expenses, such as rent and food. you be able to save each
3. Use money that is left over for personal pleasures, such as month?
going to the movies or buying a new CD.
Chapter 8 Saving and Investing 239
Figure 8.1 Your Financial Checkup
Keeping your personal finances
in order is an important step
in meeting your long-term
financial goals.
1 Balance your budget. Spend less money
than you make; stay out of debt; and limit your
credit card use. Eventually, the amount of cash
remaining after you pay your bills will increase.
You will be able to use that money to start a
savings program.
2 Have insurance. When you
are on your own, you should have
enough insurance to cover losses
from events such as a car accident,
a medical emergency, or theft.
3 Start an emergency fund.
Save money that you can access
quickly to help you pay for
unexpected situations, such as
not being able to work.You
should have enough money to
cover living expenses for three
to nine months.
4
Have other sources of cash. A source might
be a line of credit with a financial institution or
cash advance capability from a credit card com-
pany. Use it only for serious emergencies.
240 Unit 3 Investing Financial Resources
Employer-Sponsored Retirement Plans
If your employer offers a retirement plan, usually a 401(k) or
403(b) plan, you can take advantage of a ready-made investment pro-
gram. Saving is simple because an amount you choose is deducted Nest Egg
automatically from each paycheck. Many employers match part or all Before you can save and
of the money you save. For example, for every dollar you contribute, invest, you have to pay
your employer may put in 25 cents, 50 cents, or even a dollar, which your bills—every month!
That means sticking to
would double your savings. In addition, money put in a retirement
a budget. Learn about
fund is not taxed until you withdraw it—usually at retirement age. budgeting—why it is
Starting an employer-sponsored or private retirement plan is an important, how to do it,
important step toward having financial security when you are older. and how to maintain
Most people will need this retirement income in addition to Social it—and create a budget
Security as the Social Security system is revised. To learn more about that reflects your needs
today.
retirement plans, read Chapter 15.
To continue with
Task 2 of your
Elective Savings Programs WebQuest project, visit
Some employers provide the option of having money automati- finance07.glencoe.com.
cally withheld from your paycheck and deposited in a standard sav-
ings account. On your own, you can also arrange with a mutual fund
or brokerage firm to take a certain amount from your bank account
every month and invest it. This is an easy way to save because you do
not have to think about it. You may be less tempted to use the money
if you never see it. An elective savings program is an excellent way to
fund a traditional IRA or Roth IRA account.
Special Savings Effort
Another way to save is to set aside a specific time each year when
you cut back sharply on what you spend and put the money you save
in an investment fund.
Gifts, Inheritances, and Windfalls
During your lifetime, you might receive gifts of money, or you
might inherit some money. You may also receive bonuses at work, tax
refunds, and salary raises.
What would you do with that money? Often people choose to
spend this extra money on something they could not afford under
normal circumstances. Consider Jihwan’s plan and whether you
would make the same choice.
When Jihwan received his income tax refund, his friends sug-
gested that this would be the perfect time to buy a big-screen tele-
vision. Jihwan’s friends were disappointed when he decided to put
the money in a certificate of deposit that earned 6 percent interest.
Jihwan did not mind watching television on his parents’ 19-inch TV
screen because his savings deposit was increasing. No one can make
you save money to finance a savings or investment program. You
have to choose to do it.
finance07.glencoe.com Chapter 8 Saving and Investing 241
The Value of Long-Term
Investment Programs
Why should you invest in a long-term program?
Many people do not start investing because they have only a
small amount of money. Others believe that they are too young to
invest. However, having a small amount of money in a bank account
should not stop you.
Remember that small amounts of money add up because of
the time value of money. As you read in Chapter 1, the time value of
money is the increase in an amount of money due to interest earned
over time.
Figure 8.2 shows the growth of $2,000 during different time
periods and at different rates of return. A rate of return is the per-
centage of increase in the value of your savings due to earned
interest. Remember that you must continue to add money to your
investments to see the growth that is represented in Figure 8.2.
&IGURE ,ONG 4ERM )NVESTING AND 'ROWTH
"ALANCE AT %ND OF 9EAR
2ATE OF
2ETURN
'ROWING 7ILD 4HE GROWTH SHOWN IN THIS TABLE AT DIFFERENT RATES OF RETURN ASSUMES THAT YOU
WILL INVEST AT THE END OF EACH YEAR
7HY WOULD YOU BE WILLING TO INVEST A YEAR FOR A LONG TERM
242 Unit 3 Investing Financial Resources
Making Investment Decisions
What are the factors you should consider when
choosing investments?
Once you know how much money you need to meet your goals,
you then have to think about where to invest it. To make that deci-
sion, you need to understand the different risk factors. Also, you
should consider each investment’s potential for income and growth
as well as its liquidity.
Safety and Risk
In the financial world, the words safety and risk have specific
meanings. Safety means that the chance of losing your money in an
investment is fairly small. Risk indicates that you cannot be certain
about the profit of your investment. You can select investments that
are very safe or very risky, or in between these extremes.
Generally, if you choose a safe investment, your rate of return will
be low. On the other hand, a speculative investment is considered a
high-risk investment that might earn a large profit in a short time. The
disadvantage of a speculative investment is the possibility that at any
time you could lose most or all of the money you invest. Figure 8.3
categorizes each type of investment according to its safety record.
&IGURE 4YPICAL )NVESTMENT 2ISKS
3AFE #AN 6ARY (IGH 2ISK
s 'OVERNMENT BONDS s 3TOCKS s #OMMODITIES
AND DEBT SECURITIES
4REASURY BILLS s #ORPORATE BONDS s /PTIONS
4REASURY NOTES
4REASURY BONDS s -UTUAL FUNDS s 0RECIOUS METALS AND
-UNICIPAL BONDS GEMS
s 2EAL ESTATE
53 3AVINGS "ONDS
s #OLLECTIBLES SUCH AS
s 3AVINGS ACCOUNTS COINS STAMPS AND
COMIC BOOKS
s #ERTIFICATES OF DEPOSIT
#$S
)NVESTMENT 3PECTRUM /NLY YOU CAN DECIDE HOW MUCH RISK YOU ARE WILLING TO TAKE
7HY DO YOU THINK SAVINGS ACCOUNTS AND CERTIFICATES OF DEPOSIT
ARE CONSIDERED SAFE INVESTMENTS
Chapter 8 Saving and Investing 243
One basic rule sums up the relationship between the factors
TechByte
From Ticker Tape to
of safety and risk: The potential return on any investment should
be directly related to the risk you, the investor, take. Your attitude
toward risk will vary according to your circumstances. For example,
PDAs In 1870, Thomas when you are young, you may be more willing to take risks because
Edison invented the you have long-term investment goals. When you are older and close
first practical ticker-tape to retirement, you may decide to shift your investments from specu-
machine. With a printing
lative to conservative investments to be sure that you will not lose
speed of one character
per second, it enabled your life savings.
people to track changes Beginning investors may be afraid of the risk associated with
in the prices of stocks some investments. However, it helps to remember that without risk,
and bonds. Information it is impossible to obtain returns that make investments grow. The key
was printed on long thin is to determine how much risk you are willing to take. Then choose
strips of paper called
quality investments that offer higher returns without an extremely
ticker tape. Used ticker
tape was cut into a form high risk.
of confetti and tossed
in ticker-tape parades. Five Components of Risk
Today you can have data
from the world’s mar- Evaluate the overall risk factor of an investment by examining
kets, streaming charts, five different components of risk:
and analysis downloaded
to your Smart Phone or 1. Inflation
Personal Digital Assistant 2. Interest rate
(PDA) through a service 3. Business failure
called QuoTrek.
4. Financial market
Read more about 5. Global investment
how to get finan-
cial information on the Inflation Risk Inflation is a persistent economic condition that
go and make a list of
affects everyone. For example, when Harry Majors opened his deli in
the features available
with QuoTrek through 1985, he framed the first dollar he earned and hung it on the wall.
finance07.glencoe.com. Twenty years later, one of his customers reminded him that his 1985
dollar could now buy less than 50 cents’ worth of salami. The loss of
value to Harry’s dollar was a result of inflation, which is a general rise
in prices that affects everybody.
Investing your money can help you stay ahead of inflation. How-
ever, during periods of rapid inflation, the return from your invest-
ments might not keep up with the inflation rate. When that happens,
you lose buying power, and your money will buy less.
You can calculate the effect of inflation on your investments.
First, subtract your rate of interest from the inflation rate. This is your
loss of buying power converted to a percentage. Then multiply that
percentage by the original amount of your investment. The result is
your loss of buying power in dollars. (See the Go Figure box.)
In addition, you can find out the current price of your invest-
ment, based on the rate of inflation during the period that you held
the investment. Multiply the original price of the investment by the
rate of inflation. Add that figure to the original price of the invest-
ment. The result is how much it would cost you to purchase the same
investment today.
244 Unit 3 Investing Financial Resources finance07.glencoe.com
Some investments will protect you from inflation better than
others. For example, over the period from 1926 to 2002, the com-
pounded rate of return on common stocks adjusted for inflation was
7 percent. Concurrently, U.S. Treasury bills (T-bills) had an inflation-
adjusted compounded rate of return of only 0.6 percent. During that
time, common stocks provided a better protection against inflation
than did T-bills.
Interest Rate Risk If you put money in an investment that
gives you a fixed rate of return (stable rate), such as government or
corporate bonds, the value of your investment will go down if interest
rates go up. If you have to sell your bonds, you will get less than you
originally paid.
To figure out the market price of a $1,000 bond if interest rates
go up, divide one year of interest at a fixed rate of 8 percent by the
new higher interest rate of 10 percent. (See the Go Figure box on
page 246.) If you hold onto the bond until maturity, you will get your
full $1,000 back, but you will receive only 8 percent annual interest.
GO FIGURE FINANCIAL MATH
INFLATION RATE AND Solution: $500 ⫻ 2% or .02 ⫽ $10
INVESTMENTS Nina lost $10.
Synopsis: When prices and the cost of living rise in C. Calculate how much it would cost to buy the
one year, your money will buy less and be worth less same investment today:
than it was during the prior year. For example, $500
Formula: (Original Price of Investment ⫻ Inflation
this year will buy less than it did last year.
Rate) ⫹ Original Price of Investment ⫽ Current Price
Example: Nina put $500 in a certificate of deposit of Investment
for one year at 3 percent interest. The inflation
Solution: ($500 ⫻ 5% or .05) ⫹ $500 ⫽ $525
rate during that year was 5 percent. How much of
her buying power did she lose? How much money Nina would need $525 at the end of the year to buy
would she need at the end of the year to buy what what she bought a year ago with $500.
she bought a year ago with $500?
A. Calculate the percentage of the loss of buying
power:
Formula: Inflation Rate ⫺ Interest Rate ⫽ Loss-of-
Buying-Power Percentage YOU FIGURE
Solution: 5% ⫺ 3% ⫽ 2% Loss of Buying Power A year ago, you worked part-time and put
$1,000 in a savings account. The interest rate for
B. Calculate the loss of buying power in dollars:
one year was 6 percent. The inflation rate dur-
Formula: Original Price of Investment ⫻ Loss of ing that year was 4 percent. How much money
Buying Power Percentage ⫽ Loss of Buying Power would you need at the end of the year to buy
in Dollars what you bought a year ago with $1,000?
Chapter 8 Saving and Investing 245
GO FIGURE FINANCIAL MATH
A BOND’S MARKET PRICE Solution: $80
⫽ $800
WHEN INTEREST RATES GO UP 10% or .10
Synopsis: A bond’s interest earnings can be reduced You would get $800, which equals a loss of $200.
if you sell it before the maturity date when bond rates ($1,000 ⫺ $800 ⫽ $200).
are higher than those at time of purchase.
Example: You buy a $1,000 corporate bond that YOU FIGURE
pays a fixed rate of 8 percent interest. You earn $80 You buy a $1,500 corporate bond that pays
a year ($1,000 ⫻ 8% or .08 ⫽ $80) until maturity. a fixed rate of 8.5 percent interest. You earn
What price would you get if you sold it before the $127.50 a year ($1,500 ⫻ .085 or 8.5% ⫽
maturity date when bond rates were 10 percent? $127.50) until maturity. What price would you
Formula: Annual Interest Earned get if you sold it before the maturity date when
⫽ Market Price
New Interest Rate bond rates were 11 percent?
Business Failure Risk This type of risk applies to common stock,
preferred stock, and corporate bonds. When you buy stocks or corporate
bonds, you are investing in a particular company. You are betting that
the company will succeed. However, it could fail, especially if the
company is managed poorly. Even if the company offers a valuable
product or service, positive response from customers is not guaranteed.
Lower profits usually mean lower dividends, which are distributions of
money, stock, or other property that a corporation pays to stockholders.
If the company declares bankruptcy, your investment may become
worthless. Your best protection is to do careful research on companies
in which you might invest. Another good idea is to invest your money
LANGUAGE ARTS in more than one company.
It is commonly thought
that choosing a foreign Financial Market Risk Sometimes the prices of stocks, bonds,
investment is more com- mutual funds, and other investments go up or down because of the
plicated than choosing a overall state of financial markets. The value of a stock may decrease,
domestic one. In actual- even though a company is financially healthy. Factors that affect
ity, however, the process
is much the same. When
financial markets include social and political conditions. For example,
searching for a foreign the price of oil stocks may be affected by the political situation in the
mutual fund, for example, Middle East, where much of the world’s oil supply is produced.
you should look for the
characteristics you would Global Investment Risk Today many investors are investing their
look for in a domestic one, money in stocks and bonds issued by companies in other countries.
such as strong relative Because these types of investments may be risky, financial analysts
performance over time advise small investors to invest in global mutual funds, instead of
and reasonable expenses. individual international stocks. Global mutual funds are offered by
Research foreign invest-
U.S. firms. These mutual funds specialize in companies that operate
ments and write a para-
graph describing its benefits in another nation or region of the world. A mutual fund includes
and its drawbacks. stocks or bonds from many companies and may offer more safety
than one company’s stocks or bonds.
246 Unit 3 Investing Financial Resources
GO FIGURE FINANCIAL MATH
A BOND’S MARKET PRICE WHEN Solution: $80
⫽ $1,333.33
INTEREST RATES GO DOWN 6% or .06
Synopsis: You may profit from selling a bond You would receive $1,333.33, which equals a profit
before maturity when bond interest rates are lower of $333.33 ($1,333.33 ⫺ $1,000 ⫽ $333.33).
than those at time of purchase.
Example: Your $1,000 corporate bond pays a fixed
rate of 8 percent interest, or $80 a year ($1,000
⫻ 8% or .08 ⫽ $80). What price would you get if YOU FIGURE
you sold it before maturity when bond rates were Your $1,200 corporate bond pays a fixed rate of
6 percent? 8.5 percent interest, or $102 a year ($1,200 ⫻
8.5% or .085 ⫽ $102). What price would you get
Formula: Annual Interest Earned
⫽ Market Price if you sold it before maturity when bond rates
New Interest Rate
were 6 percent?
If you plan to invest in companies outside the United States,
take these steps:
1. Evaluate international investments as if they were
U.S. investments: Be aware that because of different
accounting standards in other countries, it may be hard to
discover the true financial condition of foreign companies.
2. Consider the currency exchange rate: This rate may
affect the return on your investment, favorably or unfavor-
EXPLORING NEW
ably. For example, if you buy stock in a French company,
WORLDS When investing
stock dividends will be paid to you in euros and then con-
in global mutual funds,
verted to dollars.
evaluate the choices care-
Also, keep in mind that the economic and political stability of a fully. How does the currency
country can affect the value of your investment. It is risky to invest in exchange rate affect the
stocks and bonds issued by individual companies in other countries. return on an international
Only experienced investors should consider this option. investment?
Investment Income
There are a variety of other types
of investments for income. If you want a
dependable source of income, you have sev-
eral choices. The safest and most predict-
able investments include: savings accounts,
certificates of deposit (CDs), U.S. Savings
Bonds, and U.S. Treasury bills. With these
programs, you know the interest rate and
how much interest income you will receive
on a specific date.
Chapter 8 Saving and Investing 247
TAKING CHANCES Only Other sources of investment income include government bonds,
experts may be able to han- corporate bonds, preferred stocks, utility stocks, certain common
dle the risk of speculative stocks, annuities, and stable mutual funds. Before investing in stocks
investments. Can you afford or corporate bonds, obtain information about the company’s overall
to lose money on a speculative profits, its history of dividend payments, and its outlook for the future.
investment? Be sure to check out the costs associated with annuities before invest-
ing. See Chapters 9 and 10 for more information on stocks, bonds, and
mutual funds.
Real estate rental property also offers income, but it is not guar-
anteed. For example, your profits from a rental property may be lower
than expected if you have vacancies or expensive repairs. In addition,
Real Estate Investment Trusts, or REITs, also offer income that is not
guaranteed. These trusts are similar to mutual funds. See Chapter 11
for more information on real estate and other investments.
Speculative investments, such as commodities, options, precious
metals and gems, and collectibles, offer little potential for income
and are risky. These types of investments are more appropriate for
investors who have expertise and experience in these markets.
Investment Growth
To investors, growth means that their investments will increase
in value. The best opportunities for growth usually come from com-
mon stocks and growth stocks. A growth stock is a common stock
issued by a corporation. This type of stock has the potential to earn
above-average profits in comparison to other corporate stocks.
248 Unit 3 Investing Financial Resources
Growth companies usually reinvest their profits rather than
pay dividends. Retained earnings are profits that a company rein-
As You
vests, usually for expansion or to conduct research and development.
Read
Growth that is financed by retained earnings usually contributes to QUESTION
increasing the stock’s value. Therefore, if you buy stock in a growth
company, you may not receive immediate cash dividends, but you If you want to buy a house
in ten years, should you
will benefit because your stock may increase in value.
put your money in a CD or
invest it in growth stocks?
Investment Liquidity Why?
A final factor to consider when choosing investments is
investment liquidity—the ability to buy or sell an investment
quickly without substantially reducing its value. You may be able to
sell some investments quickly, but market conditions or other factors
may prevent you from regaining your original investment.
A passbook savings account is an example of a high-liquidity
investment, because you can withdraw all your money immediately. A
low-liquidity investment requires more time to sell your investment.
An investment in real estate is usually a low-liquidity investment
because finding a buyer takes time.
Section 8.1 Assessment
QUICK CHECK Analyze With a small group of
1. What steps should you take when prepar- classmates, discuss the five compo-
ing to establish an investment program? nents of risk. Decide which components of
2. How can you obtain the money you need risk might affect every investor.
to start investing?
SOLVE MONEY PROBLEMS
3. What factors might affect your investment
choices? 6. Preparing for Emergencies Roya and
Sashi are performing a financial check-up.
THINK CRITICALLY They are trying to decide how much
4. A friend wants to invest a $500 bonus she money to put into an emergency fund and
received. What would you advise? what type of account to open. The couple
has $3,000 in take-home pay a month and
USE COMMUNICATION SKILLS monthly living expenses of $2,600. They
5. Risk Tolerance Everyone has a different have a young child and a limited health
tolerance for risk. Some people will try any- insurance plan. They are worried about
thing once, including skydiving and white- unexpected expenses.
water rafting. Others take every precaution Write About It Write a plan
to avoid danger. describing how much money Roya
and Sashi should have in their emergency
fund and what type of account they should
choose for the fund.
Chapter 8 Saving and Investing 249
Section 8.2
Focus on
Reading
Savings and
Investment Options
Read to Learn
• How to identify the main
types of savings and Types of Investments
investment alternatives. How would you invest your money?
• How to explain the steps
involved in developing When you have your personal finances in order, an emergency
a personal investment fund, and money for investments, and you know how much risk
plan. you can take, you can begin to research different types of investment
alternatives: stocks, bonds, mutual funds, and real estate.
Main Idea
The more you know about
different investment oppor-
Stocks
tunities and the planning A business that is owned by one person gets operating money
process, the better able you
from that one owner, who is the sole proprietor. In a partnership,
will be to select a savings
or investment program that the partners provide the money, or equity capital. Equity capital
meets your needs. is money that a business gets from its owners in order to operate. A
corporation gets its equity capital from its stockholders, who become
Key Terms owners when they buy shares of stock in the company. The two basic
• equity capital types of stock are common and preferred.
• common stock
• preferred stock Common Stock Common stock is a unit of ownership of a
• corporate bond company, and it entitles the owner, or stockholder, to voting privi-
• government bond leges. Common stock can sometimes provide a source of income if
• mutual fund the company pays dividends. Stock can provide growth profits if
• diversification the dollar value of the stock increases. In addition, if the company
“splits” its stock, or divides shares into a larger number of shares, the
stockholder gains because he or she will get more shares. Most large
corporations generate money they need by selling common stock.
Before
You Read Preferred Stock A corporation may also issue preferred stock.
Preferred stock is a type of stock that gives the owner the advantage
PREDICT
of receiving cash dividends before common stockholders receive
Since stock investments cash dividends. This is important if a company is having financial
can be risky, why do you problems. If a company fails, preferred stockholders receive dividends
think people choose them? first and any assets that are left before common stockholders receive
anything. Chapter 9 discusses other factors you should consider
when buying common or preferred stock.
Stock can be an attractive investment because, as owners, stock-
holders share in the success of the company. However, you should
consider several facts before you invest in stock.
250 Unit 3 Investing Financial Resources
1. A corporation does not have to repay you what you paid for
the stock. If you want to sell your stock, another investor
As You
must buy your shares through a stockbroker.
Read
2. The current value of your stock is partially determined by RELATE
how much another investor is willing to pay for your shares.
3. The corporation does not have to pay dividends. If the Are you willing to invest
your money in stock, or
company has a bad year or decides to reinvest earnings,
would you prefer to keep
the board of directors can vote to eliminate dividend your money in a CD?
payments.
Corporate and Government Bonds
You may also consider investing in bonds. There are two types
of bonds an investor can consider: a corporate bond and a govern-
ment bond. A corporate bond is a corporation’s written pledge to
repay a specific amount of money, along with interest. A govern-
ment bond is the written pledge of a government or a municipality,
such as a city, to repay a specific sum of money with interest. When
you buy a bond, you are lending money to a corporation or govern-
ment entity for a period of time.
The Value of a Bond Two key factors affect the value of a bond:
(1) whether the bond will be repaid at maturity and (2) whether
the corporation or government entity
will be able to pay interest until
maturity. Maturity dates range from 1
to 30 years, and interest on bonds is
usually paid every six months. You can
keep a bond until maturity and then
redeem it, or you can sell it to another
investor. In either case, the value of
the bond is closely tied to the ability
of the corporation or government
agency to repay the bond at maturity.
If a corporation or government agency
cannot pay the interest on its bonds,
the value of those bonds will decrease.
Some investors also make money on
bonds by receiving regular interest
payments until maturity.
PAYING UP Government bonds offer a
fixed rate of interest. What are two key con-
siderations for buying a government bond?
Chapter 8 Saving and Investing 251
Mutual Funds
A mutual fund is an investment in which investors pool their
money to buy stocks, bonds, and other securities selected by profes-
sional managers who work for an investment company. Their knowl-
edge is an advantage for inexperienced investors. If one of the fund
stocks or other securities performs poorly, the loss can be offset by
gains in another stock or security within the mutual fund. Chapter 10
provides information on types of funds.
Real Estate
The goal of real estate investing is to own property that increases
in value so that you can sell it at a profit—or to receive rental income.
When you invest in real estate, you need to find out if the property is
priced as similar properties. You also need to know what financing is
available and the cost of property taxes.
Before making a decision to purchase any property, ask the fol-
lowing questions: Why are the present owners selling? Is the property
in good condition? What is the condition of other properties in the
area? Is there a chance that the property will decrease in value?
When you sell real estate, consider these questions: Can you find
an interested buyer? Can the buyer get financing to buy the property?
Chapter 11 provides more information on real estate investments.
Careers in Finance
CREDIT ANALYST
INVESTMENT Michelle Bondi
ANALYST Robert Half Finance & Accounting
Michelle Bondi is fascinated with the world of finance. She studies and tracks the performance of
financial market sectors, such as finance or construction. In addition to tracking the performance of
individual stocks, Michelle studies the factors that affect them and compares the stocks’ results with
other similar stocks. She prepares internal and external reports on a stock’s financial health on a daily
basis or as requested. Investment analysts enjoy making connections between the news and eco-
nomics, as well as finding patterns in the unpredictable world of finance.
SKILLS: Math, statistics, economics, and teamwork skills
PERSONAL TRAITS: Analytical, methodical, rigorous, self-starting, and up-to-date in current events
EDUCATION: High school diploma or equivalent; bachelor’s degree in finance, accounting,
economics, or business
ANALYZE Why would an investment analyst need to be aware of news and current events?
To learn more about career paths for investment analysts, visit finance07.glencoe.com.
252 Unit 3 Investing Financial Resources finance07.glencoe.com
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: A Savings Goals Your Motive: In order to make large
Worksheet purchases or achieve lofty financial goals,
A savings goals worksheet contains this you need a savings plan. A savings plan will
information: help you determine how much you need to
• Your savings goal reach your goals and how long it will take
• Amount you have to achieve them.
• Amount you need to achieve your goal
• Target date to goal
Savings Goals Worksheet
Name: Susan Sharpe
Amount Years to Amount
Target Current
Goals Cost Still Target to Save
Dates Assets
Needed Date This Year
Down payment to
2010 $30,000 $5,000 $25,000 5 years $5,000
purchase a house
Buy a new car 2008 $22,000 $7,000 $15,000 3 years $5,000
Save for retirement 2035 $500,000 $10,000 $490,000 30 years $10,000
Key Points: A savings plan should be Find the Solutions
ambitious but not unrealistic. Do not try to 1. How much should Susan save to reach her
set goals that you know you cannot reach. goal?
You should also reevaluate your savings plan 2. What should Susan save this year to be on
at least once each year to make sure your track to achieve her goals?
3. What assets other than savings might Susan
savings plan is on track with your goals.
use to help pay for a new car?
4. Why might Susan need to adjust her plan
each year?
5. Susan’s retirement savings plan calls for
saving $10,000 each year for 30 years to save
$300,000. However, she needs $490,000.
What missing factor will enable Susan to
achieve her savings goal?
Chapter 8 Saving and Investing 253
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Evaluating Investment
As You Alternatives
Read How would you diversify your investments?
QUESTION You have learned how safety, risk, income, growth, and liquidity
affect investment choices. You have also examined different invest-
Why is diversification ment possibilities. Which ones would you choose?
important?
As you make your choices, remember it is wise to diversify.
Diversification is the process of spreading your assets among several
different types of investments to reduce risk. You should avoid “put-
ting all your eggs in one basket.” Some financial advisers suggest that
you think of your investment program as a pyramid, as illustrated in
Figure 8.4. This strategy provides both financial growth and pro-
tection no matter what your age, circumstances, or level of financial
knowledge. Level 1 provides a solid foundation with safe invest-
ments. Once that foundation is built, you may choose from the alter-
natives listed in Levels 2 and 3, which carry moderate risk. Because
the investments in Level 4 are highly speculative, you may want to
skip that level entirely.
254 Unit 3 Investing Financial Resources
Developing a Personal
Investment Plan
How do you create an investment plan?
To be a successful investor, develop a plan and put it into action.
Each person has different ideas and goals. Establish your investment
goals first, and then continue to follow through. Often the follow-
through is the most important component of a successful, long-range,
personal investment plan. Follow a series of steps and begin earning
money through investment.
Consider this case: Ginny is single and has recently started
her first full-time job after graduation. Her monthly take-home pay
(after deductions for taxes and other items) is $1,600. Her monthly
expenses are $1,200. She has a surplus of $400 a month. She is using
her surplus to set up an emergency fund. She recently received an
inheritance of $5,000 when her grandfather died. She plans to use
this money to fund her investments.
Figure 8.5 illustrates how Ginny developed her individual
investment plan. Your plan may be quite different, but the steps will
be the same.
&IGURE 'INNYS 0ERSONAL )NVESTMENT 0LAN
3TEP 3TEP 3TEP
-Y )NVESTMENT 'OALS -ONEY .EEDED TO 2EACH 'OALS -ONEY !VAILABLE .OW
3TEP 3TEP ! 3TEP "
)NVESTMENT 2ISK &ACTOR FOR 0ROJECTED 2ETURN FOR
!LTERNATIVE %ACH !LTERNATIVE %ACH !LTERNATIVE
3TEP 3TEP 3TEP
4OP #HOICES &INAL $ECISION #ONTINUE %VALUATION
OF #HOICES
-ASTER 0LAN 'INNY DECIDED TO CHOOSE LOW RISK AND MODERATE RISK INVESTMENTS
7HY DO YOU THINK SHE MADE THIS DECISION
Chapter 8 Saving and Investing 255
You may find these steps helpful to get started:
Put on
Your 1. Establish investment goals.
2. Decide how much money you will need to reach those goals
Financial by a particular date.
Planner’s 3. Determine the amount of money you have to invest.
Cap 4. List all the investments you want to evaluate.
5. Evaluate the risks and potential return for each investment
Your client is young and on your list.
nervous, making a first
6. Reduce your list of possible investments to a reasonable number.
time investment of $5,000.
Would you advise investing 7. Choose at least two investments so that you have some
in a savings account or CD, diversity. You may want to add more investments as the
mutual fund, growth stock, value of your holdings grows.
or real estate? Explain why. 8. Because your investment goals may change as you go through
life, recheck your investment program regularly. Remember
that changes in the economy can affect your investments. For
example, if interest rates on certificates of deposit are high,
you might invest some of your money in a CD.
To develop your personal investment plan, establish your goals,
and then follow through. If your goals are important to you, you will
be willing to work to attain them.
Section 8.2 Assessment
QUICK CHECK Role-Play With a partner, role-
1. What are the main types of investment play two financial advisors: one who
alternatives? explains why high-risk investments, such
2. When choosing investment alternatives, as collectibles, are not wise; and one who
why is it wise to diversify? discusses why this type of investment is
3. What are the steps in developing a personal attractive to some people.
investment plan?
SOLVE MONEY PROBLEMS
THINK CRITICALLY 6. Developing an Investment Plan
4. Explain why financial advisers suggest that Every day after school, Trent volunteers at
your investment program be set up like a his neighborhood community center. He
pyramid. helps the young children with their home-
work and organizes sports activities. Trent
USE COMMUNICATION SKILLS really believes in the work that the center
5. Hidden Treasures? Today many people is doing. He wants to invest some money
purchase collectible items as investments. to donate to the center.
They buy baseball cards, commemorative Write About It Write a personal
coins, stuffed animals, and art. investment plan for Trent so that he
can reach his goal.
256 Unit 3 Investing Financial Resources
Section 8.3
Reducing Risk Focus on
Reading
and Sources of
Information Read to Learn
• How to describe your
role in a personal invest-
ment program.
Financial Planners • How to identify sources
of financial information.
What is the role of a financial planner?
When making your investment decisions, you may want to con- Main Idea
sult a financial planner, a specialist who is trained to offer specific By becoming an informed
financial help and advice. investor, you will be able
There are two main factors to consider when deciding if you to reach your investment
goals.
need a financial planner: (1) your income level and (2) your willing-
ness to make your own financial decisions. If you make less than
Key Terms
$45,000 a year, you may not need a planner’s services.
• financial planner
• tax-exempt income
Types of Financial Planners • tax-deferred income
• capital gain
Financial planners work for various insurance companies, invest- • capital loss
ment companies, real estate agencies, and law firms. Some are self- • prospectus
employed. There are four main types of financial planners:
1. Fee-only planners charge an hourly rate from $75 to $200
or a flat fee, ranging from about $500 to several thousand
Before
dollars. They may also charge an annual fee ranging from 0.04
percent to 1 percent of the value of the investments
You Read
they manage. PREDICT
2. Fee-offset planners charge an hourly or annual fee, but
How might investing
they reduce, or offset, it with the commissions, or earnings, change your income tax
they make by buying or selling investments. reporting?
3. Fee-and-commission planners charge a fixed fee for
a financial plan and earn commissions from the products
they sell.
4. Commission-only planners earn all their money through
the commissions they make on sales of insurance, mutual
funds, and other investments.
When hiring a financial planner, find out the exact fees for spe-
cific services. Also discuss how and when the fees will be collected
from you. There should be no hidden commission charges if the
financial planner provides “fee only” services.
Chapter 8 Saving and Investing 257
Selecting a Financial Planner
Look for a financial planner who will provide these basic
Giving Is Fun services:
1. Give whatever you
• Assess your current financial situation
can afford to your
favorite charity. • Offer a clearly written plan with investment recommendations
2. Donate old clothes,
• Discuss the plan with you and answer questions
toys, books, or eye- • Help you keep track of your progress
glasses instead of • Guide you to other financial experts and services as needed
money.
You can find a financial planner by looking in the yellow pages,
3. Cash in your bot-
by contacting financial institutions, and by getting recommenda-
tles and cans at
a recycling cen- tions from friends, coworkers, or professional contacts. Figure 8.6
ter and give the suggests questions that you might ask a financial planner to help you
money to charity. make a decision.
4. Volunteer at a
hospital, nursing
home, animal
Certification of Financial Planners
shelter, or favorite The requirements for becoming a financial planner vary from
charity. state to state. Some states require that financial planners pass an
5. Save $1 a week for exam. Other states issue licenses to individual planners and plan-
a year, and make
ning companies. Some states have no regulations at all. The federal
a donation to your
favorite charity. government requires that the Securities and Exchange Commission
(SEC) monitor the largest financial planning companies.
A financial planner may have credentials, such as Certified Finan-
cial Planner (CFP) or Chartered Financial Consultant (ChFC). Not all
planners are licensed, however. You should research and investigate
any financial planner you might be considering.
&IGURE 3ELECTING A &INANCIAL 0LANNER
7HEN EVALUATING A FINANCIAL PLANNER ASK THE FOLLOWING QUESTIONS
s 7HAT ARE YOUR AREAS OF EXPERTISE
s !RE YOU AFFILIATED WITH A MAJOR FINANCIAL SERVICES COMPANY OR DO YOU WORK
INDEPENDENTLY
s !RE YOU LICENSED OR CERTIFIED
s 7HAT IS YOUR EDUCATION AND TRAINING
s (OW IS YOUR FEE DETERMINED )S THIS AMOUNT SOMETHING ) CAN AFFORD
s !M ) ALLOWED A FREE INITIAL CONSULTATION
s -AY ) SEE A SAMPLE OF A WRITTEN FINANCIAL PLAN
s -AY ) CONTACT SOME OF YOUR CLIENTS AS REFERENCES
s )S FINANCIAL PLANNING YOUR PRIMARY ACTIVITY
2ESEARCH 2ESEARCH 4HIS TYPE OF INVESTIGATION TAKES TIME AND EFFORT
7HY DO YOU THINK IT IS WORTHWHILE
258 Unit 3 Investing Financial Resources
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis-
tics, information, and news, and analyzes this data for "EIJING
international businesses, governments, and individuals
to help guide their financial decisions.
CHINA
Though lagging behind the United States, China
is catching up as the number one consumer of oil. The
United States uses 20.5 million barrels of oil per day;
China uses 6.3 barrels. By 2010, that number may DATABYTES
double. The country’s swelling population—the world’s
largest—and increasing affluence has stimulated a Capital Beijing
fuel-driven economy. Thousands of factories stretch Population 1,288,679,000
across the country; car sales are up by 55 percent;
Languages Chinese (Mandarin), Cantonese,
and China’s electric power grids are on overdrive.
and other dialects and languages
Once energy independent, the country imports half of
Currency yuan, or Renminbi
its oil. Soon China
will be in serious Gross Domestic
competition with Product (GDP) $6.4 trillion (2003 est.)
other oil-consuming GDP per capita $5,000
nations for a dwin- Industry: Iron, steel, coal, machinery, armaments,
dling supply of oil. textiles and apparel, petroleum, and cement
Meanwhile, the Agriculture: Rice, wheat, potatoes, sorghum, pork,
country copes. In and fish.
one city, shopping Exports: Machinery and equipment, textiles, apparel,
malls lowered their footwear, toys, sporting goods, and mineral fuels
thermostats. In
Natural Resources: Coal, iron ore, crude oil, mercury,
another, electricity
tin, and hydropower
was cut off four days
a week to save on oil
consumption. Think Globally
Would you buy stock in a Chinese electricity company?
Why or why not?
Managing Your Investments
What should you do to manage your investments?
Most people do not have professional financial planners and
need to learn how to manage their own finances. Managing your
savings and investments requires ongoing attention. You can take
an active role by taking these steps: Evaluate investments; monitor
investments; keep accurate records; and consider tax consequences.
Chapter 8 Saving and Investing 259
As You Evaluating Investments
Read Always research and evaluate before you invest so that you can
RELATE make an informed decision. Suppose that you invest $2,000. With a
5 percent return the first year, you will earn $100. While your money
Would you want to man- is earning, you also need to continue to evaluate your current invest-
age your own investments ment. Evaluate future investment opportunities as well.
or hire a financial planner?
Monitoring Your Investments
Many people forget to keep track of or monitor the value of their
investments. Always keep track of the value of your stocks, bonds, or
mutual funds by checking price quotations reported on the Internet,
in newspapers, and on financial news programs. Keep a chart of the
value of your investments to check their progress over time.
LOOKING AHEAD Even if
an investment company han-
dles your money, always track
and evaluate your invest-
ments on a regular basis.
They will pay off for years to
come. What investment records
should you keep?
260 Unit 3 Investing Financial Resources
Keeping Accurate Records
Accurate recordkeeping helps you notice opportunities to
increase your profits or reduce losses. It can also help you decide Common
whether to put more money in a stock, bond, or other investment—
or to sell a particular investment. Keep purchase records that list the
CENTS
cost of the investment and commissions or fees you have paid. Also
A Dollar a Day
keep the sources of information you used to evaluate an investment. Do you know that if you
With these records, you will know where to begin your research when save a dollar a day—less
it is time to reevaluate the investments you own. than what you would
spend on a soda and a
candy bar—and save or
Tax Considerations invest it at 5 percent inter-
est, in five years you will
It is your responsibility to determine how taxes may affect your
have more than $2,000?
investments. The city, state, and federal governments charge various In ten years you will have
amounts of tax to individuals and businesses for income they earn. $4,600! How much would
In general, investment income falls into three categories: tax- you have in 40 years?
exempt, tax-deferred, and taxable. Tax-exempt income is income
that is not taxed. For example, the interest you can receive from
most state and municipal bonds is exempt from federal income tax.
Tax-deferred income is income that is taxed at a later date. The
most common type of tax-deferred income is earned from a tradi-
tional individual retirement account (IRA). When you withdraw earn-
ings from your IRA, you must pay federal income tax. The 401(k) and
403(b) retirement plans offered by your employer or privately are also
tax-deferred. Income from most other investments is taxable.
Dividends, Interest Income, and Rental Income You must
report cash dividends on your tax return as ordinary income. You also
have to pay tax on the interest from banks, credit unions, and savings
and loan associations. In addition, interest you receive from bonds
(unless tax-exempt), promissory notes, loans, and U.S. securities must
be reported as income. Income from rental property is also taxable.
Capital Gains and Capital Losses A capital gain is the profit
from the sale of assets such as stocks, bonds, or real estate. Capital
gains are taxed according to how long you own an asset—over a short
term or a long term.
Under current law, a short-term capital gain is profit you make
when you sell an asset owned for 12 months or less. It is taxed as
ordinary income. For example, if you are in the 15 percent tax bracket
for general income taxes, you will also pay 15 percent tax on your
short-term capital gains.
The profit from selling investments owned for more than
12 months is considered a long-term capital gain. Long-term capital
gains are usually taxed at the rate of 5 to 15 percent. Investors in low
tax brackets are taxed at only 5 percent. As of 2008, these investors
pay no tax on long-term capital gains. Some personal property, such
as collectibles, is taxed at a higher rate. Examples of collectible assets
include rare books and stamp collections. You will learn more about
collectibles in Chapter 11.
Chapter 8 Saving and Investing 261
A capital loss is the sale of an investment for less than its pur-
chase price. You can subtract up to $3,000 a year in capital losses from
your ordinary income. If your losses are greater than $3,000, you can
subtract the rest of the loss in later tax years.
Sources of Investment
Information
Where can you find information about investments?
Because there is so much investment information available, both
complex and basic, you need to be selective. The important thing is
to be sure that the source of advice and information that you receive
is accurate and reliable.
The Internet and Online Services
The Internet offers a wealth of information on investments with
As You the click of a button. One of the best ways to find what you need is to
Read use a search engine. Search engines are available through many Inter-
QUESTION net service providers (ISPs), including commercial Internet compa-
nies. Just type the key words for your topic into a search engine, and
How can you ensure that you will get a list of Web sites that provide information on that topic.
online sources of invest- Most large investment firms have Web sites where you can obtain a
ment information are
variety of information and services:
accurate and reliable?
• Interest rates for certificates of deposit
• Prices of stocks, bonds, and other securities
• Advice on starting an investment program
• Trading of securities through online brokers
Newspapers and News Programs
The financial page of your metropolitan newspaper or The Wall
Street Journal is another source of investment information that is easy
to access. In addition, many radio and television stations broadcast
investment market summaries and economic information as part
of their regular news programs. Several television channels, such as
CNN Fn (Financial), are also dedicated to financial news.
Business and Publications
Barron’s, BusinessWeek, Forbes, Fortune, Harvard Business Review,
and similar business publications provide general news about the
economy as well as information about individual companies. Other
publications cover specific industries. In addition, magazines, such as
Money, Consumer Reports, Smart Money, and Kiplinger’s Personal Finance,
provide information and advice designed to improve your investment
skills. In addition, national news magazines often feature stories on the
economy and finance.
262 Unit 3 Investing Financial Resources
IN THE KNOW Keeping up with financial news helps you track your
investments and may help you reach your goals. Name at least three
publications that could help you become a smart investor.
Government Publications
The United States federal government is also an excellent resource
of information—and much of it is free. The Federal Reserve Bulletin,
published by the Federal Reserve System, and the Survey of Current
Business, published by the Department of Commerce, are just two
sources of useful financial information. You can read articles from
both of these publications on the Internet.
Corporate Reports
As required by the federal government, any corporation selling
new issues of securities must provide investors with a prospectus. A
prospectus is a document that discloses information about a com-
pany’s earnings, assets and liabilities, its products or services, a par-
ticular stock, and the qualifications of its management. All publicly
owned corporations also send investors quarterly reports and annual
reports that contain detailed financial data.
Chapter 8 Saving and Investing 263
Statistical Averages
You can keep track of the value of your investments by follow-
ing one or more recognized statistical averages, such as the Standard
& Poor’s 500 Stock Index or the Dow Jones Industrial Average. These
averages are reported daily online and in newspapers. The average
indicates whether the category it measures is increasing or decreasing
in value. It will not pinpoint the value of a specific investment, but it
will show the general direction of stocks, bonds, mutual funds, and
other investments. Figure 8.7 lists some of the most widely used
statistical averages.
&IGURE 3TATISTICAL !VERAGES FOR %VALUATING )NVESTMENTS
3TATISTICAL !VERAGE 4YPE OF )NVESTMENT
$OW *ONES )NDUSTRIAL !VERAGE 3TOCKS
3TANDARD 0OORS 3TOCK )NDEX 3TOCKS
6ALUE ,INE 3TOCK )NDEX 3TOCKS
.EW 9ORK 3TOCK %XCHANGE )NDEX 3TOCKS ON .EW 9ORK 3TOCK %XCHANGE
!MERICAN 3TOCK %XCHANGE )NDEX 3TOCKS ON !MERICAN 3TOCK %XCHANGE
.!3$!1 #OMPOSITE 3TOCK )NDEX /VER THE COUNTER STOCKS
,IPPER -UTUAL &UNDS )NDEX -UTUAL FUNDS
$OW *ONES "OND !VERAGE #ORPORATE BONDS
4HE 7ALL 3TREET *OURNAL #ONSUMER 2ATES )NDEX )NTEREST AND FINANCE RATES
.EW 2ESIDENTIAL 3ALES )NDEX 2EAL ESTATE
$OW *ONES 3POT -ARKET )NDEX #OMMODITIES
3OTHEBYS !RT 3ALES )NDEX !RTPAINTINGS
,INNS 4RENDS OF 3TAMP 6ALUES 3TAMPS
4REND 7ATCHERS 9OU CAN LOCATE THESE STATISTICAL AVERAGES IN THE NEWSPAPER AND ON THE )NTERNET
(OW DO THESE AVERAGES AFFECT INVESTMENTS
264 Unit 3 Investing Financial Resources
Investor Services After You
Many stockbrokers and financial planners mail free newsletters Read
to their clients. In addition, investor services, such as Moody’s Inves- REACT
tors Service, sell subscription newsletters that are available in print
and on the Internet. Would it be useful to follow
Five widely used and useful publications are: the Dow Jones Industrial
Average and/or the
• Standard & Poor’s Stock and Bond Guide Standard and Poor’s 500
• Value Line Investment Survey® Stock Index before making
• Handbook of Common Stocks (information on companies) investments? Why or
why not?
• Morningstar Mutual Funds™
• Wiesenberger Investment Companies Yearbook (information on
mutual funds)
In addition to these publications, securities exchanges provide
information in print and on the Internet. They include the American
Stock Exchange, the Chicago Mercantile Exchange, the New York Stock
Exchange, and the NASDAQ market. All of these sources of financial
information are most often used by professionals. Many individual
private investors also refer to them to become well-informed when
making investment decisions.
Section 8.3 Assessment
QUICK CHECK Calculate How much will Elliott
1. What is a financial planner’s role in a pay in capital gains tax on the profits
personal financial program? from his stock sale?
2. What is your role in your personal finan-
SOLVE MONEY PROBLEMS
cial program?
3. What are some sources of financial 6. Finding a Financial Planner Helene
information? has decided to hire a financial planner. She
has to rely on ads and the yellow pages
THINK CRITICALLY for names because she is new in town. She
4. Why do you think some people do not wants to meet with several people before
keep track of their investments? Give choosing one.
reasons why they should. Write About It Compile a list of
specific questions that Helene should
USE COMMUNICATION SKILLS ask candidates when she interviews them.
5. Tax Considerations Elliott is going to
receive capital gains on some stock he just
sold. He owned the stock for less than a
year and made a profit of $200. He is in the
15 percent tax bracket.
Chapter 8 Saving and Investing 265
Chapter 8 Review & Activities
CHAPTER SUMMARY
• Before investing, set financial goals that • Steps in developing a personal invest-
are compatible with your values. ment plan include establishing goals,
• Obtain money to start investing by determining funds needed and funds
setting aside funds before you buy other available, evaluating investments in
things; by contributing to employer- terms of risk and return, and choosing
sponsored retirement plans and savings at least two investments.
programs; and by saving gifts of money • Check your investments for yourself,
and unexpected windfalls. keep track of them, keep accurate
• An investment’s safety or degree of records, and consider the tax conse-
risk, income potential, and liquidity quences of buying and selling.
are factors to consider before choosing • A great deal of investment information
an investment. Also, diversifying your is available on the Internet, in books,
investments is wise. magazines, newspapers, government
• Saving and investment alternatives publications, as well as from individual
include savings accounts, certificates of corporations and investment
deposit, stocks, bonds, some annuities, companies.
mutual funds, and real estate.
Communicating Key Terms
You are a financial planner. One of your clients, who owns a medium-sized company with
75 employees, asks you to speak to her employees to encourage them to participate in the company
401(k) retirement savings plan. Use as many of the terms below as possible in writing your speech.
• emergency fund • common stock • financial planner
• speculative investment • preferred stock • tax-exempt income
• dividends • corporate bond • tax-deferred income
• retained earnings • government bond • capital gain
• investment liquidity • mutual fund • capital loss
• equity capital • diversification • prospectus
Reviewing Key Concepts
1. Explain why it is important to have a goal before making investments.
2. Describe sources of funds for investing.
3. Describe a demographic group that may not prefer investment risk. Describe another
demographic group that may be more comfortable with a greater degree of risk.
4. Compare the main types of investment alternatives in terms of their risk and liquidity.
5. Write an investment plan for yourself.
6. Describe the role of the investor in the investment process.
7. List four specific sources of financial information.
266 Unit 3 Investing Financial Resources
Chapter 8 Review & Activities
Economics You should buy insurance and establish an emergency fund
before you invest, and you should invest early.
Write About It Write several paragraphs explaining why you should take
these steps before investing and how you can do both.
Investing Your Money You are evaluating two investments that
each require $1,000. One is a municipal bond that pays 9 percent interest
annually. The interest is exempt from federal and state taxes. The other is a
corporate bond that pays 11 percent interest, but its earnings are subject to
20 percent capital gains tax if kept for less than 12 months, and 15 percent
capital gains tax if kept for more than 12 months.
1. Calculate (a) Which bond provides the largest return? (b) Does the
situation change if you need to sell the bond before 12 months?
2. Compute by using spreadsheet software to create scenarios about the
circumstances under which each investment gives a bigger return.
Connect with Economics Risk associated with investments can
be categorized as diversifiable risk and undiversifiable risk. This is one
reason mutual funds are so popular—many investors’ money is pooled and
numerous stocks are purchased. Some of the risk is reduced because you buy
a piece of so many different companies. Undiversifiable risks are those over
which you have no control, such as the risks described in Section 8.1.
1. Research Use an Internet search engine or look in the newspaper or
magazine to find descriptions of three mutual funds.
2. Think Critically Select one mutual fund of interest to you. Why did
you select it?
401(k) Retirement Savings Many employers offer 401(k)
retirement savings plans as an employee benefit. Many companies match a
certain percentage of each employee’s deposits in the plan.
Log On Use an Internet search engine to find Web sites of two
companies you might be interested in working for in the future.
Answer the following questions:
1. Do they offer 401(k) plans profit-sharing or other savings programs?
2. Do your relatives, neighbors, or friends participate in such plans? Why?
Newsclip: Less Savings Americans do not save as they once did.
Weak savings mean fewer investments in the economy, and that contributes
O N L I N E
to slower economic growth.
Log On Go to finance07.glencoe.com and open Chapter 8. Learn
more about the different types of investments. Write down what type
of investment you would buy and explain why.
finance07.glencoe.com Chapter 8 Saving and Investing 267
Chapter 8 Review & Activities
ARE YOU A RISK TAKER?
As a general rule, the greater the promised return on an investment, the
greater the risk involved. Risk tolerance is your ability to ride the ups and
downs of the market without panicking when the value of your invest-
ment goes down. This quiz will help you gauge your own risk tolerance.
Answer the following questions on a separate sheet of paper:
1. Which best describes your feelings about investing?
a. Better safe than sorry
b. Moderation in all things
c. Nothing ventured, nothing gained
2. Which is most important to you as an investor?
a. You receive a steady income.
b. You receive a steady income and growth.
c. The price of your investments rises rapidly.
3. You won! Which prize would you pick?
a. $4,000 in cash
b. A 50 percent chance to win $10,000
c. A 20 percent chance to win $100,000
4. The stocks you own have dropped 20 percent since the last quarter. What would you do?
a. Sell the stocks to avoid losing more
b. Keep the stocks and wait for their value to rebound
c. Buy more stocks because they are cheaper now
5. The stocks you own have gone up 20 percent since the last quarter. What would you do?
a. Sell the stocks and take the gains
b. Keep the stocks and hope the price goes up higher
c. Buy more stocks because the price may go up higher
6. Would you borrow money to take advantage of a good investment opportunity?
a. Never b. Maybe c. Yes
7. How would you characterize yourself?
a. I do not like to take risks.
b. I am a moderate risk taker.
c. I enjoy taking risks.
Give yourself one point for each question that you answered with “a.”
Give yourself two points for each question that you answered with “b.”
Give yourself three points for each question that you answered with “c.”
If you scored 7–11 points, you’re a conservative investor who prefers to minimize financial risks.
If you scored 12–16 points, you’re a moderate risk taker.
If you scored 17–21 points, you’re comfortable taking risks in pursuit of greater returns.
Source: “Five-Minute Quiz” from Standard & Poor’s Your Financial Future, ©1996 by The McGraw-Hill Companies.
268 Unit 3 Investing Financial Resources
Chapter 8 Review & Activities
Your Financial Portfolio
Avoiding Future Shock
Mackenzie is already showing signs of being a great scholar at age three. At least that
is what her dad, Jasper, thinks. He wants Mackenzie to be able to continue her educa-
tion, so he has decided to start a college fund for her now. Jasper has $2,000 to start
and has decided to invest $175 a month. He has developed an investment plan to reach
his goal.
Jasper figures he has 15 years to invest and will invest in an aggressive stock mutual
fund. He feels that the diversity of a mutual fund will be safer and give greater returns.
Jasper has plenty of time to take a fair amount of risk and is comfortable that he will
have Mackenzie’s college money when she needs it.
Goal Tending
Established goal: College
Amount of money needed: $50,000
Initial amount to invest: $2,000
Possible investment alternatives: (1) savings account (4) mutual fund
(2) CD (5) stock
(3) money market account
Risk factor for each alternative: (1) low risk (4) moderate risk
(2) low risk (5) high risk
(3) low risk
Expected return on each alternative: (1) 1% –3% (4) 6% –10%
(2) 4% – 5% (5) 6% –12%
(3) 4% – 6%
Top 3 choices: (1) mutual fund (3) CD
(2) stock
Final choice: mutual fund
Prepare
Choose a short-term or long-term financial goal you would like to reach. On a sepa-
rate sheet of paper, prepare an investment plan for yourself using the same guidelines as
shown above. Research some of the available investments and come up with your own
investment alternatives. Explain the reasons for your final choice.
Chapter 8 Saving and Investing 269
9
CHAPTER
Stocks
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 9.1
• Explain the reasons for investing
in common stock.
• Explain the reasons for investing
in preferred stock.
Section 9.2
• Identify the types of stock
investments.
• Identify sources of information
to evaluate stock investments.
• Discuss the factors that affect
stock prices.
Section 9.3
• Describe how stocks are bought
and sold.
• Explain the trading strategies
used by long-term investors and
short-term investors.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
270
In the Real World . . .
S hari Rogers thought investing in stocks was something
only older or wealthy people did. However, thanks to the Internet, she
has discovered that anyone can have access to stock information. She has
been considering opening an account with an online broker. She feels she un-
derstands the risks involved, but she is still unsure of how to pick a stock. Before
Shari can begin to successfully trade stocks, she will learn how to evaluate a stock’s
chances for profit. She also needs to determine if she believes in the products
and policies of the companies in which she would like to invest. Then Shari
can choose a stock and start building a balanced portfolio.
As You Read Consider why you should research stocks
before you buy them.
Stock Certificates
ASK Q: My parents gave me stock certificates for a
graduation present. Is it a good idea to put them in
a safe-deposit box and save them for retirement?
A: A safe-deposit box is a good way to store important documents, but a better option
for stock certificates would be to place them in a brokerage account with a bank or bro-
kerage firm. This will make it easier for you to buy or sell shares of these or other stocks.
Also, you will receive statements showing the value of your shares and dividends.
Ask Yourself Why do you think it is easier to buy and sell shares of stock if
you have a brokerage account?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com Chapter 9 Stocks 271
Section 9.1
Focus on
Reading
Common and
Preferred Stocks
Read to Learn
• How to explain the
reasons for investing Common Stock
in common stock. Why do companies offer common stock?
• How to explain the
Investors have a choice of securities, which are all of the invest-
reasons for investing
in preferred stock. ments—stocks, bonds, mutual funds, options, and commodities—
that are bought and sold on the stock market.
Main Idea When investors buy shares of stock in a company, the company
Recognizing the reasons uses that money to make and sell its products, fund its operations,
for investing in common and expand. If the company earns a profit, the stockholders (owners
and preferred stock will of shares of stock in the company) earn a return, or gain, on their
enable you to make the investment. People buy and sell stocks for one reason: They want
best investments for your larger returns than they can get from more conservative investments,
financial situation.
such as savings accounts or government bonds.
Before you invest your money in stock, it might help you to
Key Terms
understand why corporations issue common stock.
• securities
• private corporation
• public corporation Why Corporations Issue Common Stock
• par value
Companies issue common stock to raise money to start up
their businesses and then to help pay for ongoing activities. A
private corporation, or a closely held corporation, is a company
Before that issues stock to a small group of people. A private corporation’s
You Read stocks are not traded openly in stock markets. On the other hand,
a public corporation, or publicly held corporation, is one that
PREDICT sells its shares openly in stock markets, where anyone can buy them.
What do you think it Some large corporations, such as AT&T, General Electric, Procter &
means to own stock in a Gamble, and General Motors, have thousands or even millions of
company? stockholders.
A Form of Equity Because corporations do not have to repay the
money a stockholder pays for stock, they are able to use that money
to fund their ongoing activities. For the stockholder to make money
on the stock, he or she sells the stock to another investor. The price is
set according to how much the buyer is willing to pay. As the demand
for a certain company’s stock increases or decreases, the price goes
up or down accordingly. News on expected sales revenues, earnings,
company expansions, or mergers with other companies can make
demand for the stock go up or down.
272 Unit 3 Investing Financial Resources
Dividends Not Mandatory It is up
to the corporate board of directors, a
group of individuals elected to make the
major decisions for the corporation, to
decide whether any profits will be paid to
stockholders as dividends. Companies that
are growing quickly might pay low or no
dividends. They may decide to use profits to
expand the company even further. Of course,
any company’s board of directors can reduce
or even stop dividend payments when a
corporation has a bad year.
Why Investors Purchase
Common Stock
Most investors purchase common stock
to make money in three different ways: They
profit when they receive dividends, when
the dollar value of their stock appreciates
(increases), and when the stock splits and
increases in dollar value. UNDERSTANDING
Income from Dividends A corporation’s board members do not STOCKS Investors buy
have to pay dividends, but they do want to keep stockholders happy stocks in the hopes of earn-
because those same stockholders are funding the corporation’s business. ing a large return on their
As a result, board members often vote to pay dividends if possible, investments. What causes the
unless they decide to place the profits back into the company. demand for stock to change?
With a cash dividend, each common stockholder receives an
equal amount per share. Most dividends are paid quarterly, or every
three months. Some companies that have large increases in earnings
might declare a special cash dividend at the end of the year. You might
also receive a dividend of company stock—or of company products,
though this is very unusual.
Appreciation of Stock Value If the market value of the stock
increases, or appreciates, you must decide whether to sell your
stock at the higher price or continue to hold on to it. If you sell, the
difference between the price that you paid and the price at which you
sell is your profit. Of course, if the value of the stock falls, then your
return will be less than your original investment. Figure 9.1 on page
274 provides tips for tracking your stock investment. If a company’s
board decides to place profits back into the company, it might reward
its stockholders through dollar appreciation of stock value instead of
dividends.
Increased Value from Stock Splits Your profits can also increase
through a stock split. A stock split occurs when the shares of stock
owned by existing stockholders are divided into a larger number of
shares.
Chapter 9 Stocks 273
For example, in a two-for-one stock split, the corporation dou-
bles the number of outstanding shares. Suppose that a corporation
has 10,000 shares of stock valued at $50 a share. If the corporation
splits its stock, the value of each share decreases to $25, but the num-
ber of outstanding shares increases to 20,000. If you owned 200 shares
before the split, you would own 400 shares after it.
Before After
Shares issued $10,000 $20,000
Value 50 25
Your shares 200 400
Your value $10,000 $10,000
Why do corporations split their stock? Often the management
believes that the stock should be trading within an ideal price range.
If the market value is a lot higher than this range, a stock split brings
the market value back into line. The lower price of stocks after they
are split often attracts more investors. As a result, the price starts to
rise again. The public wants to buy because of the belief that most
corporations split their stock only when the company’s financial
future looks very good. Be aware that a stock’s market value is not
guaranteed to go up after a stock split.
&IGURE 4RACKING 9OUR 3TOCK )NVESTMENTS
-ONITOR
'RAPH THE DOLLAR VALUE OF YOUR STOCK ON A DAILY OR WEEKLY BASIS
7ATCH THE FINANCIALS
#ONTINUALLY EVALUATE THE COMPANYS CURRENT SALES AND PROFITS AND THOSE
PROJECTED FOR THE FUTURE #OMPARE ITS PROGRESS TO THE PERFORMANCE OF
OTHER COMPANIES IN THE SAME INDUSTRY )F IT CAN NOT COMPETE SELL
4RACK THE PRODUCTS
0OOR QUALITY PRODUCTS OR A LACK OF NEW OR UP TO DATE PRODUCTS CAN
MAKE THE VALUE OF A COMPANYS STOCK DROP
7ATCH THE ECONOMY
4HE INFLATION RATE THE STATE OF THE OVERALL ECONOMY AND OTHER ECONOMIC
FACTORS CAN AFFECT YOUR COMPANYS STOCK PRICE
"E PATIENT
)F YOU THINK THAT YOU HAVE BOUGHT INTO A GOOD COMPANY HANG ON /VER
TIME YOUR INVESTMENT WILL USUALLY INCREASE IN VALUE
%VALUATING 3TOCKS "Y KEEPING UP WITH INFORMATION ABOUT THE COMPANIES THAT ISSUE STOCK YOU OWN
YOU ARE MORE LIKELY TO INCREASE THE RETURN ON YOUR INVESTMENT
7HY IS PATIENCE IMPORTANT IN INVESTING
274 Unit 3 Investing Financial Resources
Voting Rights and Control of the Company In addition to the
profit that stockholders may make on their investments, they are also
As You
given certain rights in return for the money they invest. For example,
Read
a corporation is required by law to hold a yearly meeting at which RELATE
stockholders can vote on company business. Stockholders usually get
one vote for each share they own. Imagine that you own
stock in a small Web design
Some states require that corporations offer existing stockhold- firm. Describe a situation
ers a preemptive right. A preemptive right gives current stockholders where preemptive rights
the right to buy any new stock a corporation issues before its stock would benefit you.
is offered to the public. By buying more shares, a stockholder can
keep the same proportion of ownership in the company. This can be
important when a corporation is small and control is critical.
Preferred Stock
Is preferred stock preferable?
You could buy preferred stock in addition to, or instead of,
common stock. Remember from Chapter 8 that preferred stock
gives the owner the advantage of receiving cash dividends before
common stockholders receive any cash dividends. If a company
is struggling financially, then the preferred stockholder might get
the dividends.
Preferred stockholders should know the amount of the dividend
they will receive. It is either a specific amount of money or a percent-
age of the par value of the stock. The par value is an assigned dollar
TechByte
Playing Games One
value that is printed on a stock certificate. If the par value of a stock is of the best ways to learn
$30 and the dividend rate is 5 percent, then the dollar amount of the about how the stock mar-
ket works without risk-
dividend is $1.50 per share ($30 X 5% or .05 = $1.50). Unlike market
ing any of your money
value, par value does not change. is to play a stock market
simulation game. In a
Why Corporations Issue Preferred Stock simulation game, players
work in teams and cre-
Few corporations use preferred stock as a way of raising money. ate a stock portfolio using
However, for some companies, it is another method of financing virtual money. Based on
which may attract more conservative investors who do not want their research of market
trends, economic condi-
to buy common stock. Preferred stockholders receive limited vot-
tions, and business news,
ing rights, and they usually vote only if the corporation issuing the the teams select and trade
stock is in financial trouble. common or preferred
stocks. Portfolios “earn”
interest and “pay” com-
Why Investors Purchase Preferred Stock missions—and make and
Preferred stock is considered a “middle investment.” The yield on lose virtual money.
preferred stock is generally lower than the yield on corporate bonds Read a review of
but higher than the yield on common stock. Preferred stock is consid- stock market
simulation games and
ered a safer investment than common stock, but not as safe as bonds.
list those you would like
People who want a steady source of income often buy preferred stock. to play through
However, preferred stocks lack the potential for growth that common finance07.glencoe.com.
stocks offer. As a result, preferred stocks are not considered a good
investment for most people.
finance07.glencoe.com Chapter 9 Stocks 275
To make preferred stocks more attractive to investors, some cor-
As You porations may offer cumulative preferred stock, convertible preferred
Read stock, or a participation feature.
QUESTION Cumulative Preferred Stock Cumulative preferred stock is
Why might it be rare for stock whose unpaid dividends build up and must be paid before any
corporations to offer a par- cash dividend is paid to the common stockholders. This means that
ticipation feature to their if a corporation decides to omit one or more dividend payments to
stockholders? preferred stockholders, people who hold cumulative preferred stock
will still receive those dividend payments during a later payment
period.
Convertible Preferred Stock Convertible preferred stock is stock
that can be exchanged for a specific number of shares of common
stock. This feature provides an investor with the safety of preferred
stock and the possibility of greater returns through conversion to
common stock.
Participation Feature Some corporations offer a participation
feature, which allows preferred stockholders to share in the cor-
poration’s earnings with the common stockholders. After a required
dividend is paid to preferred stockholders and a stated dividend
is paid to common stockholders, the remainder of earnings is shared
by preferred and common stockholders. This feature is rare.
Section 9.1 Assessment
QUICK CHECK Write About It Write a paragraph
1. Why do corporations issue common stock? that tells why a stockholder might
2. Why do investors purchase common stock? wish to exercise his or her voting rights.
3. Why do investors purchase preferred stock?
SOLVE MONEY PROBLEMS
THINK CRITICALLY 6. Perks of Preferred Stock Kwame’s
4. Justify a corporation’s decision to split grandmother recently gave him 25 shares
its stock when the stock price has risen of preferred stock. Kwame would like to
significantly. figure out the actual dollar amount of the
dividend, which is a percentage of the par
USE COMMUNICATION SKILLS value of the stock.
5. Part Owners Investors purchase com- Calculate According to the stock
mon stock as a way to increase their certificates that Kwame’s grand-
income. As stockholders, they earn the mother gave to him, the par value of each
right to vote on company business. share is $45 and the dividend rate is 6 per-
cent. What is the total dollar amount that
Kwame should receive each year?
276 Unit 3 Investing Financial Resources
Section 9.2
Evaluating Stocks Focus on
Reading
Types of Stock Investments Read to Learn
How are stocks classified?
• How to identify the types
Financial professionals classify most stocks into the following cat- of stock investments.
egories: blue-chip stocks, income stocks, growth stocks, cyclical stocks, • How to identify sources
defensive stocks, large-cap stocks, small-cap stocks, and penny stocks. of information to evalu-
ate stock investments.
• How to discuss the factors
Blue-Chip Stocks that affect stock prices.
A blue-chip stock is considered a safe investment that gen-
erally attracts conservative investors. These stocks are issued by the Main Idea
strongest and most respected companies, such as AT&T, General Elec- Knowing how to evaluate,
buy, and sell stocks helps
tric, and Kellogg. If you are interested in a blue-chip stock, look for
you increase the value of
a company that shows leadership in an industry, a history of stable your investments.
earnings, and consistency in the payment of dividends.
Key Terms
Income Stocks • blue-chip stock
• income stock
An income stock pays higher-than-average dividends com- • growth stock
pared to other stock issues. The buyers of preferred stock are also • cyclical stock
attracted to this type of common stock because the dividends are • defensive stock
predictable. Stocks issued by companies such as Bristol-Myers Squibb • large-cap stock
• capitalization
and Dow Chemical are classified as income stocks. This is also the
• small-cap stock
type of stock issued by gas and electric companies. • penny stock
• bull market
• bear market
• current yield
• total return
• earnings per share
• price-earnings (PE) ratio
CLASSIFYING STOCKS
This corporation issues blue-
chip stocks. Why do conser-
vative investors like blue-chip
stocks?
Chapter 9 Stocks 277
ECONOMY DEPENDENT
When the economy is doing
well, people have more
money to spend, which
allows the economy to grow
even more. What kind of stock
is most closely linked with the
state of the economy?
Before Growth Stocks
You Read
A growth stock is issued by a corporation whose potential earn-
PREDICT ings may be higher than the average earnings predicted for all the cor-
porations in the country. Stocks issued by these corporations generally
What type of stock do you
think would be best for a do not pay dividends. Look for signs that the company is engaged in
person who is just begin- activities that produce higher earnings and sales revenues: building
ning to make investments? new facilities; introducing new, high-quality products; or conducting
recognized research and development. Growth companies in the early
2000s included Home Depot and Southwest Airlines.
Cyclical Stocks
A cyclical stock has a market value that tends to reflect the state
of the economy. When the economy is improving, the market value of
a cyclical stock usually goes up. During an economic decline, the mar-
ket value of a cyclical stock may decrease. This is because the products
and services of these companies are linked directly to the activities of
a strong economy. Investors try to buy these stocks when they are still
inexpensive, just before the economy starts to improve. Then they seek
to sell them just before the economy declines. Stocks issued by Ford
and Centex (a construction firm) are considered cyclical stocks.
Defensive Stocks
A defensive stock is a stock that remains stable during declines
in the economy. The companies that issue such stocks have steady
earnings and can continue dividend payments even in periods of eco-
nomic decline. Many blue-chip stocks and income stocks, such as
those issued by Procter & Gamble, are defensive stocks.
278 Unit 3 Investing Financial Resources
Large-Cap and Small-Cap Stocks
A large-cap stock is stock from a corporation that has issued a
large number of shares of stock and has a large amount of capitaliza-
tion. Capitalization is the total amount of stocks and bonds issued
by a corporation. The stocks listed in the Dow Jones Industrial Aver-
ages, a stock indicator which measures the overall condition of the
stock market, are typically large-cap stocks. These stocks appeal to
conservative investors because they are considered secure.
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis-
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals
to help them guide their financial decisions.
,ONDON
UNITED KINGDOM
In 1698, the London Stock Exchange (LSE) got its
start at Jonathan’s Coffee House, located in London’s
bustling Change Alley. The founders created a simple
list entitled “The Course of the Exchange and Other
DATABYTES
Things,” which announced stock and commodity
prices to the local traders. Today, more than 300 years Capital London
later, the LSE lists more than 2,700 companies—from
Population 59,200,000
high profile to high tech—that are worth a total of
over $2.7 billion. The LSE has become Europe’s larg- Languages English, Welsh, and Scottish form
est stock exchange and of Gaelic
one of the world’s most Currency British pound
famous. It is headquar- Gross Domestic
tered close to where it Product (GDP) $1.66 trillion (2003 est.)
originated, at the heart GDP per capita $27,700
of London’s financial Industry: Tools, electric power equipment, automated
district. Displayed on equipment, railroad equipment, and shipbuilding
the stock exchange Agriculture: Cereals, oilseed, potatoes, vegetables,
building’s exterior is cattle, and fish
the LSE’s coat of arms, Exports: Manufactured goods, fuels, chemicals, food,
which boasts the Latin beverages, and tobacco
motto Dictum Meum Natural Resources: Coal, crude oil, natural gas,
Pactum, which means tin, limestone
“My Word is My Bond.”
Think Globally
Do you think the LSE lists large-cap stocks? Why or
why not?
Chapter 9 Stocks 279
A small-cap stock is a stock issued by a company with a capi-
As You talization of $500 million or less. Since these stocks are issued by
Read smaller, less-established companies, they are considered to be a higher
RELATE investment risk.
What type of stock would
you buy? Why? Penny Stocks
A penny stock typically sells for less than $1 a share, although
it can sell for as much as $10 a share. These stocks are issued by new
companies or companies whose sales are very unsteady. The prices of
these stocks can go up and down wildly. It is difficult to keep track of
a penny stock’s performance because information about them is hard
to find. Penny stocks should be purchased only by investors who
understand the risks.
Sources for Evaluating Stocks
How do you assess a stock investment?
There are many sources where you can find information about stocks
before making investment decisions. Some sources include: newspapers,
the Internet, stock advisory services, and corporate news publications.
UTILIZING THE INTERNET This search engine is one example of the many Web sites that can be
used to find financial information. What Web sites would help you find up-to-date information about a
corporation’s financial status?
280 Unit 3 Investing Financial Resources
Newspapers
Most major newspapers have financial sections that contain
information about stocks that are listed on major stock exchanges,
such as the New York Stock Exchange (NYSE) and the American Stock
Exchange (AMEX). Newspapers may also cover stocks of local inter-
est. Figure 9.2 illustrates the detailed information provided in The
Wall Street Journal about common stock.
The Internet
Today most corporations have their own Web sites. The infor-
mation may be more up to date and detailed than material from the
corporation’s printed publications.
You can also use search engines to find information about invest-
ing in stocks. Sites provide general financial news and specific infor-
mation about a company and its stock’s performance.
&IGURE #OMMON 3TOCK )NFORMATION IN 4HE 7ALL 3TREET *OURNAL
.AME OF THE
(IGHEST PRICE PAID ,OWEST PRICE PAID COMPANY -ATTEL .UMBER OF SHARES OF
FOR ONE SHARE OF FOR ONE SHARE OF -ATTEL TRADED DURING
-ATTEL DURING THE -ATTEL IN THE PAST THE DAY EXPRESSED IN
PAST WEEKS WEEKS 4ICKER SYMBOL OR LETTER HUNDREDS OF SHARES
THAT IDENTIFIES A STOCK
FOR TRADING -!4
9TD 7EEK 9LD 6OL .ET
#HG (I ,O 3TOCK 3YM $IV 0% S #LOSE #HG
n -ATTEL -!4 F n
n -AVRCK 4UBE -6+
-AXIMUS --3
94$ CHANGE 0ROJECTED ANNUAL 0RICE EARNINGS $IFFERENCE BETWEEN
REFLECTS THE STOCK DIVIDEND FOR NEXT 0% RATIO THE PRICE PAID FOR
PRICE CHANGE FOR YEAR BASED ON THE THE LAST SHARE TRADED
THE CALENDAR YEAR AMOUNT OF THE FIRMS TODAY AND FOR THE
TO DATE -ATTELS LAST DIVIDEND 0RICE PAID IN THE LAST SHARE TRADED
STOCK PRICE HAS CLOSE TRANSACTION ON THE PREVIOUS
DECREASED OF THE DAY DAY n
SINCE *ANUARY 9IELD PERCENTAGE OR THE
PERCENTAGE OF RETURN
BASED ON THE DIVIDEND AND
CURRENT PRICE OF THE STOCK 3OURCE 2EPUBLISHED WITH PERMISSION OF $OW *ONES )NC
FROM 4HE 7ALL 3TREET *OURNAL *ANUARY PERMISSION
CONVEYED THROUGH #OPYRIGHT #LEARANCE #ENTER )NC
2EADING &INANCIAL .EWS -ANY MAJOR NEWSPAPERS OFFER A WEALTH OF FINANCIAL INFORMATION
7HAT IS REPRESENTED IN THE COLUMN h.ET #HGv
Chapter 9 Stocks 281
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: A Stock Your Motive: When you buy or sell stock,
Confirmation Report you will receive a confirmation report
A stock confirmation report contains the that the purchase or sale has occurred.
following information: Be sure to check that the transaction was
• Name and address of the stock owner completed correctly. Check to see that the
• Account number correct number of shares were purchased or
• Name of the stock purchased or sold sold, and that the fees for completing the
• Price of the stock transaction are reasonable.
• Number of shares held
• Commission and fees
4AYLOR &INANCIAL 3ERVICES
-ONTROSE !VENUE
#INCINNATI /(
!CCOUNT .UMBER $2
(ECTOR 'ONZALES
-AYFAIR ,ANE
#INCINNATI /(
4RADE DATE nn
$ATE PROCESSED nn
0AYMENT $ATE nn
3/,$
1UANTITY $ESCRIPTION 0RICE 'ROSS !MOUNT #OMMISSION &EES 4OTAL !MOUNT
!NALOG $EVICES
Key Points: When you own stock, there Find the Solutions
will be times when you want to sell or buy 1. Who performed the stock transaction?
more. You may also want to purchase stocks 2. Did Hector purchase or sell stock?
from other companies as well. When you 3. How many shares were involved in the
make these transactions, you will receive a transaction?
4. Why is there a difference between the gross
stock confirmation report that will help you
amount and the total amount Hector
keep track of all your stock transactions.
received?
5. When will Hector be sent his money?
282 Unit 3 Investing Financial Resources
Stock Advisory Services As You
In addition to newspapers and the Internet, you can use stock Read
advisory services to evaluate potential stock investments. Many stock QUESTION
advisory services, such as Moody’s Investors Service, charge fees for
their information, which can vary from simple alphabetic listings to What are some sources for
detailed financial reports. As mentioned in Chapter 8, three widely evaulating stock?
used sources for information on companies’ stock are Standard &
Poor’s Stock and Bond Guide, Value Line Investment Survey, and Mer-
gent’s Handbook of Common Stocks.
As shown in Figure 9.3 on page 284, basic financial report
from Mergent’s Handbook of Common Stocks consists of six sec-
tions. One section contains information about stock prices and
capitalization, earnings, and dividends. A background section,
“Business,” provides a detailed description of the company’s
major operations, such as the products they produce. A third sec-
tion, “Recent Developments,” offers current information about
net income and sales revenue. A “Prospects” section describes
the company’s outlook, or prospects for the future. The “Annual
Financial Data” section provides important statistics on the com-
pany for a specific length of time in the past. A final section lists
information such as important officers in the corporation and
the location of its headquarters.
ONCE A YEAR An annual report can provide a great deal of information for
investors. How can you get a copy of an annual report?
Chapter 9 Stocks 283
&IGURE ! "ASIC &INANCIAL 2EPORT
3OURCE (ANDBOOK OF #OMMON 3TOCKS ¥ BY -ERGENT )NC 2EPRINTED BY PERMISSION
5P AND $OWN 4HIS FINANCIAL REPORT FROM -ERGENTS (ANDBOOK OF #OMMON 3TOCKS PROVIDES
INFORMATION ABOUT 2EEBOCK )NTERNATIONAL ,TD
7HAT IS REPORTED IN THE LOWER SECTION OF THE GRAPH
284 Unit 3 Investing Financial Resources
BULL AND BEAR MARKETS
Corporate News Publications
Knowing the current market
Annual and quarterly reports offer a summary of a corporation’s is important when you make
activities as well as detailed financial information. You do not have to decisions as an investor How
be a stockholder to get an annual report. Simply call, write, or e-mail does a bull market affect stocks?
to request a copy from the company’s headquarters. Financial pub-
lications such as Barron’s, BusinessWeek, Fortune, Kiplinger’s Personal
Finance, Money, and Smart Money also provide information about spe-
cific companies.
Factors that Influence the
Price of Stock
How would you determine whether your investment
is increasing or decreasing in dollar value?
When you are deciding whether it is the right time to buy or sell
a particular stock, you must first consider the overall condition of the
stock market. A bull market is a market condition that occurs when
investors are optimistic about the economy and buy stocks. Because
of the greater demand for stock, the value of many stocks and the
value of the stock market as a whole increases. A bear market is a
market condition that occurs when investors are pessimistic about
the economy and sell stocks. As a result of this decline in demand, the
value of individual stocks and the stock market as a whole decreases.
Next you should consider the company’s profits, losses, and
other numerical measures of its financial situation.
Chapter 9 Stocks 285
Numerical Measures for a Corporation
Using numerical measures such as current yield, total return,
earnings per share, and the price-earnings ratio is a good way to find
Nest Egg out about the health of a corporation.
How do you tell where
Current Yield One of the most common calculations investors
stocks are headed? When
is the best time to buy use to track the value of their investments is the current yield.
or sell a stock? Making Current yield is the annual dividend of an investment divided
good decisions about by the current market value. The current yield is expressed as a
when to buy and when percentage. As a general rule, an increase in current yield is a healthy
to sell is difficult because sign for any investment.
it involves predicting the
future of stock prices. Total Return The current yield calculation is useful, but you also
Learn about how investors need to know whether your investment is increasing or decreasing in
make these crucial finan-
dollar value. Total return is a calculation that includes the annual
cial decisions.
dividend as well as any increase or decrease in the original purchase
To continue with price of the investment.
Task 3 of your To calculate total return, add the current return on your invest-
WebQuest project, visit
ment to its capital gain. The current return is the total amount of div-
finance07.glencoe.com.
idends paid to you, based on the number of shares you own and how
long you have held them. To figure out your current return, multiply
your dividend amount per share by the number of shares and the
length of time that you have held the shares.
Next determine your capital gain. As you learned in Chapter 8,
capital gain is the profit you make from the sale of an asset, or the
difference between the selling price and the purchase price. To com-
pute capital gain, subtract the purchase price per share from the
selling price per share. Then multiply that number by the number
of shares held.
GO FIGURE FINANCIAL MATH
CURRENT YIELD OF A Formula: Annual Dividend
⫽ Current Yield
STOCK INVESTMENT Current Market Value
Synopsis: Computing the current yield of your Solution: $1.20
⫽ 0.05 ⫽ 5% or .05
stocks will help you to determine the value of your $24.00
investment. Tanika’s current yield would be 5 percent.
Example: Suppose that Tanika purchases stock in
EatGrapes.com. Assume that EatGrapes.com pays an YOU FIGURE
annual dividend of $1.20 and is currently selling for
If your stock pays an annual dividend of $.80 and
$24 a share. What is Tanika’s current yield?
is currently selling for $18 a share, what is your
current yield?
286 Unit 3 Investing Financial Resources finance07.glencoe.com
GO FIGURE FINANCIAL MATH
TOTAL RETURN B. Calculate the capital gain:
Synopsis: Calculating the total return of your (Selling Price per Share ⫺ Purchase Price per
investment will let you know whether your invest- Share)
ment is increasing or decreasing in value. ⫻ Number of Shares Held ⫽ Capital Gain
Example: Two years ago Mark bought 40 shares ($120 - $70) ⫻ 40 ⫽ $2,000
of Ferguson’s Motor Company for $70 a share. The The capital gain is $2,000
stock pays an annual dividend of $1.50. Mark is
C. Find the total return:
going to sell his stock at the current price of $120 a
share. What would be the total return on his invest- Current return ⫹ Capital Gain ⫽ Total Return
ment? $120 ⫹ $2,000 ⫽ $2,120
Formula: The total return on Mark’s investment would be
Current Return ⫹ Capital Gain ⫽ Total Return $2,120.
Solution:
A. Find the current return:
Dividend ⫻ Number of Shares ⫻ Years Held YOU FIGURE
⫽ Current Return If your current return on a stock is $60 and your
$1.50 ⫻ 40 ⫻ 2 ⫽ $120 capital gain is $1,280, what is your total return?
The current return is $120.
Once you have determined your current return and your capital
gain, add those two figures to arrive at your total return.
In the Go Figure example, Mark’s investment in Ferguson’s
Motor Company increased in value, so the total return was greater
than the current return. For an investment that decreases in value,
the total return will be less than the current return. The larger the
dollar amount of the total return, the better.
Earnings Per Share Another measurement of a company’s
performance is earnings per share. Earnings per share are a
corporation’s net, or after-tax, earnings divided by the number of
outstanding shares of common stock. This calculation measures the
amount of corporate profit assigned to each share of common stock.
This figure gives a stockholder an idea of a company’s profitability.
In general, an increase in earnings per share is a good sign for any
corporation and its stockholders.
Price-Earnings Ratio The price-earnings (PE) ratio is the
price of one share of stock divided by the corporation’s earnings
per share of stock over the last 12 months. This measurement is
commonly used to compare the corporate earnings to the market
price of a corporation’s stock.
Chapter 9 Stocks 287
GO FIGURE FINANCIAL MATH
EARNINGS PER SHARE Solution: $800,000
⫽ $8
100,000
Synopsis: Figuring out the earnings per share can
help you find out a company’s profits. This informa- The corporation’s earnings per share were $8.
tion can help you determine the general health of
the company in which you are investing.
Example: EFG Corporation had net earnings of YOU FIGURE
$800,000 last year. EFG had 100,000 outstanding You recently invested in an up-and-coming home
shares of common stock. What were EFG’s earnings improvement company and you want to know
per share? about the company’s health. If the company
had net earnings of $400,000 last year and had
Formula: Net Earnings
⫽ Earnings Per Share 80,000 outstanding shares of common stock,
Common Stock
Outstanding what were the company’s net earnings per share?
The PE ratio is a key factor that serious investors as well as begin-
ners can use to decide whether to invest in a stock. A low PE ratio
indicates that a stock may be a good investment: The company has
a lot of earnings when compared to the price of the stock. A high PE
ratio tells you that it might be a poor investment. The company has
little earnings when compared to the price of the stock.
Generally, you should study the PE ratio for a corporation over a
period of time so that you can see a range. Although PE ratios vary by
industry, they range between 5 and 35 for most corporations.
GO FIGURE FINANCIAL MATH
PRICE-EARNINGS RATIO Solution: $96
⫽ 12
$8
Synopsis: The price-earnings ratio is the most com-
mon measure of how expensive a stock is. Deter- The corporation’s price-earnings ratio is 12.
mining the price-earnings ratio can help you decide
whether a stock is worth purchasing.
Example: EFG’s stock is selling for $96 a share.
EFG’s earnings per share are $8. What is EFG’s price-
YOU FIGURE
earnings ratio? If a company’s market price per share is $67
and its earnings per share is $6, what is the
Formula: Market Price Per Share Price-Earnings
⫽ company’s price-earning ratio?
Earnings Per Share Ratio
288 Unit 3 Investing Financial Resources
Careers in Finance
CREDIT ANALYST
STOCKBROKER Wendy Ross
Scottrade
Wendy loves the process of observing the stock market, making speculations, and turning a
profit. As a stockbroker, Wendy serves as an agent between her company’s clients and the stock
exchange. She assists clients with trades, quotes, and account inquiries via telephone and e-mail.
Simply put, she helps people buy and sell stocks. Like most stockbrokers, Wendy enjoys the chal-
lenge of working with the unpredictable stock market and likes to introduce new customers to
Wall Street.
SKILLS: Communication, math, customer-service, computer and data-entry,
and multitasking skills
PERSONAL TRAITS: Organized, people oriented, able to travel 4 to 6 weeks
per year, discreet, and positive
EDUCATION: Bachelor’s degree in finance, business, or a related area or equivalent
experience; current Series 7 and Series 63 licenses
ANALYZE The Internet enables individuals to trade their own stocks. What advantages might
come from hiring a stockbroker instead of handling your stock trades yourself?
To learn more about career paths for stockbrokers, visit finance07.glencoe.com.
Investment Theories
Which investment theory do you think
makes the most sense?
Over the years theories have developed about ways to evaluate
possible investments. Three investment theories dominate:
• The fundamental theory
• The technical theory
• The efficient market theory
The Fundamental Theory
The fundamental theory assumes that a stock’s real value is
determined by looking at the company’s future earnings. If earn-
ings are expected to increase in the future, then the stock’s price
should go up, too. People who believe in the fundamental theory
also look at the financial strength of the company, the type of
industry the company is in, its new products, and the state of the
economy.
finance07.glencoe.com Chapter 9 Stocks 289
The Technical Theory
The technical theory is based on the idea that a stock’s value is
Put on
really determined by forces in the stock market itself. Technical theo-
Your rists look at factors such as the number of stocks bought or sold over
Financial a certain period or the total number of shares traded.
Planner’s
Cap The Efficient Market Theory
Your clients, Mayra and In the efficient market theory, sometimes called the random walk
Bob, have $25,000 they theory, the argument is that stock price movements are purely ran-
want to invest. Bob is dom. This theory declares that all investors have considered all of the
enthusiastic about invest- available information on a stock as they make their decisions. There-
ing in something that fore, according to the efficient market theory, it is impossible for an
will make a quick return.
investor to outperform the stock market average over a long period
Mayra does not want to
jeopardize their savings. of time.
How should this couple
invest their money?
Section 9.2 Assessment
QUICK CHECK Calculate Use the formula from
1. What are the different types of stock this section to determine the total
investments? return on Andrei’s shares in Snowland.
2. What are the sources that you might use
SOLVE MONEY PROBLEMS
to evaluate stock investments?
3. What numerical measures of corpo- 6. Finding Stock Information Sandy’s
rations can be used to evaluate stock mother works for Arf, a nationwide chain
investments? of dog kennels. She is receiving company
stock as part of her employee retirement
THINK CRITICALLY plan. She wants to track the stock’s perfor-
4. Explain how the calculations that involve mance to see how her retirement nest egg
a company’s earnings might help you to is doing.
make a decision about buying or selling a Write About It List two items
particular stock. in the stock reports in the finan-
cial section of the newspaper for Sandy’s
USE MATH SKILLS mother to review every week to get an idea
5. Total Return Two years ago, Andrei of how the company’s stock is doing. Write
bought 100 shares of Snowland, a ski a paragraph explaining to Sandy why this
apparel company. The price of the stock is information is useful and important to
up $10 from the $20-a-share purchase price, monitor.
and the stock even paid a dividend of $0.50
per share each year. Andrei wants to deter-
mine his total return on the stock.
290 Unit 3 Investing Financial Resources
Section 9.3
Buying and Selling Focus on
Reading
Stocks
Read to Learn
• How to describe how
Markets for Stocks stocks are bought and
What are the markets for stocks? sold.
• How to explain the trad-
To buy common or preferred stock, you usually have to go ing strategies used by
through a brokerage firm. In turn, the brokerage firm must buy the long-term investors and
stock in the primary or secondary markets. short-term investors.
The Primary Markets Main Idea
By understanding the stock
The primary market is a market in which investors purchase new markets and buying and
security issues from a corporation through an investment bank or selling techniques, you can
some other representative of the corporation. An investment bank is a cut costs and increase your
profit.
financial firm that helps corporations to raise funds, usually by helping
to sell new securities. The investors are commercial banks, insurance
companies, pension funds, mutual funds, and the general public.
Key Terms
• securities exchange
An initial public offering (IPO) occurs when a company sells
• over-the-counter (OTC)
stock to the general public for the first time. Companies use IPOs to market
fund new business start-ups or to finance new corporate growth and • portfolio
expansion. IPOs are considered a high-risk investment.
A corporation can also get financing through the primary mar-
ket by selling directly to its current stockholders. By doing so, the cor-
poration bypasses the investment bank, avoids any fees it might have Before
had to pay, and therefore obtains financing at a lower cost. You Read
PREDICT
The Secondary Markets
How would you go about
Once a company’s stocks have been sold on the primary mar- buying stock?
ket, they can then be sold in the secondary market. The secondary
market is a market for existing financial securities currently traded
among investors.
Securities Exchanges A securities exchange is a marketplace
where brokers who represent investors meet to buy and sell securities.
Many securities issued by national corporations are first registered
and then traded at either the NYSE or AMEX. There are also regional
exchanges in San Francisco, Boston, Chicago, and other cities that
trade stocks of companies in their respective regions. For example,
American firms that do business abroad may also trade on the Tokyo,
London, or Paris exchanges.
Chapter 9 Stocks 291
The NYSE is one of the largest securities exchanges in the world,
listing more than 3,000 corporations with a total market value of
about $16 trillion. Most of its 1,366 members, or seats, represent bro-
kerage firms. In addition to meeting other requirements, a corpora-
ECONOMICS tion must have a very large capitalization and trade many shares in
On October 19, 1987, the order to be listed on the NYSE. Companies that cannot meet the NYSE
United States stock market requirements can use AMEX or regional exchanges.
plunged 508 points—the
largest one-day stock mar- Over-the-Counter Market Not all stocks are traded on organized
ket crash in history. So exchanges. Several thousand companies trade their stock in the over-
how did the nation avoid the-counter market. The over-the-counter (OTC) market is a net-
an economic depres- work of dealers who buy and sell the stocks of corporations that are
sion such as the Great
not listed on a securities exchange.
Depression that followed
the 1929 crash? The Fed Most over-the-counter stocks are traded through NASDAQ (pro-
reacted quickly and low- nounced “NAZZ-dack”), an electronic marketplace for more than
ered short-term interest 4,000 different stocks. NASDAQ stands for the National Association
rates to prevent a bank- of Securities Dealers Automated Quotation System. The association
ing crisis. This allowed the was established in 1939 to regulate the OTC. When you want to buy
market time to recover
or sell a stock that trades on NASDAQ, such as Microsoft®, your bro-
from its losses. Create a
timeline of the events that kerage firm sends your order in to the NASDAQ computer system. It
helped to trigger the 1987 shows up on a screen with all the other orders from people who want
stock market crash. to buy or sell Microsoft. Then a NASDAQ dealer matches the orders of
those who want to buy and those who want to sell Microsoft. Once a
match is found, your order is completed.
Typically, NASDAQ handles trades for many forward-looking com-
panies, many of which are fairly small. However, some very large com-
panies such as Microsoft, Intel, and MCI are also traded on NASDAQ.
THE BIG BOARD The New York Stock Exchange (NYSE) is one of the largest securities exchanges in
the world. What qualifications must a corporation have to be traded on the NYSE?
292 Unit 3 Investing Financial Resources
How to Buy and Sell Stock As You
Why is it important to be directly involved in your Read
investment program?
RELATE
There are many decisions that you need to make before begin-
If you had $5,000 to invest
ning to buy and sell stock. You must decide on a brokerage firm, an
in the stock market right
account executive, and on what type of order—market order, limit now, what type of broker-
order, or stop order—you want to use to make your transaction. age firm would you choose?
Explain your reasoning.
Brokerage Firms
Today you can choose a full-service or discount brokerage firm
or trade stocks online. The biggest difference is the amount of the
commissions you will be charged when you buy or sell securities. A
commission is a fee charged to an investor by a brokerage firm for
the buying and/or selling of a security. Generally, full-service and dis-
count brokerage firms charge higher commissions than online broker-
age firms. Full-service firms usually charge the highest commissions
in exchange for personalized service and free research information.
However, there may be other differences among the types of firms.
First, consider the amount of research information that will be
available to you and how much it costs. All of these firms offer excel-
lent research materials, but you are more likely to pay extra for informa-
tion if you choose a discount brokerage or online firm. Although most
discount brokerage firms do not charge
a lot of money for research reports, the
fees can add up. Second, consider how
much help you will need in order to
make an investment decision. The full-
service account executive may not have
a lot of time to spend with each client,
but you can expect him or her to answer
questions and make recommendations.
Discount and online firms gener-
ally believe that you alone are in charge
of your investment plan and that the
most successful investors are totally
involved in their programs. They usu-
ally have printed material or informa-
tion on their Web sites to help you
become a better investor.
ANOTHER WAY More than 4,000 dif-
ferent stocks are traded on NASDAQ.
What market does NASDAQ serve?
Chapter 9 Stocks 293
Account Executives
An account executive, or stockbroker, is a
licensed individual who buys or sells securities, or
stocks, for clients. Account executives usually work
for brokerages.
Whether he or she is called an account execu-
tive or stockbroker, this person deals with all types
of securities, not just stocks, and can handle your
entire portfolio. A portfolio is a collection of all
the securities held by an investor. Some account
executives will take risks, while others are more
conservative. When you are choosing an account
executive, be sure that you can clearly describe
your short- and long-term financial goals so that
you will receive the best service for your needs.
Remember that account executives can make
errors, so be sure to stay actively involved in deci-
sions concerning your investments. Never let the
stockbroker take action on your account without
your permission. Brokerage firms are usually not
responsible for financial losses that are the result of
a recommendation by your account executive.
Be aware of a practice known as “churning.”
Churning occurs when an account executive does
a lot of buying and selling of stocks within your
YOUR BROKER One of portfolio to generate more commissions. Although churning is ille-
the biggest advantages of a gal, it is difficult to prove. Note that the value of your portfolio does
full-service brokerage firm is not increase through churning; rather, it stays about the same.
personal attention from an Most traditional brokerage firms have a minimum commission
account executive. How can that ranges from $25 to $55 for buying and selling stocks. However,
you protect your portfolio from commissions for online brokerage firms can be as low as $10. Addi-
a dishonest or incompetent tional fees based on the number of shares and the value of the stock
account executive? can also be charged. On the floors of the exchanges, stocks are traded
in round lots, which are 100 shares or multiples of 100 shares of a par-
ticular stock. An odd lot contains fewer than 100 shares of a stock.
Types of Orders
When you are ready to trade a stock, you will execute an order
to buy or sell. Most investors do this either over the telephone or on
the Internet. You can also go to a brokerage firm and place your order
in person. The types of orders used to trade stocks include market
orders, limit orders, and stop orders.
Market Orders A market order is a request to buy or sell a stock
at the current market value. Because the stock market is essentially
an auction, the account executive’s representative will try to get the
best price possible and make the transaction as soon as possible.
Figure 9.4 illustrates how a typical market order on the NYSE
would be executed.
294 Unit 3 Investing Financial Resources
Figure 9.4 Trading Stock
1
Several steps are involved in trad-
ing stock on the New York Stock Receiving an Order
Exchange (NYSE). Your account executive
receives your order to
sell stock and relays the
order electronically to
2
the brokerage firm’s
Signal to Floor Broker A clerk representative at the
for the firm signals the transac- stock exchange.
tion to a floor broker on the
stock exchange floor.
3
Trading The floor broker goes to the trading post at
which this stock is traded and trades with a floor broker
(from another firm) who has an order to buy.
4
To the Ticker System The floor broker signals
the transaction back to the clerk. Then a floor
reporter—an employee of the NYSE—collects
the information about the transaction and inputs
it into the ticker system.
5
On the Board The sale appears on the price
board, and a confirmation is relayed to your
account executive, who notifies you of the
completed transaction.
Chapter 9 Stocks 295
Note that every stock listed on the NYSE is traded at a computer-
equipped trading post on the floor of the exchange. A computer
monitor above the trading post indicates current price information
Stock Research for all stocks traded at each post.
1. Choose a few com- Then each transaction is recorded, and the necessary information—
panies whose prod-
the ticker symbol (the letters that identify a stock for trading), num-
ucts interest you.
ber of shares, and price—is transmitted through a communications
2. Look up the stocks
in the newspaper
network called the ticker system. The NYSE also uses the SuperDot
or on the Internet. system, which transmits orders electronically and can handle daily
3. Watch how their trading volumes of more than 2 billion shares.
prices change and Payment for stocks is generally required within three business
graph their prog- days of the sale. About four to six weeks later, the broker sends a stock
ress weekly. certificate (proof of ownership) to the purchaser. Figure 9.5 shows
4. Request and a sample of a common stock certificate. However, the investor’s bro-
study an annual kerage firm can receive the certificate and hold it, which is conve-
report from each nient when it comes time to sell the stock. The phrase left in the street
company.
name is used to describe investor-owned securities held by a broker-
5. Research the com-
age firm.
panies in Value
Line Investment Limit Orders A limit order is a request to buy or sell a stock at a
Survey. specified price. You agree to buy the stock at the best price up to a
certain dollar amount. When you are selling, the limit order ensures
that you will sell at the best price and not below a certain price.
&IGURE ! #OMMON 3TOCK #ERTIFICATE
0APER 4RAIL 4HIS COMMON STOCK CERTIFICATE IS VALUABLE BECAUSE IT SERVES AS PROOF
OF OWNERSHIP
7HO HANDLES THE PURCHASE OF THESE STOCK CERTIFICATES
296 Unit 3 Investing Financial Resources
For example, if you place a
limit order to buy Kellogg common
stock for $34 a share, the stock will
not be purchased until the price
drops to $34 or lower. If you place
a limit order to sell a stock, the Kel-
logg stock will not be sold until the
price rises to $34 or higher.
However, a limit order does
not guarantee that the purchase or
sale will be made when the desired
price is reached. Limit orders are
filled in the order in which they
are received, so other investors
may get orders filled before you
do. If the price of Kellogg, for
example, continues to rise while
purchase orders ahead of yours are
COMPUTERIZED TRANSACTIONS Internet brokerage com-
being filled, then when your turn
panies offer instant access to your account information and
comes, the price may reach $36,
the ability to buy and sell online. Why would having this be
and you will miss the chance to
beneficial?
buy the stock at $34.
Stop Orders You can also place a stop order, which is used for selling
stock. A stop order is a type of limit order to sell a particular stock at the
next available opportunity when the market price reaches a specified
amount. A stop order does not guarantee that your stock will be sold at
the price you want, but it does guarantee that it will be sold at the next
available opportunity. Both stop and limit orders can be good for a day,
a week, a month, or until you cancel them.
Computerized Transactions
More and more people are using their computers to make secu-
rities transactions. To meet the demand for this service, discount
brokerage firms and some full-service firms allow investors to trade
online. You can use a software package or the brokerage’s Web site to
help you evaluate stocks, track your portfolio and monitor its value,
and buy and sell securities online. Of course, you are still responsible
for doing research and analyzing the information you get.
Investment Strategies
Which type of investment strategy would you use:
long term or short term?
Once you purchase stock, the investment may be categorized
as long term (held for ten years or more), or short term (held for one
year or less). Generally, if you hold investments for at least a year, you
are considered an investor. If you buy and sell investments within
short periods of time, you are a speculator or a trader.
finance07.glencoe.com Chapter 9 Stocks 297
Long-Term Techniques
Long-term techniques such as the buy-and-hold technique,
Common dollar cost averaging, direct investment, and dividend reinvestment
CENTS are used by all investors who are interested in avoiding losses in
their investments.
Listen Up Buy-and-Hold Technique A typical long-term investing method is
It is smart to shop at music to buy stock and hold on to it for a number of years, often ten or more.
stores that let you listen to
During that time, you may get dividends, and the price of the stock may
CDs before you purchase
them. You can also check go up. The stock may also be split, which increases its value as well as
out your friends’ music to number of shares owned.
see if you like it. You will
Dollar Cost Averaging With this method, you buy an equal dollar
save money by not buying
CDs you will not use. amount of the same stock at equal intervals. For example, suppose
What are some other types that you invested $2,000 in Johnson & Johnson common stock each
of purchases to which you year for a period of three years. When the price of the stock went up,
could apply this method? your $2,000 purchased fewer shares, and when it went down, your
$2,000 purchased more shares. This system protects investors from
buying at high prices and selling at low prices. The price you pay for
the stock averages out over time.
Direct Investment and Dividend Reinvestment Plans A large
number of companies sell their stock directly to investors. This plan
lets you buy stock without going through your account executive
at a brokerage firm and paying commissions. You have the same
advantage of not paying fees with a dividend reinvestment plan,
which automatically reinvests any dividends you earn by buying
As You more shares of that stock with those earnings.
Read
QUESTION Short-Term Techniques
What is the advantage of Investors sometimes use more speculative, short-term tech-
a dividend reinvestment niques. These methods are quite risky. Only investors who fully
plan? understand the risks should use techniques such as buying on mar-
gin and selling short.
Buying on Margin When buying stock on margin, an investor
borrows through a brokerage firm part of the money needed to
purchase a stock. The Federal Reserve Board currently limits the
margin requirement to 50 percent and $2,000, which means that
you can borrow up to half of the purchase price as long as you have
at least $2,000 in your brokerage account. Investors buy stock on
margin in order to purchase more shares. If the shares go up in value,
the investor makes more money. However, if the shares go down in
value, the investor loses more money.
Selling Short Your ability to make money buying and selling
securities is related to how well you can predict what the stock is
going to do—whether it will rise or fall in value. Normally you want
to buy a stock that will go up in value, and this is called buying long.
Of course, the value of stocks can decrease, too.
298 Unit 3 Investing Financial Resources
You can actually make money by selling short when the value
of a stock appears as if it may go down. Selling short is selling a stock
After You
that has been borrowed from a brokerage firm and that must be
Read
replaced at a later date. You sell the stock you have borrowed today, REACT
knowing that you will have to buy the stock again at a later date.
Here is how it is done: Using the information
provided in this chapter,
1. Arrange to borrow a certain number of shares of a particular do you think you could
stock from a brokerage firm. develop an investment plan
2. Sell the borrowed stock, assuming that it will drop in value for yourself?
in a reasonably short period of time.
3. Buy the stock at a lower price than the price it sold for in
Step 2.
4. Use the stock you purchased in Step 3 to replace the stock
that you borrowed from the brokerage firm in Step 1.
Remember that when you borrow the stock, it really belongs
to someone else, so if a dividend is due, you must pay it. Eventually
these dividends may absorb all the profits you make on the transac-
tion. To make money, you have to predict correctly that the value of
the stock will go down. If the value increases, you lose money.
Section 9.3 Assessment
QUICK CHECK Present Choose one of your favorite
1. What is the difference between the primary songs and create song lyrics for it that
and secondary stock markets? warn of the dangers of short-term trading
2. What are characteristics of full-service, methods. Be as specific about the methods
discount, and online brokerage firms in as you can, noting why beginning investors
terms of service and cost? could get “burned.”
3. What are the trading techniques that are
SOLVE MONEY PROBLEMS
used by investors and speculators?
6. Using a Broker Bruce is a high school
THINK CRITICALLY senior with a busy fall schedule. He saved
4. Design a handout for students that explains enough money to start investing, but he
the various long-term investment strategies. has no time to monitor his investments
or make decisions. He wants to let his
USE COMMUNICATION SKILLS account executive buy or sell stocks
5. Short-Term Trading Some of your without bothering him.
classmates are boasting that they can make Analyze List and explain the dan-
a killing by trading stocks over a short gers of Bruce’s plan to let his account
period of time. executive act without consulting him.
Chapter 9 Stocks 299
Chapter 9 Review & Activities
CHAPTER
CHAPTER SUMMARY
SUMMARY.
• Investors choose common stock because • Factors affecting stock prices include
stocks provide a greater potential general attitudes about current economic
return than bank savings accounts and conditions and corporate performance.
government bonds. • Stocks are bought and sold in primary
• Investors choose preferred stocks markets, such as in an initial public
because they are less risky than common offering (IPO), and in secondary
stocks and because they provide a steady markets, such as securities exchanges
income in the form of dividends. and the over-the-counter (OTC) market.
• Types of stock investments include blue- • Long-term investors buy and hold
chip stocks, income stocks, growth stocks, stocks, use dollar-cost averaging to
cyclical stocks, defensive stocks, large- and smooth out the prices they pay for stocks
small-cap stocks, and penny stocks. they buy regularly, and reinvest their
• Information about stocks’ risk can be dividends and buy more stock directly
found in newspapers, stock advisory from companies in which they have
services, corporate reports, and on the already invested to avoid stockbroker
Internet. commissions. Short-term speculators
use techniques such as buying stock on
margin and selling short.
Communicating Key Terms
You have a client who owns a company with 75 employees. She asks you to describe the stock
option offered to employees in the company’s 401(k) retirement savings plan. Use as many of the
terms below as possible to develop a presentation for these employees.
• securities • defensive stock • total return
• private corporation • large-cap stock • earnings per share
• public corporation • capitalization • price-earnings (PE) ratio
• par value • small-cap stock • securities exchange
• blue-chip stock • penny stock • over-the-counter (OTC)
• income stock • bull market market
• growth stock • bear market • portfolio
• cyclical stock • current yield
Reviewing Key Concepts
1. Explain why corporations prefer to issue common stock to raise funds for their operations.
2. Explain how cumulative preferred and convertible preferred stock offer advantages to investors.
3. Describe why a small-cap stock is more likely to be a growth stock rather than an income stock.
4. Identify the advantages and disadvantages of a stock advisory service to evaluate a stock.
5. Describe why the price-earnings ratio is a good measure of a stock investment.
6. List the differences among market order, limit order, and stop order.
7. Identify the tax advantages of long-term investment strategies.
300 Unit 3 Investing Financial Resources
Chapter 9 Review & Activities
Language Arts Sometimes the best career information comes from
informational interviews with people working in the real world.
Write About It Interview a stockbroker and ask him or her questions
about the background, education, training, and experience needed to work
in that profession. Then write an article based on the interview for your
school or class newsletter.
Buying and Selling Stocks You bought 200 shares of a stock at
$17 per share in 2001. After 12 months, the stock doubled in value, and you
sold 100 shares. Eighteen months later, the stock reached $60 and split. After
another year, the stock is now selling at $52 a share.
1. Calculate (a) how much you received when you sold 100 shares in 2002;
(b) your capital gain; (c) how many shares of this stock you own today;
and (d) your gain on these shares.
2. Compute by using spreadsheet software to make these calculations.
Connect with Government The capital gains received on stock
sales is considered income, and you have to pay taxes on it. To encourage
people to invest and to hold on to those investments, the U.S. government
taxes capital gains on investments held less than 12 months at the investor’s
regular tax rate, but capital gains on investments held longer are taxed at 15
percent—which for most people is less than the regular tax rate.
1. Research Use the Internet to find out more about why the government
wants to encourage investors to hold on to their investments.
2. Think Critically How does the tax difference (15 percent tax rate
versus regular tax rate) provide an incentive to people to invest in
corporations, as opposed to corporate bonds or government bonds?
Institutional Investors Many investors buying stocks are not indivi-
duals, but institutions, such as retirement plans and mutual funds, which have
extremely large amounts of money to buy and sell large blocks of stock.
Log On Use an Internet search engine to find Web sites of companies
that manage such funds. One is TIAA-CREF, which manages the retire-
ment funds of teachers in many states. Answer the following questions:
1. What types of investments do institutional investors make?
2. What can you say about their tolerance for risk?
Newsclip: Investor Concern Despite a growing economy, investor
concern has decreased the popularity of stocks. However, quality stocks are
O N L I N E
usually sound even in shaky times.
Log On Go to finance07.glencoe.com and open Chapter 9. Learn
more about what affects stock prices and make a list of safe stocks.
finance07.glencoe.com Chapter 9 Stocks 301
Chapter 9 Review & Activities
TAKING STOCK
Test your knowledge of stocks after you read the chapter. Write your
answers on a separate sheet of paper. If you had the money, would you
be ready to invest in stocks?
1. All stocks pay dividends.
True False
2. Blue-chip stocks are generally a safe investment that attracts conservative investors.
True False
3. A bull market occurs when ranchers take their cattle to the stockyards.
True False
4. An initial public offering (IPO) occurs when a company first sells its products or services to
the public.
True False
5. The price-earnings (PE) ratio is the price of one share of stock divided by the stock’s earn-
ings per share.
True False
6. A good way to learn about the financial health of a company is by reading its
annual report.
True False
7. An income statement shows a company’s profits and losses.
True False
8. The appeal of investing in high-risk stocks is the possibility of large returns.
True False
302 Unit 3 Investing Financial Resources
Chapter 9 Review & Activities
Your Financial Portfolio
Investing in Stock
Rick would like to invest in the stock market. Before he invests any money, Rick is
researching a company he thinks has potential. He picked eSongz, an online music
store that lets you rent or purchase MP3 players and buy songs for them directly from
its site. Along with the price of stock, he watches for any announcements or industry
changes that may affect the stock.
Rick’s Research
eSongz
Highest price paid per share during the past 52 weeks $41.80
Lowest price paid per share in the past 52 weeks $19.89
Current price paid per share $35.35
Price-earnings (PE) ratio 20
Earnings per share $1.78
Rick has studied eSongz’ financial reports and also keeps tabs on its financial news
reports. He believes eSongz will continue to be successful, but he plans to watch the
stock a little longer before he makes his decision to invest.
Research
In your workbook or on a separate sheet of paper, choose a stock you would like to
buy and research it. You can get information about a company in the financial section of
major newspapers, the Internet, and from the companies themselves. You can also find
information from Standard & Poor’s Stock and Bond Guide, Mergent’s Handbook of Com-
mon Stocks, or Value Line Investment Survey. What type of stock would you be interested
in purchasing? Explain why. Do you think the company you chose to research would be
a wise investment choice? Explain your answer.
Chapter 9 Stocks 303
10
CHAPTER
Bonds and
Mutual Funds
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 10.1
• Describe the characteristics of
corporate bonds.
• Identify the reasons
corporations sell bonds.
• Explain why investors buy
corporate bonds.
• Discuss the reasons
governments issue bonds.
• Identify the types of
government bonds.
Section 10.2
• Identify sources of information
for selecting bond investments.
Section 10.3
• Identify types of mutual funds.
Section 10.4
• Discuss sources of information
for selecting mutual funds.
• Describe the methods of buying
and selling mutual funds.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
304
In the Real World . . .
W hen Julie Schmidt read her sample ballot, she no-
ticed several government bond measures for everything from hir-
ing new firefighters to building an elementary school. She was particularly
interested in a bond measure that would pay for building an athletic facility
and field at her former high school. She did not know much about government
bonds, so she asked her local banker about them. The banker said they are al-
most risk-free as investments. She also learned that there are corporate bonds,
which carry more risk but may earn more profit. So Julie decided to vote for
the measure and invest in bonds.
As You Read Consider investment options such as bonds and
mutual funds.
Mutual Funds
ASK Q: I have about $50 a month to invest. What is a
good investment choice for me?
A: Many mutual fund companies offer systematic investment programs in which
you invest the same amount each month regardless of changes in the share price. As
a result, your money buys more shares when prices are low and fewer shares when
prices are high. Over time, this strategy can result in a lower average cost per share;
however, it does not guarantee a profit or protect against a loss.
Ask Yourself Why is it a good idea to invest even a small amount of money
each month?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com Chapter 10 Bonds and Mutual Funds 305
Section 10.1
Focus on
Reading
Corporate and
Government Bonds
Read to Learn
• How to describe the
characteristics of corpo- Corporate Bonds
rate bonds. What is a corporate bond?
• How to identify the
reasons corporations When you buy a corporate bond, you are basically loaning
sell bonds. money to a corporation. As discussed in Chapter 8, a corporate bond
• How to explain why is a corporation’s written pledge to repay a bondholder (the person
investors buy corporate who bought the bond) a specified amount of money with interest.
bonds. Figure 10.1 on page 313 shows an example of a typical corporate
• How to discuss the bond. The bond’s interest rate, maturity date, and face value are stated
reasons governments on the bond. The maturity date is the date when a bond will be
issue bonds. repaid. The face value is the dollar amount that the bondholder will
• How to identify the types receive at the bond’s maturity. Typically, the face value of a corporate
of government bonds. bond is $1,000. However, corporate bonds can have face values as
Main Idea high as $50,000.
Understanding bonds and Between the date when you buy a bond and the maturity date,
why they are bought and the corporation pays you annual interest at the rate stated on the
sold will give you more bond. Interest is usually paid semiannually (twice a year). By mul-
choices to consider when tiplying the face value by the interest rate, you can calculate how
investing your money.
much interest you would earn each year.
Key Terms At the maturity date, you cash in the bond and receive a check
• maturity date in the amount of the bond’s face value. Maturity dates for bonds can
• face value range from 1 to 30 years. Maturities for corporate bonds are classified
• debenture as short term (less than 5 years), intermediate term (5 to 15 years),
• mortgage bond and long term (more than 15 years).
• convertible bond
• sinking fund
• serial bonds Types of Corporate Bonds
• registered bond
• coupon bond There are several types of corporate bonds. These types include
• bearer bond debentures, mortgage bonds, subordinated debentures, and convert-
• zero-coupon bond ible bonds.
• municipal bond
Debentures Most corporate bonds are debentures. A debenture
is a bond that is backed only by the reputation of the issuing
corporation, rather than by its assets. Investors buy this type of bond
because they believe that the company, or corporation, that issues
them is on solid financial ground. Investors expect the company to
repay the face value of the bond and make interest payments until
the bond matures.
306 Unit 3 Investing Financial Resources
GO FIGURE FINANCIAL MATH
A BOND’S ANNUAL INTEREST Formula:
Face Value ⫻ Interest Rate ⫽ Annual Interest
Synopsis: The interest on a bond is paid twice
Solution:
a year. By calculating the annual interest on your
$1,000 ⫻ 8.5% or .085 ⫽ $85
bond, you will be able to determine how much
You would receive interest of $85 a year from Mobil,
money you will earn on the bond each year.
paid in two installments of $42.50.
Example: Suppose that you purchase a $1,000
Mobil Corporation bond. The interest rate for the
bond is 8.5 percent (8.5%). How much annual YOU FIGURE
interest would you earn on this bond? If you purchased two $2,000 bonds that had
an interest rate of 7 percent, how much annual
interest would you earn?
Mortgage Bonds A bond issue occurs when a company makes
available a quantity of bonds at one time. To make these bonds more
appealing to conservative investors, a corporation may also issue
mortgage bonds. A mortgage bond, sometimes referred to as a
secured bond, is a bond that is backed by assets of a corporation.
A mortgage bond is a safer investment than a debenture because
it is backed by corporate assets. These assets, such as real estate or
equipment, can be sold to repay the mortgage bondholders if the
corporation fails to make good on its bonds. Though safer, mortgage
bonds usually earn less interest than debentures because their risk to
the investor is lower.
Subordinated Debentures A subordinated debenture is a type of
unsecured bond that gives bondholders a claim to interest payments
and assets of the corporation only after all other bondholders have
been paid. Because subordinated debentures are more risky than other
bonds, investors who buy them usually receive higher interest rates
than other bondholders.
Convertible Bonds A convertible bond is a bond that an
investor can trade for shares of the corporation’s common stock.
Because of the unique flexibility that it offers investors, the interest
rate on a convertible bond is often 1 to 2 percent lower than interest
rates on other types of corporate bonds. Before
Many bondholders choose not to convert their bonds into stock You Read
even when stock values are high. The reason for this is simple: As the
market value of a company’s common stock increases, the market PREDICT
value of the company’s convertible bonds also increases. Bondholders What do you think govern-
benefit from this increase in value while keeping the relative safety of ment bonds are?
a bond and its interest income.
Chapter 10 Bonds and Mutual Funds 307
䊱 A CORPORATE BOND
Mobil Corporation issued
this bond with an interest
Methods Corporations Use to
rate of 8.5 percent. What is Repay Bonds
the face value of this bond? Today most corporate bonds are “callable,” which means they
have a call feature that allows a corporation to buy back bonds from
bondholders before the maturity date. Corporations may get the
money to call a bond by selling stock, by using profits, or by selling
new bonds at a lower interest rate.
For example, suppose that Mobil Corporation issued bonds at
8.5 percent, but later, interest rates on comparable bonds dropped to
4.5 percent. Mobil Corporation might decide to call the bonds it had
issued at 8.5 percent. By buying back those bonds early, Mobil would
not have to pay bondholders interest at that high rate.
Premiums Usually, companies agree not to call their bonds for the
first five to ten years after the bonds are issued. When they do call their
bonds, they may have to pay bondholders a premium. A premium is
an additional amount above the face value of the bond. The amount
of the premium is stated in a bond indenture, which details all the
conditions pertaining to a particular bond issue.
Sinking Funds A corporation may use one of two methods to
make sure that it has enough funds to pay off a bond issue. First, the
corporation may set up a sinking fund. A sinking fund is a fund to
which a corporation makes deposits for the purpose of paying back
a bond issue. If the bond indenture states that the corporation will
deposit money in a sinking fund, the company will be able to repay
its bonds.
308 Unit 3 Investing Financial Resources
Serial Bonds Second, a corporation may issue serial bonds. Serial
bonds are bonds issued at the same time but which mature on dif-
As You
ferent dates. For example, Seaside Productions issued $100 million of
Read
serial bonds for a 20-year period. None of the bonds matured during RELATE
the first ten years. Therefore, during that time the company did
not have to pay anything but the interest owed on the outstanding Do you think that investing
in corporate bonds would
bonds. Instead, Seaside Productions used the funds raised by selling
be a good way to reach
the bonds to grow its business. After that, only 10 percent of the your financial goals? Why?
bonds matured each year until all the bonds were retired at the end
of 20 years. That allowed Seaside Productions to repay its bonds a few
at a time instead of having to repay all $100 million at once.
Why Corporations Sell Bonds
What are a corporation’s responsibilities to its
stockholders and to its bondholders?
Corporations sell bonds to raise money when it is difficult or
impossible to sell stock. Companies also often use bonds simply to
finance regular business activities. Selling bonds can also reduce the
amount of tax a corporation must pay because the interest paid to
bondholders is tax-deductible.
A corporation may sell both bonds and stocks to help pay for
its activities. However, the corporation’s responsibility to investors
is different for bonds and for stocks. Bondholders must be repaid at
a future date for their investments. Stockholders do not have to be
repaid. Companies are required to pay interest on bonds. They can
choose whether to pay dividends to their stockholders. Finally, if a
corporation files for bankruptcy, bondholders’ claims to assets are
paid before the claims of stockholders.
䊴 SECURE FOOTING
Mortgage bonds may be
backed by a company’s real
estate, stock, or machinery
and equipment. Why would
an investor want to buy a
mortgage bond?
Chapter 10 Bonds and Mutual Funds 309
Why Investors Buy
Common Corporate Bonds
Why are bonds considered safe investments?
CENTS Historically, stocks have resulted in greater profits than bonds.
Savings Mind-Set Why, then, should you consider investing in bonds? Many corpo-
It is exciting when you get rate and government bonds are safe investments. Some investors use
a raise or finally pay off a corporate and government bonds to diversify their investment port-
loan. You know you have folios (all the securities held by an investor). Bonds offer you three
more money available. other benefits:
Be a smart saver—stick
to your current budget • Most bonds provide interest income.
and stash that newfound • Bonds may increase in value, depending on the bond market,
money in your savings or overall interest rates in the economy, and the reputation and
investment account.
assets of the issuer.
If you received a $30 per
week raise in net pay and • The face value of a bond is repaid when it reaches maturity.
were paid four times per
month, how much “extra” Interest Income
money would you have in
ten months from February Bondholders usually receive interest payments every six months.
to November? Would you The dollar amount of annual interest is determined by multiplying
save or invest that money?
the interest rate by the face value of the bond. The method used by a
Why or why not?
company to pay you interest depends on the type of corporate bond
you purchase:
• Registered bond
• Coupon bond
• Bearer bond
• Zero-coupon bond
Registered Bonds A registered bond is a bond registered in the
owner’s name by the company that issues the bond. This ensures that
only the owner can collect money from the bond. Interest checks for
registered bonds are mailed directly to the bondholder.
Coupon Bonds A registered coupon bond is a bond that is
registered in the owner’s name for only the face value and not
for interest. This type of bond comes with detachable coupons.
Because the face value of the bond is registered, only the bond’s
owner can collect the face value. However, anyone who holds the
coupons can collect the interest. To collect an interest payment on
a registered coupon bond, you simply present one of the detachable
coupons to the issuing corporation or to the appropriate bank or
broker.
Bearer Bonds A bearer bond is a bond that is not registered in
the investor’s name. As with registered coupon bonds, the owner
of a bearer bond must present coupons in order to collect interest
payments. Anyone who has physical possession of the bonds or
their coupons can collect on them. A few bearer bonds are still in
circulation, but they are no longer issued by corporations.
310 Unit 3 Investing Financial Resources
Zero-Coupon Bond A zero-coupon bond is a bond that does
not produce interest payments. It is sold at a price far below its face
As You
value, but it is redeemed for its full face value at maturity. Because
Read
you buy it for less than its face value, you automatically make a profit QUESTION
when your zero-coupon bond is repaid.
What type of investor
would be interested in a
Market Value of a Bond zero-coupon bond?
Many beginning investors think that a $1,000 bond is always
worth $1,000. Actually, the market value of a corporate bond may
fluctuate before its maturity date. Usually, shifts in bond prices result
from changes in overall interest rates in the economy.
For example, suppose that Vanessa has a bond with a 7.5 percent
interest rate. If overall interest rates fall below 7.5 percent, Vanessa’s
bond will go up in market value because it earns more interest than
bonds issued at the new lower rate. If overall interest rates rise above
7.5 percent, the market value of Vanessa’s bond will fall because it
earns less interest than bonds issued at the new, higher rate.
When a bond is selling for less than its face value, it is said to be sell-
ing at a discount. When a bond is selling for more than its face value, it is
said to be selling at a premium. You can calculate a bond’s approximate
market value by using a formula that compares the bond’s interest rate
to that of similar new corporate bonds. (See Go Figure on page 312.)
Find the dollar amount of the bond’s annual interest by multiplying
the face value by the annual interest rate. Then, compute the bond’s
approximate market value by dividing the dollar amount of annual
interest by the interest rate of comparable new corporate bonds.
The market value of a bond may also be affected by the financial
condition of the company that issues it. In addition, the law of supply
and demand changes in the economy and can affect a bond’s value.
䊴 REDEEMABLE COUPONS
Registered coupon bonds
come with detachable
coupons. How are the
coupons used?
Chapter 10 Bonds and Mutual Funds 311
GO FIGURE FINANCIAL MATH
APPROXIMATE MARKET VALUE Face Value of Bond ⫻ Annual Interest Rate ⫽
OF A BOND Dollar Amount of Annual Interest
$1,000 ⫻ 4.5% or .045 ⫽$45
Synopsis: The market value of a bond can change
The dollar amount of annual interest is $45.
many times before its maturity date. Calculating the
approximate market value of a bond can help you B. Solve for approximate market value.
Dollar Amount of Annual Interest Approximate
determine what your bond will be worth at its matu- ⫽
Interest Rate of Comparable Market Value
rity date.
New Corporate Bonds
Example: Shawn purchased a New York Telephone
bond that pays 4.5 percent interest based on a face $45
⫽ $642.86
value of $1,000. Comparable new corporate bond 7% or .07
issues are paying 7 percent. How much is Shawn’s The approximate market value of Shawn’s New York
bond worth? Telephone bond is $642.86.
Formula:
Dollar Amount of Annual Interest
⫽ Approximate YOU FIGURE
Interest Rate of Comparable Market Value
New Corporate Bonds You bought two $1,000 bonds, each with an
interest rate of 5.5 percent. New corporate bonds
Solution:
being issued are paying 8 percent interest. What
A. Find the dollar amount of annual interest.
is the approximate market value of your bonds?
Repayment at Maturity
Corporate bonds are repaid at maturity. After you purchase a
bond, you have two choices. You can keep the bond until its matu-
rity date and then cash it in. You can also sell the bond at any time to
another investor. In either case, the value of the bond is closely tied
to the corporation’s ability to repay it. Other investors will pay more
money to get a quality bond that has solid prospects of repayment.
A Typical Bond Transaction
Where can you purchase corporate bonds?
Most bonds are sold through full-service brokerage firms, dis-
count brokerage firms, or online. If you use a full-service brokerage
firm, your account executive should provide information and advice
about bond investments. If you use a discount brokerage firm or buy
bonds online, you must do your own research and make your own
decisions. However, you will probably pay a lower commission.
You can also buy corporate bonds directly from account execu-
tives or brokerage firms. If you buy or sell a bond through an account
executive or brokerage firm, you should expect to pay a commission.
312 Unit 3 Investing Financial Resources
Purchasing in Primary and
Secondary Markets
Bonds are purchased in the same way as stocks. Corporate bonds
may be purchased in the primary or secondary markets. In the primary
market, you purchase financial securities from an investment banker
representing the corporation or government agency that issued them.
In the secondary market, you trade financial securities with other
investors. Corporate bonds issued by large companies are traded on
the New York Bond Exchange and American Bond Exchange.
Sample Bond Transaction
Figure 10.1 shows an example of a bond transaction—
Ms. Mansfield’s Borden bond transaction. On October 8, 1995, Ms.
Mansfield purchased an 8.375 percent corporate bond issued by Bor-
den, Inc. She paid $680 for the bond plus a $10 commission ($680
⫹ $10 ⫽ $690). On October 8, 2006, she sold it at its current market
value of $1,030 minus a $10 commission ($1,030 ⫺ $10 ⫽ $1,020).
After paying commissions for buying and selling her Borden
bond, Ms. Mansfield had a capital gain of $330 ($1,020 ⫺ $690 ⫽
$330). The market value of the bond increased because overall inter-
est rates in the economy declined during the time she owned the
bond. Borden also established a good business reputation during this
period, making the bond more secure and, therefore, more valuable.
&IGURE -S -ANSFIELDS "ORDEN )NC "OND 4RANSACTION
)NTEREST PERCENT MATURITY DATE PURCHASED /CTOBER SOLD /CTOBER
#OSTS WHEN PURCHASED
BOND
4RANSACTION SUMMARY
0LUS COMMISSION hhh
$OLLAR RETURN
4OTAL INVESTMENT -INUS TOTAL INVESTMENT
0ROFIT FROM BOND SALE
2ETURN WHEN SOLD
0LUS INTEREST FOR YEARS
BOND
-INUS COMMISSION hhh 4OTAL RETURN ON THE TRANSACTION
$OLLAR RETURN
4RANSACTION &EES -S -ANSFIELD PAID A COMMISSION FEE WHEN SHE BOUGHT HER BOND AND AGAIN WHEN
SHE SOLD IT
(OW DID THESE FEES AFFECT THE COST OF HER INVESTMENT AND THE PROFIT SHE
MADE FROM SELLING THE BOND
Chapter 10 Bonds and Mutual Funds 313
Ms. Mansfield also made money on her Borden bond by collect-
ing interest payments. For each of the 11 years she owned the bond,
Borden paid her $83.75 ($1,000 ⫻ 8.375% ⫽ $83.75) in interest. By
Savvy Savings the time she sold the bond, she had received interest payments total-
Bonds ing $921.25. These earnings, together with her $330 capital gain,
1. President Frank- added up to a total return of $1,251.25.
lin D. Roosevelt
bought the first
$500 Series EE Government Bonds
Savings Bond in
a radio broadcast and Securities
on April 30, 1941. Why does the government issue bonds and securities?
2. Savings bonds can
earn interest tax- Like private corporations, the federal government as well as state
free for your col- and local governments issue bonds to help raise the money they need
lege education. to operate.
3. Over 55 million The federal government sells bonds and other securities to help
people own sav- fund its regular activities and services, and to finance the national
ings bonds. debt. U.S. government securities are considered to be almost risk-free.
4. If your savings They are backed by the full faith and credit of the United States gov-
bond is acciden- ernment. However, because they have a low risk of default, which
tally destroyed, it
means failure to pay debts, government bonds offer lower interest
can be replaced.
rates than corporate bonds.
5. You can buy paper-
less savings bonds
online through Treasury Bills, Notes, and Bonds
the Department
of Treasury’s The U.S. Department of the Treasury issues three basic types of
Web site. securities: Treasury bills (T-bills), Treasury notes, and U.S. government
savings bonds. Treasury bonds, another type of security, were sold by
the Treasury Department until October 2001.
You can buy Treasury bills and Treasury notes online through
Treasury Direct, which is a Web site operated by the Department of
the Treasury. When you buy through Treasury Direct, you do not
have to pay a commission. You can also buy these securities through
banks or brokers, which charge a commission for their services. U.S.
government savings bonds can also be purchased through Treasury
Direct, commercial banks, savings and loan associations, or other
financial institutions.
You can hold U.S. government securities until maturity or cash
before the maturity date. You must pay federal income tax on interest
you receive from these investments. However, state and local govern-
ments do not tax this income.
Treasury Bills Treasury bills are sold in units of $1,000. They may
reach maturity in 4 weeks, 13 weeks, 26 weeks, or 52 weeks. T-bills
are discounted securities. That means that the actual purchase price
you pay when you buy a T-bill is less than the face value of the T-bill.
On the maturity date, you receive the full face value of the T-bill. A
T-bill held until maturity can be reinvested in another bill or can be
paid to the owner.
314 Unit 3 Investing Financial Resources
GO FIGURE FINANCIAL MATH
DOLLAR AMOUNT OF RETURN Formula:
Dollar Amount
ON A T-BILL Face Value – Purchase Price =
of Return
Synopsis: The purchase price of a Treasury bill is Solution: $1,000 ⫺ $950 ⫽ $50
less than its full face value. By calculating the return The dollar amount of return on your T-bill would
you will receive at the T-bill’s maturity date, you will be $50.
be able to determine how much money you earned
on your investment.
Example: Suppose that you buy a 52-week T-bill YOU FIGURE
for $950. On the maturity date, you receive $1,000. The maturity date of your 13-week T-bill is
What is the dollar amount of return on the T-bill? coming up. If you paid $1,500 for a T-bill with a
face value of $2,000, what is the dollar amount
of your return?
To figure out the dollar amount of return on a T-bill, just sub-
tract the purchase price of the T-bill from the face value.
After you have determined the dollar amount of return on your T-
bill, you can calculate the rate of return by dividing the dollar amount
of return by the purchase price. (See Go Figure on page 316.)
Treasury Notes Treasury notes are issued in $1,000 units with a
maturity of between one and ten years. Interest rates for Treasury
notes are slightly higher than those for Treasury bills because investors
must wait longer to get their money back.
Treasury Bonds As mentioned earlier, the Treasury Department
no longer issues Treasury bonds. However, many are still in existence
and may be purchased in the secondary market through a broker or
other financial institution.
Treasury bonds were issued in minimum units of $1,000 with
maturities that ranged from 10 to 30 years. The most common matu-
rity is 30 years. Because of the length of time to maturity, interest
rates for Treasury bonds are usually higher than those for Treasury
bills or Treasury notes.
Series EE Savings Bonds As you learned in Chapter 5, the federal
government also offers savings bonds called Series EE Savings Bonds.
The purchase price for a Series EE bond is one-half of its face value.
For example, a $100 bond costs $50. You can redeem a savings bond
anytime from 6 months to 30 years after you purchase it. You receive
the amount that you paid for it plus interest. Series EE bonds can
accumulate interest for up to 30 years. The interest on Series EE bonds
is not taxed by state or local governments. You do not pay federal
taxes on the interest until you cash in the bond.
Chapter 10 Bonds and Mutual Funds 315
GO FIGURE FINANCIAL MATH
RATE OF RETURN ON A T-BILL Solution: $50 ⫼ $950 ⫽ .0526 or 5.26%
Synopsis: Calculating the rate of return on your The rate of return on your T-bill is 5.26 percent.
T-bill will help you determine whether the T-bill is a
good addition to your investment portfolio.
Example: The dollar amount of return on your
T-bill is $50. What is the rate of return on the T-bill? YOU FIGURE
If the dollar amount of return on your T-bill is
Formula:
$500 and you paid $1,500 for it, what is the
Dollar Amount of Return ⫼ Purchase Price ⫽
rate of return on your T-bill?
Rate of Return
Series I Savings Bonds The federal government offers other types
of savings bonds, too. The most popular bonds, Series I bonds, are
inflation-indexed. This means that Series I bonds pay a fixed interest
rate that is lower than the rate of traditional savings bonds, but they
also pay a variable rate that increases with inflation.
TechByte
Security in an
The inflation rate is measured by the Consumer Price Index,
which measures the change in cost of a fixed group of products
and services such as gasoline, food, and automobiles. The inflation
Uncertain Time Just rate for Series I bonds is recalculated twice a year. Series I bonds pay
like paper money, stock interest for up to 30 years. If you redeem the bond less than five
certificates, corporate
years from the date purchased, there is a penalty of three months
bonds, and U.S. Treasury
bills have value and can of earnings.
be counterfeited. Since
1877, the Bureau of
Engraving and Printing Bonds Issued by
(BEP) has been the sole
maker of U.S. currency
Federal Agencies
and other financial What are agency bonds?
instruments, including
In addition to the securities issued by the Department of the
U.S. Treasury bills, notes,
and savings bonds. The Treasury, bonds are issued by other federal agencies as well. Agency
BEP has been committed bonds, such as the participation certificates issued by the Federal
to advanced security for National Mortgage Association (sometimes referred to as Fannie Mae)
more than a century. and the Government National Mortgage Association (sometimes
Read about how referred to as GinnieMae), are almost completely risk-free. However,
the Bureau of they offer a slightly higher interest rate than securities issued by the
Engraving and Printing treasury department and have an average maturity of about 12 years.
maintains a secure envi-
Generally, their minimum denomination is $25,000. Securities issues
ronment and describe
the technology through by federal agencies have maturities ranging from 1 year to 30 years,
finance07.glencoe.com. with an average life of about 12 years. You will learn more about these
types of investments in Chapter 11, which discusses real estate and
other investments.
316 Unit 3 Investing Financial Resources finance07.glencoe.com
䊱 TEAM EFFORT State and local governments often finance major
projects, such as schools, airports, and highways, by selling municipal
bonds. Where can you buy municipal bonds?
Bonds Issued by State and
Local Governments
What are the two classifications of municipal bonds?
A municipal bond, sometimes called a muni, is a security
issued by a state or local government (town, city, or county) to pay
for its ongoing activities. These bonds may also pay for major projects,
such as the building of airports, schools, and highways. You can buy
municipal bonds directly from the government that issues them or
through an account executive.
State and local government securities are classified as either gen-
eral obligation bonds or revenue bonds. A general obligation bond
is a bond that is backed by the full faith and credit of the govern-
ment that issued it. A revenue bond is a bond that is repaid from the
income generated by the project it is designed to finance. For exam-
ple, a municipal sports arena would generate profits that would repay
the investors who bought the bond to build the arena.
Although these bonds are relatively safe, on rare occasions, gov-
ernments have defaulted, or failed to repay, their bonds. If a govern-
ment defaults, investors could lose millions of dollars.
Chapter 10 Bonds and Mutual Funds 317
Insured Municipal Bonds
If the risk of default worries you, you might consider buying
insured municipal bonds. Some states offer to guarantee payments
on these selected securities. Also, three large private insurers guar-
antee such bonds: MBIA, Inc.; the Financial Security Assurance
Corporation; and the American Municipal Bond Assurance Corpo-
ration. Because of the reduced risk of default, insured municipal
securities usually carry a slightly lower interest rate than unin-
sured bonds.
The interest on municipal bonds may be exempt from fed-
eral taxes. Tax-exempt status depends on how the funds generated
by the bonds are used. Before you invest in a particular municipal
bond, find out whether the interest that you will receive from it is
taxable.
Like a corporate bond, a municipal bond may be callable by the
government that issued it. In most cases, the municipality that issues
the bond agrees not to call it for the first ten years. If your municipal
bond is not called, you can hold the bond until the maturity date or
sell it to another investor.
Section 10.1 Assessment
QUICK CHECK SOLVE MONEY PROBLEMS
1. What are three characteristics of bonds? 6. Personal and Financial Goals The
2. Why might the government or a company county in which Marie Kilbane lives is sell-
decide to issue bonds? ing bonds to finance a new storm sewer
3. What are reasons investors buy bonds? system. Marie knows that the storm sew-
ers need replacing because her street was
THINK CRITICALLY flooded last week. At the same time, she
4. Discuss ways in which securities issued by knows that her county is not very stable
state and local governments are similar to financially. She is not sure that the bonds
corporate bonds. are a good investment.
USE COMMUNICATION SKILLS Analyze Use what you have
learned about personal satisfaction
5. Comparing Bonds You have decided
and financial goals in previous chapters to
to diversify your investment portfolio. To
help Marie decide what to do. Should she
research, compare a type of corporate bond
buy the bonds to help improve her com-
with a type of government security.
munity and her own personal living con-
Write About It Write one or two ditions, or should she invest her money
paragraphs making a case for both in another way that has a better chance
bonds. Then write a one-paragraph sum- of helping her meet her financial goals?
mary describing which investment you Explain your reasoning.
think would be best for diversifying your
portfolio.
318 Unit 3 Investing Financial Resources
Section 10.2
Investing in Bonds Focus on
Reading
Determining Investment Value Read to Learn
How do you determine the investment value of a bond?
• How to identify sources
Before you make a decision to include bonds in your investment of information for select-
portfolio, you must learn how to accurately determine the investment ing bond investments.
value of a bond. By understanding bond price quotations, research-
ing various sources of information on bonds, checking bond ratings, Main Idea
and calculating the yield of your bond investment, you will be able Knowing how to read,
analyze, and calculate
to determine whether a bond is a good investment.
bond information in news-
papers and annual reports
Bond Price Quotations can help you make wise
investments.
Before you buy or sell bonds, you should become familiar with
bond price quotations. Not all local newspapers contain bond price Key Terms
quotations, but many metropolitan newspapers publish complete • investment-grade bonds
information on the subject. Two other valuable sources for bond • yield
information are The Wall Street Journal and Barron’s.
In a bond price quotation, the price of a bond is given as a per-
centage of its face value. Remember that a bond’s face value is usually
$1,000. To find the current market value, or price, for a bond, you Before
must multiply the face value ($1,000) by the price quotation given in You Read
the newspaper. For example, a price quoted as “84” means that the
current market value is 84 percent of the face value. Therefore, the PREDICT
selling price is $840 ($1,000 ⫻ 84% ⫽ $840). Purchases and sales of Do you think buying gov-
bonds are reported in tables. (See Figure 10.2 on page 320.) ernment bonds would free
For government bonds, most financial publications include two you from watching your
price quotations: the bid price and the asked price. The bid price is investments?
the amount a seller could receive for the bond. The asked price repre-
sents the amount a buyer could pay to purchase the bond. Newspaper
bond sections also provide information about interest rates, maturity
dates, and yields.
Sources of Information on Bonds
As a bondholder, you should always be aware of the financial sta-
bility of the issuer of your bonds. The most important questions are:
• Will the bond be repaid at maturity?
• Will you receive interest payments until maturity?
To help answer these questions, annual reports, the Internet,
business magazines, and government reports are good resources.
Chapter 10 Bonds and Mutual Funds 319
&IGURE #ORPORATE "OND )NFORMATION
#ORPORATE "ONDS
-ONDAY *ANUARY
&ORTY MOST ACTIVE FIXED COUPON CORPORATE BONDS
,!34 ,!34 %34 %34 6/,
#/-0!.9 4)#+%2 #/50/. -!452)49 02)#% 9)%,$ 302%!$ 534 S
'ENERAL -OTORS !CCEPTANCE '- $EC
'ENERAL -OTORS '- *UL
'ENERAL -OTORS !CCEPTANCE '- -AY
&ORD -OTOR #REDIT & /CT
%NCANA (OLDINGS &INANCE %#!#. -AY
4ARGET 4'4 -AR
'ENERAL -OTORS !CCEPTANCE '- 3EP
'ENERAL %LECTRIC '% &EB
,OOK AT THE BOND QUOTATION HIGHLIGHTED ABOVE %ACH COLUMN INCLUDES INFORMATION ABOUT
THIS BOND 2EADING FROM LEFT TO RIGHT
#OLUMN #OMPANY 4ICKER 4HE NAME OF THE ISSUING FIRM IS 4ARGET )TS ABBREVIATED
NAME IS 4'4
#OLUMN #OUPON4HIS BONDS CURRENT YIELD OR RETURN BASED ON TODAYS MARKET PRICE
IS PERCENT
#OLUMN -ATURITY4HE DATE THIS BOND MATURES IS -ARCH
#OLUMN ,AST 0RICE4HE CURRENT MARKET PRICE OF THIS BOND AT THE CLOSE OF TRADING ON
THIS DAY WAS PERCENT OF THE BONDS FACE VALUE
#OLUMN %STIMATED 6OLUME/N THIS DAY BONDS OF THIS ISSUE WERE
TRADED
3OURCE 2EPRINTED BY PERMISSION OF 4HE 7ALL 3TREET *OURNAL *ANUARY PERMISSION CONVEYED THROUGH #OPYRIGHT #LEARANCE #ENTER )NC
"OND 6ALUES .EWSPAPER BOND QUOTATIONS INDICATE A BONDS INTEREST YIELD AND PRICE
7HAT WAS THE LAST PRICE OF THE 4ARGET 4'4 BOND
Annual Reports Annual reports provide detailed financial infor-
mation about a company and its products, services, activities, goals,
and future plans. You will also find news about the company’s
position in its industry and the industry’s major trends. A typical
annual report contains the following sections:
• Letter to stockholders from the chief executive officer
• Company highlights for the year
• Detailed company review for the year
• Financial statements
• Notes to financial statements
• Independent auditors’ report
• List of directors and officers
• Investor information
320 Unit 3 Investing Financial Resources
To receive an annual report, call, e-mail, or write to the corpo-
ration’s headquarters and request one. Many large companies have As You
toll-free telephone numbers for customers. You may also find annual Read
reports for major corporations on the Internet or in the reference sec- RELATE
tion of some large libraries.
As you read an annual report, look for signs of financial strength What section of an annual
report would be most
or weakness and ask:
important for you to read?
• Is the firm profitable? Why?
• Are sales increasing?
• Are long-term liabilities increasing?
• How might the company’s current activities and future plans
affect its ability to repay bonds?
The Internet You can access a wealth of information about bond
investments on the Internet. You will find answers to many of your
questions on corporate Web sites, which typically offer information
about the particular company’s financial performance. Some sites
even include financial information from past years, which allows you
to compare one year’s performance with another’s.
Other sites are devoted to general information about bonds.
However, some bond Web sites charge a fee for their research and
recommendations.
When investing in bonds, you can use the Internet to obtain
price information on specific bond issues to track investments. If you
live in a small town or rural area without access to newspapers that
provide bond coverage, the Internet can be a good source of current
bond prices. You also might visit Web sites operated by Standard &
Poor’s or Moody’s to obtain detailed information about both corpo-
rate and government bonds.
Once your research is completed, you can even use the Internet
to purchase bonds, to monitor the value of your bonds, and to man-
age your investments. If you trade bonds online, you might pay lower GOVERNMENT
commissions than you would if you used a full-service or discount Federal, state, and local
brokerage firm. governments issue bonds
to help raise money for
Business Magazines Another way to research possible bond various activities and to
relieve debt. It is the job
investments is by reading business magazines. They provide
of the Bureau of the Pub-
information about the overall economy and give detailed financial lic Debt, a division of the
data about companies that issue bonds. U.S. Department of the
Treasury, to promote the
Government Reports and Research You can also consult sale of U.S. Savings Bonds.
reports and research published by the government to track the Research the Bureau of the
nation’s economy. This information is available in printed form Public Debt and write a
and on the Internet. If you want to buy U.S. Treasury bills or notes, paragraph about its origins
and duties.
or U.S. savings bonds, check Web sites run by the Federal Reserve
System. In addition, you can review information from the Securities
and Exchange Commission by accessing its Web site. State and local
governments will also give you information about specific municipal
bond issues upon request.
Chapter 10 Bonds and Mutual Funds 321
&IGURE "OND 2ATINGS
1UALITY -OODYS 3TANDARD 0OORS $ESCRIPTION
(IGH GRADE !AA !!! "ONDS THAT ARE JUDGED TO BE OF THE BEST QUALITY 4HEY
HAVE THE LOWEST RISK AND THE MOST SECURE INTEREST AND
PRINCIPAL PAYMENTS
!A !! "ONDS THAT ARE JUDGED TO BE OF HIGH QUALITY BY ALL
STANDARDS 0ROTECTION OF PRINCIPAL AND INTEREST PAYMENTS
IS ONLY SLIGHTLY LESS THAN THE BEST
-EDIUM GRADE ! ! "ONDS THAT HAVE MANY FAVORABLE INVESTMENT ATTRIBUTES
AND ADEQUATE SECURITY
"AA """ "ONDS THAT ARE NEITHER HIGHLY PROTECTED NOR
POORLY SECURED
3PECULATIVE "A "" "ONDS THAT HAVE SOME RISKY ELEMENTS /FTEN THEIR
PROTECTION OF PRINCIPAL AND INTEREST PAYMENT IS VERY
MODERATE
" " "ONDS THAT LACK THE CHARACTERISTICS OF A DESIRABLE
INVESTMENT )NVESTORS CANNOT BE SURE THAT INTEREST AND
PRINCIPAL WILL BE PAID IN THE FUTURE
$EFAULT #AA ### "ONDS THAT ARE OF POOR STANDING 4HEY ARE CURRENTLY
UNLIKELY TO BE REPAID
#A ## "ONDS THAT ARE HIGHLY RISKY
# -OODYS LOWEST RATED CLASS OF BONDS CONSIDERED THE
POOREST INVESTMENTS
# 3TANDARD 0OORS RATING GIVEN TO BONDS WHOSE ISSUERS
HAVE FILED FOR BANKRUPTCY
$ "OND ISSUES THAT ARE IN DEFAULT OR ARE FAILING TO MAKE
PAYMENTS
3OURCE h2ATINGS $EFINTIONS v STANDARDANDPOORSCOM -ARCH
+NOW 9OUR !!!"#S 3MART INVESTORS CHECK A BONDS RATING BEFORE THEY BUY
7HY ARE THESE RATINGS IMPORTANT TO INVESTORS
Bond Ratings
Before you invest in a particular corporate or municipal bond,
you should check its rating. This rating will give you a good idea
of the quality and risk associated with that bond. Bond issues are
rated or evaluated by independent rating companies. These compa-
nies assign to each bond a rating based on the financial stability of
its issuer.
Two of the best-known sources of bond ratings are Moody’s Bond
Survey, published by Moody’s Investors Service, Inc., and Standard &
Poor’s Stock and Bond Guide, published by Standard & Poor’s. Investors
rely on this information when making investment decisions. You can
also find bond ratings on the Internet, in financial magazines, and at
your public library.
322 Unit 3 Investing Financial Resources
As you can see in Figure 10.3, bond ratings are generally catego-
rized from AAA (the highest—the best) to D (the lowest—the worst).
The top four categories (Moody’s Aaa, Aa, A, and Baa and Standard
& Poor’s AAA, AA, A, and BBB) include investment-grade bonds.
Investment-grade bonds are bonds that are issued by financially
stable companies or municipalities. They are considered safe invest-
ments that will provide a predictable source of income.
Bonds in the next two categories (Moody’s Ba and B and Stan-
dard & Poor’s BB and B) are considered riskier, or speculative. Bonds
in the C and D categories may be in default or cannot continue inter-
est payments to bondholders.
U.S. government securities are usually not rated because they are
basically risk-free. Long-term municipal bonds are rated in much the
same way as corporate bonds. However, short-term municipal bonds
are rated differently. Standard & Poor’s rates municipal bonds that
have maturity dates of three years or less with the following system:
• SP-1: Strong ability to pay face value and interest (Bonds with
very safe characteristics get a plus (⫹) sign.)
• SP-2: Satisfactory ability to pay face value and interest
• SP-3: Doubtful ability to pay face value and interest
Yield of a Bond Investment
To determine the return that a particular bond may produce,
investors calculate and track its yield. The yield is the rate of return,
usually stated as a percentage, earned by an investor who holds a
bond for a certain period of time.
GO FIGURE FINANCIAL MATH
CURRENT YIELD OF A Formula:
BOND INVESTMENT Dollar Amount of
Annual Interest Income
Synopsis: Yield is the rate of return an investor ⫽ Current Yield of a Bond
earns. By calculating the current yield of a bond, Current Market Value
you can determine the return on a bond. Solution: $75
⫽ 0.078 or 7.8%
$960
Example: Suppose that you own a $1,000 AT&T
corporate bond that pays 7.5 percent interest per The current yield is 7.8 percent.
year. This means that each year you will receive $75
in interest ($1,000 ⫻ 7.5% ⫽ $75). Assume that
YOU FIGURE
the current market value of the AT&T bond is $960.
You receive $120 in interest each year on your
What is the current yield of your bond investment?
$2,000 corporate bond. What is the current
yield of your bond?
Chapter 10 Bonds and Mutual Funds 323
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: A Mutual Fund Your Motive: When you invest in a
Account Statement mutual fund, you need to monitor how
A mutual fund account statement contains effectively your investment is growing.
the following information: Periodically, you may find it necessary to
• Name of the fund sell a mutual fund and place your money
• Account number in another mutual fund that has a potential
• Beginning and ending share balance to grow faster.
• Activity since the last statement
President’s Group
P.O. Box 605, Springfield, NY 12345
Tanya Sawyer
5744 Pioneer Trail, Harrison, UT 54321
Account number: 6875430001 Account statement: DECEMBER 31, 2005
JEFFERSON MUTUAL INVESTORS FUND
Dollar Shares This Share
Trade Date Description Share Price
Amount Transaction Balance
Beginning
10/1/05 $34.20 721.273
share balance
10/19/05 Income dividend $104.58 $34.20 3.058 724.331
11/11/05 Income dividend $105.03 $33.45 3.140 727.471
11/28/05 Direct investment $1,000.00 $34.70 28.818 756.289
12/05/05 Direct investment $700.00 $32.26 21.699 777.988
Ending share
777.988
balance
Ending value as of 12/31/05 was $25,097.89
Key Points: An account statement for a Find the Solutions
mutual fund will list your contributions 1. How many shares did Tanya have at the
and any dividends your account has beginning of the period?
earned. It will also tell you how many 2. How is the Shares This Transaction amount
shares of the mutual fund you own and calculated?
3. Why is the share price different for each
what the value of each is on a given day.
transaction?
4. How is the ending value calculated?
5. Did the value of Tanya’s account grow or
decline during this time period?
324 Unit 3 Investing Financial Resources
The simplest way to measure a bond’s yield is to calculate its
current yield. To find the current yield of a bond, divide the dollar As You
amount of annual interest income by its current market value. (See Read
Go Figure on page 323 for an example.) QUESTION
This calculation lets you compare the yield on a bond invest-
ment with the yields of other investment alternatives such as savings Why might an investor
consider purchasing Ba, B,
accounts, certificates of deposit, common stocks, preferred stocks, and
or BB bonds?
mutual funds. If the current market value is higher than the bond’s
face value, the current yield decreases. If the current market value is
less than the bond’s face value, the current yield increases. The higher
the current yield, the better the return is for the investor.
Investors may also consider the yield to maturity of a bond.
This calculation takes into account the relationship between a bond’s
maturity value, the time to maturity, the current price, and the dol-
lar amount of interest. Like the current yield, the yield to maturity
allows you to compare returns on a bond investment with other
investments, which is another strategy to track and evaluate your
investment finances.
Section 10.2 Assessment
QUICK CHECK Calculate Figure out the current
1. What are three pieces of information about market value of that bond.
corporate bonds that you could find in the
SOLVE MONEY PROBLEMS
bond section of a newspaper?
2. What information in a company’s annual 6. Calculating Bond Yields Tom and
report would be important to an investor Rika Nagata plan to retire in ten years. In
who is interested in its corporate bonds? 2004, they purchased three bonds:
3. How could you use the Internet to help • Two 20-year AT&T corporate bonds, each
you learn about investing in bonds? with a face value of $1,000 and 7 percent
annual interest. The purchase price was
THINK CRITICALLY $830 each. The current market value is
4. Identify two sources for bond ratings, and $910 each.
explain what a bond rating tells you about
• A 30-year Coca-Cola corporate bond,
a bond.
with a face value of $1,000 and 8.5
USE MATH SKILLS percent annual interest. The purchase
price was $1,050. The current market
5. Bond Quotations Every day Elise looks
value is $1,020.
at the bond section of The Wall Street Jour-
nal to see if she can get a good deal on a Calculate To plan ahead, Tom and
$1,000 bond and add it to her portfolio. Rika need to know the current yield
This morning a price quotation of 98 for on their bonds. Use the formula in this
TechnoWiz, a telecommunications firm, section to calculate the current yield on
caught her interest. their bond investments.
Chapter 10 Bonds and Mutual Funds 325
Section 10.3
Focus on
Reading
Mutual Funds
Read to Learn
Defining Mutual Funds
What are mutual funds?
• How to identify types of
mutual funds. Mutual funds are an excellent choice for many investors. A
mutual fund is an investment alternative in which investors pool
Main Idea their money to buy stocks, bonds, and other securities based on the
Understanding the many selections of professional managers who work for an investment
kinds of mutual funds will company. By buying shares in a mutual fund, even an investor with
help you decide which
limited resources can own part of an entire portfolio of diverse secu-
funds might be smart
investments for you. rities. These funds can also be used for retirement accounts, such as
401(k) and 403(b) plans, individual retirement accounts (IRAs), and
Key Terms Roth IRAs, which are discussed in Chapter 15.
• closed-end fund
•
•
open-end fund
net asset value (NAV)
Why Investors Buy Mutual Funds
• load fund What is a key benefit of purchasing a mutual fund?
• no-load fund
One major reason for purchasing a mutual fund is professional
management. Investment companies employ professional fund man-
agers who try to pick the best securities for their mutual fund portfo-
lios. However, this can lead some investors to become careless. Many
Before mutual fund investors assume that their investments will increase in
You Read value. They might not research and evaluate funds carefully before
PREDICT they buy. They may also neglect to keep track of the performance of
the funds they own. Even the best portfolio managers make mistakes.
Based on its name, what
Therefore, wise investors should monitor and review their mutual
do you think is the defini-
tion of a mutual fund? funds regularly.
Another key reason for buying a mutual fund is diversification.
Mutual funds include a variety of securities, which reduces the share-
holders’ risk. An occasional loss from one investment in a mutual fund
is usually offset by gains from other investments in the same fund.
Researching and tracking the right mutual fund can provide great
results with less effort than it would take to maintain such a diverse
portfolio on your own.
Because of these advantages, mutual funds have become extremely
popular investments. In 1970, there were 361 mutual funds. By 2003,
there were more than 8,300 mutual funds, and the combined assets
owned by mutual funds in the United States were worth more than
$6 trillion. In the month of April 2003 alone, investors poured more
than $16.1 billion into mutual fund investments. Read the material in
this section to see if mutual funds are right for you.
326 Unit 3 Investing Financial Resources
䊴 GREAT TIP Mutual funds
can be wise investments for
people who have limited
time and limited funds to
invest. Why might a mutual
fund be a good choice for such
an investor?
Types of Mutual Funds
What is the difference between a closed-end and an
open-end fund?
An investment company is a firm that invests the pooled funds
of many investors in various securities. The firm receives fee for this
service. Mutual funds managed by investment companies are classi-
fied as either closed-end funds or open-end funds.
Closed-End Funds
About 6 percent of all mutual funds are closed-end funds offered
by investment companies. A closed-end fund is a mutual fund with
a fixed number of shares that are issued by an investment company
when the fund is first organized. After all the original shares have
been sold, an investor can buy shares only from another investor.
Shares of closed-end funds are traded (bought and sold) on the floors
of stock exchanges or in the over-the-counter market. A special sec-
tion of The Wall Street Journal provides information about closed-end
funds.
Open-End Funds
Most mutual funds are open-end funds. An open-end fund is a
mutual fund with an unlimited number of shares that are issued and
redeemed by an investment company at the investors’ request. Shares
of open-end funds are bought and sold on any business day by con-
tacting the investment company that manages the mutual fund.
Chapter 10 Bonds and Mutual Funds 327
GO FIGURE FINANCIAL MATH
NET ASSET VALUE Formula:
Value of the Fund’s
Synopsis: Investors can buy and sell shares in an
Portfolio ⫺ Liabilities
open-end mutual fund at the net asset value (NAV). ⫽ Net Asset Value
Number of Shares
The net asset value is the amount that one share of Outstanding
a mutual fund is worth. Investors use the net asset
value formula to assess the real worth of their port- Solution:
folios and make buying decisions. $124 million ⫺ $4 million
⫽ $20 per share
Example: Beth owns shares in the New Ameri- 6 million shares
can Frontiers Mutual Fund. The value of the fund’s The net asset value of each of Beth’s shares is $20.
portfolio is $124 million, and its liabilities total
$4 million. If this mutual fund has 6 million shares YOU FIGURE
outstanding, what is the net asset value of each of
You own shares in an open-end mutual fund
Beth’s shares?
that has a portfolio value of $220 million. Its
liabilities are $6 million, and it has 8 million
shares outstanding. What is the net asset value
of your shares?
Net Asset Value Investors are free to buy and sell shares at the
net asset value. The net asset value (NAV) is the amount that
one share of a mutual fund is worth. To calculate the net asset value
of a mutual fund, subtract the fund’s liabilities from the value of
the fund’s portfolio, and divide the result by the number of shares
outstanding. Shares outstanding are the number of shares held by all
the investors.
Services If you buy shares of an open-end fund from an investment
company, you gain access to a wide variety of services. These services
include payroll deduction programs, automatic reinvestment pro-
grams, and automatic withdrawal programs.
Load Funds
Before investing in any mutual fund, compare its cost or fees
with the cost of other types of investments. Mutual funds are classi-
fied as either load funds or no-load funds. A load fund (sometimes
referred to as an “A” fund) is a mutual fund for which you pay a com-
mission every time you buy or sell shares. The commission, or sales
charge, can be as high as 8.5 percent. The average load charge for
mutual funds is between 3 and 5 percent. The supposed advantage of
a load fund is that the fund’s representatives, such as account exec-
utives and financial planners, will offer advice and guidance about
when shares of the fund should be bought or sold.
328 Unit 3 Investing Financial Resources
No-Load Funds
A no-load fund is a mutual fund that has no commission fee.
No-load funds do not charge commissions when you buy shares
because they have no salespeople. No-load funds offer the same
investment opportunities as load funds. If you have a choice between
a load fund and a no-load fund, and both offer the same investment
opportunities, choose the no-load fund.
Management Fees and Other Charges
The investment companies that sponsor mutual funds also
charge management fees. This fee is a fixed percentage of the fund’s
asset value. The fees generally range from 0.5 to 1.25 percent of the
fund’s assets.
Instead of charging investors a fee when they purchase shares,
some mutual funds charge a back-end load, which is a fee that is
charged for withdrawing money from the fund. Fees range from 1 to
5 percent and are based on how long you own shares of the mutual
fund. A back-end load is designed to discourage early withdrawals. A
12b-1 fee is a fee that an investment company charges to help pay for
the marketing and advertising of a mutual fund. It is approximately
1 percent of a fund’s assets per year.
Careers in Finance
CREDIT ANALYST
CERTIFIED Matt Tucker
FINANCIAL PLANNER Self-Employed
Matt enjoys helping people reach their goals in life. He advises individuals and companies about
managing their money wisely and effectively. He interviews his clients to determine their assets,
liabilities, cash flow, insurance coverage, tax status, and financial objectives. Then he identifies and
analyzes their income, spending, and investment patterns to develop a customized financial plan.
Plans may include investment strategies, securities, insurance, pension plans, real estate, and tax
strategies. Matt is self-employed, but certified financial planners may work for credit unions, banks,
and other companies.
SKILLS: Communication, math, economic, financial, and customer-service skills
PERSONAL TRAITS: Good listener, people-oriented, detail-oriented, trustworthy, discreet, honest,
and tactful
EDUCATION: Bachelor’s degree; Certified Financial Planner (CFP) or Chartered Financial
Consultant (ChFC) designation
ANALYZE What sort of company might need help from a certified financial planner?
To learn more about career paths for certified financial planners, visit
finance07.glencoe.com.
finance07.glencoe.com Chapter 10 Bonds and Mutual Funds 329
䊳 WORLD-CLASS
OPPORTUNITIES Investment
firms that create international
and global mutual funds are
always looking for stocks in
countries that are experienc-
ing growth. Why would an inves-
tor choose a fund that includes
stocks from India or another such
country?
YOU SEE AN ANCIENT CULTURE.
WE SEE MODERN HOMEOWNERS.
Templeton fund managers spot global investment opportunities others might miss.
In 1998, our fund managers recognized
TEMPLETON
FUNDS the investment opportunity presented by
a mortgage company serving India’s
rapidly growing middle class. We purchased stock in
the company, and our fund shareholders were able to
get in on the ground floor of a dynamic housing boom.
Taking advantage of a global opportunity like this
requires a unique perspective. One that comes from
having offices in over 25 countries and on-the-ground
analysts utilizing research techniques that have been
honed for over 50 years. It’s what’s made Templeton
a pioneer in global investing.
For more information on how Templeton’s
experience and expertise in global investing may
benefit your clients’ portfolio, call 1-800-FRANKLIN
or visit franklintempleton.com.
Investors should carefully consider a fund’s investment goals, risks, charges and expenses before investing. To obtain a prospectus that contains this and other
information, call us at 1-800-342-5236. Investors should read the prospectus carefully before investing.
Foreign investing involves special risks including currency fluctuations and political uncertainty. Holdings subject to change.
Franklin Templeton Distributors, Inc., One Franklin Parkway, San Mateo, CA 94403.
Courtesy of Franklin Templeton Investments. Copyright 2004–2005. Franklin Templeton
Investments. All Rights Reserved.
As You Categories of Mutual Funds
Read What are the three main groups of mutual funds?
RELATE The managers of mutual funds match their investment portfo-
lios to the investment objectives of their customers. Usually a fund’s
Have you seen advertise-
objectives are clearly explained in its prospectus—a report that pro-
ments for mutual funds on
television or the Internet? vides potential investors with detailed information about a company
What information do these and its products, such as a particular mutual fund. It can be helpful
ads give you? to sort mutual funds into three main groups: stock mutual funds,
bond mutual funds, and mixed mutual funds. Within each group,
mutual funds may fall into one of many categories. Note that differ-
ent sources of investment information may use different categories
for the same mutual fund.
330 Unit 3 Investing Financial Resources
Stock Mutual Funds
Most mutual funds are part of the stock mutual funds group.
Stock mutual funds are made up of stocks. These funds fall into
14 categories, which describe the fund objectives and types of stock.
Aggressive Growth Funds Aggressive growth funds (sometimes
called capital appreciation funds) seek to grow money rapidly by
investing in stocks whose prices will increase greatly in a short period
of time. Because the stocks are often risky, the market value of shares
in this type of fund frequently swings between low and high.
Equity Income Funds Equity income funds include stocks issued
by companies with a long history of paying dividends. The major
objective of these funds is to provide steady income. These funds are
investment choices for conservative or retired investors.
Global Stock Funds Global stock funds invest in stocks of
companies throughout the world, including the United States. The
managers of global funds are not restricted by national boundaries.
Growth Funds Growth funds buy shares of companies expecting
higher-than-average revenue and earnings growth. Growth funds
tend to invest in larger, less risky companies that may pay some
dividends. As a result, the market value of shares in a growth fund is
more stable when compared to aggressive growth funds.
Growth and Income Funds Growth and income funds purchase
stocks that provide both a steady source of dividend income and
the potential for growth. These funds are considered conservative
because they invest in large, established companies.
Index Funds Index funds include stocks of companies that are listed
in an index such as Standard & Poor’s 500 Stock Index. Fund managers
select stocks issued by the companies that are included in the index.
Thus, an index fund should provide about the same performance as
the index. Index funds may have lower management fees.
International Funds International funds include foreign stocks
that are sold in securities markets throughout the world. That way, if
the economy in one region or nation is in a decline, profits can still
be earned in others. Such funds invest outside of the United States.
Large-Cap Funds Large-cap funds generally invest in companies
with market values greater than $8 billion. For most investors, a
large-cap fund is a long-term holding used for retirement savings.
Mid-Cap Funds Mid-cap funds include stocks of companies with
total assets of at least $500 million. Mid-cap funds offer more security
than small-cap funds and more growth potential.
Small-Cap Funds Small-cap funds include shares of small, inno-
vative companies with total assets of less than $500 million. They
offer high growth potential but are riskier.
Chapter 10 Bonds and Mutual Funds 331
Micro-Cap Funds As the name suggests, micro-cap funds invest
Put on
in the smallest companies. Micro-cap funds buy shares of companies
Your with market values below $250 million. These funds tend to include
Financial start-up companies, takeover companies, or companies about to
Planner’s exploit new growing markets. With stocks this small, the risk is always
extremely high, but the growth potential is exceptional.
Cap
Regional Funds Regional funds include stocks that are traded
If your client wanted to
within one region of the world. Examples include the European
expand his or her investment
portfolio by purchasing a region, the Latin American region, and the Pacific region.
mutual fund, what type of Sector Funds Sector funds invest in companies within the same
mutual fund would you
industry. Examples of sectors include health and biotechnology,
suggest?
science and technology, computers, and natural resources.
Utility Funds Utility funds include stocks of companies that
provide utility services to their customers. Because these funds are
generally safe and stable investments, they are often chosen by
conservative investors, such as retired people.
Bond Mutual Funds
Mutual funds in the bond mutual funds group invest only in
bonds. The bond fund categories are based on the type of bond the
mutual funds purchase.
High-Yield (Junk) Bond Funds High-yield (junk) bond funds
invest in high-yield, high-risk corporate bonds.
Insured Municipal Bond Funds Insured municipal bond funds
include municipal bonds that provide tax-exempt income. An outside
company insures them against the risk of default, or nonpayment.
Intermediate Corporate Bond Funds Intermediate corporate
bond funds invest in investment-grade corporate bonds that have
maturities between five and ten years.
Intermediate U.S. Bond Funds Intermediate U.S. bond funds
include U.S. Treasury notes that have maturities between five and ten
years.
Long-Term Corporate Bond Funds Long-term corporate bond
funds buy investment-grade corporate bonds that have maturities of
more than ten years.
Long-Term U.S. Bond Funds Long-term U.S. bond funds include
U.S. Treasury bonds and zero-coupon bonds that have maturities of
longer than ten years.
Municipal Bond Funds Municipal bond funds invest in municipal
bonds that provide investors with tax-exempt interest income.
Short-Term Corporate Bond Funds Short-term corporate bond
funds include investment-grade corporate bond issues that have
maturities of between one and five years.
332 Unit 3 Investing Financial Resources
Short-Term U.S. Bond Funds Short-term U.S. bond funds invest
in U.S. Treasury bills and some Treasury notes that have maturities of
between one and five years.
Mixed Mutual Funds
Other mutual funds are part of a third group—mixed mutual
funds. These funds invest in a mix of stocks and bonds or in various
other types of securities. The funds fall into three categories: balanced
funds, money-market funds, and stock/bond blend funds.
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis-
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals
to help them guide their financial decisions. "RASILIA
BRAZIL
Latin America is “Hot, hot, hot!” but it is not
due to the climate. This enthusiastic description refers
to the region’s financial markets. Although stocks in
a number of Latin countries have been riding high, DATABYTES
Brazil has been the “darling of the investing public.”
Since the Brazilian president made a number of eco- Capital Brasilia
nomic reforms in 2003, the stock market has soared.
Population 176,464,000
The easy money—over 100 percent return—may have
been made already. Some stocks, however, still show Languages Portuguese, Spanish, English,
promise. Brazil’s Petrobras, a state-run oil giant, is a and French
favorite, especially Currency real
with the increasing Gross Domestic
cost of fuel. AmBev, Product (GDP) $1.38 trillion (2003 est.)
the country’s only GDP per capita $7,600
[C10-04P] Pepsi distributor, Industry: Textiles, shoes, chemicals, cement, lumber, and
[PHOTO] is another popular iron ore
stock. For the more
[ C 1 0- Agriculture: Coffee, soybeans, wheat, rice, and beef
conservative inves-
07A] [MAP] tors, advisors suggest Exports: Transport equipment, iron ore, soybeans,
mutual funds as the footwear, and coffee
safest way to go. Natural Resources: Bauxite, gold, iron ore, manganese,
and nickel
Think Globally
What type of mutual fund would include stocks from
Brazilian companies? Would that fund be a good
investment choice? Why or why not?
Chapter 10 Bonds and Mutual Funds 333
Balanced Funds Balanced funds include both stocks and bonds to
As You provide income while avoiding excessive risk. Often the percentage
Read of stocks and bonds is stated in the fund’s prospectus.
QUESTION Money-Market Funds Money-market funds invest in certificates
Which of these investments, of deposit, government securities, and other safe investments. It is
stock, bond, or mixed relatively easy to withdraw money from a money-market fund.
mutual funds, do you think
would be a good invest- Stock/Bond Blend Funds Stock/bond blend funds invest in both
ment? Why? stocks and bonds, enabling investors to diversify their holdings with
a single fund.
Variety of Funds A variety of mutual funds managed by one
investment company is called a family of funds. Each mutual fund
within the family has a different financial objective. For instance,
one fund may be a short-term U.S. bond fund and a growth stock
fund. Most investment companies make it easy for shareholders to
switch among the mutual funds within a family. This allows investors
to adjust their investments conveniently to suit their changing needs
or to maximize their profits over time.
Section 10.3 Assessment
QUICK CHECK Calculate and Advise What is
1. What are the characteristics of closed-end the dollar amount of the commission
mutual funds? that Noah must pay the investment com-
2. What is an open-end mutual fund? pany to invest in this fund? Should he look
3. What are three categories of funds that fall for a no-load fund? Why or why not?
under the bond mutual fund group?
SOLVE MONEY PROBLEMS
THINK CRITICALLY 6. Fund Objectives Hilda wants to invest
4. Choose three categories of stock or bond her savings in a mutual fund, but she is
funds in which you think you might like concerned about the risk of investing. She
to invest. Explain why you think they are wants a fund that is stable and safe. Her
good investments. friend Ana recommends that she consider
utility funds and money-market funds. Her
USE MATH SKILLS friend Jack says she should explore aggres-
5. Load Fund Noah is thinking about sive growth funds and high-yield (junk)
investing $1,000 in a global mutual fund. bond funds.
However, the fund is a load fund, which Write About It Review the char-
charges a commission of 8.5 percent. The acteristics of utility funds, money-
investment company would deduct this market funds, aggressive growth funds, and
fee from Noah’s $1,000 before his money is high-yield (junk) bond funds. Write down a
invested in the fund. list of the objectives for these funds. Whose
advice is best? Why?
334 Unit 3 Investing Financial Resources
Section 10.4
Investing in Focus on
Reading
Mutual Funds
Read to Learn
• How to discuss sources
Making an Informed Decision of information for select-
What steps can you take to decide on mutual ing mutual funds.
fund investments? • How to describe the
methods of buying and
Which mutual funds are best for you? When should you buy or selling mutual funds.
sell your shares? You will have to answer these questions for yourself.
However, by considering your financial goals and consulting various Main Idea
sources of information on mutual funds, you will be able to deter- Knowing how to evaluate,
mine the best approach for investing in mutual funds. buy, and sell mutual funds
will enable you to invest
wisely.
Considering Your Financial Goals
You can consider several questions when you are in the process Key Terms
of identifying your investment goals: • income dividends
• How old are you?
• What is your family situation?
• How much risk do you want to take?
Before
• How much money do you make now?
• How much money are you likely to make in the future?
You Read
After you have considered these factors and answered these ques-
PREDICT
tions, you can set your investment goals. Once you know your goals, What would be your defini-
find a mutual fund with investment objectives that match your own. tion of capital gain?
Information on Mutual Funds
You will find a great deal of information that can guide you
through the decision-making process of buying or selling shares in
a mutual fund. The main sources of information on mutual funds
include:
• Newspapers • Financial publications
• Quotations • Professional advice
• Prospectuses • Internet
• Annual reports
Newspapers Metropolitan newspapers and financial newspapers,
such as The Wall Street Journal and Barron’s, provide a wealth of
information.
Chapter 10 Bonds and Mutual Funds 335
&IGURE -UTUAL &UND )NFORMATION IN 4HE 7ALL 3TREET *OURNAL
(OW TO 2EAD THE -ONTHLY 0ERFORMANCE 4ABLES
0ERFORMANCE TABLES ARE PROVIDED BY ,IPPER )NC 0ERFORMANCE CALCULATIONS ASSUME REINVESTMENT OF ALL
4HESE TABLES INCLUDE ALL PRIMARY FUNDS LISTED BY DISTRIBUTIONS AND ARE AFTER SUBTRACTING ANNUAL EXPENSES
.!3$!1 "OND PERFORMANCE NUMBERS ARE PRELIMINARY "UT FIGURES DO NOT REFLECT SALES CHARGES hLOADSv OR
4HOUGH VERIFIED THE DATA CANNOT BE GUARANTEED BY REDEMPTION FEES
,IPPER OR ITS DATA SOURCES $OUBLE CHECK WITH FUNDS
BEFORE INVESTING
4/4!, 2%452.
#HANGE IN NET ASSET VALUE WITH REINVESTMENT OF ALL
DISTRIBUTIONS INCLUDING DIVIDENDS FOR THE PERIOD IN
.%4 !33%4 6!,5% PERCENT 0ERCENTAGES ARE ANNUALIZED FOR PERIODS -!8)-5-
LONGER THAN ONE YEAR #ALCULATIONS ARE BASED ON ).)4)!, 3!,%3
-ONTH END VALUE AT WHICH SHARES LATEST DATA FROM FUND
CAN BE BOUGHT OR SOLD EXCLUDING #/--)33)/.
SALES OR REDEMPTION CHARGES AS )N PERCENT "ASED ON
CALCULATED BY THE FUND PROSPECTUS
/NE YEAR &IVE YEARS
#/-0!.9 *ULY 4HREE YEARS YEARS
&UND FAMILIES
IN BOLDFACE
"
#
" "
! #
89: -UTUAL )" " "
! #
"OND P '2 "
!
'ROWTH -#
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7HAT DOES THE LETTER hPv INDICATE ABOUT A FUND
Quotations As shown in Figure 10.4, mutual fund quotations
contain information about a fund’s net asset value, objective,
performance, and cost. When you read mutual fund quotations,
remember to note any letters beside the name of a specific fund. Then
look up their meanings in the quotation footnotes.
336 Unit 3 Investing Financial Resources
Mutual Fund Prospectuses After you have narrowed your search,
check out the prospectuses of the mutual funds that most interest
you. To get a copy of a prospectus, call, write, or e-mail the investment
company that manages the mutual fund. Many investment companies
have toll-free telephone numbers that you can find by calling the toll- Nest Egg
free information number (1-800-555-1212). An investment company Have you ever pooled
sponsoring a mutual fund must give a potential investor a prospectus your money with friends
or family to buy party
when requested.
supplies or donate to a
Read the prospectus completely before you invest. The prospec- charity? If you have, then
tus summarizes the fund and lists any fees you will have to pay. The you know something
prospectus usually provides the following information: about mutual funds. In
the world of investing
• A description of the fund’s objective and finance, a mutual
• The risk factor associated with the fund fund contains a group of
• A fee table stocks, and you can buy a
• A description of the fund’s past performance small piece of all of them
• A description of the type of investments contained in the by investing in the fund.
Choosing a mutual fund
fund’s portfolio
that is right for you usu-
• Information about dividends, distributions, and taxes ally involves some careful
• Information about the fund’s management research.
• Information on limitations or requirements the fund must
To continue with
honor when choosing investments
Task 4 of your
• The process by which investors can buy or sell shares of the WebQuest project, visit
mutual fund finance07.glencoe.com.
• A description of services provided to investors
• Fees for services
• Information about how often the fund’s investment portfolio
changes (sometimes referred to as turnover ratio)
• Information about how to open a mutual fund account
Mutual Fund Annual Reports If you are a potential investor,
you may request an annual report by mail, telephone, or e-mail.
When you become a shareholder, the investment company will
automatically send you an annual report. Annual reports may also
be posted on a company’s Web site. A fund’s annual report contains
a letter from the president of the investment company, the fund
manager, or both.
Do not forget the role of the fund manager in determining a
fund’s success. If a fund’s present manager has been doing a good job
for five years or longer, chances are that he or she will continue to
perform well in the future.
The annual report contains detailed financial information
about the fund’s assets and liabilities. It also includes a statement
of operations that describes expenses and day-to-day operating costs
of the fund, a statement of changes in net assets, and a schedule of
investments.
Finally, most annual reports include a letter from the fund’s inde-
pendent auditors. This letter backs up the accuracy of the information
contained in the report.
finance07.glencoe.com Chapter 10 Bonds and Mutual Funds 337
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Financial Publications Financial magazines such as Business-
Week, Forbes, Kiplinger’s Personal Finance, and Money are sources of
information about mutual funds. These publications provide annual
surveys and rankings of mutual funds, such as the example from
BusinessWeek magazine shown in Figure 10.5.
In addition to annual surveys, a number of mutual fund guide-
books are available at bookstores or your local public library.
338 Unit 3 Investing Financial Resources
&IGURE -ORNINGSTAR -UTUAL &UND 2ESEARCH
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Chapter 10 Bonds and Mutual Funds 339
Professional Advice Professional advisory services also provide
As You detailed information on mutual funds (see Figure 10.6). Popular
Read sources include Standard & Poor’s, Lipper Analytical Services,
RELATE Morningstar, Inc., Value Line, and Wiesenberger Investment
Companies. In addition, various mutual fund newsletters provide
Of the several listed financial information to subscribers for a fee. These publications
resources available to
research mutual funds,
are expensive, but you may be able to obtain copies of them from
which two seem most brokerage firms or public libraries.
important to you? Why? Professional advisory services, such as Morningstar, also offer
online research reports for mutual funds. Many investors find that the
research reports provided by such companies are worth the fees they
charge. The information is basically the same as that in the printed
reports. However, the ability to obtain the information quickly can
be a real advantage.
Internet Many investors research mutual fund investments on the
Internet. You may access this information online by one of several
methods. If you know the name or the four- or five-letter symbol for
a fund, you may obtain current market values by using Web sites such
as Yahoo! Finance. You can also get a price history and a profile.
Most investment companies that sponsor mutual funds have
Web sites. These sites are another source of useful information. To
obtain information, use a search engine, such as Google, and type
in the name of the fund. You will find information regarding sta-
tistics about individual funds, procedures for opening an account,
promotional literature, and investor services. However, investment
companies want you to become a shareholder, and therefore, their
Web-site material may read like a sales pitch. Look at the facts before
you invest your money.
GO FIGURE FINANCIAL MATH
CAPITAL GAIN Formula:
Capital Gain
Sales Price ⫺ Purchase Price ⫽
Synopsis: Capital gain is the amount by which per Share
a share’s selling price exceeds its purchase price.
Solution: $19.50 ⫺ $17.00 ⫽ $2.50
Determining the capital gain that you will receive
when you sell the shares of your mutual fund will The capital gain per share on Sani’s mutual fund
tell you how much the return on your investment was $2.50.
will be.
Example: Sani purchased shares in the Fidelity
Stock Selector Fund at $17 per share. Two years
YOU FIGURE
later, Sani sold the shares at $19.50 per share. If you purchased mutual fund shares at $8.50
What was the capital gain per share on Sani’s each and sold them for $11 per share, what
mutual fund? would be your capital gain?
340 Unit 3 Investing Financial Resources
Return on Investment As You
What is the difference between a capital gain Read
distribution and a capital gain?
QUESTION
Whether you choose a closed-end fund or an open-end fund,
What factors influence the
the purpose of investing in a mutual fund is to receive income. As a
price of a fund’s shares?
mutual fund shareholder, you may gain income in one of three ways.
First, you may receive income dividends. Income dividends
are the earnings a fund pays to shareholders. Second, you may earn
capital gain distributions. Capital gain distributions are payments
made to shareholders that result from the sale of securities in the
fund’s portfolio. Third, you may make a good return by buying shares
at a low price and then selling them after the price increases.
When you sell shares in a mutual fund, the profit that results
from an increase in value is referred to as a capital gain. As discussed
in Chapter 8, a capital gain is the profit from the sale of an asset such
as stocks, bonds, or real estate. Of course, if the price of a fund’s shares
goes down between the time of purchase and the time of sale, you
lose money. Note the difference between a capital gain distribution
and a capital gain. A capital gain distribution occurs when the fund
sells securities within the fund’s portfolio and distributes profits to
shareholders. A capital gain occurs when the shareholder sells some
of his or her shares in the mutual fund.
Taxes and Mutual Funds
How are mutual fund earnings taxed?
Income dividends, capital gain distributions, and capital gains
are all taxable earnings. At the end of every year, investment compa-
nies and brokerage firms send each shareholder a statement detailing
the income dividends and capital gain distributions he or she received.
Usually, this information is provided on the IRS Form 1099DIV. How-
ever, the investor is responsible for maintaining clear and accurate
records of the purchase and sale prices. The following are some gen-
eral guidelines on how mutual fund transactions are taxed:
• Income dividends are reported along with all other dividend
amounts you have received. They are taxed as regular income.
• Capital gain distributions are reported on your federal income
tax return.
• Capital gains or losses that result from your selling shares in a
mutual fund are reported on your federal income tax return.
You should be aware of two factors when you pay taxes on your
mutual funds. First, almost all investment companies allow you to
reinvest the capital gains distributions and income dividends you earn
instead of receiving cash. These distributions are taxable and must be
reported on your income tax return. Second, you decide when to sell
your stocks or bonds.
Chapter 10 Bonds and Mutual Funds 341
䊱 THE GOLDEN YEARS Many people use mutual funds to save for
their retirement. What is the advantage of starting to invest in a mutual
fund at a young age?
Thus, you can pick the tax year when you pay tax or deduct
losses on these investments. Mutual funds, on the other hand, buy
and sell securities on a regular basis during any 12-month period.
Unlike investments that you manage, you have no control over when
the mutual fund sells securities. Therefore, you have no control over
when you are taxed on capital gain distributions.
Buying and Selling Mutual Funds
How do you buy and sell mutual funds to help you
meet your financial goals?
The main reason for investing is the opportunity to make money
on your investment. Mutual funds can provide investors with income
dividends, capital gain distributions, and profits that result from their
decision to sell their shares. Various purchase options and withdrawal
options allow you to manage your mutual fund investments and prof-
its to help you meet your financial goals.
342 Unit 3 Investing Financial Resources
Purchase Options
Before you buy shares in a fund, you will need to consider several
different purchase options. As discussed earlier in this chapter, differ-
ent types of funds are sold by different means. Closed-end funds are
traded through stock exchanges, such as the New York Stock Exchange
or in the over-the-counter market. You can purchase shares of an open-
end fund from a brokerage firm or by contacting the investment com-
pany that sponsors the fund.
A wide variety of both no-load and load funds can also be bought
from mutual fund supermarkets that are available through brokerage
firms such as Charles Schwab and E*Trade. Mutual fund supermarkets
offer at least two advantages. First, instead of dealing with several
investment companies, you can make one toll-free phone call to buy
or sell a large number of mutual funds. Second, you receive one state-
ment from the brokerage firm instead of receiving a statement from
each investment company. This statement provides the information
that you need to monitor all of your investments in one place and in
the same format.
When you buy shares in an open-end mutual fund from an invest-
ment company, you have several purchase options. You can choose a
regular account transaction, a voluntary savings plan, a payroll deduc-
tion plan, a contractual savings plan, or a reinvestment plan.
Regular Account Transactions A regular account transaction is
the most popular and least complicated way to buy shares. With this
method you decide how much money to invest and when to invest
it. Then you simply buy as many shares as possible.
Voluntary Savings Plans A voluntary savings plan lets you
make smaller purchases than the minimum required by the regular
account transaction. However, when you make your first purchase,
you also must commit to making regular minimum purchases of the
fund’s shares. Such small monthly investments can be a great way to
save for long-term objectives. For most voluntary savings plans, the
minimum purchase ranges from $25 to $100.
Payroll Deduction Plans Most voluntary savings plans also offer
payroll deduction plans. This means that with your approval, the
investment company will deduct a certain amount from your paycheck
each month and invest it in your mutual fund. Mutual fund savings
plans can also be used to invest money that is contributed to tax-
deferred 401(k) and 403(b) retirement plans or individual retirement
accounts (IRAs).
Contractual Savings Plans Contractual savings plans require
you to make regular purchases of shares over a specific period of time,
usually 10 to 20 years. You will pay penalty fees if you do not make
the required purchases. Financial experts and government agencies
disapprove of contractual savings plans because many investors lose
money with these plans.
Chapter 10 Bonds and Mutual Funds 343
Reinvestment Plans You can also buy shares in an open-end
After You fund by using the fund’s reinvestment plan. With a reinvestment
Read plan, your income dividends and capital gain distributions are
REACT automatically reinvested to buy additional shares of the fund. Most
reinvestment plans allow shareholders to reinvest without having
Which mutual fund pur- to pay additional sales charges or commissions. Reinvestment is a
chasing plan do you think
great way to add to your portfolio.
would be best for a young
investor and for a retired
investor? Why? Withdrawal Options
If you choose to invest in mutual funds, you will also need to
know how you can take your money out of a fund. You can sell shares
of closed-end funds to another investor anytime you want on the
stock exchange or in the over-the-counter market. Shares in an open-
end fund can be sold to the investment company that sponsors the
fund. In this case, provide proper notification, and the fund will send
you a check for the net asset value of your shares. With some funds,
you can write checks to withdraw money. If you have at least $5,000
worth of shares in a mutual fund, most funds will offer you four addi-
tional ways of withdrawing money.
Investment Period Withdrawal First, you may withdraw a
certain amount each investment period until your fund has been
exhausted. Typically, an investment period is three months, and most
funds require investors to withdraw a minimum amount, usually $50,
if the investor chooses to withdraw funds.
GO FIGURE FINANCIAL MATH
PERCENTAGE OF ASSET Asset Growth ⫻ Prearranged Percentage ⫽
GROWTH WITHDRAWAL Withdrawal Amount
Solution: $1,800 ⫺ $1,500 ⫽ $300
Synopsis: Most mutual funds will allow an investor
to withdraw a prearranged percentage of his or her $300 ⫻ 60% or .60 ⫽ $180
investment’s asset growth—or the amount that the Marco can withdraw $180.
investment has grown during a period.
Example: Marco invested $1,500 in a green energy
mutual fund. This first period, his investment was YOU FIGURE
reported to be worth $1,800. He is allowed to with- You invested $1,000 in a mutual fund special-
draw 60 percent of the asset growth per period. izing in cell-phone technology. During the first
How much can he withdraw? period, your portfolio has a value of $1,235.
Formula: Your prearranged withdrawal percentage is
Current Portfolio Value ⫺ Original Portfolio Value ⫽ 40 percent of net asset growth. How much can
Asset Growth you withdraw?
344 Unit 3 Investing Financial Resources
Investment Period Liquidation A second option is to liquidate
or “sell off” a certain number of shares each investment period. Of
course the net asset value of shares in a fund varies from one period to
the next. Therefore, the amount of money you receive will also vary.
Asset Growth Withdrawal A third choice lets you withdraw a
prearranged percentage of your investment’s asset growth, which is the
amount by which your portfolio has increased in value. For example,
suppose that you arrange to receive 60 percent of the asset growth
of your portfolio. The asset growth of your portfolio was $800 in a
particular investment period. For that period you will receive a check
for $480 ($800 ⫻ 60% ⫽ $480). If the value of your portfolio does not
increase, you receive no payment. Under this option, your principal
(the amount of your original investment) remains untouched.
Dividend and Distribution Withdrawal A final option allows
you to withdraw all income that results from income dividends and
capital gains distributions earned during an investment period. Under
this option, too, your principal remains untouched.
Section 10.4 Assessment
QUICK CHECK Present Prepare a flyer that will
1. What type of information does a mutual convince people to invest in your
fund quotation provide to help you evalu- fund. Name your fund, and give as many
ate a fund? reasons as possible why it would be a solid
2. What are three ways in which you can investment. Make your flyer appealing by
receive income from your mutual fund using exciting language and by including
investments? pictures, charts, and graphs.
3. What are the withdrawal options that
SOLVE MONEY PROBLEMS
are available when selling shares in a
mutual fund? 6. Purchase Options Malia has invested
in a mutual fund. She wants to add to her
THINK CRITICALLY investment on a regular basis and is trying
4. Newspaper mutual fund quotations, financial to decide which purchase option to use.
magazines, and the Internet are three sources Her mutual fund offers a voluntary savings
you might use to research a mutual fund that plan, a contractual savings plan, and a rein-
matches your financial goals. Decide which vestment plan.
source you would use first, and explain why. Analyze Analyze the advantages
and disadvantages of the three pur-
USE COMMUNICATION SKILLS chase options available to Malia. Which
5. Sales Pitch Imagine that you are the purchase option would you suggest to
professional manager of a large mutual her? Why?
fund. You are looking for investors to buy
shares in your fund.
Chapter 10 Bonds and Mutual Funds 345
Chapter 10 Review & Activities
CHAPTER SUMMARY
• Corporate bonds have the following • Information on bonds is available in
characteristics: interest rates, maturity the financial press, corporate annual
dates, and face values. reports, bond rating reports, and
• Corporations sell bonds to raise online.
funds for operations, expansions, or • Types of mutual funds include closed-
purchases. end mutual funds, open-end mutual
• Investors buy bonds because they funds, load funds, and no-load funds.
provide regular income, plus the • Mutual fund information is found
principal must be repaid by maturity. in newspapers, annual reports, and
• Governments sell bonds for reasons financial publications, and through
similar to corporations: to fund regular Web sites and advisors.
activities and finance the national debt. • Methods of buying and selling include
• Government bonds include Treasury regular account transactions, voluntary
bills, Treasury notes, and U.S. savings savings plans, payroll deduction plans,
bonds (Series EE). contractual savings plans, reinvestment
plans, and withdrawal options.
Communicating Key Terms
You meet with employees who will retire in five years to discuss adding bonds to their 401(k)
plans. Explain the benefits of bond investments, using as many of these key terms as possible.
• maturity date • registered bond • closed-end fund
• face value • coupon bond • open-end fund
• debenture • bearer bond • net asset value (NAV)
• mortgage bond • zero-coupon bond • load fund
• convertible bond • municipal bond • no-load fund
• sinking fund • investment-grade bonds • income dividends
• serial bonds • yield
Reviewing Key Concepts
1. Explain the advantages of the call feature on bonds to corporations and to investors.
2. Explain why corporations may prefer to issue bonds to raise funds for their operations.
3. Explain how the market value of a bond is determined.
4. List three examples of reasons state and local governments might issue bonds.
5. Describe the characteristics of a municipal bond, including tax factors.
6. Explain the meaning of bond ratings and their impact on buying decisions.
7. Describe the characteristics of a closed-end, open-end, load, and no-load mutual fund.
8. Describe a mutual fund prospectus.
9. Compare the three ways you can purchase mutual funds.
346 Unit 3 Investing Financial Resources
Chapter 10 Review & Activities
History Today mutual funds are very popular investment options.
However, since their origin in 1924, they have fallen in and out of favor.
Write About It Research and write a one-page essay on the history of
mutual funds in the United States.
Bond Market Value You own 12 20-year General Electric Capital
Services corporate bonds with face values of $1,000. Their coupon rate is
7.5%. Their current yield is 5.2%.
1. Calculate (a) What is the current market value of one of these bonds? (b)
Of the total investment? (c) If you do not have an immediate need for the
cash, what would be your best course of action, sell and reinvest in some
other security or hold?
2. Compute by using spreadsheet software to make and present these
calculations.
Connect with Economics You just inherited $4,000. You need to
decide whether to invest this money in a mutual fund, pay down your credit
card debt, or simply hold the money in an interest-bearing checking account
to pay upcoming bills.
1. Think Critically What is your current financial situation, and do you
foresee a legitimate need for extra funds in the short term?
2. Analyze What is the “health” of your emergency fund?
Mutual Fund Prospectus The prospectus of a mutual fund is where
you find out about the structure, fees, and “rules” of investing in the fund.
Log On Use an Internet search engine and find Web sites of mutual
fund companies, such as Fidelity and T. Rowe. Review at least one
mutual fund’s prospectus. Answer the following questions:
1. What are the investment orientation, risk tolerance, and goals of the
managers of this fund?
2. Would you recommend this fund? Why or why not?
Newsclip: Reliable Bonds? A bond fund is a mutual fund
comprised mainly of bonds. These types of funds are usually safe
O N L I N E
investments with greater opportunity for returns.
Log On Go to finance07.glencoe.com and open Chapter 10.
O N L I N E
Learn more about the different types of bond funds. Write a list of
points you have learned about bond funds. Would you invest in a bond
fund? Why or why not?
finance07.glencoe.com
nance07.glencoe.com/careers Chapter 10 Bonds and Mutual Funds 347
Chapter 10 Review & Activities
WHAT’S YOUR INVESTING IQ?
The more you know about investing, the greater your chance for
higher returns. Before you read this chapter, answer the questions
below on a separate sheet of paper. After you have studied the chap-
ter in class, take the quiz again to see how much you have learned.
1. Liquidity is the ability to __________ .
a. easily convert your financial resources into cash without a loss in value
b. invest in any liquid substance
c. transfer funds electronically
2. The least speculative investment listed below is __________ .
a. municipal bonds
b. treasury bonds
c. zero-coupon bonds
3. A mutual fund prospectus is __________ .
a. a possible date for Saturday night
b. a report that provides potential investors with information about the fund
c. a statement of your earnings
4. Federally tax-exempt interest can be earned on __________ .
a. an annuity
b. a convertible bond
c. a municipal bond
5. Investors buy junk bond funds because __________ .
a. of the possibility of a high yield
b. municipalities always need to remove junk
c. they usually resist fluctuations in the stock market
6. Mutual funds are popular because __________ .
a. they generally receive the highest (AAA) rating
b. investors can choose which stocks are in their portfolio
c. investors can acquire a diversified portfolio
348 Unit 3 Investing Financial Resources
Chapter 10 Review & Activities
Your Financial Portfolio
Evaluating Mutual Funds
Eric is looking at a mutual fund because it might earn a greater return than a CD. He
used the following checklist as a way to evaluate the Pacific Sun Growth Fund, a stock
mutual fund.
After evaluating Pacific Sun Growth Fund, Eric has decided that he likes the poten-
tial for a high return. He may go with the fund, even though he needs $1,000 to make
his initial investment.
Pacific Sun Growth Fund
1. Name of mutual fund 1. Pacific Sun Growth Fund
2. Mutual fund group and category 2. Stock mutual fund/aggressive growth
3. Mutual fund’s objective 3. Aggressive growth of capital
(Aggressive growth, moderate growth,
income and safety, and income)
4. Yield in the last twelve months 4. 15%
5. Average return or yield for last five years 5. 11%
6. Average return or yield for last ten years 6. 18%
7. Load fees or redemption fees 7. no fees
8. What is the minimum investment? 8. $1,000
9. Is the fund closed to new investors? 9. No
10. Morningstar rating (in stars and risk) 10. Three-star rating and moderate risk
Research
Call an investment company for a prospectus of a mutual fund. You can also visit
your local library and look in Morningstar Mutual Funds or the Weisenberger Investment
Companies Yearbook. On a separate sheet of paper, fill in the information on the check-
list to evaluate the fund.
Chapter 10 Bonds and Mutual Funds 349
11
CHAPTER
Real Estate
and Other
Investments
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 11.1
• Explain the different types of
real estate investments.
• Discuss the advantages and
disadvantages of real estate
investments.
Section 11.2
• Identify the different types
of precious metal and gem
investments.
• Describe collectibles
investments.
• Analyze the risks of investing
in precious metals, gems, and
collectibles.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
350
In the Real World . . .
E rica Sato loves to visit thrift shops, where she looks for
rare books and records that cannot be found on CDs. She has a
knack for knowing what items are in demand and supplements her income
by selling those things through online auctions. Erica also knows that old
Disney® and Coca-Cola® items are coveted by collectors around the world. The
Internet makes it easy for her to sell to people near and far, and she has built an
excellent online reputation by sending items on time and in protective boxes.
Collectibles can be a good investment, but Erica realizes they are more risky
than other investments, so she wants to diversify her investments to
include real estate and other alternatives.
As You Read Why do you think collectibles are
considered a risky investment?
Collecting
ASK Q: Are collectible action figures a smart investment
for retirement?
A: Although collecting can be an enjoyable and sometimes profitable pursuit, col-
lectibles are not a mainstay of retirement planning. It would be best if you focused
your retirement planning efforts on building a diversified portfolio that may include
stock and bond investments. You could still use collectibles as a small part of your
portfolio, but their returns are very unpredictable.
Ask Yourself Why are the returns on collectibles so unpredictable?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com Chapter 11 Real Estate and Other Investments 351
Section 11.1
Focus on
Reading
Real Estate
Investment
Read to Learn
• How to explain the dif-
ferent types of real estate Real Estate Investments
investments. What is the difference between direct and indirect
• How to discuss the investment in real estate?
advantages and disad-
vantages of real estate Real estate has always been a favorite investment for Ameri-
investments. cans. Unlike stocks and bonds, a piece of property is something you
can see and touch and take pride in. However, if you are new to the
Main Idea real estate market, you may be confused by all the different choices
Real estate investment you have.
opportunities vary widely.
Consider the advantages
and disadvantages of
Direct Real Estate Investments
each type of investment Real estate investments can be direct or indirect. The owner of
opportunity.
a direct investment holds legal title to the property he or she has
purchased. Direct investments include single-family houses, duplexes,
Key Terms apartments, land, and commercial property.
• direct investment
• commercial property A Home as an Investment What is a home? Obviously, it is the
• indirect investment place where you and your family live. However, owning a home can
• syndicate also be a good investment.
• participation certificate
(PC)
According to Mortgage Bankers Association of America, home
• financial leverage ownership is most Americans’ largest financial asset. In 2003, the
market value of homes in the United States was nearly $12 trillion,
which was 50 percent higher than five years earlier. Homeowners’
equity, the value of a home less the amount owed on the money bor-
Before rowed to purchase it, accounted for 30 percent of household wealth.
You Read As discussed in Chapter 8, during periods of inflation, the pur-
chasing power of your money declines. Investing your money can
PREDICT help you stay ahead of inflation. Owning a home is a good invest-
Why do you think so many ment because, generally, home prices have risen steadily over the
Americans invest in real years, as shown in Figure 11.1. In fact, during the past 150 years,
estate? owning a home produced an average rate of return after inflation of
about 2.5 percent. That is about the same rate of return you would
expect from a bond.
Most homeowners have mortgages, which can provide certain
tax benefits. Homeowners can report the interest charges on mortgage
payments as well as property taxes as deductions on their income tax
returns.
352 Unit 3 Investing Financial Resources
Vacation Homes Second-home mortgages also provide tax benefits.
For example, Kevin’s parents own a vacation home on Fox Lake. It is a
good investment because the family uses it year-round and never rents
it out to others. According to the federal government, that qualifies
it as a second home. Therefore, Kevin’s parents can take advantage of
certain tax deductions. If the parents rented out the home for more than
14 days each year, the government would consider it a rental property.
As a result, any tax deductions would depend on whether Kevin’s
parents managed the property and on the size of their income.
Commercial Property In addition to the vacation home on the
lake, Kevin’s parents also own commercial property. Commercial
property is land and buildings that produce rental income. Kevin’s
parents own an apartment building that adds to their income. Other
examples of commercial property include duplexes, hotels, office
buildings, and stores. Most small investors favor duplexes, four-plexes,
or small apartment buildings. Many investors start by purchasing a
small commercial property. Then they buy larger properties as the
equity in their original investment increases.
&IGURE !VERAGE 3ALES 0RICES OF .EW 3INGLE &AMILY (OMES
.ORTHEAST -IDWEST 3OUTH 7EST
3OURCE ¥ .ATIONAL
!SSOCIATION OF 2EALTORS
5P AND !WAY 4HE AVERAGE SELLING PRICE OF HOMES IN THE 5NITED 3TATES HAS RISEN STEADILY
SINCE
7HICH REGION EXPERIENCED THE GREATEST GAIN 4HE LOWEST
Chapter 11 Real Estate and Other Investments 353
Land In 1986, Kevin’s parents received quite a shock. Tax laws in
the United States were rewritten so that many popular real estate
investments, such as apartment buildings, lost some of their tax
advantages. Owning commercial property became less appealing to
Utility Savers
1. Use fluorescent some real estate investors. Many of these investors began investing in
lamps to save 30 land that was ready to be developed.
to 38 percent of Kevin’s parents talked to an investment banker before they pur-
lighting bills. chased land. She told them that while land investments often prom-
2. Seal and weather- ise tremendous gains, they also pose enormous risks. If construction
strip doors and in general slowed or business activity declined, Kevin’s parents might
windows. not be able to sell their property at a profit. Even worse, they might
3. Repair all leaky not be able to get the price that they had paid for it. Furthermore, the
faucets.
banker reminded them that unlike an apartment building, land in
4. Unplug refrigera- urban areas usually does not produce any income.
tors when not in
use.
The banker also cautioned Kevin’s parents about buying land
and then dividing it into smaller lots to build single-family houses.
5. Plant shade trees
to block heat from They must be certain that water, sewers, and other utilities would be
buildings. available. Otherwise, they would have to supply those services. The
most common and least expensive way to obtain water and sewer ser-
vice is to connect to existing services in a nearby city or town.
Indirect Real Estate Investments
Suppose that you want to invest in real estate, but you do not
have enough money to purchase property on your own. The answer
may be an indirect real estate investment. An indirect investment
is an investment in which a trustee is appointed to hold legal title
to the property on behalf of an investor or group of investors. Indi-
rect investments include real estate syndicates, real estate investment
trusts, high-risk mortgages, and participation certificates.
INVESTMENT IN LEISURE
A family vacation home can
be part of a sensible invest-
ment strategy. Why are vaca-
tion homes smart investments?
354 Unit 3 Investing Financial Resources
Real Estate Syndicates or Limited Partnerships A syndicate
is a temporary association of individuals or business firms organized As You
to perform a task that requires a large amount of funds. A real estate Read
syndicate invests in real estate. A syndicate may be organized as a RELATE
corporation or as a trust. Most commonly, however, a syndicate is
organized as a limited partnership. Do you know anyone who
owns a home or invests in
Here is how a limited partnership works: A general partner,
real estate?
who takes complete responsibility for all of the partnership’s liabili-
ties, forms the partnership. The general partner then sells participa-
tion units, or shares, to a number of limited partners, or investors.
Suppose that you decide to join the syndicate. As a limited partner,
you are liable for only the amount of money you have invested,
perhaps $5,000 or $10,000. This limited liability is an important
condition of a real estate syndicate because the syndicate’s mortgage
debt may be more than your personal net worth or that of the other
limited partners.
A real estate syndicate offers you and the other partners a variety
of benefits. For example, if the syndicate purchases several types of
property, your investment will be diversified. That is, you will be part
owner of different types of property. In addition, the property owned
by the syndicate is professionally managed. You do not need to care
for it yourself.
At one time, people would join a real estate syndicate to cre-
ate a tax shelter, which is a legal arrangement to take advantage
of income tax deductions. However, the Tax Reform Act of 1986
limits the tax advantages available to syndicate investors. For
example, investors can no longer use losses from their syndicate
investments to offset, or reduce, their income from other sources.
The 1986 law limits deductions for interest and for depreciation,
which is the cost of general wear and tear. It also raised the tax
on capital gains.
Real Estate Investment Trusts (REITs) Joshua’s grandfather
gave him $3,000 for graduation. Joshua would like to invest that
money in real estate, but realizes that he cannot buy an apartment
building or condominium for that much money. One real estate
investment choice Joshua could consider is a real estate investment
trust (REIT). A REIT works much like a mutual fund. Like mutual
funds, REITs combine money from many investors. However, while
mutual funds are investments in stocks, bonds, and other securities,
REITs are investments of the investors’ money in real estate or in
construction or mortgage loans. Shares in REITs are traded on stock
exchanges or on the over-the-counter market.
There are three types of REITs: equity, mortgage, and hybrid. If
you choose an equity REIT, your money will be invested in proper-
ties. Choosing a mortgage REIT will put your money to work financ-
ing construction loans and mortgages on developed properties. If you
want to combine the investment goals of equity and mortgage REITs,
you can choose a hybrid REIT.
Chapter 11 Real Estate and Other Investments 355
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: A County Real Estate Your Motive: Real estate property, such as
Valuation a house or land, is taxed based on its value.
A county real estate valuation contains the The higher the value, the more taxes you
following information: pay to the local government. You will need
• Property parcel ID number to make sure that your property is valued
• Description of the property correctly so that you do not pay excessive
• Appraised value taxes.
• Assessed value
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AZ\Va9ZhXg^ei^dc/ 7ILLIAMSBURG #OLONY 0HASE # ,OT
AVcY9ZhXg^ei^dc/ FT BY FT
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#OLONIAL FRAME STORY SQ FT BUILT ABOUT WITH TOTAL ROOMS WITH
BEDROOMS WITH BATHROOMS WITH HALF BATH WITH FULL BASEMENT WITH NO ATTIC
WITH CAR BASEMENT GARAGE WITH FIREPLACE
9ZhXg^ei^dcD7N EgdedhZY'%%, '%%,6hhZhhZYKVajZ
7j^aY^c\ h KVajZ 6eegV^hZYKVajZ
7$ 7OOD $ECK ,AND 4OTAL
"UILDINGS ,AND
4OTAL "UILDINGS
4OTAL
Key Points: The county government Find the Solutions
assesses the value of real estate property to 1. What is the parcel ID number?
determine how much tax should be paid 2. How many square feet of interior space does
for the property. County auditors review the building have?
the value of recent real estate purchases and 3. What style is the building?
4. What is the appraised value of the wood
any improvements made to the property.
deck?
The auditors then determine an appraised
5. What is the total square footage of the lot?
value for the property and an assessed
value. The assessed value determines the
amount of tax. Then a statement is sent
to the property owner explaining the
valuation.
356 Unit 3 Investing Financial Resources
According to federal government
regulations, REITs are required to:
• Distribute at least 90 percent
of their net annual earnings to
shareholders.
• Avoid investing in risky, short-
term real estate holdings in the
hope of selling them for quick
profits.
• Hire independent real estate
professionals to carry out certain
management activities.
• Have at least 100 shareholders,
with no more than half the shares
owned by five or fewer people.
If you are interested in finding
out more about REITs, you can contact
the National Association of Real Estate
Investment Trusts.
High-Risk Mortgages Some inves-
tors accept high risk in exchange for
possible profits. For example, Mr. Moy is
a wealthy investor who purchases high-
risk mortgages and other debt contracts.
Because he is wealthy, Mr. Moy is willing
to take risks that financial institutions, such as banks and savings and PART OF SOMETHING BIG
loan associations, will not. For example, Mr. Moy might purchase the Giant corporate complexes
mortgage on a property that is not in demand because the title to can cost millions of dollars to
the property may not be legally clear or insurable. Because of such build and maintain. Do you
risks, Mr. Moy and other similar investors might receive a high rate of need to be extremely wealthy
return on their investments. Even though Mr. Moy is not guaranteed to invest in large commercial
a high rate of return, he hopes that the demand for his property will properties? Why or why not?
increase so he will make a handsome profit in the future. On the
other hand, if the demand does not increase, Mr. Moy may lose most
or all of his investment.
Participation Certificates Unlike Mr. Moy, investors cannot
afford to take such risks with their money. If you are looking for a
risk-free real estate investment, then participation certificates might
be a good choice for you. A participation certificate (PC) is an
investment in a group of mortgages that have been purchased by a
government agency. Because the investment is made in a group of
mortgages, it is considered a mutual fund. You can buy participation
certificates from these federal agencies:
• Government National Mortgage Association (Ginnie Mae)
• Federal Home Loan Mortgage Corporation (Freddie Mac)
• Federal National Mortgage Association (Fannie Mae)
• Student Loan Marketing Association (Sallie Mae)
Chapter 11 Real Estate and Other Investments 357
A few states also issue participation certificates. You can purchase
As You PCs from the State of New York Mortgage Agency (Sonny Mae) and the
Read New England Education Loan Marketing Corporation (Nellie Mae).
QUESTION Agencies with close ties to the federal government guarantee Maes
and Macs. The PCs they issue are as secure as U.S. Treasury bonds and
Why do people join limited notes. You can invest as little as $1,000 to buy shares. Each month, you
partnerships and/or REITs?
can receive a check for the principal and interest or reinvest the profits.
Real Estate Investment:
Pros and Cons
What should you know when considering
real estate investment?
Before you invest in real estate, you will want to weigh the
advantages and disadvantages.
Advantages of Real Estate Investments
There are several advantages enjoyed by certain types of real
estate investments:
Hedge Against Inflation When inflation rises, your purchasing
power decreases. Both direct and indirect investments in areas such as real
estate are wise because they provide some protection against inflation.
Historically, real estate continues to increase in value or at least hold its
value, thus protecting investors from declining purchasing power.
Easy Entry By making an indirect investment in a real estate
syndicate, you can easily become a part owner of an apartment
building or a shopping center. By combining your money with that
of other investors, you can purchase commercial property.
Limited Financial Liability An indirect investment in a real estate
syndicate allows you to be a limited partner. That means you are not
Nest Egg liable, or responsible, for losses beyond your original investment. This
Is it a waste of time for advantage is important if the syndicate is investing in a risky venture.
a young person to think
about investing in real Financial Leverage Financial leverage is the use of borrowed
estate? Buying a home is funds for direct investment purposes. By using borrowed money,
just for married couples, you can purchase more expensive property. If property values and
right? Not necessarily. incomes are rising, this can be an advantage.
You can make owning For example, suppose that Deborah buys a building for $100,000
real estate a part of your
with no borrowed funds. She then sells the building for $120,000.
plan for the future starting
right now. Learn about Deborah’s $20,000 profit equals a 20 percent return on her $100,000
the basic steps for invest- investment ($20,000 ⫼ $100,000 ⫽ 0.20 or 20%).
ing in real estate. On the other hand, suppose that Deborah invested just $10,000
of her own money and had a $90,000 mortgage with an interest rate
To continue with
Task 5 of your of 8.5 percent. After three years, she sells the property for $120,000,
WebQuest project, visit with a profit of $7,721 ($20,000 profit ⫺ $12,279 in interest ⫽ $7,721).
finance07.glencoe.com. Her profit would represent a 77 percent return on her $10,000 invest-
ment ($7,721 ⫼ $10,000 ⫽ 0.7721 or 77.21%).
358 Unit 3 Investing Financial Resources finance07.glencoe.com
Disadvantages of Real Estate Investments
Unfortunately, investors such as Deborah cannot be certain that
their real estate investments will pay off. There are several possible
disadvantages to real estate investments:
Illiquidity Real estate is an illiquid investment, which means that
it cannot be easily converted into cash without a loss in value. It may
take months or even years to sell commercial property or shares in a
limited partnership.
Declining Property Values As discussed earlier, real estate
investments usually offer some protection against inflation. However,
when interest rates fall, or if the economy is in a decline, the value of
real estate investments may decrease. If you own property, you may
have to make the difficult decision to sell your property for less than
you paid for it and accept a loss.
Lack of Diversification Because real estate is expensive, many
investors can afford only one or two properties. Subsequently, it may
be difficult to build a diversified real estate investment portfolio. Keep
in mind, however, that REITs, PCs, and syndicates do offer various
levels of diversification.
Careers in Finance
COMMERCIAL Yvonne Inger
PROPERTY MANAGER Hartman Management
Yvonne has always been able to manage many tasks at once. As the commercial property manager
for three retail buildings, this skill comes in handy. Yvonne monitors and maintains the building sys-
tems, vendor contracts, tenant relations, and profit and loss responsibilities for all three buildings. To
keep in touch with her tenants, she visits the retail sites regularly and attends weekly and monthly
tenant meetings. In addition to handling her tenants’ concerns, she takes care of the properties’
bills, licenses, and any emergencies that may arise. As a commercial property manager, Yvonne is
able to work independently and acts as her own boss.
SKILLS: Communication, math, management, customer-service, organization, and
time-management skills
PERSONAL TRAITS: Discretion, good judgment, and tactfulness
EDUCATION: Bachelor’s degree or master’s degree in business administration, finance,
administration, or related fields
ANALYZE How might a skilled commercial property manager affect the value of the property?
To learn more about career paths for commercial property managers, visit
finance07.glencoe.com.
finance07.glencoe.com Chapter 11 Real Estate and Other Investments 359
Lack of a Tax Shelter In the past, real estate syndicates were tax
shelters for investors. However, the Tax Reform Act of 1986 eliminated
that advantage. Syndicate investors cannot deduct real estate losses
from the income they receive through other sources, such as wages,
dividends, and interest.
Management Problems When you invest in REITs, syndicates, or
PCs, property management is provided as a part of your investment.
When you invest in mortgages, property management is not an issue.
However, when you buy your own properties, you must manage
them. That means that you are responsible for such things as finding
reliable tenants, replacing worn carpeting, and fixing the furnace.
Property management can be a full-time job, and many investors are
not willing to take on that much responsibility.
Investment Options
If you consider all the advantages and disadvantages of invest-
ing in real estate and you believe it is too risky or too complicated,
you might consider other tangible investments. Gold and other pre-
cious metals, gems, and collectibles are options that some investors
choose. However, these investments carry risk with the reward, as
discussed in the next section.
Section 11.1 Assessment
QUICK CHECK Write About It Write a persuasive
1. What are examples of direct and indirect ad that points out the advantages of
real estate investments? participation certificates. Be sure to include
2. What are the advantages of indirect real information that highlights the risk-free
estate investments? nature of these investments.
3. What are the disadvantages of direct and
SOLVE MONEY PROBLEMS
indirect real estate investments?
6. Diversification Teresa has been work-
THINK CRITICALLY ing as an advertising copywriter for five
4. Identify some similarities and differences years. She has been saving money and now
among syndicates, REITs, and PCs. has $10,000 to invest in real estate. Teresa
wants to make sure that her real estate
USE COMMUNICATION SKILLS investments will be diversified, not too
5. Selling Participation Certificates PCs risky, and easy for her to manage.
are considered risk-free investments. This Analyze Give Teresa some advice
makes them appealing to investors who are about the different types of real estate
looking for protection against inflation but investments that would best meet her
who do not have a lot of money to invest. investment goals.
How would you interest potential investors
in these certificates?
360 Unit 3 Investing Financial Resources
Section 11.2
Precious Metals, Focus on
Reading
Gems, and
Collectibles Read to Learn
• How to identify the
different types of pre-
cious metal and gem
Gold investments.
• How to describe collect-
Why do people invest in gold and other ibles investments.
precious metals?
• How to analyze the risks
Precious metals include such valuable ores as gold, platinum, of investing in precious
and silver. Many people invest their money in precious metals as a metals, gems, and
collectibles.
hedge, or protection, against inflation.
When Mark graduated from high school, his grandfather gave
Main Idea
him a gold pocket watch. Ever since, Mark has been fascinated by
Understanding the risks
gold and has wanted to own more of it. If you are interested in pur-
and rewards of investing in
chasing gold, you have several choices, as shown in Figure 11.2 on precious metals, gems, and
page 362. collectibles will help you
The price of gold rises when people believe that war, political build a sound, diversified
unrest, or inflation may be just around the corner. As international portfolio.
tensions ease or the political situation stabilizes, the price of gold
falls. In January 2005, the price of gold was about $425 per ounce. Key Terms
Figure 11.3 on page 363 shows how the price of gold rose and fell • precious metals
from 1979 to 2003. • precious gems
• collectibles
Silver, Platinum, Palladium,
and Rhodium Before
What is one disadvantage of investing in a You Read
precious metal such as platinum?
PREDICT
Other precious metals that rise in value during times of political
or economic trouble are silver, platinum, palladium, and rhodium. Do you think investments
Silver prices have ranged from a historic low of 24.25 cents an ounce in precious metals, gems,
or collectibles are risky
in 1932 to more than $50 an ounce in early 1980. In January 2005,
or safe?
the price of silver was about $6.80 an ounce.
Platinum, palladium, and rhodium, which are three lesser-
known precious metals, are also popular investments. All of these
metals have industrial uses, particularly in automobile production. In
January 2005, platinum sold for about $877 an ounce, palladium for
about $200 an ounce, and rhodium for about $1,300 an ounce.
Chapter 11 Real Estate and Other Investments 361
Figure 11.2 Investing in Gold
When the economy weakens or political unrest develops, some people believe that gold is the safest
investment they can make. Investments in gold can take many forms.
1
Bullion You can purchase gold bullion, which is
offered in bars and wafers, from dealers of precious
metals and from banks. The seller’s commission can
range from 1 to 8 percent. If you do not store the
gold with the dealer, you must have it reassayed
(tested for quality) before you can resell it.
2
Coins Gold coins represent a simple way to invest in
this precious metal. Most coin dealers require a mini-
mum order of ten coins and will charge you a seller’s
commission of at least 2 percent.
Stocks You can diversify your invest-
3 ment portfolio by purchasing common
stock in gold mining companies. When
the economy is healthy, the price of
gold stocks tends to fall while the value
of other investments rises. When the
economy falters so that traditional
investments lose value, gold stocks tend
to rise in value.
362 Unit 3 Investing Financial Resources
Storing precious metals can be tricky. Twenty thousand dollars’
worth of gold, for example, is about the size of a thick paperback
book. That same amount in silver weighs more than 200 pounds and
could require several safe-deposit boxes for storage space.
TechByte
Collectibles Are you
In addition, remember that while stocks, bonds, and other inter- interested in antiques
est-bearing investments are earning money for you, precious metals or other collectibles? In
sit in vaults, earning nothing. In order to make a profit when you order to make sure your
initial investment grows,
sell precious metals, you must correctly predict the behavior of the
you have to buy items at
market and sell the metals when their value is higher than what you the right price. To better
paid for them. understand what objects
sell for and what makes
something valuable, you
Precious Gems can visit the Web site of an
What is one of the advantages of investing auction house and view
in precious gems? collectible objects and
their suggested prices.
When the Queen of England opens the British Parliament, she Select a type of
wears a crown and carries a scepter, both of which are covered with antique or work of
diamonds, rubies, sapphires, and other glittering gems. As soon as the art that interests you and
ceremony is over, the royal ornaments are quickly locked up again in create a list of sale prices
the Jewel House at the Tower of London. for these items through
Throughout world history people have valued the precious gems finance07.glencoe.com.
that lie below the earth’s surface. Precious gems are rough min-
eral deposits (usually crystals) that are dug from the earth by miners
and then cut and shaped into brilliant jewels. These gems include
diamonds, sapphires, rubies, and emeralds. They appeal to investors
because of their small size, ease of storage, great durability, and their
potential as a protection against inflation.
&IGURE #HANGING 0RICE OF 'OLD 3INCE
$OLLARS PER TROY OUNCE
ON *AN
,ONDON GOLD FIXING
'OLDS 7ILD 2IDE 4HE VALUE OF GOLD FLUCTUATED WIDELY DURING THE LAST QUARTER OF THE S
7HAT MIGHT EXPLAIN THE SPIKE IN GOLD PRICES DURING
finance07.glencoe.com Chapter 11 Real Estate and Other Investments 363
CROWN JEWELS
Throughout history, precious
gems have been associated
with royalty. Why do you
think diamonds, rubies, and
other precious stones fascinate
people?
The inflation that occurred in the United States during the 1970s
prompted investors to put more of their money into tangible assets
such as gemstones. The result was a 40-fold increase in the price of
GEOGRAPHY diamonds. A few lucky investors made fortunes during that time.
Precious metals and stones Whether you are buying precious gems to store in a safe-deposit
have fascinated people box or to wear as jewelry, keep in mind the risks associated with this
around the world for cen- type of investment. First, you cannot easily convert diamonds and
turies. Billions of dollars other precious gems into cash. Also, as a beginning investor, you may
change hands each year as have difficulty determining whether the gems you are purchasing are
valuable metals and stones
are bought and sold. Many
of high quality. Political unrest in gem-producing countries can affect
people invest in precious supply and pricing. In addition, you will likely have to buy your
metals and stones as a way gems at higher retail prices and sell them at lower wholesale prices.
of diversifying their invest- The difference is usually 10 to 15 percent and sometimes as high as
ment portfolios. Print a 50 percent.
world map and mark the The best way to know exactly what you are getting in an expen-
places where gold, silver,
platinum, diamonds, emer-
sive precious gem is to have the stone certified by an independent geo-
alds, and rubies are found. logical laboratory, such as the Gemological Institute of America. The
Use a color key to identify certificate should list the stone’s characteristics, including its weight,
each precious metal and color, clarity, and quality of cut. The grading of gems, however, is not
gem on the map. an exact science. Experiments have shown that the same stone submit-
ted twice to the same laboratory may get two different ratings.
364 Unit 3 Investing Financial Resources
Despite the attraction of precious metals and gems, the invest-
ment risks are sizable. The primary risk is the great fluctuation in
As You
prices, which can be influenced by global, economic, financial, and Read
political factors. For example, in 1980, world events caused the prices RELATE
of precious metals and gems to shoot up. Investors bought gold for as
much as $850 an ounce, and a one-carat diamond for $62,000. Would you purchase precious
metals? Why or why not?
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis-
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals
to help them guide their financial decisions.
SOUTH AFRICA
Diamonds, one of the oldest substances on Earth,
are today’s most popular gem. They were once used to
0RETORIA
guard against “evil spirits” but have since become a
token of everlasting love. They are used to commemo-
DATABYTES
rate engagements, April birthdays, and 75th wedding
anniversaries. Diamonds are mined in about 25 coun-
Capital Pretoria (administrative capital),
tries and on every continent but Europe and Antarctica.
Bloemfontein (judicial capital),
One country that is well-known for its diamond
and Capetown (legislative capital)
mining is South Africa. Diamonds were discovered there
Population 44,024,000
in 1867. News spread quickly, and thousands of pros-
pectors staked their claims and began to mine South Languages Afrikaans, English, Ndebele, Pedi,
Africa’s diamond fields. This spurred economic growth Sotho, Swazi, Tsonga, Tswana,
in South Africa. Some Venda, Xhosa, and Zulu
of the world’s most Currency rand
beautiful and famous Gross Domestic
diamonds were found Product (GDP) $456.7 billion (2003 est.)
in South Africa. In fact, GDP per capita $10,700 (2003 est.)
the world’s largest dia-
Industry: Mining, automobile assembly, metalworking,
mond was found in
and machinery
1905 among the rich
Agriculture: Corn, wheat, sugarcane, fruits, and beef
deposits of South Africa.
It weighed 3,106.75 Exports: Gold, diamonds, platinum, other metals and
carats. When cut, the minerals, and machinery and equipment
stone produced 105 Natural Resources: Gold, diamonds, chromium,
gems, including the antimony, coal, and iron ore
famous 530.20-carat
Think Globally
“Star of Africa.”
With technology making it possible to manufacture
imitation diamonds, do you think real diamonds will
continue to be valued highly? Why or why not?
Chapter 11 Real Estate and Other Investments 365
Put on Collectibles
Your What are collectibles?
Financial Collectibles are another type of investment. Collectibles
Planner’s include rare coins, works of art, antiques, stamps, rare books, comic
Cap books, sports memorabilia, rugs, ceramics, paintings, and other items
that appeal to collectors and investors. Each of these items offers the
Julius and Martha are a knowledgeable collector or investor both pleasure and an opportu-
middle-aged couple who
nity for profit. Many collectors have been surprised to discover that
have asked your advice. All
of their investments are in items they bought for their own enjoyment have increased greatly in
CDs, but you have recom- value while they owned them.
mended that they diversify For example, when Hannah was a little girl, her Aunt Sylvia
their investments. They have bought her two collectible dolls. As she grew up, Hannah received
$25,000 to invest, and Julius more dolls as gifts and also bought some of her own. She now has
wants to put $15,000 into
an extensive collection of over 100 different dolls. Although Han-
precious metals. Martha
wants to put all the money nah never really thought of her dolls as an investment, she recently
into undeveloped land. What discovered that several of them are worth $500 each, which is more
is your advice? than three times what she paid for them.
UNEXPECTED RICHES Collecting can be an enjoyable and some-
times profitable pastime. Are collectibles a wise investment?
366 Unit 3 Investing Financial Resources
CYBER AUCTIONS When buying or selling collectibles through These materials have been repro-
duced with the permission of eBay
online auction sites, do your research on quality and current values. Inc. COPYRIGHT © EBAY INC. ALL
What are some advantages and disadvantages of collecting via the Internet? RIGHTS RESERVED
Collectibles on the Internet
Before the era of the World Wide Web, finding items to add to
your collections could be very time-consuming. You would have to Common
pore over collectors’ trade magazines to research the value of items you
wished to buy. Then you would have to go to shows, sometimes far
CENTS
away, where collectors met to buy and sell their merchandise. Collectible Gifts
That process has changed. The Internet has made buying and Suggest to your family and
selling collectibles efficient and convenient, and the number of Web friends that you make gifts
sites for collectors has exploded. In 1999, when Guernsey’s Auction for each other instead of
House offered Mark McGwire’s 70th home run baseball to bidders, buying them for special
days and holidays. You will
they opened the bidding process to online buyers as well. Although
all save money, and your
the baseball went to an anonymous telephone bidder (later known to gifts may become fam-
be the famed comic book artist Todd McFarlane) for $3 million, the ily heirlooms. How much
use of the Internet as an auction site was firmly established. money do you think you
It is easy to see why the Internet appeals to collectors. As a buyer, could save each year by
you can search for items to add to your collection with a few key- making gifts instead of buy-
ing them?
strokes, and sellers can reach people all around the world. Prices are
not necessarily lower on the Internet, but comparison shopping is
easier, and most sites do not charge a buyer’s commission.
Of course, collecting through the Internet has its drawbacks. As
an online buyer, you cannot assess a dealer face-to-face or examine
the objects for flaws or trademarks. Furthermore, fraud is an ever-
present danger.
Chapter 11 Real Estate and Other Investments 367
&IGURE 3TOCKS FOR THE ,ONG 4ERM
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vÌiÀÊiÊÞi>À]ÊÜ V Ê>ÃÃiÌÊ«ÀÛ`i`ÊÌ iÊ } iÃÌÊ>ÛiÀ>}iÊ>Õ>
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Let the Collector Beware
Collecting can be a satisfying hobby and a good investment.
Nevertheless, a wise collector must always be alert for scams—on or
off the Internet. For example, how do you know that the fielder’s
glove you bought was actually signed by Mickey Mantle? Could your
Civil War–era postage stamps be counterfeit? Is that Barbie® doll,
Lionel® locomotive, or Darth Vader™ action figure really as rare and
valuable as you have been told?
As You When you trade collectibles, be aware that some online auction
Read and exchange sites are more reliable than others. According to figures
QUESTION from Internet Fraud Watch, which is sponsored by the National Con-
sumers League (NCL), 76 percent of the fraud complaints it received
Take a mental inventory of during the period between January and June of 2004 were related to
your keepsakes and favorite online auctions. Consumers can report suspected Internet fraud by
possessions. Do you own
calling the NCL Fraud Hotline.
any items that might be
considered collectibles in The safest way to steer clear of collectibles-related fraud is to
the future? learn everything you can about the items you collect and to buy and
sell only with reputable dealers and auction Web sites.
368 Unit 3 Investing Financial Resources
Remember that collectibles do not offer interest or dividends.
Also, you may have a hard time selling items at a good price on short After You
notice. If your collection grows significantly in value, you will have Read
to purchase insurance against damage and theft. REACT
With the information pro-
Planning Investments vided in this chapter, do
How do you choose the best types of investments? you think that you could
make a wise investment in
Investments such as stocks and bonds may not be very interest- precious metals, gems, or
ing or exciting, but as you can see in Figure 11.4, they have proven collectibles?
to be the most stable types of investments in the long run. Investing
in collectibles may seem interesting, but it may not be the best way
for you to achieve your financial goals.
Wise planning is the best way to get the most out of your invest-
ments. Be sure to research the types of investments that are available
so you can make an informed decision. Weigh the advantages and
disadvantages of each type of investment. Ask yourself how much
risk and responsibility you are willing to assume. By taking these
steps, you will be able to make a decision that is best for your finan-
cial future.
Section 11.2 Assessment
QUICK CHECK Calculate What was Raul’s profit in
1. What are the risks of investing in precious 1980 and in 1982? What would Raul’s
metals? profit have been if he had sold all of his
2. Why do precious gems appeal to investors? gold in 1980?
3. How has the Internet increased the risks of
SOLVE MONEY PROBLEMS
investing in collectibles?
6. Evaluating an Inheritance Samantha
THINK CRITICALLY inherited a diamond-and-ruby necklace
4. Describe two different scenarios: one that from her grandmother’s estate. Unfortu-
causes the price of diamonds to rise and one nately, the settings for the stones are dam-
that causes the price to fall. aged beyond repair. Samantha is trying to
decide what to do with her inheritance.
USE MATH SKILLS Analyze Create a strategy that will
5. Golden Investment In 1978, Raul help Samantha determine the value of
bought 50 ounces of gold for $1,750 as her inheritance and how she might increase
protection against rising inflation. He sold that value.
half the gold in 1980 at a price of $800 an
ounce. Raul sold the other half in 1982
when the price was $400 an ounce.
Chapter 11 Real Estate and Other Investments 369
Chapter 11 Review & Activities
CHAPTER SUMMARY
• The owner of a direct investment in real Lack of liquidity and diversification, risk
estate directly holds the legal title to the of declining property values, fewer tax
residential or commercial property and incentives, and potential management
is responsible for its maintenance and problems are disadvantages.
management. An indirect investment • Precious metals include gold, silver,
is similar to investing in mutual funds. platinum, palladium, and rhodium.
A group of investors buys property, Precious gems include diamonds,
and legal title is held by a trustee. Real sapphires, rubies, and emeralds.
estate syndicates, limited partnerships, • Collectibles include rare coins, works
and real estate investment trusts (REITs) of art, antiques, stamps, rare books,
are examples of indirect investments. comic books, sports memorabilia, rugs,
• The advantages of investments (syndi- ceramics, and other items.
cates and REITs) in real estate are: • The value of precious metals and gems
use as a hedge against inflation, ease can fluctuate greatly, making them a
of entering the market, and limited risky investment. It is also difficult to
liability. predict the value of collectibles.
Communicating Key Terms
Your friend, Jeremiah, is the sole heir of a recently deceased relative. Jeremiah has discovered
that his relative had invested in several REITs and Ginnie Mae certificates. Plus, Jeremiah found
two diamond rings, as well as a collection of 40 Hummels, which are ceramic figurines made in
Germany. Jeremiah asks your advice in determining which investments to keep and which to sell.
Use the terms below to prepare your recommendations.
• direct investment • financial leverage
• commercial property • precious metals
• indirect investment • precious gems
• syndicate • collectibles
• participation certificate (PC)
Reviewing Key Concepts
1. Compare and contrast direct and indirect real estate investments.
2. List two advantages and two disadvantages of real estate investments.
3. Describe precious metal and gem investments and why they remain popular despite their
speculative nature.
4. Explain what is meant by the term collectible, and give some examples of collectible items
you or your family may own.
5. Explain why so many fraud complaints are related to online auctions.
370 Unit 3 Investing Financial Resources
Chapter 11 Review & Activities
Communication Skills A friend of yours tells you that his parents
plan to pay for his college education by selling some family jewelry.
Write About It Write a paragraph explaining why you might question
this plan.
Comparative Return Imagine that you have $10,000 to invest. Use
a newspaper, the Internet, or other source to select a mutual fund. Use the
same source to find out how much gold you could buy for $10,000. Track the
performance of these two investments for 30 days.
1. Calculate (a) the rate of return if you invested the $10,000 and sold
the investment 30 days later. Disregard tax consequences or mutual fund
withdrawal penalties. (b) How much return would you receive if you had
put the money in a savings account with 4 percent interest?
2. Compute by using graphics or presentation software to show the two
investments’ performance.
Connect with Economics Your brother recently graduated from
college and started his first job. He rents half a duplex, but the owner has put
the building up for sale. Your brother thinks that purchasing the building
would be a good investment for him. He asks for your opinion.
1. Research Use the newspaper or search the Internet to find current
prices for duplexes.
2. Think Critically What are the positives and negatives of your brother
buying the building? What factors need to be considered?
PBS Antiques Roadshow The PBS television program, Antiques
Roadshow, has generated enormous interest among viewers to find out the
value of the furniture, art, jewelry, and collectibles they own.
Log On Go to finance07.glencoe.com for a link to the Web site
of the Antiques Roadshow television program.
1. Click on “Follow the Stories” and select an area of interest and at least
three stories from the Antiques Roadshow.
2. Summarize the stories you selected in one or two paragraphs. Add more
information by using an Internet search engine to find out more about
the area of interest you selected.
Newsclip: A Piece of Childhood Animation art, hand-painted
images from which cartoons used to be made, is a popular collectible.
O N L I N E
Log On Go to finance07.glencoe.com and open Chapter 11.
Learn more about the different types of alternative investments,
such as collectibles. Write a paragraph about the kinds of things you like to
collect. Could any of them be valuable?
finance07.glencoe.com Chapter 11 Real Estate and Other Investments 371
Chapter 11 Review & Activities
ALL THAT GLITTERS
Whether you want to buy precious stones and metals as an invest-
ment, a gift, or for yourself, you will have the edge when you know
what you are buying. Test your knowledge of gems and precious
metals. Write your answers on a separate sheet of paper.
1. Precious stones generally have more commercial value than semiprecious stones.
Some precious stones are (choose all that apply):
_____ garnet _____ black onyx
_____ diamond _____ amethyst
_____ turquoise _____ opal
_____ pearl _____ topaz
_____ ruby _____ emerald
_____ sapphire
2. Rank these precious metals from 1 (most valuable per ounce) to 4 (least valuable):
_____ silver _____ platinum
_____ gold _____ copper
3. The word brilliant describes a diamond’s __________ .
_____ color _____ clarity
_____ cut
4. When it comes to diamonds, the word flawless refers to __________ .
_____ cut _____ clarity
_____ color
5. All diamonds have a cubic crystal structure and are made primarily of __________ .
_____ boron _____ nitrogen
_____ carbon
372 Unit 3 Investing Financial Resources
Chapter 11 Review & Activities
Your Financial Portfolio
Collecting Treasures
Russell inherited three diamonds from his grandmother and needs to
decide whether to keep them or sell them. He already had them evaluated
for the “4 Cs”—clarity, color, cut, and carat weight—but not their actual
dollar value. He took the diamonds and the evaluation papers to the Dia-
mond Mart downtown.
A sales representative at the Diamond Mart appraised them. The four-
carat diamond was the most valuable because it was beautifully cut in a
marquise shape, and it also had good clarity, meaning it had few micro-
scopic bits of other elements embedded in it. Its color, which was very
close to the whitest end of the scale, also added to its value. The other two
diamonds, a matched set of one-carat gems cut as round brilliants, were
of a higher quality in clarity but more yellow. The appraiser told Russell
that the three diamonds could be worth $5,000, but gem dealers would
probably offer him about half that. He also told him that the Diamond
Mart would not be interested in buying them.
Russell went to another store that had a sign, “We Buy Diamonds,”
but the most the store could offer was $2,350. Rather than settling for
a price well below the actual worth of the diamonds, Russell decided to
keep them in a safe-deposit box. By keeping them, he had the option
of turning them into cash in the future, possibly selling them for more
money. He also liked the idea of making them into jewelry someday. After
researching his grandmother’s diamonds, Russell is now interested in find-
ing out more about other gems. One day he would like to start a gem
collection.
Apply
On a separate sheet of paper, list five things you might enjoy collecting that will
keep their value or possibly be worth more in the future. Choose one and describe why
it appeals to you. Describe how an expert could appraise its value, using such criteria
as age, quality, rarity, and popular demand. Why would this collectible be interesting
for you to keep?
Do you think it would be a good or bad long-term investment? Explain why.
Chapter 11 Real Estate and Other Investments 373
Unit 3 LAB
Get a Financial Life!
Investment Strategies Procedures
Overview STEP A The Process
Imagine that you are a finan-
cial planner. Carrie and David have hired you to
Carrie and David are about to celebrate help them make investment decisions for their
their 36th birthdays. Carrie recently accepted a future. They have $25,000 in savings that they
new position as a fashion design supervisor at a want to invest in stocks, bonds, mutual funds,
sportwear company. David is now an assistant and/or real estate.
principal at a high school specializing in tech-
nology and Internet applications. Through the 1. Prepare a mock résumé for yourself as a
years, they have saved money in traditional sav- financial planner. Showcase your experi-
ings accounts and certificates of deposit. In addi- ences and qualifications so that Carrie and
tion, Carrie has invested money in a 401(k) plan David will feel confident that they have
at work. Because David has been working for hired an expert.
the public school system, he has been investing 2. Recommend appropriate investment options
in a 403(b) plan. Besides saving for retirement, for Carrie and David. To ensure a diverse
Carrie and David realize that they will have to portfolio, you must make at least three dif-
accumulate enough money to put their children, ferent recommendations.
Eva and Jack, through college someday. There- 3. Using the various sources of investment
fore, they would like to expand their investment information (the financial section of a news-
strategies. paper, business magazines, the Internet,
investor services, and corporate reports), col-
lect articles and other relevant information
about the investment options that you will
Resources & Tools recommend. Your research should demon-
strate to Carrie and David that your recom-
• Career development book
mendations are sensible.
• Crayons, markers, colored pencils
4. Contact a financial planner, investment
• Internet (optional)
counselor, banker, or accountant. Arrange for
• Multimedia tools (videos, music,
a time when you can either meet or speak
and so on)
on the phone to discuss the investment deci-
• Portfolio (ring binder or file folder)
sions you have made for Carrie and David.
• Poster board
Prepare a report of your conversation.
• Presentation software (optional)
• Public or school library
• Word processor
374 Unit 3 Investing Financial Resources
STEP B Create Your Portfolio
As you work through the pro- STEP C Teamwork
Teamwork is essential in today’s
cess, save the results so that you can refer, workplace. Many companies are replacing the
review, and refine. Create a professional-looking traditional management with self-managed work
portfolio of investment recommendations that teams. Team members must be able to accept
you will present to Carrie and David. more responsibility, communicate effectively,
and get along well with others.
1. The first page should be a title page with the
Create a team of at least four classmates.
following information centered:
Prepare a 15-minute seminar and present it to
• Investment Options other members of your class or to other classes
• Presented to Carrie and David Lanier in the school. Organize your team in order to
• By (Your Name) accomplish the following tasks in the best and
2. Next include the résumé that you prepared. most efficient way possible.
3. Prepare a section in the portfolio for each
1. Choose one topic from Chapters 8–11 for
investment option that you recommend.
your seminar.
Include the recommendation and the
2. Prepare an oral presentation, using presenta-
research that supports your suggestion.
tion software, multimedia tools, posters, or
4. In the last section, include the report of the
other visuals.
conversation you had with the financial
3. Draft a written outline and relate the topics
expert you interviewed in Step A (4) on the
to financial planning for Carrie and David in
previous page.
the presentation.
4. Create handouts for the audience.
5. Prepare a pre-test and post-test for the audi-
ence. Compile the results in a graph.
6. Present the seminar to your class or to other
classes in the school.
375
Unit 4
#
Protecting
Your
Finances
Internet
Project
Avoiding Financial
Fraud
You might experience financial trouble if you
trust the wrong person or buy financial products
from a disreputable company. You should plan for
unforeseen problems. In this project, you will learn
how to spot financial fraud and scams, and write a
plan designed to help you protect your finances.
Log on to finance07.glencoe.com. Begin
by reading Task 1. Then continue on your
WebQuest as you study Unit 4.
Section 12.3
1.2 13.3
2.2 14.4
3.2 15.3
4.1
Page 392
xx 432
xx 467
xx 510
xx
376 finance07.glencoe.com/careers
finance07.glencoe.com
FINANCE FILE
So What’s the Plan?
Once you know how much you
will need to retire, crafting a detailed
map of your future financial moves is
the next step. If you think you’re too
young to bother with a plan, remember
that when it comes to building savings,
time is on your side.
When I asked several financial
planners how they work with clients
who have figured out the amount of
money they’ll need in retirement, they
said they start by compiling informa-
tion on the client’s financial status and
potential retirement resources. Brewster
[a planner] asks clients to provide up to
26 different types of documents, includ-
ing investment- and retirement-account
statements, tax returns, mortgage state-
ment, insurance policies, and wills.
He raises such issues as whether
the client has a realistic idea of future
pension income. If the client were to
switch jobs ten years before retirement,
the final pension could end up being
less than anticipated.
One of the findings [of the Retire-
ment Confidence Survey was]: More
than a quarter of those who feel “very
confident” about their retirement pros-
pects owe that peace of mind to “doing
a good job of preparing financially.”
— By Ellen Hoffman
Write About It How might
financial planning protect you?
Log On To read the complete
BusinessWeek article and do the
BusinessWeek Extension activity to
help you learn more about planning
your finances for the present and
future, go to finance07.glencoe.com.
finance07.glencoe.com 377
12
CHAPTER
Planning Your
Tax Strategy
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 12.1
• Discuss the importance of tax
planning.
• Identify your taxable income.
• Explain deductions and tax
credits.
• Explain the W-4 form.
Section 12.2
• Describe the types of federal
income tax forms.
Section 12.3
• Identify tax strategies.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
378
In the Real World . . .
B rigette Lindsey has just started her first job, and she is sur-
prised at the amount of money that is taken out of her paycheck for
taxes. In addition to federal tax, she has to pay state tax. Besides these payroll
taxes, Brigette, like most people, also pays other taxes, such as sales tax and gaso-
line tax when she makes purchases. She has also learned that she must file income
tax forms with the federal and state governments by April 15th of each year. The
instructions for filing seem complicated. She is considering learning more about
filing, buying a software program, or paying an accountant to do it. Brigette
realizes that tax dollars fund civic activities, schools, libraries, and
roads, but she would like to plan strategies to lower her taxes.
As You Read Consider how income tax strategies
could help you save money.
Electronic Taxes
ASK Q: I would like to file my income tax form electroni-
cally. Is it risky to file through the Internet?
A: If you are concerned about being charged late penalties if your tax return is not
received by the IRS via the Internet, you can protect yourself by using filing services
that offer a receipt, such as a confirmation number or e-mail confirmation.
Ask Yourself What would be the advantage of filing income tax forms elec-
tronically instead of by mail?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com Chapter 12 Planning Your Tax Strategy 379
Section 12.1
Focus on
Reading
Income Tax
Fundamentals
Read to Learn
• How to discuss the
importance of tax Taxes and You
planning. Why are taxes so important?
• How to identify your
taxable income. Taxes are an everyday expense of life that allow your local, state,
and federal governments to provide important services. Taxes pay the
• How to explain deduc-
tions and tax credits. bills for those services such as Medicare, Medicaid, the military, the
• How to explain the national debt, police and fire protection, public schools, road main-
W-4 form. tenance, parks, libraries, and safety inspection of foods, drugs, and
other products.
Main Idea You pay some type of tax every time you get a paycheck, buy a
Taxes are an important part new CD, or fill up your car’s gas tank. Each year the Tax Foundation,
of financial planning. There an independent public policy research group, determines how much
are several types of taxes of the year the average person works to pay taxes. In recent years, “Tax
and terms to know for pre- Freedom Day” came in early May. This means that from January 1
paring your tax return.
until early May, all the money you earn goes toward paying taxes.
Effective tax planning can help you to have money left after
Key Terms paying taxes and living expenses. Use several strategies to plan for
• tax liability
taxes. First, find out how the current tax laws and regulations affect
• estate tax
• inheritance tax you. Second, maintain complete and accurate tax records. Third,
• income tax learn how to make decisions that can reduce your tax liability,
• income tax return which is the total amount of taxes owed. If you follow these strate-
• exclusion gies, you will pay a fair share of taxes while taking advantage of tax
• adjusted gross income benefits that allow you to owe less money.
• taxable income
• tax deduction
•
•
standard deduction
itemized deduction
Types of Taxes
• exemption
What are the different types of taxes?
• tax credit Throughout your life, you will pay different types of taxes in
• allowance
four major categories: purchases, property, wealth, and earnings.
Taxes on Purchases
You probably already pay sales tax each time you buy a product.
These taxes are added to the prices of most products you purchase and
are collected by state and local governments. Many states do not charge
sales tax on food and medicine. Another type of sales tax is an excise
tax, a tax on specific goods and services (such as gasoline, air travel,
and telephone service) collected by federal and state governments.
380 Unit 4 Protecting Your Finances
Taxes on Property Before
Real estate property tax is a major source of income for local gov- You Read
ernments. This tax is based on the value of land and buildings. As the PREDICT
value of any real estate, such as a home, goes up, the amount of prop-
erty tax may increase as well. In some areas of the country, state and Why would planning a tax
local governments may assess taxes on the value of property, such as strategy be a good idea?
automobiles, boats, furniture, and farm equipment.
Taxes on Wealth
An estate tax is a federal tax collected on the value of a person’s
property at the time of his or her death. Unfortunately, that is not
always the end of tax liability. States may collect an inheritance tax.
An inheritance tax is a state tax collected on the property left by a
person to his or her heir(s) in a will. Therefore, before heirs can claim
their inheritance, they have to pay the inheritance tax.
Another type of federal tax on wealth is the gift tax. A gift tax is
a tax collected on money or property valued at more than $11,000,
given by one person to another in a single year. However, gifts of any
amount that are designated for educational or medical expenses are
not subject to gift taxes.
䊱 YOUR TAX DOLLARS Public museums, parks, and roads are built and maintained with your taxes.
What other expenses are paid with tax funds?
Chapter 12 Planning Your Tax Strategy 381
Taxes on Earnings
Income tax is the tax on wages, salaries, and self-employed
earnings. Wages are payments received for hourly work, but salaries
are payments received for weekly or monthly work, regardless of the
number of hours worked. The personal income tax, or tax you pay on
the income you receive, is the federal government’s main source of rev-
enue (money). Social Security funds are also collected as a tax. These
funds finance retirement, disability, and life insurance benefits of the
federal government’s Social Security program. Current and future revi-
sions to the Social Security program may affect amount of benefits.
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis-
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals
2IYADH
to help them guide their financial decisions.
SAUDI ARABIA
Unlike U.S. citizens, Saudis are not required to
pay income tax. They also do not pay local, regional,
property, or most sales taxes. There is one exception.
Saudi citizens must pay a religious tax called the DATABYTES
zagat. The zagat amounts to an annual 2.5 percent
of an individual’s net worth. Before oil was discov- Capital Riyadh
ered, when Saudi Arabia was a land of desert dwell-
Population 24,070,000
ers, the government survived with small taxes on
Languages Arabic
religious pilgrims and
on tobacco. Although Currency Saudi riyal
many people think Gross Domestic
that Saudi Arabia’s oil Product (GDP) $286.2 billion (2003 est.)
wealth is responsible GDP per capita $10,500
for its low tax status, Industry: Crude oil, petroleum, basic petrochemicals,
scholars point to the and cement
independent nature
Agriculture: Wheat, barley, tomatoes, melons,
of the population.
and mutton
The national atti-
Exports: Petroleum and petroleum products
tude toward taxation
might be summed up Natural Resources: Crude oil, natural gas, iron ore,
by the 1920s decree gold, and copper
of the country’s lead-
ers: “Taxes, we have Think Globally
ruled, are completely Do you think the United States could operate under a
illegal.” similar taxation system? Why or why not?
382 Unit 4 Protecting Your Finances
The Internal Revenue Service (IRS) The Internal Revenue Service
(IRS) is the federal agency that collects these taxes, or tax revenues.
As You
Headquartered in Washington, D.C., the IRS is an agency of the
Read
Department of the Treasury. The two primary missions of the IRS are to RELATE
collect federal income taxes and to enforce the nation’s tax laws.
Taxes on earnings are collected on a pay-as-you-earn basis. Your What kinds of taxes do you
already pay?
employer must withhold, or take out, Social Security and income tax
payments from your paycheck and send the money to the IRS. If you
are self-employed, own your own business, or are retired, you could
be required to make your own estimated tax payments. When you
complete your federal income tax return forms each year, you deter-
mine if you have paid too much or too little income tax. At that time
you either pay more tax or you receive a refund from the IRS.
Understanding Income Taxes
How do you determine how much tax you owe?
Every year millions of taxpayers in the United States prepare
income tax returns and send their completed forms to the IRS by
mail or through the Internet. An income tax return is a form, such
as 1040 or 1040EZ, on which a taxpayer reports how much money he
or she received from working and other sources and the exact taxes
that are owed. TechByte
Collecting Taxes
You determine the amount of tax you owe when filling out the
returns. Then you compare that amount to the total income tax Helping federal, state,
and local governments
your employer withheld from your paychecks during the year. If the
collect taxes is a grow-
income tax you paid through your employer was greater than your ing market. Microsoft
tax liability, you will receive a refund. However, if your tax liability has partnered with sev-
is greater than the tax you paid, you will need to pay the differ- eral companies who
ence to the U.S. Treasury because you owe more taxes than were have used Microsoft’s
withheld. technology to create
tax collection software
and integrated systems
Gross and Adjusted Gross Income designed to be used
by various government
Most but not all income is subject to taxation. Gross income, or entities. For example,
total income, can include one, two, or three main components: some programs help
local municipalities col-
1. Earned income—the money you receive for working, lect property taxes, and
including wages, salary, commissions, fees, tips, bonuses, others help govern-
and self-employed earnings ment agencies distribute
2. Interest income—the interest that you receive from banks, unemployment benefits
and collect taxes from
credit unions, and savings and loan associations
those employers who
3. Dividend income—the cash dividends that you receive fund this program.
from investments
Read more about
Your gross income can also be affected by exclusions—amounts Microsoft’s partner-
ships with tax collection
of income that do not have to be included in your gross income.
software makers through
An exclusion is also called tax-exempt income, or income that is finance07.glencoe.com.
not subject to taxes. For example, interest earned on most municipal
bonds is exempt from federal income tax.
finance07.glencoe.com Chapter 12 Planning Your Tax Strategy 383
Another kind of income is tax-deferred income, or income that
will be taxed at a later date. The earnings on an individual retirement
account (IRA) are tax-deferred income. Although these earnings are
credited to your account now, you do not have to pay tax on this money
until you withdraw it from the account, usually at retirement.
You pay income tax on your adjusted gross income, not on your
gross income. Your adjusted gross income is your gross income
after calculating certain reductions. These reductions are called
adjustments to income. They include items such as contributions to
an IRA or student loan interest. The correct amount of your adjusted
gross income is important because it is the basis for other tax calcu-
lations. (Note: If you have adjustments to income, you cannot use
Form 1040EZ.)
Your Taxable Income
When you determine your adjusted gross income, you can figure
out your taxable income. Your taxable income is your adjusted gross
income less any allowable tax deductions and exemptions. Your income
tax is calculated based on the amount of your taxable income.
Tax Deductions A tax deduction is an expense that you can
subtract from your adjusted gross income to figure your taxable
income. Every taxpayer receives at least the standard deduction,
an amount of money set by the IRS that is not taxed. In 2004, a single
person’s standard deduction was $4,850. A married couple filing a
joint tax return could deduct $9,700. People over age 65 or people
䊲 MEDICAL DEDUCTIONS who are blind are entitled to higher standard deductions.
Medical expenses can help You may qualify for other deductions that can reduce your tax-
reduce the taxes you owe. able income. An itemized deduction is a specific expense, such as
What are medical expenses? a medical expense, that you deduct from your adjusted gross income.
You can take the standard deduction or item-
ize your deductions, but you cannot take both.
You would take the standard deduction if it were
greater than your total itemized deductions.
A few of the most common itemized deduc-
tions include:
• Medical and Dental Expenses These
include doctors’ fees, prescription medica-
tions, hospital expenses, medical insurance
premiums, eyeglasses, hearing aids, and
medical travel that has not been reimbursed
or paid by others, such as a health insurance
provider. You can deduct only the amount of
your medical and dental expenses that is more
than 7.5 percent of your adjusted gross income
(as of 2004). Therefore, if your adjusted gross
income is $10,000, you can deduct only the
amount of non-reimbursed medical and dental
expenses that exceeds $750.
384 Unit 4 Protecting Your Finances
&IGURE 4HE 3IX 2ATE 3YSTEM FOR &EDERAL )NCOME 4AXES
2ATE ON 4AXABLE )NCOME 3INGLE 4AXPAYERS -ARRIED 4AXPAYERS
£ä¯ 1«ÊÌÊfÇ]äää 1«ÊÌÊf£{]äää
£x¯ fÇ]äääÊqÊfÓn]{ää f£{]äääÊqÊfxÈ]nää
Óx¯ fÓn]{ääÊqÊfÈn]nää fxÈ]nääÊqÊf££{]Èxä
Ón¯ fÈn]nääÊqÊf£{Î]xää f££{]ÈxäÊqÊf£Ç{]Çää
Îί f£{Î]xääÊqÊfΣ£]xäÊ f£Ç{]ÇääÊqÊfΣ£]xä
Îx¯ fΣ£]xäÊ>`ÊÕ« fΣ£]xäÊ>`ÊÕ«
4AX 2ATES / iÊÃÝÀ>ÌiÊÃÞÃÌiÊÃÊ>ÊiÝ>«iÊvÊ>Ê«À}ÀiÃÃÛiÊÌ>Ý°
7 >ÌÊ`ÊÞÕÊÌ ÊÃÊi>ÌÊLÞʺ«À}ÀiÃÃÛiÊÌ>Ý»¶
• Taxes You can deduct state and local income tax, real estate
property tax, and state and local personal property tax.
• Interest You can deduct home mortgage interest and home
equity loan interest.
• Contributions You can deduct contributions of cash or
MATH
property to qualified charities. If your contribution is more
In states that charge sales
than 20 percent of your adjusted gross income, the deduction is
tax, even people who live
subject to certain limitations. outside the state have to
pay taxes on purchases
You must keep records to document tax deductions. For more
they make within the
information about financial records, review Chapter 3. state. This means that
Exemptions An exemption is a deduction from adjusted gross tourists who purchase
items in a state that col-
income for the taxpayer, the spouse, and qualified dependents. A
lects sales tax are helping
dependent is someone you support financially, such as a child. To to pay for the upkeep of
qualify as a dependent, a person must meet all of the following the state. If you live in a
requirements: state that collects a sales
tax of 6.25 percent, how
1. A dependent must not earn more than a set amount unless he much sales tax do you owe
or she is under age 19 or is a full-time student under age 24. on a $125 purchase?
2. He or she must be a specified relative or live in the home of
the taxpayer who claims him or her on the tax return.
3. More than half of a dependent’s support must be provided
by the taxpayer who claims him or her on the tax return.
4. A dependent must meet certain citizenship requirements.
Calculating Your Tax
Once you know your taxable income, you can calculate how
much income tax you owe. Most taxpayers use either a Tax Table or
a Tax Rate Schedule to figure income tax. The Tax Rate Schedules are
based on the six rates shown in Figure 12.1. The examples in this
book use a Tax Table instead of Tax Rate Schedules.
Chapter 12 Planning Your Tax Strategy 385
Tax Credits Your income tax may be reduced by a tax credit,
As You
which is an amount of money that can be subtracted directly from
Read
taxes you owe. A tax credit is different than a deduction. A tax
QUESTION deduction is an expense that you can subtract from your adjusted
gross income. However, a tax credit results in a dollar-for-dollar
Why is it important for you
reduction in the amount of taxes you owe. For example, suppose you
to keep accurate and orga-
nized tax records? owe $300 in taxes. If you can get a $100 tax credit, you can subtract
that and owe only $200 ($300 – $100 = $200).
Lower-income workers can benefit from a tax credit called earned
income credit (EIC). This federal tax credit is for people who work and
whose taxable income is less than a certain amount. People who do not
earn enough to owe federal income tax are also eligible for the EIC.
Making Tax Payments
How do you make income tax payments to the IRS?
You can pay your income taxes to the federal government in
different ways: through estimated payments or payroll withholding
payments. People who are self-employed may pay estimated taxes
each quarter.
Payroll Withholding
When James Irving began his job at a company, his employer
asked him to complete a W-4 form, or the Employee’s Withhold-
ing Allowance Certificate. (See Figure 12.2). The amount of federal
income tax an employer withholds, or deducts from your paycheck
to send to the IRS, depends on the number of allowances you claim
on a W-4 form. An allowance is an adjustment to the tax withheld
from your paycheck, based on your marital status and whether you
have dependents. An allowance can reduce the amount of income
taxes your employer withholds.
Completing a W-4 Form To fill out the W-4 form, follow these
simple instructions:
1. Fill in your name and address.
2. Fill in your Social Security number.
3. Indicate whether you are single or married by checking the
appropriate box.
4. Check the box if your last name is different from the name
shown on your Social Security card.
5. Write the number of allowances you are claiming. To figure
out how many allowances you can claim, complete the Per-
sonal Allowances Worksheet at the top of the W-4 form.
6. Indicate how much additional money, if any, you wish to
have withheld.
7. If you meet the conditions listed on the form and indicate
that you are exempt, or excused, from paying income tax, no
income tax will be withheld.
8. Sign and date the form.
386 Unit 4 Protecting Your Finances
&IGURE 4HE 7 &ORM
0ERSONAL !LLOWANCES 7ORKSHEET +EEP FOR YOUR RECORDS
! %NTER hv FOR YOURSELF IF NO ONE ELSE CAN CLAIM YOU AS A DEPENDENT !
s 9OU ARE SINGLE AND HAVE ONLY ONE JOB OR
" %NTER hv IF s 9OU ARE MARRIED HAVE ONLY ONE JOB AND YOUR SPOUSE DOES NOT WORK OR "
s 9OUR WAGES FROM A SECOND JOB OR YOUR SPOUSES WAGES OR THE TOTAL OF BOTH ARE OR LESS
# %NTER hv FOR YOUR SPOUSE "UT YOU MAY CHOOSE TO ENTER h v IF YOU ARE MARRIED AND HAVE EITHER A WORKING SPOUSE OR
MORE THAN ONE JOB %NTERING h v MAY HELP YOU AVOID HAVING TOO LITTLE TAX WITHHELD #
$ %NTER NUMBER OF DEPENDENTS OTHER THAN YOUR SPOUSE OR YOURSELF YOU WILL CLAIM ON YOUR TAX RETURN $
% %NTER hv IF YOU WILL FILE AS HEAD OF HOUSEHOLD ON YOUR TAX RETURN SEE CONDITIONS UNDER (EAD OF HOUSEHOLD ABOVE %
& %NTER hv IF YOU HAVE AT LEAST OF CHILD OR DEPENDENT CARE EXPENSES FOR WHICH YOU PLAN TO CLAIM A CREDIT &
.OTE $O NOT INCLUDE CHILD SUPPORT PAYMENTS 3EE 0UB #HILD AND $EPENDENT #ARE %XPENSES FOR DETAILS
' #HILD 4AX #REDIT INCLUDING ADDITIONAL CHILD TAX CREDIT
s )F YOUR TOTAL INCOME WILL BE BETWEEN AND AND IF MARRIED ENTER hv FOR EACH ELIGIBLE CHILD PLUS ADDITIONAL
IF YOU HAVE THREE TO FIVE ELIGIBLE CHILDREN OR ADDITIONAL IF YOU HAVE SIX OR MORE ELIGIBLE CHILDREN
s )F YOUR TOTAL INCOME WILL BE BETWEEN AND AND IF MARRIED ENTER hv IF YOU HAVE ONE OR TWO ELIGIBLE CHILDREN
hv IF YOU HAVE THREE ELIGIBLE CHILDREN hv IF YOU HAVE FOUR ELIGIBLE CHILDREN OR hv IF YOU HAVE FIVE OR MORE ELIGIBLE CHILDREN '
( !DD LINES ! THROUGH ' AND ENTER TOTAL HERE .OTE 4HIS MAY BE DIFFERENT FROM THE NUMBER OF EXEMPTIONS YOU CLAIM ON YOUR TAX RETURN (
s )F YOU PLAN TO ITEMIZE OR CLAIM ADJUSTMENTS TO INCOME AND WANT TO REDUCE YOUR WITHHOLDING SEE THE $EDUCTIONS
&OR ACCURACY AND !DJUSTMENTS 7ORKSHEET ON PAGE
COMPLETE ALL s )F YOU HAVE MORE THAN ONE JOB OR ARE MARRIED AND YOU AND YOUR SPOUSE BOTH WORK AND THE COMBINED EARNINGS
WORKSHEETS FROM ALL JOBS EXCEED SEE THE 4WO %ARNER4WO *OB 7ORKSHEET ON PAGE TO AVOID HAVING TOO LITTLE TAX
THAT APPLY WITHHELD
s )F NEITHER OF THE ABOVE SITUATIONS APPLIES STOP HERE AND ENTER THE NUMBER FROM LINE ( ON LINE OF &ORM 7 BELOW
#UT HERE AND GIVE &ORM 7 TO YOUR EMPLOYER +EEP THE TOP PART FOR YOUR RECORDS
&ORM 7 %MPLOYEES 7ITHHOLDING !LLOWANCE #ERTIFICATE /-" .O
$EPARTMENT OF THE 4REASURY
)NTERNAL 2EVENUE 3ERVICE &OR 0RIVACY !CT AND 0APERWORK 2EDUCTION !CT .OTICE SEE PAGE nn
4YPE OR PRINT YOUR FIRST NAME AND MIDDLE INITIAL ,AST NAME 9OUR SOCIAL SECURITY NUMBER
(OME ADDRESS NUMBER AND STREET OR RURAL ROUTE
3INGLE -ARRIED -ARRIED BUT WITHHOLD AT HIGHER 3INGLE RATE
.OTE )F MARRIED BUT LEGALLY SEPARATED OR SPOUSE IS A NONRESIDENT ALIEN CHECK THE h3INGLEv BOX
#ITY OR TOWN STATE AND :)0 CODE )F YOUR LAST NAME DIFFERS FROM THAT SHOWN ON YOUR SOCIAL SECURITY
CARD CHECK HERE 9OU MUST CALL FOR A NEW CARD
4OTAL NUMBER OF ALLOWANCES YOU ARE CLAIMING FROM LINE ( ABOVE OR FROM THE APPLICABLE WORKSHEET ON PAGE
!DDITIONAL AMOUNT IF ANY YOU WANT WITHHELD FROM EACH PAYCHECK
) CLAIM EXEMPTION FROM WITHHOLDING FOR nn AND ) CERTIFY THAT ) MEET BOTH OF THE FOLLOWING CONDITIONS FOR EXEMPTION
s ,AST YEAR ) HAD A RIGHT TO A REFUND OF ALL &EDERAL INCOME TAX WITHHELD BECAUSE ) HAD NO TAX LIABILITY AND
s 4HIS YEAR ) EXPECT A REFUND OF ALL &EDERAL INCOME TAX WITHHELD BECAUSE ) EXPECT TO HAVE NO TAX LIABILITY
)F YOU MEET BOTH CONDITIONS WRITE h%XEMPTv HERE
5NDER PENALTIES OF PERJURY ) CERTIFY THAT ) AM ENTITLED TO THE NUMBER OF WITHHOLDING ALLOWANCES CLAIMED ON THIS CERTIFICATE OR ) AM ENTITLED TO CLAIM EXEMPT STATUS
%MPLOYEES SIGNATURE
&ORM IS NOT VALID
UNLESS YOU SIGN IT $ATE
%MPLOYERS NAME AND ADDRESS %MPLOYER #OMPLETE LINES AND ONLY IF SENDING TO THE )23 /FFICE CODE %MPLOYER IDENTIFICATION NUMBER
OPTIONAL
#AT .O 1
4AX 7ITHHOLDING 4HE 7 FORM ALLOWS EMPLOYERS TO WITHHOLD FEDERAL INCOME TAX FROM
THEIR EMPLOYEES PAYCHECKS
(OW MANY ALLOWANCES MIGHT YOU CLAIM ON YOUR 7 IF YOU ARE
MARRIED YOU HAVE ONLY ONE JOB AND YOUR SPOUSE DOES NOT WORK
Estimated Payments
Every summer John earns money by running his own landscap-
ing business. How does he pay his taxes since he does not have an
employer? Like other self-employed workers, John makes estimated
payments to the government. These payments are due April 15th,
June 15th, September 15th, and January 15th (the last payment is for
the previous year). John’s payments are based on his estimate of taxes
due at the end of the year. Estimated payments must be at least equal
to the taxes he owed last year or be at least 90 percent of the current
year’s taxes to avoid penalties for underpayment.
Chapter 12 Planning Your Tax Strategy 387
Claiming Allowances
Some employees claim fewer allowances on their W-4 forms than
they actually have and, consequently, more tax money is withheld
from their paychecks. Some employees claim no allowances. In both
of these cases, employers withhold more money than is required from
each paycheck. As a result, the employees look forward to receiving
large refunds from the government when they file their tax returns.
Claiming few or no allowances on their W-4 forms is one way to get
that refund. They may view the extra tax withheld as a “forced savings
account.” However, as employees, they might use a payroll deduction
plan for savings instead. They may be forgetting the opportunity cost
of withholding excessive amounts of their money. These taxpayers
may not realize that the extra deducted money is like providing an
interest-free loan to the government. The government does not have
to return that extra money for up to a year until tax returns are filed,
usually by April 15th of each year. Wise taxpayers claim all the allow-
ances to which they are entitled when preparing the W-4 form. That
puts the money into their pockets.
Section 12.1 Assessment
QUICK CHECK Analyze Weigh the pros and
1. What is the relationship between taxes and cons of each alternative and make a
personal financial planning? recommendation to the state.
2. What is your taxable income?
SOLVE MONEY PROBLEMS
3. What are the steps to complete a W-4 form?
6. Withholding Eric is single; he has no
THINK CRITICALLY children or other dependents; and he is
4. Explain how deductions and tax credits not claimed as a dependent on anyone
affect the amount of income tax you pay. else’s tax return. He has only one job, as a
manager at the local supermarket, and he
USE MATH SKILLS earns $35,000 a year. Leland is married and
5. Raising Funds As budget director for a has twin daughters whom he will claim as
small state, you must raise $350 million for dependents. He works full-time at an archi-
emergency repairs to the state’s bridges. You tecture firm and also earns $35,000 a year.
have several ways to fund the project. Your Calculate Using the Personal
options include: place a sales tax of 5 per- Allowances Worksheet on the
cent on all purchases except food and pre- W-4 form, determine who will have more
scription drugs; place a personal property money withheld from his paycheck, Eric or
tax on cars based on the purchase price and Leland.
age of the vehicle; or place tolls of about
$4 per round-trip for using each bridge.
388 Unit 4 Protecting Your Finances
Section 12.2
Preparing an Income Focus on
Reading
Tax Return
Read to Learn
• How to describe the
The W-2 Form types of federal income
What information does the W-2 form provide? tax forms.
Each year, when it is time for James to file his annual income Main Idea
tax return, his employer sends him a W-2 form, or the Wage and Tax Special information and
Statement. This form lists his annual earnings and the amount with- documents are needed
held from his paychecks for federal income taxes, Social Security, and to prepare income tax
any applicable state and local income taxes. By law, your employer returns. You can choose
must send you this form by January 31st each year. one of three main federal
tax return forms.
Understanding the Federal Key Term
Income Tax Return • extension
What should you know about the federal income tax
return?
When you know how to compute your taxable income, you are Before
ready to begin the yearly task of filling out your income tax return You Read
and sending it to the IRS. Before you begin, consider some basic
information:
PREDICT
What factors might deter-
• Who must file
mine whether you have to
• Deadlines and penalties file income taxes?
• Tax forms
Who Must File?
Are you a citizen or a resident of the United States? Are you a
U.S. citizen who resides in Puerto Rico? If so, then you are required
to file a federal income tax return if your income is above a certain
amount. That amount is based on your filing status and other fac-
tors, such as your age. For example, Kerry is a single person under the
age of 65, and her gross annual income is more than $7,700. She is
required to file an income tax return. Kerry would also be required to
file an income tax return if she were a single person over age 65 and
had a gross income of more than $8,850. Even if Kerry did not meet
the filing requirements, she should still file a tax return to obtain a
refund of the income tax withheld from her paycheck.
Chapter 12 Planning Your Tax Strategy 389
These are the five filing status categories:
• Single—an individual who never married, or is divorced or
legally separated with no dependents
• Married, filing a joint return— a husband and wife with
combined income
• Married, filing separate returns—each spouse paying for
his or her own tax
• Head of household—an unmarried individual or a surviving
spouse who maintains a household, paying more than one-half
of the costs for a child or other dependent relative
• Qualifying widow or widower—an individual whose
spouse died within the last two years and who has a dependent
Deadlines and Penalties
You are required to file an income tax return each year by
April 15th, unless that date falls on a Saturday or Sunday. In that case,
you must file by the following Monday. If you have a refund owed to
you, file your return as early as possible to avoid a long wait. You may
have to pay financial penalties if you do not file on time, even if you
are just one day late.
Careers in Finance
CREDIT ANALYST
TAX PREPARER Mario Cendreda
Self-Employed
Mario has always been able to manipulate and make sense of numbers. Because tax laws change
annually and can be confusing, many individuals choose to hire a preparer instead of filing taxes on
their own. From January through April, Mario is extremely busy interviewing clients, reviewing their
tax records, and preparing their tax returns. A typical meeting may include reviewing wage state-
ments and previous tax returns, asking about income, expenses, investments, and other information,
and printing out the final forms to send to the Internal Revenue Service. Unusual returns may require
more time and the consultation of tax law handbooks or bulletins. The difficulty of each client’s
taxes determines the fee for his or her job.
SKILLS: Communication, mathematical, organizational, reasoning and problem-
solving, and time-management skills
PERSONAL TRAITS: Detail oriented, good judgment, and tactful
EDUCATION: High school diploma or equivalent; college-level courses in economics,
business, and computers; tax preparation training
ANALYZE Why might a tax preparer require training every year?
To learn more about career paths for tax preparers, visit finance07.glencoe.com.
390 Unit 4 Protecting Your Finances finance07.glencoe.com
If you cannot meet the deadline, you can file Form 4868 by
April 15th to receive a four-month extension, which is an extended
deadline for filing an income tax return; but it does not delay your tax
liability. When you submit Form 4868, you must also send a check for Advantages of
the estimated amount of the tax you may owe. 401(k) Plans
If you make quarterly estimated tax payments, they must be 1. Many companies
on time. If you underestimate the amount owed, you have to pay match up to 100
interest plus the amount you should have paid. Underpayment due percent of your
401(k) savings.
to negligence or fraud can result in large penalties. Failing to file a
2. You do not pay
required tax return is a serious violation of the tax code and can result
taxes on the
in a substantial penalty. money until you
The good news is that if you claim a refund several months or withdraw it.
years late, perhaps because you discovered a calculation error or you 3. Your contribution
did not take an allowable deduction, the IRS will pay you interest plus is automatically
your refund. You must claim your refund and interest within three deducted from
years of filing a return or within two years of paying the tax. your paycheck.
4. You have sev-
eral investment
Choosing the Tax Form choices.
The IRS offers about 400 tax forms and schedules. However, you 5. You can watch
have a choice of three basic forms: the short forms known as Form 1040EZ your money grow
over the years.
and Form 1040A, and the long form known as Form 1040.
Form 1040EZ Form 1040EZ is the simplest tax form to complete.
You may use this form if you meet the following qualifications:
• Your taxable income is less than $100,000.
• You are single or married (filing a joint tax return).
• You are under age 65.
• You claim no dependents.
• Your income consisted of only wages, salaries, and tips, and no
more than $1,500 of taxable interest.
• You will not itemize deductions, claim any adjustments to
income, or claim any tax credits.
For example, Yasmeen is a high school senior who works part
time at a health clinic. She is single, earned less than the amount
needed to file, and had only $11 in interest income last year. So,
Yasmeen was able to use Form 1040EZ to obtain a tax refund.
Form 1040A You may use this form if any of the following apply:
• You have less than $100,000 in taxable income.
• You have capital gains distributions but not capital gains or
losses.
• You claim the standard deduction.
• You claim deductions for IRA contributions.
• You claim a tax credit for child and dependent care, education,
earned income, adoption, or retirement savings contributions.
• You have deductions for IRA contributions, student loan interest,
educator expenses, or higher education tuition and fees.
• You have no itemized deductions.
Chapter 12 Planning Your Tax Strategy 391
Form 1040 Form 1040 is an expanded version of Form 1040A. It
includes sections covering all types of income. You are required to use
this form if your taxable income is more than $100,000, or if you have
interest or dividends over a set limit, self-employment income, or
Avoiding Financial income from the sale of property. Many taxpayers who earn less than
Fraud $100,000 use this form and find Form 1040 offers tax advantages.
As a taxpayer, it is impor- Itemize deductions on this form by using Schedule A. Deduct
tant to be very careful
expenses, such as medical and dental expenses, home mortgage inter-
when choosing a profes-
sional to prepare your tax est, and real estate property tax. These deductions will reduce your tax-
return. While most tax able income and, therefore, reduce the amount of tax you must pay.
preparers are honest, and
intend to provide good
service to their clients, Completing the Federal
some are willing to file
false information and take
Income Tax Return
advantage of their clients What do you need to complete the three main
for their own gain. Look income tax forms?
for warning signs to help
identify a fraudulent tax Filling out a federal income tax return does not have to be dif-
preparer. ficult as long as you are prepared, have the correct documents and
information, and understand the form you are using. Make a rough
To continue with
draft of your tax return before you complete a final draft.
Task 2 of your
WebQuest project, visit
finance07.glencoe.com. Gathering Information and Documents
Being prepared at tax time means you have all the necessary
documents. The following checklist of documents will help you com-
plete a successful tax return:
• Tax Forms and Instruction Booklets Be sure that you
have the most current forms and instruction booklets that
contain the latest tax information. After you have filed your
first tax return, the IRS will send these to you each year in
January. If you need different or additional forms, you can
download them from the Internal Revenue Service’s Web site.
You can also find them at some post offices, libraries, banks,
and at your local IRS office.
• Copies of Your Tax Returns Have copies of your tax
returns from previous years for reference—unless, of course,
you are filing for the first time.
• Your W-2 Form You must attach a copy of your W-2 form to
your tax return if you are filing by mail. If you worked for more
As You than one employer during the tax year, you will receive more
Read than one W-2.
• Interest and Dividend Forms You may also receive
RELATE
Form 1099-INT, which reports your interest income, (see
Have you filed income Figure 12.3), and Form 1099-DIV, which reports your
taxes yet? If not, do you dividend income.
consider yourself a tax-
payer anyway? Why or After you complete your returns, be sure to save copies of these
why not? forms and all supporting documents and paperwork in a safe place
for at least six years.
392 Unit 4 Protecting Your Finances finance07.glencoe.com
&IGURE 4HE )NTEREST )NCOME &ORM
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Completing the Form 1040EZ
After you have collected all the necessary tax documents, it is
time to begin filling out your tax return. Take a look at Figure 12.4
on pages 394 and 395, which illustrates a sample tax return. Here is
how James Irving would complete Form 1040EZ:
1. After printing his name, address, and Social Security number,
James enters the total wages from his W-2 form on line 1 in
the income section.
2. James earned $45 in interest on his savings account. (This was
reported on Form 1099-INT.) He enters this amount on line 2.
3. James has nothing to report on line 3, so he leaves it blank.
4. James adds lines 1, 2, and 3 to get his adjusted gross income.
He records it on line 4.
5. James’s parents claim him as a dependent on their income
tax return, so James uses the worksheet on the back of Form
1040EZ to calculate his maximum standard deduction. He
enters $4,850 on line 5. (See Figure 12.4.)
6. He subtracts his deduction from his adjusted gross income and
computes his taxable income: $5,445. He writes it on line 6.
7. On line 7, in the payments and tax section, James enters the
amount of income tax that was withheld from his paychecks
($1,375) as reported on his W-2 form.
Chapter 12 Planning Your Tax Strategy 393
&IGURE &ORM %:
$EPARTMENT OF THE 4REASURY)NTERNAL 2EVENUE 3ERVICE
&ORM
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%: *OINT &ILERS 7ITH .O $EPENDENTS nn /-" .O
9OUR FIRST NAME AND INITIAL ,AST NAME 9OUR SOCIAL SECURITY NUMBER
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"
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#ITY TOWN OR POST OFFICE STATE AND :)0 CODE )F YOU HAVE A FOREIGN ADDRESS SEE PAGE
33.S ABOVE
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DO NOT ATTACH SEE PAGE
ANY PAYMENT
!DD LINES AND 4HIS IS YOUR ADJUSTED GROSS INCOME
#AN YOUR PARENTS OR SOMEONE ELSE CLAIM YOU ON THEIR RETURN
.OTE 9OU
9ES %NTER AMOUNT FROM .O )F SINGLE ENTER
MUST CHECK WORKSHEET ON BACK )F MARRIED FILING JOINTLY ENTER
9ES OR .O 3EE BACK FOR EXPLANATION
3UBTRACT LINE FROM LINE )F LINE IS LARGER THAN LINE ENTER
4HIS IS YOUR TAXABLE INCOME
0AYMENTS
&EDERAL INCOME TAX WITHHELD FROM BOX OF YOUR &ORMS 7
AND TAX
A %ARNED INCOME CREDIT %)# A
B .ONTAXABLE COMBAT PAY ELECTION B
!DD LINES AND A 4HESE ARE YOUR TOTAL PAYMENTS
4AX 5SE THE AMOUNT ON LINE ABOVE TO FIND YOUR TAX IN THE TAX TABLE ON PAGES
n OF THE BOOKLET 4HEN ENTER THE TAX FROM THE TABLE ON THIS LINE
2EFUND
(AVE IT DIRECTLY A )F LINE IS LARGER THAN LINE SUBTRACT LINE FROM LINE 4HIS IS YOUR REFUND A
DEPOSITED 3EE
PAGE AND FILL B 2OUTING NUMBER C 4YPE #HECKING 3AVINGS
IN B C
AND D
D !CCOUNT NUMBER
!MOUNT )F LINE IS LARGER THAN LINE SUBTRACT LINE FROM LINE 4HIS IS
YOU OWE THE AMOUNT YOU OWE &OR DETAILS ON HOW TO PAY SEE PAGE
$O YOU WANT TO ALLOW ANOTHER PERSON TO DISCUSS THIS RETURN WITH THE )23 SEE PAGE 9ES #OMPLETE THE FOLLOWING .O
4HIRD PARTY
DESIGNEE $ESIGNEES
NAME
0HONE
NO
0ERSONAL IDENTIFICATION
NUMBER 0).
5NDER PENALTIES OF PERJURY ) DECLARE THAT ) HAVE EXAMINED THIS RETURN AND TO THE BEST OF MY KNOWLEDGE AND BELIEF IT IS TRUE CORRECT AND
3IGN ACCURATELY LISTS ALL AMOUNTS AND SOURCES OF INCOME ) RECEIVED DURING THE TAX YEAR $ECLARATION OF PREPARER OTHER THAN THE TAXPAYER IS BASED
HERE ON ALL INFORMATION OF WHICH THE PREPARER HAS ANY KNOWLEDGE
9OUR SIGNATURE $ATE 9OUR OCCUPATION $AYTIME PHONE NUMBER
*OINT RETURN
3EE PAGE
+EEP A COPY 3POUSES SIGNATURE )F A JOINT RETURN BOTH MUST SIGN $ATE 3POUSES OCCUPATION
FOR YOUR
RECORDS
$ATE 0REPARERS 33. OR 04).
0REPARERS
0AID SIGNATURE
#HECK IF
SELF EMPLOYED
PREPARERS &IRMS NAME OR %).
USE ONLY YOURS IF SELF EMPLOYED
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&OR $ISCLOSURE 0RIVACY !CT AND 0APERWORK 2EDUCTION !CT .OTICE SEE PAGE #AT .O 7 &ORM %:
394 Unit 4 Protecting Your Finances
&IGURE &ORM %: CONTINUED
! 2EFUND /PTION *AMES HAS A CHOICE ABOUT HOW TO RECEIVE HIS REFUND
7HAT ARE THE PURPOSES OF LINES B C AND D
Chapter 12 Planning Your Tax Strategy 395
8. James cannot claim any earned income credit, so he leaves
As You line 8 blank.
Read 9. He adds lines 7 and 8 to find his total payments ($1,375).
QUESTION He enters this amount on line 9.
10. Now James finds out how much tax he owes. He knows
What could happen if your from line 6 that his taxable income is $5,445. He checks
employer did not deduct
federal income taxes from
the tax table in the Form 1040EZ instruction booklet (see
your paychecks? Figure 12.5) and finds the column that says “If Form
1040EZ, line 6, is” and the row that corresponds with “At
least” $5,400 “But less than” $5,450. Because he is single,
he owes $543. He enters this amount on line 10.
11. James’s employer withheld more tax than James owed.
By subtracting his tax owed (line 10) from his tax with-
held (line 9), James finds that the IRS owes him a refund of
$832, which he enters on line 11a. If he fills in lines 11b,
11c, and 11d, he can have his refund deposited directly
Put on into his bank account. He leaves the lines blank so that he
Your will receive a refund check.
Financial 12. He then signs and dates his income tax return and enters
his occupation. James makes a photocopy of his tax return
Planner’s for his records, attaches his W-2 to the original tax return,
Cap and mails the completed return to the IRS.
If you were a financial plan-
ner, would you advise most Completing the Form 1040A
of your clients to consult a
CPA? Why or why not? James used Form 1040EZ because his tax situation was uncom-
plicated. Some taxpayers, however, will benefit from using Form
1040A, shown in Figure 12.6 on pages 398 and 399. Form 1040A
enables taxpayers to claim deductions that will reduce the amount of
tax they must pay.
GO FIGURE FINANCIAL MATH
1040EZ TAX DUE Taxable Income bracket on Tax Table to find
Tax Due
Synopsis: You can find out if you owe tax or if you
will get a refund by using tax tables. Solution: $10,840 ⫺ $4,850 ⫽ $5,990
Taxable Income
Example: Jacqui works part-time in a bookstore.
Her year’s adjusted gross income was $6,840. Her $5,959 to $6,000 for single person is $598 tax due.
standard deduction is $4,850. She is using the tax
table in Figure 12.5. How much is her tax?
YOU FIGURE
Formula: Adjusted Gross Income ⫺ Standard
Your adjusted gross income is $9,438. If you are
Deduction ⫽ Taxable Income
single, how much tax do you owe?
396 Unit 4 Protecting Your Finances
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Filing Your Federal Income Tax Return
You may be able to file the return using one of several options.
You can file the traditional paper return by filling out the forms and
mailing them to the IRS. If you file electronically through the Inter-
net, your return is transmitted directly to an IRS computer.
The IRS provides two ways for individuals to file electronically. First,
you can use an authorized IRS e-file provider. With this method, either
you or a tax professional would prepare your tax return. The tax profes-
sional would transmit it to the IRS. Second, you can file by using your
personal computer and tax software. The IRS Web site provides informa-
tion and instructions for preparing your own tax return via e-file.
Chapter 12 Planning Your Tax Strategy 397
&IGURE &ORM !
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-*-: 46/ 1"3, 99 9999 %"6()5&3
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)2! CONTRIBUTIONS STUDENT LOAN INTEREST AND
CERTAIN OTHER ITEMS CAN BE DEDUCTED LOWERING
THE TAXPAYERS ADJUSTED GROSS INCOME
398 Unit 4 Protecting Your Finances
&IGURE &ORM ! CONTINUED
3EVERAL TYPES OF
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TED TAX PAYMENTS
AND WITHHELD TAXES
ADD UP TO THE
TOTAL TAXES
9
)F SOMEONE OTHER
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7HICH &ORM 9OU SHOULD FILL OUT THE TAX FORM THAT BEST MEETS YOUR NEEDS
7HY WOULD SOME PEOPLE CHOOSE TO FILE &ORM INSTEAD
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Chapter 12 Planning Your Tax Strategy 399
Completing State Income Tax Returns
If you live in a state that levies income tax, you will have to
complete a state income tax return. Only seven states do not have a
state income tax:
• Alaska
• Florida
• Nevada
• South Dakota
• Texas
• Washington
• Wyoming
In most states the tax rate ranges from 1 to 10 percent and is
based on your adjusted gross or taxable income reported on your fed-
eral tax return. States usually require their income tax returns to be
filed at the same time as federal income tax returns. To find out more
about state income tax forms and preparation, contact your state’s
department of revenue or tax board.
Section 12.2 Assessment
QUICK CHECK Calculate Given the informa-
tion above, use Form 1040EZ in
1. Who must file a federal income tax return?
Figure 12.4 on pages 394 and 395 and the
2. What are the three basic tax forms discussed
corresponding tax table in Figure 12.5 on
in this section?
page 397 to determine whether Shirley will
3. What documents do you need to begin to
owe the government money or will obtain
prepare your tax return?
a refund. How much money will she owe,
THINK CRITICALLY or how much will her refund be?
4. Briefly describe situations in which it SOLVE MONEY PROBLEMS
would be advantageous to use Form 1040A
6. Planning for Tax Time Poor Fred.
instead of Form 1040EZ. When would you
Tax time is drawing near, and he does not
use Form 1040EZ?
know how to begin to prepare his income
USE MATH SKILLS tax return. He has piles of forms and other
5. A Taxing Question Last year, Shirley, paperwork, but he just cannot figure out
a single college student, made $12,500 what to do with them. Fred needs help,
in total wages, salaries, and tips. She had and fast!
$1,200 of federal income tax withheld. Her Write About It Write instructions
taxable interest was $59. No one was able to Fred on the best way to prepare to
to claim Shirley as a dependent on his or file an income tax return. Tell him which
her tax return. forms are important and where he can go
to get forms he needs.
400 Unit 4 Protecting Your Finances
Section 12.3
Tax Assistance and Focus on
Reading
Strategies
Read to Learn
• How to identify tax
Tax Assistance strategies.
Is help available to prepare tax returns?
Main Idea
If your personal finances become more complex, your tax prepa-
As your income and invest-
ration will also become more complicated. All the rules and regu- ments increase and your
lations can be confusing, but assistance is available. You will find personal life changes,
many professionals and agencies willing to answer your questions preparing your taxes may
and offer good advice. In addition, you can choose from a variety become more complex.
of software programs for tax preparation. A visit to a bookstore will
uncover shelves of how-to books about tax planning and complet- Key Term
ing tax forms. Personal finance magazines also offer tax information. • tax audit
Figure 12.7 on page 402 shows you some of the available options.
In addition, like all government agencies, the IRS is online.
You can download forms and obtain important tax information and
advice. You will find the same services at your local IRS office. Before
You Read
Tax Audits PREDICT
What does it mean to be audited? Who do you think is an
appropriate professional
The IRS reviews all tax returns for completeness and accuracy. to hire for preparing your
If your math is incorrect, the IRS will refigure your tax return and taxes?
send you either a bill or a refund. In some cases, the IRS may audit
your tax return and request additional information. A tax audit is
a detailed examination of your tax return by the IRS. The IRS does
periodic audits to determine whether taxpayers are paying all of their
required taxes. The IRS does not discuss reasons for auditing returns;
however, the agency may look for unusually large deductions or for
deductions that you cannot claim.
If you receive an audit notice, you have the right to request time As You
to prepare. You may also ask the IRS for clarification of items they are Read
questioning. On the day of your audit, arrive on time for the appoint-
ment and bring only the documents that are relevant and consistent RELATE
with the tax law. Be sure to answer the auditor’s questions clearly, Do you have a friend or
completely, and briefly. Maintain a positive attitude during the audit. relative who has been
If you prefer, your tax preparer, accountant, or lawyer may be present. audited? What was his or
If you have kept complete and accurate financial records, the audit her reaction?
should go smoothly.
Chapter 12 Planning Your Tax Strategy 401
&IGURE 4AX !SSISTANCE )S 4HERE FOR 9OU
1
When you must file your
income tax returns, take IRS Web Site Like all government agencies, the IRS is online.
advantage of these tax assistance You can download forms and obtain important tax information
products and services. and advice.You will find the same services at your local IRS office.
2 Books Visit a book-
store to uncover
shelves of how-to
books about tax plan-
ning and completing tax
forms. Personal finance
magazines offer tax
information as well.
3 Software Tax preparation software
is updated yearly to reflect changes in
the tax laws.
4 Professionals Tax professionals can
help you with your tax preparation, answer
questions, and determine if you are eligible
for deductions and credits.
402 Unit 4 Protecting Your Finances
Planning Tax Strategies
What are some basic strategies to reduce the amount
of tax you owe? Common
Smart taxpayers know how to legally minimize the amount of tax CENTS
they have to pay. You must pay your fair share, but you do not have
to pay more. Various strategies related to purchases, investments, and Try Layaway
retirement help reduce the amount of tax you owe. Some stores offer layaway
plans. If you want to buy
that special dress, pair
Consumer Purchasing Strategies of pants, or coat, ask the
store about its layaway
The buying decisions you make can affect the amount of taxes plan. You make installment
you pay. For example, if you purchase a house, the interest you pay on payments and get the
your mortgage and your real estate property taxes are deductible. You item when the last pay-
can also deduct the interest on a home equity loan. The IRS allows you ment is made. This is a no-
to deduct the interest on home equity loans up to $100,000. Therefore, interest way of paying that
does not require a credit
buying a home provides advantages that may reduce your income tax.
card. If you want to buy a
Some job-related expenses may also be deducted. Union dues, pair of skis that costs $240,
some travel and education expenses, business tools, and certain job- how long will you make
search expenses qualify. Only the portion of these expenses that monthly payments of $30?
exceeds 2 percent of your adjusted gross income is deductible. How-
ever, expenses related to finding your first job or obtaining work in a
different field are not deductible.
Investment Decisions As You
Certain investment decisions may also reduce your income tax. Read
Moreover, some investment decisions can increase your income—and
QUESTION
lower your taxes. For example, the interest on municipal bonds is not
usually taxed. Other investments may be tax-deferred, which means What are some job-related
that the income is taxed at a later date. expenses that you can
deduct from your taxes?
䊴 BUY TO SAVE When pur-
chasing products such as
office supplies, you may be
able to take tax deductions
for business expenses. What is
one other type of expense that is
deductible?
Chapter 12 Planning Your Tax Strategy 403
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: Form W-2 Your Motive: The Form W-2 provides
A Form W-2 contains the following much of the information that you need to
information: file your yearly federal income tax return.
• Employer’s name and address You must save this form and attach copies
• Employee’s name, address, and Social to your income tax return.
Security number
• Wages the employee earned
• Taxes withheld from earnings
26 - 8310024 86.411.75 21,880.59
Group Transportation 87,900.00 5449.80
37 Main Street
Tampa, FL 33606 88,775.00 1287.24
XXX - XX-7822
Theresa C. Alvarez
1335 Smith Lane
Tampa, FL 33605
FL 61 – 281517 86411.75 5326.50 88775.00 887.75 Tampa
Key Points: A Form W-2 is a document Find the Solutions
that employers are required to prepare and 1. What are Theresa’s wages, tips, and other
distribute to each employee and the IRS compensation for 2007?
by the end of January each year. The form 2. How much was withheld from her wages for
details the wages earned by the worker Social Security?
3. How much state income tax was withheld
as well as all taxes withheld for the year.
from her wages?
The Form W-2 is labeled and numbered
4. What is the employer’s identification
to coincide with the IRS Form 1040 and
number?
Form 1040EZ income tax form. 5. What are Theresa’s total Social Security
wages?
404 Unit 4 Protecting Your Finances
Retirement Plans After You
Regardless of your age, whether you are 16 or 26, now is the Read
time to start planning for your retirement. To encourage early plan- REACT
ning, the government allows you to defer paying taxes on money
that you invest in retirement plans. If you open an Individual Retire- How does the government
ment Account (IRA) this year, the money you invest, up to a certain encourage early saving for
retirement? Do you think
amount and under certain conditions, may qualify as a tax deduc-
starting to save for retire-
tion. You do not have to pay any income tax on this money and the ment when you are young
interest it earns until you withdraw it—perhaps 50 years from now! is a good idea? Why?
Changing Your Tax Strategy
People pay taxes because they are required to do so by law.
The government tries to find ways to minimize the taxes you owe
without jeopardizing the important services it provides. This is one
reason why the tax laws are always changing. Your tax strategies
should change too. As the government allows new deductions or as
deductible amounts change, you should review your financial plans
to always take full advantage of new tax laws that may reduce the
amount you pay.
Section 12.3 Assessment
QUICK CHECK Role-Play In pairs, role-play a
1. What are three sources of tax assistance? tax professional and a client. The
2. How do purchasing decisions affect the client should ask the tax professional for
amount of taxes you pay? tax planning strategies. The tax profes-
3. What types of investments might you sional should provide accurate and helpful
make for tax purposes? answers to the client’s questions.
THINK CRITICALLY SOLVE MONEY PROBLEMS
4. Using what you have learned in this chap- 6. Tax Audits Felicia cannot believe it. She
ter, recommend several precautions that has just heard from the IRS that she will be
you might take to avoid a tax audit. audited for the past two years. She has no
idea why. Felicia does not know where to
USE MATH SKILLS begin to prepare.
5. Personalized Tax Assistance Tax pro- Write About It Help Felicia put
fessionals can provide you with advice together a plan of action. Write a
about how to minimize the amount of tax plan listing what she will need, whom she
you have to pay and still pay a fair amount. should consult, and how she should act.
Chapter 12 Planning Your Tax Strategy 405
Chapter 12 Review & Activities
CHAPTER SUMMARY
• Financial planning involves taxes Preparing the W-4 form correctly
because they reduce your take-home ensures an employer will withhold the
pay. Other financial decisions also right amount of money owed to the IRS
affect the amount of taxes you pay. and state and local taxing authorities.
• Your taxable income is earned income • Form 1040EZ is for filers with no depen-
plus interest and dividend income dents and less than a certain amount
minus exclusions, deductions, and in taxable income. Form 1040A allows
exemptions. filers to claim deductions for IRA contri-
• Tax deductions are expenses you are butions and tax credits. Form 1040 must
allowed to subtract from your adjusted be filed if you are itemizing deductions
gross income to arrive at your taxable and/or have more than a certain amount
income. The standard deduction is in taxable income.
determined by the Internal Revenue • You can make strategic decisions that
Service. Tax credits are subtracted may reduce your tax liability, such as
directly from the tax you owe. buying a home or saving money in
• An employee fills out a W-4 form, an IRA.
which determines the tax withheld.
Communicating Key Terms
Your family is hosting an exchange student from another country. He asks about the income
tax system. Using the terms below, write an explanation of the ways people pay taxes in the U.S.
• tax liability • tax deduction
• estate tax • standard deduction
• inheritance tax • itemized deduction
• income tax • exemption
• income tax return • tax credit
• exclusion • allowance
• adjusted gross income • extension
• taxable income • tax audit
Reviewing Key Concepts
1. Describe how taxes have an impact on financial planning.
2. Explain how you determine your adjusted gross income and taxable income.
3. Describe why you should itemize deductions as opposed to taking the standard deduction.
4. Identify the factors to consider when filling out the W-4 form for your employer.
5. Describe the 1040EZ, 1040A, and 1040 income tax forms.
6. List some tax advantages of retirement investing.
406 Unit 4 Protecting Your Finances
Chapter 12 Review & Activities
Civics/Government The rate or percentage at which the federal
government taxes your income is determined by your tax bracket, which is
your level of income. Each year, the tax brackets can change.
Write About It Research and write a paragraph explaining how the
government decides the income tax rates and tax brackets for taxpayers.
How Much Tax Do You Owe? Your gross earnings last year were
$33,435, and your taxable interest income was $486. You also earned $3,766
on freelance projects, on which you have not paid any income tax. Last year,
you contributed $512 to your company 401(k) retirement plan.
1. Calculate the tax you owe by using the six-rate system shown in
Figure 12.1 on page 385.
2. Compute by using financial planning or tax software to determine your
tax liability.
Connect with Social Studies The U.S. government now excludes
up to $1.5 million of an estate from tax. However, states vary in how they
tax estates, whether they tax inheritances, and how much is excluded. New
Jersey, for example, does not tax the inheritances of a deceased person’s
spouse and children but does tax other people who inherit.
1. Research Find out how your state taxes estates and inheritances.
2. Write About It Why do federal and state governments exclude parts of
estates from taxation? What is your opinion about the variation in estate
and inheritance taxes depending on the state where you die?
Charitable Contributions The IRS categorizes non-governmental
organizations into various types. Organizations that qualify for 501c3
status are charitable, educational, and beneficial. Contributions to these
organizations, including travel expenses in volunteering (but not time) are
deductible.
Log On Go to finance07.glencoe.com for a link to the IRS Web
site. Click on Charities and Non-Profits and find out about the rules
and limits on the deductibility of contributions and answer these questions:
1. What records do you need to keep?
2. Where on your income tax return do you indicate these deductions?
Newsclip: Tax Checkup Tax laws can change each year. Knowing
the new rules can help you save money.
O N L I N E
Log On Go to finance07.glencoe.com and open Chapter 12. Learn
about the laws or tax updates during 2004. What do you need to know
before filing your tax return from your summer job?
finance07.glencoe.com Chapter 12 Planning Your Tax Strategy 407
Chapter 12 Review & Activities
TEST YOUR TAX FACTS
The more you know about the way tax laws relate to your personal
finances, the easier it is to file your taxes. To test your knowledge of
tax strategy, write the answer to these questions on a separate sheet
of paper.
1. The tax-reporting requirement for cash tips is __________ .
a. you need to report tips and pay taxes on them
b. you do not need to report cash tips on your tax return
c. your employer takes care of it
2. Besides saving your tax returns you need to keep all necessary paperwork and receipts for
at least __________ .
a. 1 year b. 6 years c. 20 years
3. Tax-deferred income is __________ .
a. income that is not subject to tax
b. income that has had all its fur removed
c. income that will be taxed at a later date
4. Tax-exempt income is __________ .
a. income that is not subject to tax
b. income that you invest
c. income that will be taxed at a later date
5. You would use the standard deduction instead of itemizing your deductions when _____ .
a. itemized deductions are more than the standard deduction
b. itemized deductions are less than the standard deduction
c. line 32 on Schedule C exceeds the allowable limit of line 12 on Schedule E on
Form 1040A
6. Estate tax is a __________ .
a. tax on capital gains from selling a house
b. tax on money withdrawn from a retirement account
c. tax on the value of a person’s property at the time of death
7. The person responsible for the contents of your tax return is __________ .
a. your tax preparer
b. your mom and dad
c. you
8. If you itemize your deductions, you can deduct interest on __________ .
a. credit cards
b. mortgages, home equity, and student loans
c. car loans
408 Unit 1 Protecting Your Finances
Chapter 12 Review & Activities
Your Financial Portfolio
Take It EZ
Using a photocopy of this form, complete your income tax return. Assume that your
wages for the year were $13,220 and you earned $137 in interest. Your W-2 form shows
that you had $1,003 in federal income tax withheld. Your parents cannot claim you on
their income tax return. Find your tax using the tax table on page 397, and then calcu-
late your refund or the amount you owe.
Chapter 12 Planning Your Tax Strategy 409
13
CHAPTER
Home and Motor
Vehicle Insurance
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 13.1
• Identify types of risks and risk
management methods.
• Explain how an insurance
program can help manage risks.
• Describe the importance of
property and liability insurance.
Section 13.2
• Identify the types of insurance
coverage and policies available
to homeowners and renters.
• Analyze the factors that influence
the amount of coverage and cost
of home insurance.
Section 13.3
• Identify the important types of
motor vehicle insurance coverage.
• Explain factors that affect the
cost of motor vehicle insurance.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
410
In the Real World . . .
J osh Peterson just got his driver’s license and bought a used
car. According to state law, he was required to obtain auto insurance.
Josh was alarmed by how much auto insurance cost—it was almost as much
as his car payments. A month later, Josh became involved in his first traffic
accident. Although no one was hurt and the damage to the cars was minimal, he
was shocked to learn how much repairs cost. He was thankful he had auto insur-
ance. Because Josh caused the accident, his auto insurance premiums would
increase. His mother said they could shop around for an auto insurer with a
better rate, but they would have to pay the higher rate for now.
As You Read Consider why it is important to have
insurance for protection.
Insurance Rates
ASK Q: My brother is 17 and has an excellent driving
record. Why are his motor vehicle insurance rates
higher than rates for females in his same age group?
A: Insurance rates are based on an analysis of accident statistics for all types of
drivers. Since young men have a higher incidence of being involved in accidents than
young women have, insurance rates for young men are more expensive. Some insur-
ance companies offer discounts for young adults covered on a parent’s policy.
Ask Yourself What can you do to ensure that your insurance rate stays as
low as possible?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com Chapter 13 Home and Motor Vehicle Insurance 411
Section 13.1
Focus on
Reading
Insurance and
Risk Management
Read to Learn
• How to identify types of
risks and risk manage- What Is Insurance?
ment methods. Why is it important to have insurance?
• How to explain how an
insurance program can Insurance is protection against possible financial loss. Since
help manage risks. you cannot predict the future, you never know when something bad
• How to describe the might happen to you or your property. Insurance allows you to be
importance of property prepared for the worst. It provides protection against many risks,
and liability insurance. such as unexpected property loss, illness, and injury. Although many
kinds of insurance exist, they all have several characteristics in com-
Main Idea mon. For example, they give you peace of mind, and they protect
Recognizing the importance you from financial loss when trouble strikes.
of insurance and knowing An insurance company, or insurer, is a risk-sharing business that
how to develop an insur- agrees to pay for losses that may happen to someone it insures. A
ance program can protect
person joins the risk-sharing group by purchasing a contract known
you from financial loss.
as a policy. The purchaser of the policy is called a policyholder.
Key Terms Under the policy, the insurance company agrees to take on the risk
• insurance
of the policyholder. In return, the policyholder pays the company a
• policy premium, which is a fee for insurance. The protection provided by
• premium the terms of an insurance policy is known as coverage, and the person
• risk protected by the policy is known as the insured.
• peril
• hazard
• negligence Types of Risks
• deductible What are the most common types of risks?
• liability
Risk, peril, and hazard are important terms in insurance. In
everyday use, these terms have almost the same meanings. In
the insurance business, however, each word has a distinct and spe-
Before cial meaning.
You Read Risk is the chance of loss or injury. You face risks every day. For
example, if you cross the street, there is some danger that a motor
PREDICT vehicle might hit you. If you own property, there is risk that it will be
What do you think are the lost, stolen, damaged, or destroyed.
benefits of having a good In the insurance business, risk refers to the fact that no one can
insurance program? predict trouble. This means that an insurance company is taking a
chance every time it issues a policy. Insurance companies frequently
refer to the insured person or property as the risk.
412 Unit 4 Protecting Your Finances
Peril is anything that may possibly cause a loss. It is the reason
that someone takes out insurance. People buy policies for protection
As You
against a wide range of perils, including fire, windstorms, explosions,
Read
robbery, and accidents. RELATE
Hazard is anything that increases the likelihood of loss through
peril. For example, defective electrical wiring in a house is a hazard Do you have any insurance
now? If so, what kind?
that increases the chance that a fire will start.
The most common risks are personal risks, property risks, and lia-
bility risks. Personal risks involve loss of income or life due to illness,
disability, old age, or unemployment. Property risks include losses to
property caused by perils, such as fire or theft, and hazards. Liability
risks involve losses caused by negligence that leads to injury or prop-
erty damage. Negligence is the failure to take ordinary or reasonable
care to prevent accidents from happening. If a homeowner does not
clear the ice from the front steps of her house, for example, he or she
creates a liability risk because visitors could fall on the ice.
Personal risks, property risks, and liability risks are types of pure,
or insurable, risk. The insurance company will have to pay only if
some event that the insurance covers actually happens. Pure risks are
accidental and unintentional. Although no one can predict whether
a pure risk will occur, it is possible to predict how much it will cost if
it does.
A speculative risk is a risk that carries a chance of either loss or
gain. Starting a small business that may or may not succeed is an
example of speculative risk. Speculative risks are not insurable.
Risk-Management Methods
Why is risk management important?
Risk management is an organized plan for protecting yourself,
your family, and your property. It helps reduce financial losses caused
by destructive events. Risk management is a long-range planning pro-
cess. Your risk-management needs will change at various points in
your life. If you understand how to manage risks, you can provide
better protection for yourself and your family. Figure 13.1 on page
415 summarizes various risks and effective ways of managing them.
Most people think of risk management as buying insurance.
However, insurance is not the only way of dealing with risk.
Risk Avoidance
You can avoid the risk of a traffic accident by not driving to
work. A car manufacturer can avoid the risk of product failure by
not introducing new cars. These are both examples of risk avoidance.
They are ways to avoid risks, but they involve serious trade-offs. You
might have to give up your job if you cannot get there by driving a
car. The car manufacturer might lose business to competitors who
take the risk of producing exciting new cars.
Chapter 13 Home and Motor Vehicle Insurance 413
In some cases, though, risk avoidance is
practical. For example, by taking precautions
in high-crime areas, you might avoid the risk
of being robbed. By installing a security system
in your car, you might avoid the risk of having
it stolen.
Risk Reduction
You cannot avoid risks completely. How-
ever, you can decrease the likelihood that they
will cause you harm. For example, you can reduce
the risk of injury in a car accident by wearing a
seat belt. You can reduce the risk of developing
lung cancer by not smoking. By installing fire
extinguishers in your home, you can reduce the
damage that could be caused by a fire. In addi-
tion, you can lower your risk of illness by eating
properly and exercising regularly.
REDUCING RISKS Taking
Risk Assumption
steps to protect yourself and
your property from harm Risk assumption means taking on responsibility for the negative
can reduce your risk of results of a risk. It makes sense to assume a risk if you know that the
financial loss. Besides wearing possible loss will be small. It also makes sense when you have taken
your seat belt, what are some all the precautions you can to avoid or reduce the risk.
other ways of reducing risks When insurance coverage for a particular item is expensive, it
when you are driving? may not be worth insuring. For instance, older cars are generally
worth less than new cars. So even if an accident happens and the car
is wrecked, you may be better off financially by not paying for the
insurance coverage since the car was not worth much anyway.
Self-insurance is another option for risk assumption. By setting
up your own special fund, perhaps from savings, you can cover the
cost of loss. Self-insurance does not eliminate risks, but it does pro-
vide a way of covering losses as an alternative to an insurance policy.
Some people self-insure because they cannot obtain insurance from
an insurance company.
Risk Shifting
The most common method of dealing with risk is to shift it, which
means to transfer it to an insurance company. In exchange for the fee
you pay, the insurance company agrees to pay for your losses.
Most types of insurance policies include deductibles. Deductibles
are a combination of risk assumption and risk shifting. A deductible
is the set amount that the policyholder must pay per loss on an insur-
ance policy. For example, if a falling tree damages your car, you may
have to pay $200 toward the repairs. Your insurance company will
pay the rest.
414 Unit 4 Protecting Your Finances
Planning an Insurance Program
What factors will affect your insurance goals?
Your personal insurance program should change along with
your needs and goals. For example, Kirk and Luanne are a young mar-
ried couple. The following four steps outline how they will plan their
insurance program to meet their needs and goals.
STEP 1: Set Insurance Goals
Kirk and Luanne’s main goal should be to minimize personal,
property, and liability risks. They also need to decide how they will
cover costs resulting from a potential loss. Income, age, family size,
lifestyle, experience, and responsibilities are important factors in
determining the goals they set. The insurance that they buy must
reflect those goals.
Kirk and Luanne should try to come up with a basic risk-
management plan that achieves the following goals:
• Reduces possible loss of income caused by premature death,
illness, accident, or unemployment
• Reduces possible loss of property caused by perils, such as fire
or theft, or hazards
• Reduces possible loss of income, savings, and property caused
by personal negligence
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Chapter 13 Home and Motor Vehicle Insurance 415
Step 2: Develop a Plan
Planning is a way of taking control of your life instead of just
Saving Gas— letting life happen to you. Kirk and Luanne need to determine what
and Money risks they face and what risks they can afford to take. They also have
1. Use the correct to determine what resources can help them reduce the damage that
grade of gas for could be caused by serious risks.
your car and save
Furthermore, they need to know what kind of insurance is avail-
as much as 20
cents per gallon. able. The cost of different kinds of insurance and the way the costs
vary among companies will be key factors in their plan. Finally, this
2. Buy non-brand
name gasoline at couple needs to research the record of reliability of different insur-
lower prices. ance companies.
3. Drive at the speed Kirk and Luanne must ask four questions as they develop their
limit and not risk-management plan:
above. Speed
wastes gas. • What do they need to insure?
• For how much should they insure it?
4. Inflate your tires at
the recommended • What kind of insurance should they buy?
pressure and save • Which insurance company should they choose?
as much as $180
a year.
Step 3: Put Your Plan into Action
5. Tune up your
engine and change After they have developed their plan, Kirk and Luanne need to
the oil and filter follow through by putting it into action. During this process they
regularly. might discover that they do not have enough insurance protection.
If that is the case, they could purchase additional coverage or change
the kind of coverage they have. Another alternative would be to
adjust their budget to cover the cost of additional insurance. Finally,
Kirk and Luanne might expand their savings or investment programs
and use those funds in the case of an emergency.
The best risk-management plans will be flexible enough to allow
Kirk and Luanne to respond to changing life situations. Their goal
should be to create an insurance program that can grow or shrink as
their protection needs change.
Step 4: Review Your Results
You should take time to review a risk-management plan every
two or three years, or whenever family circumstances change.
For example, Kirk and Luanne have been satisfied with the cov-
erage provided by their insurance policies. However, when the couple
bought a house six months ago, it was time for them to review their
insurance plan. With the new house, the risks became much greater.
After all, what would happen if a fire destroyed part of their home?
The needs of a couple who rent an apartment differ from the
needs of a couple who own a house. Both couples face similar risks,
but their financial responsibilities differ greatly. When you are devel-
oping or reviewing a risk-management plan, ask yourself if you are
providing the financial resources you will need to protect yourself,
your family, if you have one, and your property.
416 Unit 4 Protecting Your Finances
Property and Liability Insurance Put on
in Your Financial Plan Your
Why is it important to include property and Financial
liability insurance in a financial plan? Planner’s
Major natural disasters have caused catastrophic amounts of Cap
property loss in the United States and other parts of the world. In If you were planning an
2004, the damage caused by Hurricane Charley resulted in $6.8 bil- insurance program for a
lion in insurance claims in the state of Florida alone. Insurance claims client, what types of things
are requests for payment to cover financial losses. Without the money would you insure?
they received from their insurance, the people affected by the hurri-
cane may not have been able to make repairs to their homes.
Most people spend a great deal of money on their houses, vehi-
cles, furniture, clothing, and other personal property. Therefore,
protecting these items from loss is extremely important. Each year
homeowners and renters in the United States lose billions of dollars
from more than 3 million burglaries, 500,000 fires, and 200,000 cases
of damage from other perils. The cost of injuries and property dam-
age caused by vehicles is also enormous. By including property and
liability insurance in your financial plan, you can help protect your-
self from such financial loss. DISASTROUS RESULTS
Think of the price you pay for insurance as an investment in the Events such as hurricanes
protection of your most valuable possessions. Although the cost of and tornados can cause
such insurance may seem high, the financial losses against which it widespread devastation.
protects could be much higher. What can you do to protect
There are two main types of risks related to your home and your property against natural
your car or other vehicle. One is the risk of damage to or loss of your disasters?
property. The second type of risk involves
your responsibility for injuries to other
people or damage to their property.
Property Damage or Loss
Property owners face two basic types
of risks. The first is physical damage caused
by perils such as fire, wind, and flood-
ing. These perils can damage or destroy
your property. For example, a windstorm
might cause a large tree branch to smash
the windshield of your car. As a result, you
would have to find another way to get
around while it was being repaired.
The second type of risk that property
owners face is loss or damage caused by
criminal behavior, such as robbery, bur-
glary, vandalism, and arson. Insurance can
help you protect yourself from loss of or
damage to your property.
Chapter 13 Home and Motor Vehicle Insurance 417
As You Liability
Read Liability is legal responsibility for the financial cost of another
QUESTION person’s losses or injuries. You can be judged legally responsible even
if the injury or damage was not your fault. For example, suppose
Why do most people want that Terry falls and gets hurt while playing in her friend Lisa’s yard.
to have their cars, homes, Terry’s family may be able to sue Lisa’s parents even though Lisa’s
and personal property parents did nothing wrong. Similarly, suppose that Sanjay acciden-
insured?
tally damages a valuable painting while helping Ed move some of his
furniture. Ed may take legal action against Sanjay to pay for the cost
of the painting.
Usually, if you are found liable (or legally responsible) in a situa-
tion, it is because negligence on your part caused the mishap. Exam-
ples of such negligence include letting young children swim in a pool
without supervision or cluttering a staircase with things that could
cause someone to slip and fall, and become injured.
Section 13.1 Assessment
QUICK CHECK Write About It Write a paragraph
1. What are the three main types of insurable discussing the personal and financial
risks? consequences of having the items on your
2. How can developing an insurance program list lost, stolen, damaged, or destroyed.
help you manage risk? Also explain the effect of having the items
3. Why are property and liability insurance insured in the event of loss.
necessary to protect a homeowner from
SOLVE MONEY PROBLEMS
financial loss?
6. Paying for Insurance Protection
THINK CRITICALLY Hans has recently purchased a fully restored
4. “Insurance is a waste of money. If and 1957 Chevy. The car cost $35,000, but for
when you suffer a financial loss because of Hans, the price was worth it. The best price
an accident or some other event, you can he can find for insurance is $2,500 per year.
pay for it from your savings account.” Do He is thinking about cutting corners on his
you agree or disagree with this statement? insurance coverage to save money. How-
Explain your position. ever, he knows he would be taking a risk by
doing so.
USE COMMUNICATION SKILLS Calculate Help Hans solve his
5. My Favorite Things Make a list of your problem by comparing the cost of his
most valuable possessions. Consider new insurance with the cost of his vehicle. Is it
and used items that may have collectible worth the insurance expense to protect his
value. Also consider how much it would prized vehicle, or is it too much to spend to
cost to replace your valuable possessions. insure what is, after all, just a car?
418 Unit 4 Protecting Your Finances
Section 13.2
Home and Property Focus on
Reading
Insurance
Read to Learn
• How to identify the types
Homeowners Insurance Coverage of insurance coverage
What does a homeowners insurance policy cover? and policies available to
homeowners and renters.
Insuring your residence and its contents is absolutely nec- • How to analyze the fac-
essary to protect your investment. Homeowners insurance is tors that influence the
coverage that provides protection for your residence and its associ- amount of coverage and
ated financial risks, such as damage to personal property and injuries cost of home insurance.
to others.
A homeowners policy provides coverage for the following: Main Idea
You need an effective risk
• The home, building, or any other structures on management plan for your
the property home or apartment and
• Additional living expenses your personal belongings.
• Personal property When purchasing insur-
• Personal liability and related coverages ance, your goal is to get
the best protection at the
• Specialized coverages
lowest cost.
Buildings and Other Structures Key Terms
• homeowners insurance
The main purpose of homeowners insurance is to protect you
• personal property floater
against financial loss in case your home is damaged or destroyed. • medical payments
Detached structures on your property, such as a garage and tool shed, coverage
are also covered under a homeowners insurance policy. In fact, the • actual cash value
insurance coverage even includes trees, shrubs, and other plants, • replacement value
which are landscaping.
Additional Living Expenses
Before
If a fire or other event damages your home, additional living You Read
expense coverage pays for you to stay somewhere else. For example,
you may need to stay in a motel or rent an apartment while your
PREDICT
home is being repaired or rebuilt. These extra living expenses will Why would it be important
be paid for by your insurance. Some policies limit additional living to have homeowners
expense coverage to 10 to 20 percent of the home’s total coverage insurance?
amount. They may also limit the payment period to a maximum of
six to nine months. Other policies may pay additional living expenses
for up to a year.
Chapter 13 Home and Motor Vehicle Insurance 419
Personal Property
Household belongings, such as furniture, appliances, and cloth-
ing, are covered by the personal property portion of a homeowners
insurance policy up to a portion of the insured value of the home.
That portion is usually 55, 70, or 75 percent. For example, a home
insured for $80,000 might have $56,000 (70 percent) worth of cover-
age for household belongings.
Personal property coverage typically includes limits for the theft
of certain items, such as $1,000 for jewelry. It also provides protection
against the loss or damage of articles that you take with you when
you are away from home. For example, items you take on vacation
or use at school are usually covered up to the policy limit. Personal
property coverage even extends to property that you rent, such as a
rug cleaner, while it is in your possession.
Most homeowners policies also include optional coverage for
personal computers, including stored data, up to a certain limit. Your
insurance agent can determine whether the computer equipment is
covered against data loss as well as damage from spilled drinks or
power surges.
As You Household Inventories If something does happen to your
Read personal property, you must prove how much it was worth and
RELATE that it belonged to you. To make the process easier, you can create
a household inventory. A household inventory is a list or other
Do you own something
documentation of personal belongings, with purchase dates and cost
you think should be
insured separately from information. You can get a form for an inventory from an insurance
your parents’ homeowners agent. Figure 13.2 provides a list of items you might include if you
insurance? decide to compile your own household inventory. For items of special
value, you should have receipts, serial numbers, brand names, model
names, and proof of value.
In addition, keep a video recording or photographs of your
home and its contents with your inventory list. Make sure that closet
and storage area doors are photographed open. On the backs of the
photographs, indicate the date and the value of the objects pictured.
Update your inventory, photos, and related documents on a regular
basis. Keep a copy of each document in a secure location, such as a
safe-deposit box.
Additional Property Insurance If you own valuable items,
such as expensive musical instruments, or need added protection
for computers and related equipment, you can purchase a personal
property floater. A personal property floater is additional pro-
perty insurance that covers the damage or loss of a specific item
of high value. The insurance company will require a detailed
description of the item and its worth. You will also need to have
the item appraised, or evaluated, by an expert from time to time
to make sure that its value has not changed. In addition, keep
photographs of valuable items as well as descriptions, receipts, and
appraisals.
420 Unit 4 Protecting Your Finances
&IGURE (OUSEHOLD )NVENTORY
!TTIC
s ,UGGAGE
s (OLIDAY ITEMS
s )TEMS IN STORAGE
"EDROOMS (ALLWAY "ATHROOM
s &URNITURE s #LOCKS s -IRRORS s ,INENS
s %LECTRONIC EQUIPMENT s #ARPETS s &URNITURE s %LECTRICAL
s %LECTRICAL APPLIANCES s ,AMPS s #ARPETS APPLIANCES
s 0ICTURES s *EWELRY
s "OOKS AND BOOKCASES s #LOTHES
s -IRRORS s !CCESSORIES
'ARAGE ,IVING 2OOM $INING 2OOM +ITCHEN
s ,AWN MOWER s &URNITURE s &IREPLACE s &URNITURE s &URNITURE
s 'ARDEN TOOLS s %LECTRONIC EQUIPMENT s $INNERWARE s $ISHES
s "ICYCLES EQUIPMENT s 7ALL HANGINGS s ,INENS AND PANS
s #AMPING s !IR s "OOKS AND s 'LASSWARE
EQUIPMENT CONDITIONER BOOKCASES s 3ILVERWARE
s 3PORTS s ,AMPS s #LOCKS s %LECTRICAL
EQUIPMENT s -USICAL APPLIANCES
s ,AWN EQUIPMENTS
FURNITURE
"ASEMENT
s 7ASHING MACHINE s 7ORKBENCH
s $RYER s 0OWER TOOLS
&ULL (OUSE ! HOUSEHOLD INVENTORY SHOULD LIST THE ITEMS IN EACH ROOM OF YOUR HOME
7HY IS IT IMPORTANT TO CREATE A HOUSEHOLD INVENTORY
Personal Liability and Related Coverages
Every day people face the risk of financial loss due to injuries
to other people or their property. For example, a guest could fall on
a patch of ice on the steps to your home and break his arm. A spark
from the barbecue in your backyard could start a fire that damages a
neighbor’s roof, or your son or daughter could accidentally break an
antique lamp while playing at a neighbor’s house.
In these situations, you could be held responsible for paying for
the damage. The personal liability portion of a homeowners policy
protects you and members of your family if others, except regular
employees, sue you for injuries they suffer or for damage to their
property. This coverage includes the cost of legal defense.
Chapter 13 Home and Motor Vehicle Insurance 421
ADDITIONAL PROTECTION Amounts of Coverage Most homeowners policies provide
The purchase of a valuable basic personal liability coverage of $100,000, but often that is not
item such as a high-qual- enough. An umbrella policy, also called a personal catastrophe policy,
ity musical instrument is a supplements basic personal liability coverage. This added protection
major investment. Why would covers all kinds of personal injury claims. For example, an umbrella
a person who buys an expensive policy will cover you if someone sues you for saying or writing
piano get a personal property something negative or untrue, damaging his or her reputation.
floater for it? Extended liability policies are useful for wealthy people and for
businesses. The policies are sold in amounts of $1 million or more. If
you are a business owner, you may need other types of liability cover-
age as well.
Medical payments coverage pays the costs of minor acciden-
tal injuries to visitors on your property. It also covers minor injuries
caused by you, members of your family, or even your pets, away from
home. Settlements under medical payments coverage are made with-
out determining who was at fault. This makes it fast and easy for the
insurance company to process small claims, generally up to $5,000. If
the injury is more serious, the personal liability portion of the hom-
eowners policy covers it. Medical payments coverage does not cover
injury to you or the other people who live in your home.
If you or a family member should accidentally damage another
person’s property, the supplementary coverage of homeowners
insurance will pay for it. This protection is usually limited to $500
or $1,000. Again, payments are made regardless of fault. If the dam-
age is more expensive, however, it is handled under the personal
liability coverage.
422 Unit 4 Protecting Your Finances
Specialized Coverages
Homeowners insurance usually does not cover losses from floods
and earthquakes. If you lived in an area that had frequent floods or
earthquakes, you would need to purchase special coverage. In some
places the National Flood Insurance Program, run by the federal gov-
ernment, makes flood insurance available. This protection is separate
from a homeowners policy. An insurance agent or the Federal Emer-
gency Management Agency (FEMA) of the Federal Insurance Admin-
istration can give you additional information about this coverage.
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis-
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals
to help them guide their financial decisions. "ERLIN
GERMANY
Sometimes called the “Motherland of the Auto-
motive Industry,” Germany is one of the world’s
leading car manufacturers. From the luxurious
Mercedes-Benz to the sleek and sporty Porsche to the DATABYTES
unique and practical Volkswagen Beetle, Germans
design cars that turn heads. In fact, the German- Capital Berlin
made Volkswagen Beetle has been called the “most
Population 82,621,000
popular vehicle of all time.”
The German Languages German
economy has experi- Currency euro
enced ups and downs, Gross Domestic
but car manufacturing Product (GDP) $2.27 trillion (2003 est.)
has remained one of GDP per capita $27,600
its cornerstones. The
Industry: Iron, steel, coal, cement, chemicals,
industry pulls in over
machinery, vehicles, machine tools, and electronics
$90 million in sales
within the country Agriculture: Potatoes, wheat, barley, sugar beets,
and over $145 billion and cattle
from other countries. Exports: Machinery, vehicles, chemicals, metals,
The United States, with foodstuffs, and textiles
its fondness for sta- Natural Resources: Iron ore, coal, potash, and timber
tus cars, is Germany’s
Think Globally
number one foreign
Automobile insurance is higher for someone who owns
market.
a sports car such as a Porsche. Why?
Chapter 13 Home and Motor Vehicle Insurance 423
You may be able to get earthquake or flood insurance as an
endorsement (addition of coverage) to a homeowners policy or through
a state-run insurance program. The most serious earthquakes occur in
the Pacific Coast region. However, earthquakes can happen in other
regions, too. If you purchase a home in an area that has a high risk of
LANGUAGE ARTS
earthquakes or floods, you may have to buy insurance for those risks.
The property belonging
to most renters is not cov-
ered under a landlord’s
insurance. Therefore, with-
Renters Insurance
out renters insurance, a Why is it important for a renter
renter must pay for replac- to get renters insurance?
ing possessions if they
For people who rent, home insurance coverages include per-
are stolen from his or her
apartment or destroyed by sonal property protection, additional living expenses coverage, and
a fire or some other unex- personal liability and related coverages. Renters insurance does not
pected event. Choose three provide coverage on the building or other structures.
companies offering rent- The most important part of renters insurance is the protection it
ers insurance and compare provides for personal property. Many renters believe that they are cov-
what each company covers
ered under their landlords’ policies. However, that is true only when
and the costs of coverage.
Then choose the company the landlord is liable for damage. For example, if bad wiring causes a
you believe offers the best fire and damages a tenant’s property, the tenant may be able to collect
deal and write a paragraph money from the landlord. Renters insurance is relatively inexpensive
explaining why. and provides protection similar to homeowners insurance.
Home Insurance Policy Forms
What coverage is offered by each type of policy form?
Home insurance policies are available in several forms. The
forms provide different combinations of coverage. Some forms are
not available in all areas.
The basic form (HO-1) protects against perils such as fire, light-
ning, windstorms, hail, volcanic eruptions, explosions, smoke, theft,
vandalism, glass breakage, and riots. The broad form (HO-2) covers
an even wider range of perils, including falling objects and damage
from ice, snow, or sleet.
The special form (HO-3) covers all basic- and broad-form risks,
plus any other risks except those specifically excluded from the pol-
icy. Common exclusions are flood, earthquake, war, and nuclear acci-
dents. Personal property is covered for the risks listed in the policy.
The tenants’ form (HO-4) protects the personal property of rent-
ers against the risks listed in the policy. It does not include coverage
on the building or other structures.
The comprehensive form (HO-5) expands the coverage of the
HO-3. The HO-5 includes endorsements for replacement-cost coverage
on contents and guaranteed replacement-cost coverage on buildings.
Condominium owners insurance (HO-6) protects personal prop-
erty and any additions or improvements made to the living unit.
These might include bookshelves, electrical fixtures, wallpaper, or
carpeting. The condominium association purchases insurance on the
building and other structures.
424 Unit 4 Protecting Your Finances
Manufactured housing units and mobile homes usually qualify
for insurance coverage with conventional policies. However, some
mobile homes may need special policies with higher rates that are
dependent on the home’s location and the way it is attached to the
ground. Mobile home insurance is quite expensive: A $50,000 mobile
home can cost as much to insure as a $150,000 house.
Though some risks are not covered by home insurance (see
Figure 13.3), home insurance policies do include coverage for
addtional costs:
• Credit card fraud, check forgery, and counterfeit money
• Removal of damaged property
• Emergency removal of property to protect it from damage
• Temporary repairs after a loss to prevent further damage
• Fire department charges in areas with such fees
How Much Coverage
Do You Need?
What is the actual cash value method?
You can get the best insurance value by choosing the right
amount of coverage and knowing the factors that affect insurance
costs. Your insurance should be based on the amount of money you
would need to rebuild or repair your house, not the amount you paid
for it. As construction costs rise, you should increase the amount of
coverage. In fact, today most insurance policies automatically increase
coverage each year as construction costs rise.
&IGURE .OT %VERYTHING )S #OVERED
#ERTAIN PERSONAL PROPERTY IS NOT COVERED BY HOMEOWNERS INSURANCE
s )TEMS INSURED SEPARATELY SUCH AS JEWELRY FURS s !IRCRAFT AND PARTS
BOATS OR EXPENSIVE ELECTRONIC EQUIPMENT s 0ROPERTY BELONGING TO TENANTS
s !NIMALS OR FISH s 0ROPERTY CONTAINED IN A RENTAL APARTMENT
s -OTORIZED VEHICLES NOT LICENSED FOR ROAD USE s 0ROPERTY RENTED BY THE HOMEOWNER TO OTHER
EXCEPT THOSE USED FOR HOME MAINTENANCE PEOPLE
s 3OUND DEVICES USED IN MOTOR VEHICLES SUCH AS s "USINESS PROPERTY
RADIOS AND #$ PLAYERS
#OVERAGE %XCLUSIONS 3EPARATE COVERAGE MAY BE AVAILABLE FOR PERSONAL PROPERTY THAT IS NOT COVERED
BY A HOMEOWNERS INSURANCE POLICY
'IVE AN EXAMPLE OF ANOTHER TYPE OF POLICY THAT WOULD COVER ONE
OF THE ITEMS LISTED HERE
Chapter 13 Home and Motor Vehicle Insurance 425
CLAIM SETTLEMENTS
Insurance companies use
two different methods for
settling insurance claims.
If your television is damaged
in a fire, how will you be
reimbursed for the television
under the actual cash value
method? Under the replace-
ment value method?
In the past, many homeowners’ policies insured a building for
only 80 percent of the replacement value. If the building were
destroyed, the homeowner would have to pay for part of the cost of
replacing it, which could be expensive. Today most companies rec-
ommend full coverage.
If you are borrowing money to buy a home, the lender will
require that you have property insurance. The amount of insurance
on your home determines the coverage on your personal belongings.
Coverage for personal belongings is usually between 55 and 75 per-
cent of the amount of insurance you have on your home.
Insurance companies base claim settlements on one of two
methods. Under the actual cash value method, the payment you
As You receive is based on the replacement cost of an item minus deprecia-
Read tion. Depreciation is the loss of value of an item as it gets older. This
means you would receive less for a five-year-old bicycle than what
QUESTION you originally paid for it.
Which policy would most Under the replacement value method for settling claims, you
likely pay you more if your receive the full cost of repairing or replacing an item. Depreciation is
home burned down? not considered. Many companies limit the replacement cost to 400
percent of the item’s actual cash value. Replacement value coverage
is more expensive than actual cash value coverage.
Home Insurance Cost Factors
Why do the location and type of construction of your
home affect your home insurance costs?
The cost of your home insurance will depend on several factors,
such as the location of the home and the type of structure and con-
struction materials used. The amount of coverage and type of policy
you choose will also affect the cost of your home insurance. Further-
more, different insurance companies offer different rates.
426 Unit 4 Protecting Your Finances
Location of Home
The location of your home affects your insurance rates. Insur-
ance companies offer lower rates to people whose homes are close to
a water supply or fire hydrant—or are located in an area that has a
good fire department. Rates are higher in areas where crime is com-
mon. People living in regions that experience severe weather, such as
tornadoes and hurricanes, may pay more for insurance.
Type of Structure
The type of structure and its construction influence the price of
insurance coverage. A brick house, for example, will usually cost less
to insure than a similar structure made of wood. However, earthquake
coverage is more expensive for a brick house than for a wooden dwell-
ing because a wooden house is more likely to survive an earthquake.
Also, an older house may be more expensive to restore to its original
condition. That means that it will cost more to insure.
Price, Coverage Amount, Policy Type
The purchase price of a house directly affects how much you pay
for insurance. Therefore, it costs more to insure a $300,000 home than
a $100,000 home. Also, the type of policy you choose and the amount
of coverage you select affect the amount of premium you pay.
LOWER YOUR PREMIUM
Fires can cause costly dam-
age to property and personal
possessions. Why might insur-
ance companies offer discounts
to people who have homes
with composite roofs instead of
wood roofs?
Chapter 13 Home and Motor Vehicle Insurance 427
Careers in Finance
CREDIT ANALYST
INSURANCE Rita Young
CLAIMS ADJUSTER 21st Century Insurance
Rita likes to help people when disasters strike. As an insurance claims adjuster, she is responsible for
investigating complex homeowner claims by interviewing, inspecting, and securing documentation
from insured clients, claimants, and witnesses. She evaluates the extent of damage to property and
determines the value of claims. Helping clients is one of her favorite parts of her job. She provides a
high level of customer service when she reviews policies with her clients and investigates claims-
coverage questions.
SKILLS: Interpersonal, problem-solving, negotiating; mathematical skills;
comprehensive knowledge of codes, home construction, repair techniques,
and legal terminology
PERSONAL TRAITS: Organizational ability and tactfulness
EDUCATION: High school diploma or equivalent; bachelor’s degree in business, insurance,
or related area; certified Associate of Claims
ANALYZE Why might an insurance claims adjuster be expected to work on weekends or holidays?
To learn more about career paths for insurance claims adjusters, visit finance07.glencoe.com.
The deductible amount listed on the policy also affects the cost
of insurance. If you increase the amount of the deductible, the pre-
mium will be lower because the company will pay out less in claims.
The most common deductible amount is $250. Raising the deductible
from $250 to $500 or $1,000 can reduce the premium you pay by 15
percent or more.
Home Insurance Discounts
Most companies offer discounts if a homeowner takes action
to reduce risks to a home. Your premium may be lower if you have
smoke detectors or a fire extinguisher. If your home has dead-bolt
locks and alarm systems, which make it harder for thieves to get in,
insurance costs may be lower.
Company Differences
A homeowner can save up to 25 percent on homeowners insur-
ance by comparing rates from several companies. Some insurance
agents work for only one company. Others are independent agents
who represent several different companies.
428 Unit 4 Protecting Your Finances finance07.glencoe.com
Do not select a company on the basis of price alone. Also con-
sider service and coverage. Not all companies settle claims in the
same way.
For example, suppose that all of the homes on Evergreen Ter-
race are hit on one side by large hailstones. They all have the same
kind of siding. Unfortunately, the homeowners discover that this
type of siding is no longer available. So all the siding on all the
houses will need to be replaced. Some insurance companies will pay
to replace all the siding. Others will pay only to replace the dam-
aged parts.
State insurance commissions and consumer organizations can
give you information about different insurance companies. Con-
sumer Reports, a magazine that provides unbiased information on a
variety of goods and services, rates insurance companies on a regu-
lar basis.
Section 13.2 Assessment
QUICK CHECK Calculate Determine how much
1. What are six home insurance policy forms insurance coverage Carolina’s policy
and their coverages? provides for her personal possessions and
2. What type of coverage does a personal whether she will receive payment for all the
property floater provide? items destroyed in the fire.
3. How can the location of a home affect
SOLVE MONEY PROBLEMS
insurance costs?
6. Analyzing Insurance Costs Kara
THINK CRITICALLY and Adam Gottlieb are in the process of
4. Describe at least two situations in which buying their first home. After months of
personal liability coverage might be shopping, they have narrowed down their
required. choices to two. One is an older house near
a river, where flooding occurs occasion-
USE MATH SKILLS ally. The other is a newer house that is
5. Insurance Coverage Homeowners located farther from the river. They need
insurance covers your personal posses- to know how much homeowners insur-
sions up to a percentage of the insured ance will cost for each house before mak-
value of your home. When Carolina’s ing a final decision.
house burned down, she lost household Analyze Given this information,
items worth a total of $25,000. Her house make your best educated guess
was insured for $80,000, and her home- about which house would be less expensive
owners policy provided coverage for per- to insure.
sonal belongings up to 55 percent of the
insured value of the house.
Chapter 13 Home and Motor Vehicle Insurance 429
Section 13.3
Focus on
Reading
Motor Vehicle
Insurance
Read to Learn Motor vehicle accidents cost more than $150 billion in lost
• How to identify important wages and medical bills every year. They can destroy people’s lives
types of motor vehicle physically, financially, and emotionally. Buying insurance cannot
insurance coverage.
eliminate the pain and suffering that vehicle accidents cause. How-
• How to explain factors ever, insurance can reduce the financial impact.
that affect the cost of
Every state in the United States has a financial responsibility law,
motor vehicle insurance.
which is a law that requires a driver to prove he or she can pay for
Main Idea damage or injury caused by an automobile accident if he or she is at
fault. As of 2003, more than 45 states had laws requiring people to
Various types of motor
vehicle insurance offer dif- carry motor vehicle insurance. When injuries and property damage
ferent coverages. A variety occur in an accident, the driver(s) is required to file a report with the
of factors affect the cost of state. In the remaining states, most people buy motor vehicle insur-
insurance. ance by choice. Very few people have the money they would need to
meet the financial responsibility requirements on their own.
Key Terms The coverage provided by motor vehicle insurance falls into two
• bodily injury liability categories: protection for bodily injury and protection for property
• uninsured motorist’s damage. (See Figure 13.4.)
protection
• property damage liability
• collision
• no-fault system
Motor Vehicle Bodily
• assigned risk pool Injury Coverages
Who is covered by bodily injury
liability insurance?
Before Most of the money that motor vehicle insurance companies pay
You Read out in claims goes for legal expenses, medical expenses, and other
costs that arise when someone is injured. The main types of bodily
PREDICT injury coverages are:
Do you think your driving • Bodily injury liability
record affects your car
• Medical payments
insurance rates? Why?
• Uninsured motorist’s protection
Bodily Injury Liability
Bodily injury liability is insurance that covers physical inju-
ries caused by a vehicle accident for which you are responsible. If
pedestrians, people in other vehicles, or passengers in your vehicle
are injured or killed, bodily injury liability coverage pays for expenses
related to the crash.
430 Unit 4 Protecting Your Finances
&IGURE -OTOR 6EHICLE )NSURANCE #OVERAGE
`ÞÊÕÀÞÊ ÛiÀ>}ià *À«iÀÌÞÊ >>}iÊ ÛiÀ>}iÃ
"ODILY -EDICAL 5NINSURED 0ROPERTY #OLLISION #OMPREHENSIVE
INJURY PAYMENTS MOTORISTS DAMAGE PHYSICAL
LIABILITY COVERAGE PROTECTION LIABILITY DAMAGE
0ROTECT 9OURSELF ÕÞ}ÊL`ÞÊÕÀÞÊ>`Ê«À«iÀÌÞÊ`>>}iÊVÛiÀ>}iÊV>ÊÀi`ÕVi
Ì iÊv>V>Ê«>VÌÊvÊ>Ê>VV`iÌ°
7 >ÌÊÌÞ«iÊvÊiÝ«iÃiÃÊÜÕ`ÊLiÊ«>`ÊvÀÊLÞÊL`ÞÊÕÀÞ
>LÌÞÊVÛiÀ>}i¶
Liability coverage is usually expressed by three numbers, such
as 100/300/50. These amounts represent thousands of dollars of cov-
erage. The first two numbers refer to bodily injury coverage. In the
100/300/50 example, $100,000 is the maximum amount that the
insurance company will pay for the injuries of any one person in
any one accident. The second number, $300,000, is the maximum
amount the company will pay for all injured parties (two or more) in
any one accident. The third number, $50,000, indicates the limit for
payment for damage to the property of others. (See Figure 13.5.)
&IGURE -OTOR 6EHICLE )NSURANCE #OVERAGE
)NDICATES LIMIT )NDICATES LIMIT )NDICATES LIMIT FOR
THAT WILL BE PAID TO ONE THAT WILL BE PAID TO ALL PAYMENT FOR DAMAGE TO
PERSON IN AN ACCIDENT PERSONS IN AN ACCIDENT THE PROPERTY OF OTHERS
"ODILY )NJURY ,IABILITY 0ROPERTY $AMAGE ,IABILITY
,IABILITY #OVERAGE 4HE THREE NUMBERS USED TO DESCRIBE LIABILITY COVERAGE REFERS TO THE
LIMITS ON DIFFERENT TYPES OF PAYMENTS
7HY DO YOU THINK THE MIDDLE NUMBER OF THE LIABILITY COVERAGE
AMOUNTS IS THE HIGHEST
Chapter 13 Home and Motor Vehicle Insurance 431
As You Medical Payments Coverage
Read Medical payments coverage is insurance for medical expenses of
RELATE anyone injured in your vehicle, including you. This coverage also pro-
vides medical benefits for you and members of your family while rid-
Does your state require ing in another person’s vehicle or if any of you are hit by a vehicle.
car owners to carry motor
vehicle insurance? If so,
what type? Uninsured Motorist’s Protection
Unfortunately, you cannot assume that everyone who is driving
has auto insurance. You can guard yourself and your passengers against
the risk of getting into an accident with someone who has no insur-
ance by having uninsured motorist’s protection.
Uninsured motorist’s protection is insurance that covers
you and your family members if you are involved in an accident with
an uninsured or hit-and-run driver. In most states it does not cover
damage to the vehicle itself. Penalties for driving without insurance
vary by state, but they generally include stiff fines and the suspension
of driving privileges.
Motor Vehicle Property
Damage Coverages
What does comprehensive physical insurance cover?
One afternoon, during a summer storm, Carrie was driving home
from her job as a hostess at a pancake house. The rain was torrential,
and she could not see very well. As a result, she did not realize that
the car in front of her had stopped to make a left turn, and she hit the
car. The crash totaled Carrie’s new car. Fortunately, she had purchased
insurance with property damage coverage. Property damage coverage
protects you from financial loss if you damage someone else’s prop-
erty or if your vehicle is damaged. It includes property damage liabil-
Avoiding Financial ity, collision, and comprehensive physical damage.
Fraud
As the owner of a vehicle,
you need to protect your Property Damage Liability
investment with an insur- Property damage liability is motor vehicle insurance that
ance policy that covers
applies when you damage the property of others. In addition, it
the variety of risks that
vehicle owners face. But if protects you when you are driving another person’s vehicle with
you become the victim of the owner’s permission. Although the damaged property is usually
an automobile insurance another car, the coverage also extends to buildings and to equipment
fraud scheme, you may such as street signs and telephone poles.
pay dearly—even with
your life. Be aware of the
different types of automo- Collision
bile insurance scams.
Collision insurance is insurance that covers damage to your
To continue with
vehicle when it is involved in an accident. You collect money no
Task 3 of your
WebQuest project, visit matter who is at fault. However, the amount that you can collect is
finance07.glencoe.com. limited to the actual cash value of your vehicle at the time of the acci-
dent. So keep a record of your car’s condition and value.
432 Unit 4 Protecting Your Finances finance07.glencoe.com
Comprehensive Physical Damage As You
Comprehensive physical damage insurance protects you if your Read
vehicle is damaged in a non-accident situation. It covers your vehicle QUESTION
against risks such as fire, theft, falling objects, vandalism, hail, floods,
tornadoes, earthquakes, and avalanches. What kind(s) of vehicle
insurance would you need
if you knocked over your
No-Fault Insurance neighbor’s mailbox with
Why are some states adopting the no-fault system? your car and the neighbor
was injured by the falling
To reduce the time and cost of settling vehicle injury cases, some mailbox?
states are trying a number of alternatives, including the no-fault sys-
tem. The no-fault system is an arrangement whereby drivers who
are involved in accidents collect money from their own insurance
companies. It does not matter who caused the accident. Each com-
pany pays the insured up to the limits of his or her coverage. No-fault
systems and coverages vary by state.
Other Coverages
When is wage loss insurance required?
Several other kinds of motor vehicle insurance are available. For
example, rental reimbursement coverage pays for a rental car if your
vehicle is stolen or is being repaired. Wage-loss insurance pays for any
salary or income you might have lost due to being injured in a vehicle
accident. States that have adopted a no-fault insurance system usu-
TechByte
Reducing Car Insurance
ally require auto owners to carry wage-loss insurance. It is available Costs High auto-theft
by choice in other states. rates lead to high auto
Emergency road service coverage pays for mechanical assistance insurance rates. Australia
in the event that your vehicle breaks down. This can be helpful on has one of the highest
long trips or during bad weather. If necessary, you can get your vehi- auto-theft rates in the
world—twice that of the
cle towed to a service station. However, once your vehicle arrives at
United States. Scientists
the repair shop, you are responsible for paying the bill. If you belong there have developed
to an automobile club, your membership may include towing cover- a high-tech solution to
age. If that is the case, paying for emergency road service coverage keep insurance rates
could be a waste of money. down. Tiny microdots
called “DataDots” are
laser-etched with vehicle
Motor Vehicle Insurance Costs identification numbers
Why is bodily injury liability coverage of and spray-glued on
engines and most other
100/300 recommended?
parts. This makes it dif-
Motor vehicle insurance is not cheap. The average household ficult to resell stolen cars
spends more than $1,000 for motor vehicle insurance yearly. The pre- and parts.
miums are related to the amount of claims that insurance companies Read more about
DataDot tech-
pay out each year.
nology and list other
Frank is a high school junior who recently got his license. At his uses for this techno-
part-time job, he earns minimum wage. Frank’s situation provides an logical advance through
example of what to consider to get the best insurance value—amount finance07.glencoe.com.
of coverage, insurance premium factors, and ways to reduce insur-
ance premiums.
finance07.glencoe.com Chapter 13 Home and Motor Vehicle Insurance 433
Amount of Coverage
The amount that Frank will pay for insurance depends on the
amount of coverage he requires. He needs enough coverage to protect
himself legally and financially.
Legal Concerns As discussed earlier, most people who are involved
in motor vehicle accidents cannot afford to pay an expensive court
settlement with their own money. For this reason, most drivers buy
liability insurance.
Many basic insurance policies provide 10/20 coverage for bodily
injury liability. However, some accident victims have been awarded
millions of dollars in bodily injury cases; therefore, coverage of
100/300 is usually recommended.
Property Values Just as medical expenses amounts of and legal
settlements have increased, so has the cost of vehicles. Therefore,
Frank should consider a policy with
a limit of $50,000 or even $100,000
for property damage liability.
Motor Vehicle
Insurance Premium
Factors
Vehicle type, rating territory,
and driver classification are three
other factors that influence insur-
ance costs.
Vehicle Type The year, make,
and model of a vehicle affect
insurance costs. High-priced vehicles
and vehicles that have expensive re-
placement parts and complicated
repairs cost more to insure. Also,
premiums can be higher for those
vehicle makes and models that are
frequently stolen.
Rating Territory In most states
the rating territory, or owner’s place
of residence, is used to determine
the vehicle insurance premium.
Different locations have different
costs. For example, accidents
and incidents of theft occur less
frequently in rural areas. Your
RATE QUOTES Shopping around for the best auto insurance insurance would probably cost less
rate can save you money in the long run. What are some factors than if you lived in a large city.
that may affect the rates offered by different companies?
434 Unit 4 Protecting Your Finances
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: An Auto Insurance Your Motive: In most states the law
Declaration requires that you insure your automobile.
The declaration lists this information: To protect yourself from financial loss, it
• Policy identification number is important to know exactly what your
• Time period of insurance policy auto insurance covers and how much it
• Amount of insurance coverage will cost.
• Premium amount
4HE 0REMIER 'LOBAL )NSURANCE #OMPANY !UTO $ECLARATIONS
0OLICY .UMBER !
0OLICY 0ERIOD &ROM 4O
3TANDARD 4IME AT THE !DDRESS OF THE .AMED )NJURED
#OVERAGES AND ,IMITS OF ,IABILITY
#OVERAGES 6EHICLE 6EHICLE
,IMIT 0REMIUM ,IMIT 0REMIUM
! "ODILY )NJURY AND
0ROPERTY $AMAGE
%ACH !CCIDENT
" -EDICAL 0AYMENTS
# 5NINSURED -OTORISTS
"ODILY )NJURY
%ACH !CCIDENT
$ $AMAGE TO 9OUR !UTO
/THER 4HAN #OLLISION
!CTUAL #ASH 6ALUE
,ESS $EDUCTIBLE
#OLLISION
!CTUAL #ASH 6ALUE
,ESS $EDUCTIBLE
!DDITIONAL #OVERAGES
4RANSPORTATION %XPENSE )NCLUDED )NCLUDED
0ER $AY-AXIMUM
4OWING AND ,ABOR #OSTS
%ACH $ISABLEMENT
4HEFT #OVERAGE %LECTRONIC
4APES 2ECORDS $ISCS
'!0 #OVERAGE
4OTAL
Key Points: An auto insurance declaration Find the Solutions
details what is covered by the policy. It 1. What is the policy identification number?
states what the policy will pay in the event 2. What is the bodily injury payment limit?
of an accident. This includes damage 3. How much will the policy pay for transpor-
to the car(s) and injury to people. The tation expenses, such as renting a car?
4. How many vehicles are covered by this policy?
declaration also explains how the premium
5. What is the cost of this policy?
is determined.
Chapter 13 Home and Motor Vehicle Insurance 435
Driver Classification Driver classification is based on age, sex,
After You marital status, driving record, and driving habits. In general, young
Read drivers (under 25) and elderly drivers (over 70) have more frequent
REACT and more serious accidents. As a result, these groups pay higher
premiums. Because Frank is under 25, he may have to pay a standard
The first Predict question higher rate. Your driving record will also influence how much you
in this chapter asked what
pay for insurance premiums. If you have accidents or receive traffic
you thought the benefits of
a good insurance program tickets, your rates will increase.
might be. How would you The cost and number of claims that you file with your insur-
revise your answer after ance company also affect your premium. If you file expensive claims,
reading the chapter? your rates will increase. If you have too many claims, your insurance
company may cancel your policy, and it will be difficult to get cov-
erage from another company. To deal with this problem, every state
has an assigned risk pool, which is a group of people who cannot
get motor vehicle insurance who are assigned to each insurance com-
pany operating in the state. These policyholders pay several times the
normal rates. If they establish a good driving record, they can reapply
for insurance at regular rates.
Reducing Vehicle Insurance Premiums
Two ways in which Frank can reduce his vehicle insurance costs
are by comparing companies and by taking advantage of discounts.
Comparing Companies Rates and services vary among motor
vehicle insurance companies. Even among companies in the same
area, premiums can vary by as much as 100 percent. Frank should
compare the services and rates of local insurance agents. Most states
publish this type of information. Furthermore, Frank can check a
company’s reputation with sources such as Consumer Reports or his
state insurance department.
DRIVER CLASSIFICATION
A driver’s age affects the
price of insurance premiums.
Who is likely to pay more for
insurance—teenagers or
parents? Why?
436 Unit 4 Protecting Your Finances
Premium Discounts The best way for Frank to keep his rates
down is to maintain a good driving record by avoiding accidents and
traffic tickets. In addition, most insurance companies offer various Common
types of discounts. CENTS
Because Frank is under 25, he can qualify for reduced rates by tak-
ing a driver training program or maintaining good grades in school. Student Discounts
In addition, installing security devices in his vehicle will decrease the Many places, such as the-
chance of theft and lower Frank’s insurance costs. Being a nonsmoker aters, zoos, and museums,
can qualify him for lower motor vehicle insurance premiums as well. offer discount prices to
students. You can also get
Discounts are also offered for insuring two or more vehicles with the
discounts for buses and
same company. Increasing the amounts of deductibles will also lead subways, movies, and cul-
to a lower premium. For example, an older car may not be worth the tural and sporting events.
cost of carrying collision and comprehensive coverage. Be sure to ask before pay-
No matter what coverage you choose, motor vehicle insurance ing full price. Why do you
is a valuable and mandatory protection to include in any personal think businesses offer dis-
counts to students?
finance plan.
Section 13.3 Assessment
QUICK CHECK Present You have probably seen or
1. What are three main types of motor vehicle heard public service announcements
insurance that cover bodily injuries? urging people not to drink and drive. Use
2. What is the difference between collision what you have learned to create your own
and comprehensive physical damage public service announcement. It may be in
coverages? the form of a radio or television script. If
3. Why do some insurance companies offer possible, get some friends to help you pro-
discounts to drivers who install security duce your spot, using audio or video record-
devices in their vehicles? ing equipment.
THINK CRITICALLY SOLVE MONEY PROBLEMS
4. Explain some ways you might reduce motor 6. Cost of Motor Vehicle Insurance
vehicle insurance premiums. Malcolm wants to buy an expensive sport-
utility vehicle. However, his mechanic has
USE COMMUNICATION SKILLS warned him that the replacement parts
5. Drinking and Driving Alcohol use is for the vehicle that he wants are costly.
a factor in more than 60 percent of all traf- His friend Ishiro is on a tight budget and
fic accidents. Interview classmates, parents, does not have a car. He is considering buy-
and others to get their views on what can ing a car that has low maintenance costs.
be done to reduce alcohol-related traffic Malcolm and Ishiro live in the same neigh-
incidents. Consider contacting an organiza- borhood. Malcolm has never had a traffic
tion such as MADD (Mothers Against Drunk accident, but he received one traffic ticket
Driving) for information. last year. Ishiro’s driving record is perfect.
Analyze Who will have a lower car
insurance rate? Why?
Chapter 13 Home and Motor Vehicle Insurance 437
Chapter 13 Review & Activities
CHAPTER SUMMARY
• Risk is the probability of loss or injury; Renters insurance covers personal
peril is something that may cause a loss; possessions, living expenses, and
hazards increase the probability of loss; personal liability.
and negligence is failing to take reasonable • Factors affecting the cost of home-
care to prevent accidents. Risk avoidance, owners insurance are home location,
risk reduction, risk assumption, and risk structural type, coverage amount and
shifting are ways of managing risk. policy type, discounts, and differences
• Insurance involves the risk management among insurance companies.
method of shifting risk: In exchange for • The types of motor vehicle insurance
fees, the insurance pays for losses. include bodily injury liability, medical
• Property insurance protects from losses payments coverage, uninsured
resulting from natural causes, fire, and motorist’s protection, property damage
criminal activity. Liability insurance liability, collision, and comprehensive
covers legal responsibility for the cost physical damage coverage.
of losses to others. • Factors affecting the cost of motor
• Homeowners insurance covers the vehicle insurance include the amount
building, living expenses, personal of coverage, type of vehicle, rating
property, and personal liability. territory, and driver classification.
Communicating Key Terms
Your older brother is preparing to take the state test for an insurance license. Help him review
the following terms by making up fill-in-the-blank sentences that define each term.
• insurance • liability • uninsured motorist’s
• policy • homeowners insurance protection
• premium • personal property floater • property damage liability
• risk • medical payments • collision
• peril coverage • no-fault system
• hazard • actual cash value • assigned risk pool
• negligence • replacement value
• deductible • bodily injury liability
Reviewing Key Concepts
1. Identify each type of risk and list the four methods of managing risk.
2. Describe how insurance uses different risk management methods to reduce risk.
3. Explain how property and liability insurance protect.
4. Identify reasons that home mortgage lenders require homeowners insurance.
5. Explain the difference between actual cash value and replacement value.
6. List advantages and disadvantages of the no-fault insurance system.
7. Discuss why lenders require drivers to carry bodily injury and property damage coverage.
438 Unit 4 Protecting Your Finances
Chapter 13 Review & Activities
Geography Prices for insurance vary in different areas of the United
States. For example, auto insurance may be less expensive in rural areas.
Research Look at a map of the United States. Find your town or city, Los
Angeles, Chicago, Dallas, and Orlando. Research the population and average
cost of auto insurance in each of these cities. Compare the cost to the
population of each city. Is there a connection? If so, explain.
Insurance Deductibles The annual premium for a 2,500 square foot
home in a medium-sized Midwestern city was $628 in 2005—with discounts
for a home security system, a good claims record, and the combination of
home and auto insurance policies. Replacement cost for the dwelling is
estimated at $237,000, and the current deductible is $1,000. The insurance
company offered to reduce the premium by $73 if the policyholder agreed to
increase the deductible to 1 percent of the replacement cost.
1. Calculate the new premium amount and new deductible amount.
2. Compute by using the Internet to locate and compare homeowners
premium and coverage information from five insurance companies.
Connect with Ethics and Social Studies Laws and penalties
for driving under the influence (DUI) are extremely strict in many states.
Furthermore, the number of motor vehicle accidents involving young drivers
has increased and become more serious, resulting in more deaths and injuries.
1. Research Access the Web site of your state’s department of motor
vehicles for the laws and penalties for DUI. Also check in your local
newspaper for recent accidents involving young drivers.
2. Think Critically Why are DUI penalties so stringent? Do you think the
higher insurance premiums charged to younger drivers are “fair”? Why?
Risk Assessment Actuaries determine the costs and risks involved with
insuring people’s property. Actuaries are experts in evaluating the likelihood
of future events. They design creative ways to reduce the likelihood of unde-
sirable events and decrease the impact of undesirable events that occur.
Log On Go to the Web sites of insurance companies and the Society
of Actuaries to find out factors that affect the cost of homeowners
insurance. Answer the following questions:
1. Should any of these factors influence decisions when buying a home?
2. How can homeowners premiums be reduced?
Newsclip: Higher Rates Car insurance companies charge higher
rates for male teenagers than female teenagers.
O N L I N E
Log On Go to finance07.glencoe.com and open Chapter 13. Learn
about why insurance companies raise rates for males and not females.
Write a list of reasons for this practice.
finance07.glencoe.com Chapter 13 Home and Motor Vehicle Insurance 439
Chapter 13 Review & Activities
VEHICLE INSURANCE QUIZ
When you insure your vehicle, you will need to make decisions about
the insurance you carry. Test your knowledge about motor vehicle
insurance by answering questions on a separate sheet of paper.
1. Liability coverage pays for __________ .
a. theft, fire, vandalism, or other damages not related to an accident
b. the accident-related cost of repairing or replacing your vehicle
c. damage or injury for which you are responsible
2. Collision coverage pays for __________ .
a. theft, fire, vandalism, or other damages not related to an accident
b. the accident-related cost of repairing or replacing your vehicle
c. damage or injury for which you are responsible
3. Comprehensive coverage pays for __________ .
a. theft, fire, vandalism, or other damages not related to an accident
b. the accident-related cost of repairing or replacing your vehicle
c. all the items that passengers lose in the backseat of your vehicle
4. If you are in an accident, your vehicle insurance medical coverage handles _________ .
a. only people injured in your vehicle
b. anyone injured
c. only people injured who were not in your vehicle
5. A higher deductible results in __________ .
a. a higher premium
b. a lower premium
c. tax savings
6. Speeding tickets or accidents may result in __________ .
a. a higher premium
b. a lower premium
c. migraine headaches
7. Safety features such as antitheft devices and automatic seat belts may result
in a __________ .
a. higher premium
b. lower premium
c. higher resale value
8. Taking driver education classes may result in a __________ .
a. higher premium
b. lower premium
c. later curfew
440 Unit 4 Protecting Your Finances
Chapter 13 Review & Activities
Your Financial Portfolio
The Price of Car Insurance
Before Mario bought the car he wanted, he needed to be sure he could afford the insur-
ance for it. In this example he chose low liability, uninsured motorist coverage, and high
deductibles to keep his insurance payments as low as possible. Clearly, Insurer B offered
a lower price for the same coverage.
Investigating Insurance Companies
Insurer A Insurer B
Bodily Injury Coverage:
Bodily injury liability $50,000 each person;
$100,000 each accident $472 $358
Uninsured motorist’s protection 208 84
Medical payments coverage
$2,000 each person 48 46
Property Damage Coverage:
Property damage liability $50,000
each accident 182 178
Collision with $500 deductible 562 372
Comprehensive physical damage with
$500 deductible 263 202
Car Rental: 40 32
Discounts: good driver, air bags,
garage parking (165)
Annual Total $1,610 $1,272
Research
Identify a make, model, and year of a vehicle you might like to own. Research two
insurance companies and get prices using this example. You can get their rates by tele-
phone. Many companies also have Web sites. On a separate sheet of paper, record your
findings. How do they compare? Which company would you choose and why?
Chapter 13 Home and Motor Vehicle Insurance 441
14
CHAPTER
Health, Disability,
and Life Insurance
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 14.1
• Explain the importance of
health insurance in financial
planning.
• Analyze costs and benefits of
various health insurance.
Section 14.2
• Differentiate between private
and government health care
plans.
Section 14.3
• Explain the importance of
disability insurance in financial
planning.
• Describe different sources of
disability income.
Section 14.4
• Describe various types of life
insurance coverage.
• Identify the key provisions in a
life insurance policy.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
442
In the Real World . . .
U pon graduating from college, Sharon Lewis discov-
ered that she was no longer covered by her parents’ health insurance.
When she found out what the monthly premium would be if she purchased
her own policy, she decided to do without one. She said, “I’m healthy, and I get
plenty of exercise skiing. I haven’t needed to visit the doctor in years.” Then she
got in an accident. Rushing out of her apartment one morning, she tripped and
fell, injuring her ankle. When she went to the emergency room, she was shocked
to learn how much the visit would cost. A follow-up visit would be an addi-
tional expense. Health, disability, and life insurance are important for
even the healthiest person.
As You Read Consider the importance of having
health insurance when you need it.
Health Care Costs
ASK Q: I am a high school student. Why should I be
concerned about my future health care costs now?
A: Your health care costs, now and in the future, can be affected by your personal
health habits. Many health problems result from poor habits, such as lack of exercise
or inadequate diet, and may take years to develop. By establishing good habits now,
you can reduce the likelihood of future health problems and related expenses.
Ask Yourself What good habits can you establish now that will help you
ensure that your health care costs will stay low in the future?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com Chapter 14 Health, Disablility, and Life Insurance 443
Section 14.1
Focus on
Reading
Health Insurance and
Financial Planning
Read to Learn
• How to explain the
importance of health What Is Health Insurance?
insurance in financial Why is it important for healthy people to have
planning. health insurance?
• How to analyze costs and
benefits of various health Health insurance is a form of protection that eases the finan-
insurance. cial burden people may experience as a result of illness or injury. You
pay a premium, or fee, to the insurer. In return, the company pays
Main Idea most of your medical costs. Plans vary, but some of the things that
Knowing how to determine they might cover are hospital stays, doctors’ visits, medications, and
the type of health insur- sometimes vision and dental care.
ance plan that you need Health insurance includes both medical expense insurance and
can help you meet your disability income insurance. Medical expense insurance typically pays
financial goals even when
only the actual medical costs. Disability income insurance provides
dealing with unexpected
medical costs. payments to make up for some of the income of a person who cannot
work as a result of injury or illness. In this chapter the term “health
Key Terms insurance” generally refers to medical expense insurance.
• health insurance Health insurance plans can be purchased as several different plans:
• coinsurance group health insurance, individual health insurance, and COBRA.
• stop-loss
• co-payment
Group Health Insurance
Most people who have health insurance are covered under group
plans. Typically, these plans are employer sponsored. This means that
Before an employer offers the plans and usually pays some or all of the premi-
You Read ums. Other organizations, such as labor unions and professional asso-
ciations, also offer group plans. Group insurance plans cover you and
PREDICT
your immediate family. The Health Insurance Portability and Account-
What does major medical ability Act of 1996 set new federal standards to ensure that workers will
expense insurance cover? not lose their health insurance if they change jobs. For example, a par-
ent with a sick child can move from one group health plan to another
plan without a lapse in coverage. Moreover, the parent will not have
to pay more for coverage than other employees do.
The cost of group insurance is fairly low because many people
are insured under the same policy, which is a contract with a risk-
sharing group or insurance company. However, group insurance
plans vary in the amount of protection that they provide. For exam-
ple, some plans limit the amount that they will pay for hospital stays
and surgical procedures.
444 Unit 4 Protecting Your Finances
Coordination of Benefits If your plan does not cover all your
health insurance needs, you have some options. If you are married,
you may be able to take advantage of a coordination of benefits
(COB) provision, which is included in most group insurance plans.
This provision allows you to combine the benefits from more than
one insurance plan. The benefits received from all plans are limited to
100 percent of all allowable medical expenses. For example, a couple
could use benefits from the wife’s group plan and from the husband’s
group plan up to 100 percent. If this type of provision is not available
to you, or if you are single, you can get added protection by buying
individual health insurance.
Individual Health Insurance
Some people may not be offered an employer-sponsored group
insurance plan. Some may not have access to one because they are
self-employed. Others are simply dissatisfied with the coverage that
their group plans provide. In these cases, individual health insurance
may be the answer. You can buy individual health insurance directly
from the company of your choice. Plans usually cover you as an indi-
vidual or as a family. Individual plans can be adapted to meet your
own needs. You should comparison shop, however, because rates can
vary between companies.
COBRA
The Consolidated Omnibus Budget Reconciliation Act of 1986,
known as COBRA, allows an employee who loses his or her job to keep
the former employer’s group coverage for a set period of time. For
example, Hakeem had a group insurance plan through his employer,
but he was laid off. He wondered how he would be able to get medical
coverage until he found a new job. Fortunately for Hakeem, COBRA
allowed him to keep coverage for a while. He had to pay the premiums
himself, but the coverage was not canceled. When he found a new
job, he was then able to switch to the new employer’s group plan
with no break in coverage.
Not everyone qualifies for COBRA. You have to work for a pri-
vate company or a state or local government to be eligible for the
benefits.
Types of Health Insurance As You
Coverage Read
Why do you think basic health insurance and major RELATE
medical insurance are often offered together?
Imagine and describe a
Several types of health insurance coverage are available, either situation in which a young,
through a group plan or through individual purchase. Some benefits healthy person would need
are included in nearly every health insurance plan; other benefits are health insurance.
less common.
Chapter 14 Health, Disablility, and Life Insurance 445
Basic Health Insurance Coverage
Basic health insurance coverage includes hospital expense cov-
erage, surgical expense coverage, and physician expense coverage.
Hospital Expense Hospital expense coverage pays for some
or all of the daily costs of room and board during a hospital stay.
Routine nursing care, minor medical supplies, and the use of other
hospital facilities are covered as well. For example, covered expenses
would include anesthesia, dressings, related X-rays, and the use of an
operating room.
Most policies set a maximum amount they will pay for each day
you are in the hospital. They may also limit the number of days they
will cover. As you may remember from Chapter 13, many policies
may also require a deductible.
Surgical Expense Surgical expense coverage pays all or part
of the surgeon’s fees for an operation, whether it is done in the
hospital or in the doctor’s office. Policies often have a list of the
services that they cover, which specifies the maximum payment
MATERNITY WARD The for each type of operation. For example, a policy might allow $500
medical costs of childbirth for an appendectomy. If the entire surgeon’s bill is not covered, the
can be high. What related policyholder has to pay the difference. People often buy surgical
costs might be paid by expense coverage in combination with hospital expense coverage.
hospital expense coverage? Physician Expense Physician expense coverage
meets some or all of the costs of physician care that
do not involve surgery. It covers treatment by a
physician in a hospital, a doctor’s office, or even
the patient’s home. Plans may cover routine doctor
visits, X-rays, and lab tests. Like surgical expense,
physician expense includes maximum benefits
for specific services. Physician expense coverage
is usually combined with surgical and hospital
coverage in a basic health insurance package.
Major Medical Expense
Insurance
Most people find that basic health insurance
meets their usual needs. The cost of a serious ill-
ness or accident, however, can quickly go beyond
the amounts that basic health insurance will
pay. For example, Chen had to have emergency
surgery, which meant an operation, a two-week
hospital stay, a number of lab tests, and several
follow-up visits. He was shocked to discover that
his basic health insurance paid less than half of
the total bill, leaving him with debts of more than
$10,000.
446 Unit 4 Protecting Your Finances
Major medical expense insurance would have better protected
Chen. This coverage pays the large costs involved in long hospital
As You
stays and multiple surgeries. In other words, it takes up where basic
Read
health insurance coverage leaves off. Almost every type of care and QUESTION
treatment prescribed by a physician, in or out of a hospital, is cov-
ered by this type of plan. Maximum benefits can range from $5,000 Why do you think major
medical expense insurance
to over $1 million per illness per year.
is expensive?
Coinsurance Of course, this type of coverage is not inexpensive. To
keep premiums lower, most major medical plans require a deductible.
Some plans also include a coinsurance provision. Coinsurance
is the percentage of the medical expenses the policyholder must
pay in addition to the deductible amount. Many policies require
policyholders to pay 20 or 25 percent of expenses after they have
paid the deductible.
For example, Ariana’s policy includes an $800 deductible and a
coinsurance provision requiring her to pay 20 percent of all bills. If
her bills total $3,800, the insurance company will first exclude $800
from coverage, which is Ariana’s deductible. It will then pay 80 per-
cent of the remaining $3,000, which would total $2,400. Therefore,
Ariana’s total costs are $1,400 ($800 for the deductible and $600 for
the coinsurance).
Stop-Loss Provisions Some major medical policies contain a stop-
loss provision. Stop-loss is a provision that requires the policyholder
to pay all costs up to a certain amount, after which the insurance
company pays 100 percent of the remaining expenses covered in
the policy. Typically, the policyholder will pay between $3,000 and
$5,000 in out-of-pocket expenses before the coverage begins.
Comprehensive Major Medical Major medical expense insur-
ance may be offered as part of a single policy that includes basic health
insurance coverage, or it can be bought separately. Comprehensive
major medical insurance is a type of complete health insurance that Common
helps pay hospital, surgical, medical, and other bills. It has a very
low deductible, usually $200 to $300. Many major medical policies
CENTS
set limits on the benefits they will pay for certain expenses, such as
Fitness Fun
surgery and hospital room and board.
Expensive exercise clothes
may look good, but they
Hospital Indemnity Policies usually do not improve
your workout. If you can-
A hospital indemnity policy pays benefits when you are hospi- not afford to pay to join
talized. Unlike most of the other plans mentioned, however, these a health club, you can
policies do not directly cover medical costs. Instead, you are paid in get your exercise by walk-
ing or jogging in your
cash, which you can spend on medical or nonmedical expenses as
neighborhood or at your
you choose. Hospital indemnity policies are used as a supplement school’s track. All you need
to—not a replacement for—basic health insurance or major medical is a good pair of athletic
insurance policies. The average person who buys such a policy, how- shoes. How can staying fit
ever, usually pays much more in premiums than he or she receives save you money?
in payments.
Chapter 14 Health, Disablility, and Life Insurance 447
Dental Expense Insurance
Dental expense insurance provides policyholders reimburse-
ment for the expenses of dental services and supplies. It encourages
preventive dental care because it pays for maintenance care. The cov-
erage normally provides for oral examinations, X-rays, cleanings, fill-
ings, extractions, oral surgery, dentures, and braces. However, some
dental expense policies do not cover X-rays and cleanings. As with
other insurance plans, dental insurance may have a deductible and a
coinsurance provision, stating that the policyholder pays from 20 to
50 percent of the dental expenses after the deductible.
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis-
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals
to help them guide their financial decisions.
CANADA /TTAWA
When faced with the frustrations of finding
affordable health care and insurance, Americans often
think Canadians have the solution. Canada offers its
citizens free doctor’s visits, free hospital care, and free DATABYTES
surgery. Children receive some dental work for free,
and people over the age of 65 receive free prescription Capital Ottawa
drugs. Taxes, which make up about 9 percent of the Population 31,630,000
country’s gross domestic product (GDP), cover these
Language English and French
health care costs.
Though the Canadian health care system pro- Currency Canadian dollar
vides many benefits, it has a down side. Some Cana- Gross Domestic
dian patients complain of overcrowding, a shortage of Product (GDP) $957.7 billion (2003 est.)
medical staff, outdated equipment, and long waits for GDP per capita $29,700
treatment. Citizens are prohibited from hiring private Industry: Transportation equipment, chemicals,
health services in processed and unprocessed minerals, and food products
Canada, but they Agriculture: Wheat, barley, oilseed, tobacco, dairy
can travel outside products, forest products, and fish
the country for
Exports: Motor vehicles and parts, industrial
care. Ironically,
machinery, aircraft, telecommunications equipment,
many Canadians
chemicals, timber, and crude petroleum
have come to the
United States for
health care. Think Globally
Why do you think medical costs have increased?
448 Unit 4 Protecting Your Finances
Vision Care Insurance
Many insurance companies offer vision care insurance as part
of group plans. Vision care insurance may cover eye examinations,
glasses, contact lenses, eye surgery, and the treatment of eye diseases.
ART
It is vitally important to
Dread Disease Policies have health insurance that
Dread disease, trip accident, death insurance, and cancer pol- covers such things as hos-
pital expenses. For exam-
icies are usually sold through the mail, in newspapers, and maga-
ple, the average hospital
zines. These policies play upon unrealistic fears, and they are illegal cost for someone injured
in many states. They only cover very specific conditions, which are in a motor vehicle accident
already fully covered under a major medical plan. is more than $14,000.
Without hospital expense
coverage you would have
Long-Term Care Insurance to pay the full amount of
those costs. Create a col-
Long-term care insurance provides coverage for the expense of
lage of pictures from maga-
daily help that you may need if you become seriously ill or disabled zines and/or newspapers to
and are unable to care for yourself. It covers a lengthy stay in a nurs- represent some situations
ing home and help at home with daily activities such as dressing, that are covered by health
bathing, and household chores. Annual premiums range from $900 insurance.
up to $15,000, depending on age and the amount of coverage.
Major Provisions in a Health
Insurance Policy
What are the benefits and limits of the major
provisions in a health insurance policy?
Although all health insurance policies have certain provisions
in common, you must be sure that you understand what your own
policy covers. What are the benefits? What are the limits? The follow-
ing provisions are included in most health insurance policies:
• Eligibility This provision defines the people covered by the
policy. That usually includes the policyholder, a spouse, and
children up to a certain age.
• Assigned Benefits You are reimbursed for payments when
you submit your bills and claim forms. When you assign
benefits, you let your insurer make direct payments to your
doctor or hospital.
• Internal Limits A policy with internal limits sets specific
levels of repayment for certain services. Even if your hospital
room costs $400 a day, you will not be able to get more than
$250 if an internal limit specifies that maximum.
• Co-payment A co-payment is a flat fee that you pay every
time you receive a covered service. The fee is usually between
$5 and $20, and the insurer pays the balance of the cost of
the service. This is different from coinsurance, which is the
percentage of your medical costs for which you are responsible
after paying your deductible.
Chapter 14 Health, Disablility, and Life Insurance 449
• Service Benefits Policies with this provision list coverage
in terms of services, not dollar amounts. For example, you
are entitled to X-rays, instead of $40 worth of X-rays per visit.
Service benefits provisions are always preferable to dollar
amount coverage because the insurer pays all of the costs for a
particular service.
• Benefit Limits This provision defines a maximum benefit,
either in terms of a dollar amount or in terms of number of
days spent in the hospital.
• Exclusions and Limitations This provision specifies
services that the policy does not cover. That may include
preexisting conditions (conditions diagnosed before the
insurance plan took effect), cosmetic surgery, and more.
• Guaranteed Renewable With this provision, the insurer
cannot cancel the policy unless you fail to pay the premiums.
It also forbids insurers from raising your premiums unless they
raise all premiums for all members of your group.
• Cancellation and Termination This provision explains
the circumstances under which the insurer can cancel your
coverage. It also explains how you can convert your group
insurance policy into an individual insurance policy.
Choosing Coverage
What type of health insurance coverage should
you choose?
SHARING THE COST
All health insurance Now that you are familiar with the available types of health
policies have certain insurance and some of their major provisions, how do you choose
provisions in common. one? The type of coverage you choose will be affected by the amount
What is a co-payment? you can afford to spend on the premiums and the level of benefits
that you feel you want and need. It may
also be affected by the kind of coverage
your employer offers, if you are covered
through your employer.
You can buy basic health coverage,
major medical coverage, or both basic
and major medical coverage. Any of these
three choices will take care of at least
some of your medical expenses. Ideally,
you should get a basic plan and a major
medical supplement. Another option is to
purchase a comprehensive major medical
policy that combines the value of both
plans in a single policy. See Figure 14.1
for a description of the basic features you
should look for in a health insurance plan.
You should also consider the trade-offs of
the various benefits.
450 Unit 4 Protecting Your Finances
Health Insurance Trade-Offs
Different health insurance policies may offer very different ben-
efits. As you decide which insurance plan to buy, you should consider
the following trade-offs.
Reimbursement Versus Indemnity A reimbursement policy
pays you back for actual expenses. An indemnity policy pays specified
amounts, regardless of how much the actual expenses may cost.
For example, Katie and Seth were both charged $200 for an office
visit to the same specialist. Katie’s reimbursement policy has a deduct-
ible of $300. Once she has met the deductible, the policy will cover the
full cost of subsequent visits. Seth’s indemnity policy will pay him only
$125, which is what his plan provides for each visit to any specialist.
Internal Limits Versus Aggregate Limits A policy with internal
limits covers only a fixed amount for an expense, such as the daily
cost of room and board during a hospital stay. A policy with aggregate
limits may limit only the total amount of coverage (the maximum
dollar amount paid for all benefits in a year), such as $1 million in
major expense benefits, or it may have no limits.
Deductibles and Coinsurance The cost of a health insurance
policy is affected by the size of the deductible, which is the set amount
that the policyholder must pay toward medical expenses before the
insurance company pays benefits. It can also be affected by the terms
of the coinsurance provision.
Figure 14.1 Health Insurance Must-Haves
A health insurance plan should:
• Offer basic coverage for hospital and doctor bills.
• Provide at least 120 days’ hospital room and board in full.
• Provide at least a $1 million lifetime maximum for each family member.
• Pay at least 80 percent for out-of-hospital expenses after a yearly deductible
of $500 per person or $1,000 per family.
• Impose no unreasonable exclusions.
• Limit your out-of-pocket expenses to no more than $3,000 to $5,000
a year, excluding dental, vision care, and prescription costs.
Essential Coverage Health insurance plans vary greatly, but all plans should have some
basic features.
Would you add anything to this list of must-haves?
Chapter 14 Health, Disablility, and Life Insurance 451
Out-of-Pocket Limits Some policies limit the amount of money
you must pay for the deductible and coinsurance. After you have
reached that limit, the insurance company covers 100 percent of any
additional expenses. Having out-of-pocket limits may help you lower
your financial risk, but those limits may also increase the price of
your premiums.
Benefits Based on Reasonable and Customary Charges Some
policies consider the average fee for a service in a particular geographical
area. They then use that average amount to set a limit on payments
to policyholders. If the standard cost of a certain procedure is $1,500
in your part of the country, then your policy will not pay more than
that amount.
Section 14.1 Assessment
QUICK CHECK SOLVE MONEY PROBLEMS
1. Why is it important to include health 6. Choosing an Insurance Plan Richard
insurance in your financial planning? is 35, single, and in reasonably good
2. What are benefits provided by hospital health. He works for a construction com-
expense coverage, surgical expense cover- pany that offers three health insurance
age, and physician expense coverage? plans. The first has a lifetime benefit of
3. What are the trade-offs between $1 million for all covered expenses, an
reimbursement and indemnity? annual deductible of $500, and a 15 per-
cent coinsurance provision up to the first
THINK CRITICALLY $2,000 in covered charges. The second
4. Explain why it is necessary for insurance requires a monthly premium of $50 and
companies to place limits on the amount sets a $500,000 lifetime limit on benefits,
of costs they will cover. has no annual deductible, and requires a
$15 co-payment per office visit. The third
USE COMMUNICATION SKILLS has an annual deductible of $250 and a
5. Benefits of Insurance Your 25-year-old 25 percent coinsurance provision up to the
sister never gets sick and leads an active, first $1,500 in covered charges, with a life-
healthy life. She sees no reason to buy time limit on benefits of $700,000.
health insurance and calls the premiums a
Analyze Help Richard determine
waste of money.
which of these three plans makes the
Role-Play With a partner, role- most sense for his particular situation. Be
play a response to your sister’s argu- prepared to defend your reasoning.
ment. Explain why she might benefit from
health insurance regardless of her current
situation.
452 Unit 4 Protecting Your Finances
Section 14.2
Private and Focus on
Reading
Government Plans
Read to Learn
• How to differentiate
Private Health Care Plans between private and
What is the difference between an HMO and a PPO? government health care
plans.
Most health insurance in the United States is provided by pri-
vate organizations rather than by the government. Private health Main Idea
care plans may be offered by a number of sources: private insurance Understanding plans
companies; hospital and medical service plans; health maintenance offered by private compa-
organizations; preferred provider organizations; home health care nies and by the govern-
agencies; and employer self-funded health plans. ment will help you choose
the plan that best meets
your physical and finan-
Private Insurance Companies cial needs now and as you
get older.
Several hundred private insurance companies are in the health
insurance business. They provide mostly group health plans to Key Terms
employers, who in turn offer them to their employees as an employ-
• Blue Cross
ment benefit. Premiums may be fully or partially paid by the employer, • Blue Shield
with the employee paying any remainder. These policies typically pay • managed care
for medical costs by sending payments directly to the doctor, hospi- • health maintenance
tal, or lab that provides the services. organization (HMO)
• preferred provider
organization (PPO)
Hospital and Medical Service Plans • point-of-service (POS)
plan
Blue Cross and Blue Shield are statewide organizations similar • Medicare
to private health insurance companies. Each state has Blue Cross and • Medicaid
Blue Shield. Blue Cross is an insurance company that provides hospi-
tal care benefits. Blue Shield is an insurance company that provides
benefits for surgical and medical services performed by physicians.
The “Blues” provide health insurance to millions of Americans. Before
You Read
Managed Care PREDICT
According to a recent industry survey, 23 percent of employed What is the difference
Americans are enrolled in some form of managed care, due to rising between insurance
health care costs. Managed care refers to prepaid health plans that provided by private
provide comprehensive health care to their members. Managed care is organizations and insur-
designed to control the cost of health care services by controlling how ance provided by the
government?
they are used. Managed care is offered by health maintenance organi-
zations, preferred provider organizations, and point-of-service plans.
Chapter 14 Health, Disability, and Life Insurance 453
PROMOTING HEALTH HMOs are based on the idea that preventive
services will minimize future medical problems. What kinds of preventive
services do HMOs cover?
Health Maintenance Organizations One managed-care option
is a health maintenance organization (HMO), which is a health
insurance plan that directly employs or contracts with selected, or
preapproved, physicians and other medical professionals to provide
health care services in exchange for a fixed, prepaid monthly premium.
HMOs are an alternative to basic health insurance and major medical
expense insurance.
HMOs are based on the idea that preventive services will mini-
mize future medical problems. Therefore, these plans typically cover
routine immunizations and checkups, screening programs, and diag-
nostic tests. They also provide customers with coverage for surgery,
hospitalization, and emergency care. If you have an HMO, you usually
pay a small co-payment for each covered service, such as a doctor’s
office visit. Supplemental services may include vision care and pre-
scription services, which are typically available for an additional fee.
When you first enroll in an HMO, you must choose a plan phy-
sician from a list of doctors provided by the HMO. This physician
provides or arranges for all your health care services. If you receive
care from a physician outside your HMO’s approved physician list,
you are responsible for the cost of the service. The only exception to
this rule is in the case of a medical emergency. If you experience a
sudden illness or injury that would threaten your life or health if not
treated immediately, you may go to the nearest emergency room. All
other care must be provided by hospitals and doctors under contract
with the HMO.
454 Unit 4 Protecting Your Finances
HMOs are not for everyone. Many HMO customers complain
that their HMO denies them necessary care. Others feel restricted by
Put on
the limited choice of doctors. Your
Here are some tips on using and choosing an HMO. Because Financial
HMOs require you to use only certain doctors, you should make sure Planner’s
that those doctors are near your home or place of work. You should
also be able to change doctors easily if you do not like your first choice.
Cap
Second opinions should always be available at the HMO’s expense, You just started your first
and you should be able to appeal any case in which the HMO denies full-time job, working for a
care. Finally, look at the costs and benefits—whether you will incur company that provides both
out-of-pocket expenses or co-payments and what services the plan an HMO and a POS plan.
Which health insurance plan
will provide.
would best fit your financial
situation?
Preferred Provider Organizations A variation on the HMO is
a preferred provider organization (PPO), which is a group of
doctors and hospitals that agree to provide specified medical services
to members at prearranged fees. PPOs offer these discounted services
to employees either directly or indirectly through an insurance
company. The premiums for PPOs are slightly higher than the
premiums for HMOs.
PPO plan members often pay no deductibles but may have mini-
mal co-payments. While HMOs require members to receive care from
HMO providers only, PPOs allow members greater flexibility. Mem-
bers can either visit a preferred provider (a physician selected from a
pre-approved list) or go to their own physicians. Patients who decide
to use their own doctors do not lose coverage as they would with an
HMO. However, they must pay deductibles and larger co-payments.
Point-of-Service (POS) Plan A point-of-service (POS) plan As You
combines features of both HMOs and PPOs. POS plans use a network Read
of participating physicians and medical professionals who have RELATE
contracted to provide services for certain fees. As with an HMO,
you choose a plan physician who manages your care and controls Would you choose an
referrals to specialists. As long as you receive care from a pre-approved HMO, PPO, or POS? Why?
provider, you pay little or nothing, just as you would with an HMO.
However, you are allowed to seek care outside the network at a higher
charge, as with a PPO.
Home Health Care Agencies
Rising hospital costs, new medical technology, and the increas-
ing number of elderly people have helped make home care one of the
fastest-growing areas of the health care industry. Home health care
consists of home health care agencies; home care aide organizations;
and hospices, which are facilities and organizations that provide care
for the terminally ill. These providers offer medical care in a home
setting in agreement with a medical order, often at a fraction of the
cost charged by hospitals for similar services.
Chapter 14 Health, Disablility, and Life Insurance 455
Employer Self-Funded Health Plans
Some companies choose to self-insure. The company runs its
Non-Smokers own insurance plan, collecting premiums from employees and pay-
Save ing medical benefits as needed. However, these companies must
1. A pack of ciga- cover any costs that exceed the income from premiums. Unfortu-
rettes each day for nately, some corporations do not have the financial assets necessary
15 years can cost to cover these situations, which can cause a financial disaster for the
about $15,000.
company and its employees.
2. Smokers miss more
work than non-
smokers do.
3. Smokers spend
Government Health Care
more money on
medical treatment.
Programs
4. Non-smokers pay
Who benefits most from government
less for health health care programs?
insurance. The health insurance coverages discussed so far are normally
5. Non-smokers
pay almost half
purchased through private companies. Some consumers, however,
as much for life are eligible for health insurance coverage under programs offered by
insurance. federal and state governments. The federal program is Medicare, and
the federal and state program is Medicaid.
Medicare
Perhaps the best-known government program is Medicare.
Medicare is a federally funded health insurance program available
mainly to people over 65 and to people with certain disabilities. Medi-
care has two parts: hospital insurance (Part A) and medical insurance
(Part B).
Medicare Part A is funded by part of the Social Security payroll
tax. Part A helps pay for inpatient hospital care, inpatient care in a
skilled nursing facility, home health care, and hospice care. Program
participants pay a single annual deductible.
Part B helps pay for doctors’ services and a variety of other medi-
cal services and supplies not covered, or not fully covered, by Part A.
Part B has a deductible and a 20 percent coinsurance provision. Medi-
care medical insurance is a supplemental program paid for by individ-
uals who feel that they need additional coverage. A regular monthly
premium is charged. The federal government matches this amount.
As You
Medicare Finances Medicare is at risk financially. Health care
Read
costs continue to grow, and the population of senior citizens in the
QUESTION United States is increasing. This situation puts Medicare in danger
of running out of funds. According to projections made in 2004, the
How might the projected
program will be bankrupt by the year 2019 if no changes are made.
shortfall in Medicare
funds affect the future of The Balanced Budget Act of 1997 created the additional program,
government health care Medicare 1 Choice. This program allows many Medicare members to
programs? choose a managed care plan in addition to their Medicare coverage.
For some additional costs, members can receive greater benefits.
456 Unit 4 Protecting Your Finances
LIVING WELL The Medicare health program covers more people
over the age of 65 than ever because of the increasing population of
senior citizens. What services do Medicare Parts A and B cover?
What Is Not Covered by Medicare? Medicare effectively covers
many medical costs, but there are some medical expenses that
Medicare will not cover at all. These expenses include certain types of
skilled or long-term nursing care, out-of-hospital prescription drugs,
routine checkups, dental care, and most immunizations. Medicare
also limits the types of services it will cover and the amount it will
pay for those services. If a doctor does not accept Medicare’s approved
amount as payment in full, the patient is responsible for paying the
difference.
Medigap People who are eligible for Medicare and who would
like to have more coverage may buy Medigap insurance. Medigap
insurance supplements Medicare by filling the gap between Medicare
payments and medical costs not covered by Medicare. It is offered by
private companies.
Chapter 14 Health, Disablility, and Life Insurance 457
Medicaid
The other well-known government health program is Medicaid,
a medical assistance program offered to certain low-income individu-
als and families. Medicaid is administered by the individual states,
but it is financed by a combination of state and federal funds. Unlike
Medicare, Medicaid coverage is so comprehensive that people with
Medicaid do not need supplemental insurance. Typical Medicaid
benefits include:
• Physicians’ services
• Inpatient hospital services
• Outpatient hospital services
• Lab services
• Skilled nursing and home health services
• Prescription drugs
• Eyeglasses
• Preventive care for people under 21
Careers in Finance
CREDIT ANALYST
INSURANCE AGENT Alicia Hopkins
Farmer’s Insurance
Alicia is an excellent salesperson who cares about her clients. She sells insurance policies to individu-
als, families, business firms, and other groups to protect them from future financial loss due to injury,
illness, death, property damage, or theft. Alicia interviews prospective clients to obtain data about
their financial resources and needs, as well as the physical condition of the person or property to be
insured. She then works out an insurance program suited to that customer, explains the program’s
costs and benefits, and writes a policy. Alicia follows up regularly with her client so she can handle
any changes and renewals to his or her policy. Alicia, like all insurance agents, is always on the look-
out for new clients.
SKILLS: Sales, communication, legal and financial awareness, mathematical, and
time-management skills
PERSONAL TRAITS: Diligent, self-confident, outgoing, tactful, and good judgment
EDUCATION: High school diploma or equivalent; a license from the State Department of
Insurance; pre-licensing and continuing education
ANALYZE Why might it be helpful for an insurance agent to be active in civic or social organizations?
To learn more about career paths for insurance agents, visit finance07.glencoe.com.
458 Unit 4 Protecting Your Finances finance07.glencoe.com
Government Consumer Health
Information Web Sites
The Department of Health and Human Services operates more
than 60 Web sites that contain a wealth of reliable information related
to health and medicine.
Healthfinder Healthfinder includes links to over a thousand Web
pages operated by government and nonprofit organizations. It lists
topics according to subject.
MedlinePlus MedlinePlus is the world’s largest Internet collection
of published medical information. It was originally designed for health
professionals and researchers, but it is also valuable for students and
others who are interested in health care and medical issues.
NIH Health Information The National Institutes of Health
(NIH) operates a Web site that can direct you to the consumer health
information in NIH publications and on the Internet.
FDA The Food and Drug Administration (FDA), a federal consumer
protection agency, provides a Web site with information about the
safety of various foods, drugs, cosmetics, and medical devices.
Section 14.2 Assessment
QUICK CHECK Calculate Under Rose’s PPO, emer-
1. What types of coverage are provided by gency room care at a network hospi-
Blue Cross and Blue Shield? tal is 80 percent covered after the member
2. What are the differences between an HMO has met a $300 annual deductible. Assume
and a PPO? that Rose went to a hospital within her
3. What is the difference between Medicare PPO network. Her total emergency room
and Medicaid? bill was $850. What amount did Rose have
to pay? What amount did the PPO cover?
THINK CRITICALLY
SOLVE MONEY PROBLEMS
4. Identify the benefits and drawbacks to
membership in an HMO. 6. HMOs Your Aunt Alice will be 65. She
pays $200 a month for an HMO she does
USE MATH SKILLS not like. She will be eligible for Medicare
5. PPOs Last month Rose was involved in and is wondering if she should drop the
a car accident and was rushed to the emer- HMO coverage at that time.
gency room. After receiving stitches for a Analyze With a partner, discuss
facial wound and treatment for a broken Aunt Alice’s alternative and if she
finger, she was released from the hospital. should drop her HMO coverage.
Chapter 14 Health, Disablility, and Life Insurance 459
Section 14.3
Focus on
Reading
Disability Insurance
Read to Learn
Disability Income
Why is it important to have disability insurance?
• How to explain the
importance of disability Before disability insurance existed, people who were ill often lost
insurance in financial more money from missed paychecks than from paying medical bills.
planning.
Disability income insurance was set up to protect against such loss
• How to describe differ-
of income. Disability income insurance provides regular cash
ent sources of disability
income. income when an employee is unable to work due to pregnancy, a non-
work-related accident, or an illness. It protects your earning power,
Main Idea which is your most valuable resource. This kind of coverage is very
Disability income insurance common today, and several hundred insurance companies offer it.
is important if you become The exact definition of the word disability varies from insurer
unable to work. to insurer. Some insurers will pay you when you are unable to work
at your regular job. Other insurers will pay only if you are so ill or
Key Term badly hurt that you cannot work at any job. A violinist with a hand
• disability income injury, for example, might have trouble doing his or her regular work
insurance but might be able to perform a range of other jobs. A good disability
income insurance plan pays you if you cannot work at your regular
job. A good plan will also pay partial benefits if you are able to work
only part-time.
Before Many people make the mistake of ignoring disability insurance,
You Read not realizing that it is very important to have. A disability can cause
PREDICT even greater financial problems than death because disabled persons
lose their earning power but still have to pay for their living expenses.
What might disability insur- In addition, they often face huge costs for the medical treatment and
ance cover? special care that their disabilities require.
Sources of Disability Income
Before you buy disability income insurance from a private insur-
ance company, remember that you may already have some form of
this insurance. This coverage may be available through worker’s com-
pensation if you are injured on the job. Disability benefits may also
be available through your employer or through Social Security in case
of a long-term disability.
Worker’s Compensation If your disability is the result of an
accident or illness that occurred on the job, you may be eligible to
receive worker’s compensation benefits. The amount of benefits will
depend on your salary and your work history.
460 Unit 4 Protecting Your Finances
Employer Many employers provide disability income insurance
through group insurance plans. In most cases, your employer will
pay part or all of the cost of such insurance. Some policies may only
provide continued wages for several months, while others will provide
long-term protection.
Social Security Social Security may be best known as a source of As You
retirement income, but it also provides disability benefits. If you are Read
a worker who pays into the Social Security system, you are eligible RELATE
for Social Security funds if you become disabled. How much you get
depends on your salary and the number of years you have been paying Do Social Security disability
into Social Security. Your dependents also qualify for certain benefits. benefits provide enough
coverage for you to feel
However, Social Security has very strict rules. Workers are considered
comfortable about your
disabled if they have a physical or mental condition that prevents financial future if you were
them from working for at least 12 months, or if they have a condition to become disabled? Why
that may result in death. Benefits start at the sixth full month the or why not?
person is disabled. They stay in effect as long as the disability lasts.
Private Income Insurance Programs Privately owned insurance
companies offer many policies to protect people from loss of income
resulting from illness or disability. Disability income insurance gives
weekly or monthly cash payments to people who cannot work due to
illness or accident. The amount paid is usually 40 to 60 percent of a
person’s normal income. Some plans pay as much as 75 percent.
ACCIDENTS HAPPEN
Disability income insur-
ance can be very important
because it provides funds if
you are unable to work due
to illness or injury. How would
disability income insurance
help a dancer who broke a leg
in a surfing accident?
Chapter 14 Health, Disablility, and Life Insurance 461
Disability Insurance Trade-Offs
TechByte
Transferable Skills
When you purchase health or disability insurance, you must
make certain trade-offs when you decide among different private
If you have a disability disability insurance policies. You should consider several factors as
claim due to illness or an you look for a plan.
accident, your disability
insurance carrier will Waiting or Elimination Period Your benefits will not begin the
require you to take a test day you become disabled. You will have to wait between one and six
called a Transferable Skills months before you can begin collecting. This span of time is called
Analysis (TSA). The TSA a waiting, or elimination, period. Usually a policy with a longer
determines if a disabled elimination period charges lower premiums.
person has the potential
to work at a job that uses Duration of Benefits Every policy names a specified period
his or her skills. Several during which benefits will be paid. Some policies are valid for only
software programs can
a few years. Others are automatically canceled when you turn 65.
perform a TSA. Insurance
companies also use TSAs Still others continue to make payments for life. You should look for a
to detect fraudulent policy that pays benefits for life. If a policy stops payments when the
claims. policyholder is age 65, then having a permanent disability could be a
Look at a sample major financial burden.
TSA and write
a description of its Amount of Benefits You should aim for a benefit amount that,
information through when added to other sources of income, will equal 70 to 80 percent of
finance07.glencoe.com. your take-home pay. Of course, greater benefits cost more money.
HIGH RISK Your chances
of becoming disabled are
greater in professions that
involve physical risk. What
program would provide dis-
ability income for a construc-
tion worker who is injured on
the job?
462 Unit 4 Protecting Your Finances finance07.glencoe.com
Accident and Sickness Coverage Some disability policies pay
only for accidents. However, accidents are not the only cause of
As You
disability, so coverage for sickness is also important.
Read
Guaranteed Renewability If your health becomes poor, your
QUESTION
disability insurer may try to cancel your coverage. Look for a plan that What are the disability
guarantees coverage as long as you continue to pay your premiums. insurance trade-offs?
Some plans may even suspend premiums if you become disabled.
Your Disability Income Needs
How do you determine your disability income needs?
After you find out what your benefits would be from the numer-
ous public and private sources, you should determine whether those
benefits would meet your disability income needs. Ideally, you want
to replace all the income you otherwise would have earned. This
money should enable you to pay your day-to-day expenses while you
are recovering. You will not have work-related expenses, and your
taxes will be lower during the time that you are disabled. In some
cases, you may not have to pay various taxes at all.
Section 14.3 Assessment
QUICK CHECK Write About It Imagine that you
1. Why is disability income insurance impor- are a health columnist for a newslet-
tant in personal financial planning? ter aimed at people in the entertainment
2. What are the four main sources of disabil- industry, such as dancers, actors, writers,
ity income? and musicians. Explain why these artists
3. What are two trade-offs that you might should make sure that they are adequately
have to make when choosing among differ- covered by disability insurance.
ent private disability insurance policies.
SOLVE MONEY PROBLEMS
THINK CRITICALLY 6. Choosing Plans Your next-door neigh-
4. Describe at least two situations for which bor has about nine months’ salary saved
a person might need disability income up. He is 58, has no dependents, and
insurance. plans to retire in seven years. He has just
changed jobs. He now works in the office
USE COMMUNICATION SKILLS of a road-building company where he has a
5. Earning Power Many people who choice of disability insurance plans.
insure their houses, cars, and other prop- Analyze What features should your
erty fail to insure their most valuable neighbor be looking for in a disability
resource—their earning power. income insurance plan?
Chapter 14 Health, Disablility, and Life Insurance 463
Section 14.4
Focus on
Reading
Life Insurance
Read to Learn
What Is Life Insurance?
Why is it important to include life insurance in your
• How to describe various
financial planning?
types of life insurance
coverage. When you buy life insurance, you are making a contract with
• How to identify the key the company issuing the policy. You agree to pay a certain amount of
provisions in a life insur- money—the premium—periodically. In return, the company agrees
ance policy.
to pay a death benefit, or a stated sum of money upon your death,
to your beneficiary. A beneficiary is a person named to receive the
Main Idea
benefits from an insurance policy.
Making decisions about
life insurance and choos-
ing the right policy takes The Purpose of Life Insurance
time, research, and careful
thought. Buying life insurance can help you protect the people who
depend upon you from financial losses caused by your death. Those
Key Terms people could include a spouse, children, an aging parent, or a busi-
• beneficiary (insurance) ness partner. Life insurance benefits may be used to:
• term insurance
• Pay off a home mortgage or other debts at the time of death.
• whole life insurance
• cash value • Provide lump-sum payments as an endowment for children
• endowment when they reach a certain age.
• Provide an education or income for children.
• Make charitable donations after death.
• Provide a retirement income.
Before • Accumulate savings.
You Read • Establish a regular income for survivors.
• Set up an estate plan.
PREDICT • Pay estate and death taxes.
Who do you think would
need life insurance most, a
65-year-old widower with The Principle of Life Insurance
grown children or a single
mother with three young No one can say with any certainty how long a particular person
children? will live. However, insurance companies are able to make some edu-
cated guesses. Over the years they have compiled tables that show an
estimate of how long people live. Using these tables, the companies
make a rough guess about a person’s life span and set the price of
insurance premiums for him or her accordingly. The sooner a person
is likely to die, the higher the premium he or she will pay to have life
insurance. For example, life insurance will cost more for a 65-year-old
woman than for a 25-year-old woman.
464 Unit 4 Protecting Your Finances
How Long Will You Live?
If history is any guide, you will live longer than your ancestors
lived. In 1900, the life expectancy of an American male was 46.3 years,
and it was 48.3 years for an American female. In contrast, by the year
2000, the life expectancy increased to 74 years for men and 80 years
for women. Figure 14.2 shows an estimate of how many years a per-
son can be expected to live today. This type of table guides insurance
companies when they set prices. For example, a 30-year-old woman
can be expected to live another 50.6 years. That does not mean that
she has a high probability of dying at age 80.6. This just means that
50.6 is the average number of additional years a 30-year-old woman
may expect to live.
Do You Need Life Insurance?
Before you buy life insurance, you will have to decide whether
you need it at all. Generally, if your death would cause financial hard-
ship for somebody, then life insurance is a wise purchase. Households
with children usually have the greatest need for life insurance. Single
people who live alone or with their parents, however, usually have
little or no need for life insurance unless they have a great deal of debt
or want to provide for their parents or a friend, relative, or charity.
Figure 14.2 Life Expectancy Table
Age Both Sexes Male Female Age Both Sexes Male Female
0 76.9 74.1 79.5 45 34.4 32.2 36.3
1 76.4 73.7 79.0 50 30.0 27.9 31.8
5 72.5 69.8 75.1 55 25.7 23.8 27.4
10 67.6 64.9 70.1 60 21.6 19.9 23.1
15 62.6 59.9 65.2 65 17.9 16.3 19.2
20 57.8 55.2 60.3 70 14.4 13.0 15.5
25 53.1 50.6 55.4 75 11.3 10.1 12.1
30 48.3 45.9 50.6 80 8.6 7.6 9.1
35 43.6 41.3 45.8 85 6.3 5.6 6.7
40 38.9 36.7 41.0
The Average Life This type of table helps insurance companies determine insurance premiums.
Use the table to find the average number of additional years a
15-year-old male and female were expected to live, based on
the statistics gathered by the U.S. government as of 2000.
Chapter 14 Health, Disablility, and Life Insurance 465
As You Types of Life Insurance Policies
Read When do you think it is most important to have
life insurance?
RELATE
You can purchase life insurance from two types of life insur-
Imagine your life 5, 10, and
ance companies: stock life insurance companies, which are owned by
15 years from now. At what
point would you want a shareholders, and mutual life insurance companies, which are owned
good life insurance policy? by their policyholders. About 95 percent of life insurance companies
in the United States are stock companies. Insurance policies can be
divided into two types: term insurance and whole life insurance.
Term Insurance
Term insurance, which is sometimes called temporary life
insurance, is insurance that provides protection against loss of life for
only a specified term, or period of time. A term insurance policy pays
a benefit only if you die during the period it covers, which may be
1, 5, 10, or 20 years, or up to age 70. If you stop paying the pre-
miums, your coverage stops. Term insurance is often the best value
for most consumers. You need life
insurance coverage most while you
are raising children. As your chil-
dren become independent and your
assets increase, you can reduce your
coverage. Term insurance comes in
many different forms.
Renewable Term The coverage of
term insurance ends at the conclusion
of the term, but you can continue it
for another term, such as five years,
if you have a renewable option.
However, the premium will increase
because you will be older. It also
usually has an age limit, which means
you cannot renew your coverage after
you reach a certain age.
Multiyear Level Term A multi-
year level term, or straight term,
policy guarantees that you will pay
the same premium for the duration
of your policy.
COMING TO TERMS Many experts
say that term insurance is best for
most people—especially growing
families. Name the types of term
insurance policies that are available.
466 Unit 4 Protecting Your Finances
Conversion Term This type of policy allows you to change from term
to permanent coverage. This change will require a higher premium.
Decreasing Term Term insurance is also available in a form that
pays less to the beneficiary as time passes. The premiums are usually Avoiding Financial
the same over the entire period of coverage. The insurance period Fraud
you select might depend on your age or on how long you want to be Choosing the right type
of life insurance policy can
covered. For example, if you have a mortgage on a house, you might
be complicated. There
buy a 25-year decreasing term policy as a way to make sure that the are many options avail-
debt could be paid if you died. The coverage would decrease as the able, and it can be diffi-
balance on the loan decreased. cult to sort out the details
to decide what is best.
Another complicating
factor is that con artists
Whole Life Insurance may try to defraud you.
Learn some of the do’s
The other major type of life insurance is known as whole life
and don’ts of choosing
insurance (also called a straight life policy, a cash value policy, or an life insurance and avoid-
ordinary life policy). Whole life insurance is a permanent policy ing fraud.
for which you pay a specified premium each year for the rest of your
To continue with
life. The insurance company pays your beneficiary a stated sum when
Task 4 of your
you die. The amount of your premium depends mostly on the age at WebQuest project, visit
which you purchase the insurance. finance07.glencoe.com.
Whole life insurance can also serve as an investment. Part of
each premium you pay is set aside in a savings account. When and
if you cancel the policy, you are entitled to the accumulated savings,
which is known as the cash value. Whole life policies are popular
because they provide both a death benefit and a savings component.
You can also borrow from your cash value if necessary, although you
must pay interest on the loan. Cash value policies may make sense for
people who intend to keep the policies for the long term or for people
who want a more structured way to save. However, the Consumer
Federation of America Insurance Group suggests that you explore
other savings and investment strategies before investing your money
in a permanent policy.
The premium on a term insurance policy will increase each time
you renew your insurance. In contrast, whole life policies have higher
annual premiums at first, but the payment amount remains the same
for the rest of your life. Several types of whole life policies have been
developed to meet the needs of different customers. These include
the limited payment policy, the variable life policy, the adjustable life
policy, and universal life insurance.
Limited Payment Policy Limited payment policies charge
premiums for only a certain length of time, usually 20 or 30 years
or until the insured reaches a certain age. At the end of this time,
the policy is “paid up” and the policyholder remains insured for life.
When the policyholder dies, the beneficiary receives the full death
benefit. The annual premiums are higher for limited payment
policies because the premiums have to be paid within a shorter period
of time.
finance07.glencoe.com Chapter 14 Health, Disablility, and Life Insurance 467
Variable Life Policy With a variable life policy, premium payments
As You are fixed. As with a cash value policy, part of the premium is placed
Read into a separate account; this money is invested in a stock, bond, or
QUESTION money market fund. The death benefit is guaranteed, but the cash
value of the benefit can vary considerably according to the ups and
What are the risks and downs of the stock market. Your death benefit can also increase if the
benefits associated with
variable life insurance?
earnings of that separate fund increase.
Adjustable Life Policy An adjustable life policy allows you to
change your coverage as your needs change. For example, if you want
to increase or decrease your death benefit, you can change either the
premium payments or the period of coverage.
Universal Life Universal life insurance is essentially a term policy
with a cash value. Part of your premium goes into an investment
account that grows and earns interest. You are able to borrow or
withdraw your cash value.
Other Types of Life Insurance Policies
Other types of life insurance policies include group life insur-
ance, credit life insurance, and endowment life insurance.
Group Life Insurance Group life insurance is a variation of term
insurance. It covers a large number of people under a single policy.
The people included in the group do not need medical examinations
to get coverage. Group insurance is usually offered by employers, who
pay part or all of the costs for their employees. It may also be offered by
professional organizations, which allow members to obtain coverage.
However, it can be more expensive than similar term policies.
Credit Life Insurance Credit life insurance pays off debts, such
as auto loans or mortgages, in the event that you die before they
are paid in full. These types of policies are not the best buy for the
protection they offer. Decreasing term insurance is a better option.
Endowment Life Insurance Endowment is life insurance that
provides coverage for a specific period of time and pays a sum of
money to the policyholder if he or she is living at the end of the
endowment period. If the policyholder dies before that time, the
beneficiary receives the money.
Key Provisions in a Life
Insurance Policy
Why should you consider adding provisions to your
life insurance policy?
Study the provisions in your policy carefully and be sure to
update the necessary information as changes in your life occur. The
following features are the most common provisions found in life
insurance policies.
468 Unit 4 Protecting Your Finances
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: A Life Insurance Policy Your Motive: If a person who holds a
Statement life insurance policy dies, the people who
A life insurance policy statement contains depended upon that policyholder can
the following information: be protected from financial losses by the
• Policy identification number life insurance policy. By obtaining a life
• Name of insured insurance policy, you are ensuring that
• Death benefit amount your loved ones, who are your beneficiaries,
• Cash value will not be stuck with your debts.
• Cost of the premium
GHL GENERAL HOME LIFE
Policy Anniversary Statement Juan Ramirez
21 First Street
Smithville, Florida 55523
Policy number: 2–615–879
Date prepared: May 18, 20--
Insured: Juan Ramirez
This policy will provide the following benefits
Plan name: Whole Life up to June 23, 2016, assuming premiums are
Face amount: $36,364
paid to that date and no other changes occur.
Premium: $41.87 monthly
Issued: June 23, 2003
Paid to: June 23, 2016
DEATH BENEFIT CASH VALUE
Basic policy $36,364.00 $4,253
Paid-up additions $81.39 $7.82
Option term $63,554.61 0.00
TOTAL $100,000.00 $4,260.82
Key Points: A life insurance policy Find the Solutions
provides a predetermined payment that 1. What is the yearly cost of this policy?
the insurance company will make in the 2. When was this policy issued or started?
event of the death of the policy owner. 3. How much will the policy pay upon Juan’s
This amount is called the death benefit. death?
In addition, the policy also accumulates a 4. When does Juan’s insurance coverage expire?
cash value over time as the holder of the 5. If Juan decides to cancel this policy, how
policy pays premiums. If the owner chooses much will the insurance company pay him?
to cancel the policy before death, he or she
will receive the policy’s cash value.
Chapter 14 Health, Disablility, and Life Insurance 469
Beneficiary Designation
You decide who receives the benefits of your life insurance pol-
icy. The beneficiary could be your spouse, your child, or your busi-
ness partner, for example. You can also name contingent beneficiaries,
those who will receive the money if your primary beneficiary dies
before or at the same time as you do. You will need to update your list
of beneficiaries as your needs change.
Incontestability Clause
The incontestability clause says that the insurer cannot cancel
the policy if it has been in force for a specified period, usually two
years. After that time the policy is considered valid during the life-
time of the insured. The incontestability clause protects the benefi-
ciaries from financial loss in the event that the insurance company
refuses to meet the terms of the policy.
Suicide Clause
Many insurance policies state that in the first two years of cov-
erage, beneficiaries of someone who dies by suicide receive only the
amount of the premiums paid. After two years from the date of death,
beneficiaries may receive the full value of death benefits. However,
some insurance policies will not provide benefits at all if a policy-
holder dies by suicide.
Riders to Life Insurance Policies
An insurance company can change the conditions of an insur-
ance policy by adding a rider to it. A rider is a document attached to
a policy that changes its terms by adding or excluding specified con-
ditions or altering its benefits. Examples of riders include a waiver of
premium disability benefit, an accidental death benefit, and a guar-
anteed insurability option.
Waiver of Premium Disability Benefit One type of rider is
a waiver of premium disability benefit. This clause allows a policy-
holder to stop paying premiums if he or she is totally and permanently
disabled before reaching a certain age, usually 60. The insurance
company will continue to pay the premiums at its own expense so
that the policy remains in force.
Accidental Death Benefit Another typical rider to life insurance
policies is an accidental death benefit, sometimes called double
indemnity. Double indemnity pays twice the value of the policy if the
insured is killed in an accident. Again, the accident must occur before
a certain age, generally 60 or 65. Experts counsel against adding this
rider to your coverage. The benefit is expensive, and your chances of
dying in an accident are slim.
470 Unit 4 Protecting Your Finances
Guaranteed Insurability Option A third important rider is a
guaranteed insurability option. This rider allows you to buy a specified
After You
additional amount of life insurance at certain intervals without
Read
undergoing medical exams. This is a good option for people who REACT
anticipate needing more life insurance in the future.
Using the information pro-
Cost of Living Protection This special rider is designed to help vided in this chapter, what
prevent inflation from eroding, or reducing, the purchasing power of insurance plans would you
the protection that your policy provides. A loss, reduction, or erosion choose to meet both your
health and financial needs?
of purchasing power refers to the effect that inflation has on a fixed
amount of money. As inflation increases the costs of goods and
services, that fixed amount of money will not buy as much in the
future as it does today.
Insurance Needs
Before you buy any type of insurance, you should always con-
sider a number of factors, such as your source of income, financial
responsibilities, savings, and net worth. As your life situation and
goals change, you need to regularly evaluate your insurance needs
to determine if you have the right kind of coverage to support your
personal financial plan.
Section 14.4 Assessment
QUICK CHECK For example, at age 50, life expectancy
1. What is the purpose of life insurance? for males and females is 80 years (50 + 30
2. What are the differences between term and = 80). What trends do you notice in your
whole life insurance? line graph?
3. What are the key provisions in a life insur-
SOLVE MONEY PROBLEMS
ance policy?
6. Life Insurance Comparisons Jon is a
THINK CRITICALLY 27-year-old single man with no children.
4. “Term insurance is often the best value He has a younger sister who has a develop-
for most consumers.” Do you agree or dis- mental disability. Both his parents are
agree with this statement? Support your living, though neither parent is in good
argument. health. Jon has an auto loan, a $50,000
mortgage on his condominium, and no
USE MATH SKILLS consumer debt.
5. Life Expectancy Review the life expec- Analyze Is Jon a good candidate
tancy tables in Figure 14.2 on page 465. for life insurance? If so, what kind
Present Show the life expectancy and how much life insurance should he
at various ages for both genders on buy? In a small group, discuss Jon’s situa-
a line graph. Add number of years lived tion and his needs to determine his ideal
to number of years expected to remain. life insurance policy.
Chapter 14 Health, Disablility, and Life Insurance 471
Chapter 14 Review & Activities
CHAPTER SUMMARY
• Health insurance is important for • Disability insurance provides regular
financial planning because it can help cash income for people who are unable
protect against the financial burden of to work due to pregnancy, a non-work-
illness or injury. related accident, or illness.
• Health insurance policies have certain • Sources of disability income are workers’
similarities but can differ in terms compensation, an employer, Social
of reimbursement versus indemnity, Security, and private disability insurance.
internal limits versus aggregate limits, • Types of life insurance policies include
deductibles and coinsurance, and out- term insurance, whole life insurance,
of-pocket limits. group life insurance, credit life insurance,
• Private health care plans are offered by and endowment life insurance.
private insurance companies, hospital • The key provisions in a life insurance
and medical service plans, health policy include naming a beneficiary, an
maintenance organizations, preferred incontestability clause, a suicide clause,
provider organizations, home health and policy riders.
care agencies, and employer self-funded
health plans. Government health care
programs are Medicare and Medicaid.
Communicating Key Terms
Choose your ideal benefits package for a job and include health and life insurance. Using the
terms below, write instructions for what insurance you want your employer to buy for you.
• health insurance • health maintenance • disability income
• coinsurance organization (HMO) insurance
• stop-loss • preferred provider • beneficiary (insurance)
• co-payment organization (PPO) • term insurance
• Blue Cross • point-of-service (POS) plan • whole life insurance
• Blue Shield • Medicare • cash value
• managed care • Medicaid • endowment
Reviewing Key Concepts
1. Explain how increasing co-payments and deductibles affects premium rates.
2. Discuss basic health insurance coverage and major medical expense insurance.
3. Compare government health care programs and those offered by private companies.
4. Explain the importance of disability insurance in financial planning.
5. Describe the advantages of worker’s compensation.
6. Identify the types of term and whole life insurance.
7. Explain the key provisions of life insurance.
472 Unit 4 Protecting Your Finances
Chapter 14 Review & Activities
Social Studies Hector Ramirez and Walter Chan are both shopping for
life insurance policies. Hector and his wife just bought a car. Walter, his wife,
and four children just moved into a new $150,000 home. Hector and Walter
have narrowed their choices to either decreasing term insurance or credit life
insurance.
Write About It Which type of insurance should each person choose?
Provide a list of reasons for each of your choices.
Heath Insurance Premiums Because you are self-employed, you
started buying individual health insurance nine years ago at a cost of $579
per quarter. Now the quarterly premium is $806.
1. Calculate what your annual premium was nine years ago and what it is
today. What was the percentage increase over those nine years?
2. Compute by using an Internet search engine to locate information on
health insurance premiums and coverage from five insurance companies.
Compare and contrast the offers using spreadsheet software.
Connect with Economics and Law Many companies that once
sold just life insurance have “reinvented” themselves as financial services
companies. Many of these firms promote themselves as “one-stop shops” for
all your financial service needs.
1. Research Access the Web site of your state’s insurance regulatory
agency and find out what requirements insurance agents must meet to be
able to sell other financial products, such as mutual funds.
2. Think Critically What are the pros and cons of buying financial
products from an insurance company versus a stockbroker?
Buying Insurance on the Internet You may not need to
purchase life insurance right now, but it is a good idea to know how much a
policy will cost so that you will be able to plan your finances accordingly.
Log On Use an Internet search engine to find the Web sites of three
insurance companies. Obtain quotes for a term life insurance policy
from the three companies. Answer the following questions:
1. What forms of term life insurance do these companies offer?
2. Choose one form of term life insurance offered by all three companies
and determine which company’s policy you feel is the best deal for you.
Explain why you would choose that policy.
Newsclip: More Choices A health savings account (HSA) is a plan
that allows employees to save for medical expenses in a tax-free account.
O N L I N E
Log On Go to finance07.glencoe.com and open Chapter 14.
Learn more about HSAs. Write a paragraph about how HSAs might
affect your future. Would you sign up for an HSA?
finance07.glencoe.com Chapter 14 Health, Disability, and Life Insurance 473
Chapter 14 Review & Activities
INSURANCE FACTS
AND FICTION
Insurance may not be a big issue for you now, but when you are no
longer covered under your parents’ or guardian’s policies or you start
full-time employment, you will need to know your options. Here is an
opportunity to test your knowledge. Write your answers to the following questions on a
separate sheet of paper.
1. Health insurance is only available as a benefit from an employer.
True False
2. You can continue your health insurance even if you leave a job.
True False
3. A co-payment is the small amount you pay for a doctor’s visit or a prescription.
True False
4. In general the younger you are, the less expensive life insurance is.
True False
5. Life insurance can also be used as an investment for retirement.
True False
6. Life insurance companies can cancel policies if you develop a serious illness after you
are insured.
True False
7. You can collect life insurance benefits before you die.
True False
8. The amount of disability insurance you can buy is based on a percentage of your
total income.
True False
474 Unit 4 Protecting Your Finances
Chapter 14 Review & Activities
Your Financial Portfolio
Comparing Life Insurance
Sean Richards is investigating the cost of life insurance. He is 28 years old, married, and
has two children. Sean contacted two reputable insurance companies and based his
comparison on $100,000 worth of insurance.
Type of Policy Company A Company B
20-year decreasing term insurance $100,000
Monthly premium $14.00 $8.25
Total premiums for 20 years $3,360.00 $1,980.00
Cash value in 20 years none none
Whole life insurance (limited payment) $100,000
Monthly premium $82.00 $62.60
Total premiums for 20 years $19,280.00 $15,024.00
Cash value in 20 years $25,000.00 $21,243.00
Sean chose the 20-year decreasing term insurance because of the low cost, even
though he cannot convert it into cash at a future date. He purchased his policy with
Company B.
Compare
On a separate sheet of paper, follow Sean’s chart to compare life insurance rates.
Using the Internet, or by visiting, calling, or writing, get quotes from two different insur-
ance companies. Base the quote on (1) a 20-year decreasing term insurance policy for
$100,000 and (2) a whole life (limited payment) insurance policy for $100,000. Use
your own age.
Chapter 14 Health, Disability, and Life Insurance 475
15
CHAPTER
Retirement and
Estate Planning
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 15.1
• Explain the importance of
retirement planning.
• Identify retirement living costs
and housing needs.
Section 15.2
• Describe the role of Social
Security in planning for
retirement.
• Discuss the benefits offered by
employer pension plans.
• Explain various personal
retirement plans.
Section 15.3
• Identify various types of wills.
• Discuss several types of trusts.
• Describe common characteristics
of estates.
• Identify the types of taxes that
affect estates.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
476
In the Real World . . .
E very summer, Shelly Garfield visits her grandparents,
who live in a retirement community designed with swimming pools
and recreation rooms. Her grandparents decided to move there after Shelly’s
grandmother broke her hip. They liked the idea of having a full medical staff on
duty. Shelly’s grandparents had saved enough money so they could afford to move
there. As the elderly population increases, Social Security, Medicare, and pensions
will be stretched, and may not cover many retirees’ total expenses. Shelly is a
high school senior, but it is not too early for her to start thinking about retire-
ment. By estimating retirement costs and housing needs now, she can
save for retirement on her own terms.
As You Read Consider why it is wise to begin a
retirement plan early.
Will Power
ASK Q: My parents do not have a lot of money, so is it
really that important for them to write up a will?
A: Even if your parents do not have a lot of money, they should have a will. If they
die without a will, their state of residence will step in and control how their estate is
distributed. It costs somewhere between $200 and $350 to have an attorney draft a
will. The peace of mind it will provide your parents will be worth the cost.
Ask Yourself If you had to write up a will right now, how would you want
your possessions and money distributed?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com Chapter 15 Retirement and Estate Planning 477
Section 15.1
Focus on
Reading
Retirement Planning
Read to Learn
Planning for Retirement
What factors should you consider when
• How to explain the
importance of retirement
planning for retirement?
planning. A recent poll from Harris Interactive reported that 95 percent of
• How to identify retire- people ages 55 to 64 years old plan to do at least some work after they
ment living costs and have retired. Another survey reported that future retirees expected to
housing needs.
continue to learn, try news things, and pursue new hobbies and inter-
ests. Someday, when you retire, you too may desire an active life.
Main Idea
Your retirement years may seem a long way off right now. You are
Estimating your retirement
still in high school, and after you graduate, you will probably work for
living costs and hous-
ing needs will enable you many years. However, it is never too early to start planning for retire-
to save or invest enough ment. Planning can help you cope with sudden changes that may occur
money to live comfortably in your life, and it can give you a sense of control over your future. Plan-
during retirement. ning can also help make the retirement years more comfortable.
If you have not done any research on the subject of retirement,
Key Term you may have some misconceptions about the “golden years.” Here
• assisted-living facility are some myths about retirement:
(ALF)
• You have plenty of time to start saving for retirement.
• Saving a small amount of money will not help.
• You will spend less money when you retire.
Before • Your retirement will last about 15 years.
You Read • You can depend on Social Security and a company pension
plan to pay your basic living expenses.
PREDICT • Your pension benefits will increase to keep pace with inflation.
When do you think you • Your employer’s health insurance plan and Medicare will cover
should begin planning for all your medical expenses.
your retirement?
Some of these statements may have been true in the past, but they
are no longer true today. You may live for many years after you retire. If
you want your retirement to be a happy and comfortable time of your
life, you will need enough money to suit your lifestyle. That is why you
should start planning and saving as early as possible. It is never too late
to start saving for retirement, but the sooner you start, the better off you
will be.
Suppose that you want to have at least $1 million when you retire
at age 65. If you start saving at age 25, you can meet that goal by put-
ting about $127 per month into investment funds that grow at a rate
of about 11 percent each year. If you wait to begin saving until age 50,
the monthly amount to achieve that goal skyrockets to $2,244.
478 Unit 4 Protecting Your Finances
Setting Long-Range Goals As You
As you think about your retirement years, consider your long- Read
range goals. What does retirement mean to you? Maybe it will be a time RELATE
to stop working and to relax. Perhaps you imagine traveling the world,
developing a hobby, or starting a second career. Ask yourself: Where do Imagine what you would
you want to live after you retire? What type of lifestyle would you like like to do when you retire.
What are three financial
to have? Then analyze your current financial situation to determine
goals for that time?
what you need to do to reach your long-range goals.
Conducting a Financial Analysis
The checklist in Figure 15.1 is an example of how you might
analyze your financial assets and liabilities. As you learned in Chap-
ter 3, an asset is any item of value that you own, including cash,
property, personal possessions, and investments. This includes cash
in checking and savings accounts, a house, a car, a television, and
so on. It also includes the current value of any stocks, bonds, other
investments, life insurance policies, and pension funds.
Your liabilities are the debts you owe, including the balance on
an automobile loan, credit card balances, other loans, and unpaid
taxes. If you subtract your liabilities from your assets, you get your
net worth. Ideally, your net worth should increase each year.
&IGURE !SSETS ,IABILITIES AND .ET 7ORTH
!SSETS ,IABILITIES
#ASH #URRENT UNPAID BILLS
#HECKING ACCOUNT (OME MORTGAGE
3AVINGS ACCOUNT REMAINING BALANCE
)NVESTMENTS !UTO LOAN
53 3AVINGS "ONDS 0ROPERTY TAXES
CURRENT CASH IN VALUE (OME IMPROVEMENT LOAN
3TOCKS MUTUAL FUNDS
4OTAL LIABILITIES
,IFE INSURANCE
#ASH VALUE ACCUMULATED
DIVIDENDS
#OMPANY PENSION RIGHTS
!CCRUED PENSION BENEFIT .ET WORTH
0ROPERTY !SSETS ,IABILITIES .ET 7ORTH
(OUSE RESALE VALUE
&URNITURE AND APPLIANCES
#OLLECTIONS AND JEWELRY
!UTOMOBILE
/THER
,OAN TO BROTHER
'ROSS ASSETS
#ALCULATING .ET 7ORTH !SSETS ARE EVERYTHING THAT YOU OWN WHILE LIABILITIES ARE EVERYTHING YOU OWE
(OW CAN YOU DETERMINE YOUR NET WORTH
Chapter 15 Retirement and Estate Planning 479
LIVING THE GOOD LIFE When you retire you may not be able to afford to take lavish vacations or
buy many expensive items. What are some of the decisions you will have to make now to ensure a comfort-
able retirement?
Reviewing Assets
Review your assets on a regular basis. You may need to make
adjustments in your saving, spending, and investments to stay on
track with your goal. As you review your assets, consider the follow-
ing factors: housing, life insurance, savings, and investments. Each
asset will have an important effect on your retirement income.
Housing A house can be your most valuable asset. However, if you
buy a home with large mortgage payments, you may be unable to
As You save money for retirement. In that case, you might consider buying a
Read smaller, less expensive place to live. A smaller house is usually easier
QUESTION and less expensive to maintain. You can use the money you save by
having lower payments to increase your retirement fund.
Does planning for your
retirement alter today’s Life Insurance At some point in the future, you might buy life
investment strategies? insurance to provide for your loved ones. If you have children, life
insurance can provide financial support in case you die while they
are still young. As you near retirement, though, your children will
probably be self-sufficient. When that time comes, you might reduce
your premium payments by decreasing your life insurance coverage.
This would give you extra money for living expenses or investments.
480 Unit 4 Protecting Your Finances
Other Investments When you review your assets, also evaluate
any other investments you have. When you originally chose those
investments, you may have been more interested in making your
money grow over time than in getting a quick return. When you
are ready to retire, you may want to use the income from those
investments to cover living expenses.
Retirement Living Expenses
What living expenses should you consider when
planning for retirement?
When planning for retirement, estimate how much money you
will need to live comfortably during your retirement years. You can-
not predict exactly how much money you will need, but you can
estimate the expense of your basic needs. To do this, think about how
your spending patterns and living situation might change.
For example, when you are retired, you may spend more money
on recreation, health insurance, and medical care than you will as a
young adult. At the same time, you may spend less money on trans-
portation and clothing. Your federal income taxes may be lower as
well. Also, some income from various retirement plans may be taxed
at a lower rate or not at all. Figure 15.2 provides an example of
retirement expenses.
&IGURE %XPENSES FOR /LDER (OUSEHOLDS YEARS
-EDICAL CARE #LOTHING AND
PERSONAL CARE
&OOD
#ONTRIBUTIONS
2EADING EDUCATION
AND ENTERTAINMENT
0ERSONAL
INSURANCE AND
PENSIONS
4RANSPORTATION /THER
(OUSING
3OURCE 53 "UREAU OF ,ABOR 3TATISTICS
3PENDING -ORE OR ,ESS 4HE AMOUNT OF MONEY YOU SPEND DURING RETIREMENT WILL VARY DEPENDING
ON MANY DIFFERENT FACTORS
#ALCULATE HOW MUCH MONEY AN OLDER HOUSEHOLD WITH AN ANNUAL
INCOME OF SPENDS ON FOOD EACH YEAR
Chapter 15 Retirement and Estate Planning 481
&IGURE )NFLATION /VER 4IME
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Remember to take inflation into account. Estimate high when
calculating how much the prices of goods and services will rise by the
time you retire. (See Figure 15.3.) Even a 3 percent rate of inflation
will cause prices to double every 24 years. Also, plan for emergencies
as you consider future retirement living expenses.
Retirement Housing
What factors should you consider regarding housing
needs during retirement?
The place where you live can have a significant impact on your
financial needs. In the years before retirement, use vacations to explore
areas and cities where you might want to settle. If you find a place you
like, go there at different times of the year. That way, you will be able to
experience the climate and environment. Meet people who live in the
area and learn about activities, transportation, and taxes.
Retirement Relocation Pitfalls
Consider the downside of moving to a new location. People
sometimes find themselves stuck in a place they really do not like.
Some retirees find they miss their children, grandchildren, and friends
and relatives left behind. Other retired people move to the location of
their dreams and discover they have made a mistake financially.
482 Unit 4 Protecting Your Finances
Researching Locations Here are some tips from specialists on
how to research taxes and other costs before moving to a new area:
• Contact the local chamber of commerce for details on area
property taxes and the local economy.
• Contact the state tax department to research income, sales,
inheritance taxes, and exemptions for retirees.
• Read the Sunday edition of the local newspaper of the town or
city you are considering.
• Check with local utility companies to estimate energy costs.
• Visit the area in different seasons and talk to local residents
about the cost of living there.
• If you plan to buy a home, take time and rent a home first.
Types of Housing
Even if you do not move to a new location, housing needs may
change during retirement. Many retirees want a home that is easy
and inexpensive to maintain, such as a smaller house, a condomin-
ium, or an apartment. Having access to public transportation, stores,
and recreation areas is also important. Figure 15.4 presents several
housing options.
Careers in Finance
CREDIT
ESTATEANALYST Paul Francisco
ADMINISTRATOR Choate, Hall & Stewart
Paul has very strong organizational and communication skills, which are essential in his work as an
estate administrator. Under the direction of the attorney responsible for estate administration, Paul
handles all phases of estate execution. He determines and informs the parties of procedural and tax
deadlines and ensures compliance with the deadlines. He also calculates debts, expenses, taxes, and
cash needs. In his role as an estate administrator, Paul may need to develop and implement steps to
uncover and reconcile conflicts between beneficiaries or family members.
SKILLS: Writing, communication, organizational, problem-solving, analytical, and
multitasking skills
PERSONAL TRAITS: Discreet, good judgment, likes working with people and numbers, tactful,
and quick thinking
EDUCATION: High school diploma or equivalent; bachelor’s degree in finance or related
field or equivalent work experience
ANALYZE How might planning for retirement affect your will?
To learn more about career paths for estate administrators, visit finance07.glencoe.com.
finance07.glencoe.com Chapter 15 Retirement and Estate Planning 483
Figure 15.4 Retirement Housing Options
Housing options for retirement
are based on personal, financial,
and medical factors.The goal of most
retirees is to have comfortable and
affordable housing that meets their
particular needs.
1 Most retired people decide to remain where they
are and continue living in their own homes.
2 Living with grown children and young
grandchildren can be a choice for some
elderly retired people and their families.
3
For retired people with dis-
abilities, a universal design home
built with special features, such as
extra-wide doors, lower appliances,
and automatic faucets, can be
both appealing and practical. These
homes help people with disabilities
to maintain their independence.
484 Unit 4 Protecting Your Finances
A great majority of people prefer to grow old in their own homes
in their own communities. Recognizing this trend, building suppli-
ers offer everything from lever door handles to faucets that turn on
automatically when you put your hand beneath the spout. Remod-
eling to accommodate aging homeowners is creating a demand for
these products. In addition, contractors are building universal design
homes from scratch that can accommodate people who use wheel-
chairs and walkers or those who simply want more convenience.
Many elderly people move into assisted-living facilities during
their retirement years. An assisted-living facility (ALF) is a resi-
dence complex that provides personal and medical services for the
elderly. Assisted-living facilities offer everything from minimal ser-
vices to full, continuous nursing care. They may vary greatly in qual-
ity, but ALFs are increasingly popular with elderly retirees, some of
whom are no longer able to live alone and care for themselves.
Section 15.1 Assessment
QUICK CHECK Present Imagine the type of life you
1. What are several reasons that early retire- would like to have when you retire.
ment planning is important? Combine pictures and words to create a col-
2. What factors should you consider when lage that expresses your thoughts and feel-
estimating your retirement living expenses? ings about your retirement dreams.
3. What are some features and benefits of an
SOLVE MONEY PROBLEMS
assisted-living facility?
6. Changing Lifestyles Jeff and Maureen
THINK CRITICALLY McBride have been retired for a couple of
4. Imagine that you are 20 years away from years. Although their income is lower than
retirement and you are thinking of spend- when they were working, they continue
ing a large portion of your income to pur- to live as they did before retirement. They
chase an expensive home. Discuss the have a three-bedroom house in New Jer-
advantages and disadvantages of this plan. sey. Twice a year, they travel to California
to visit their children and grandchildren.
USE COMMUNICATION SKILLS Unfortunately, they now find themselves in
5. Free at Last! Enrique and his wife, Mari- a financial pinch. They need to cut back on
bel, have both been working at the same their expenses and have a plan to live more
company for almost 35 years and are near- economically without giving up many of
ing retirement. They have been looking for- the activities they enjoy.
ward to the time when they will be free to Analyze Help Jeff and Maureen by
do almost anything they want. They already discussing various options they might
have a long list of places they would like to have for saving money.
visit, things they would like to do, and ways
they would like to spend their time after
they retire.
Chapter 15 Retirement and Estate Planning 485
Section 15.2
Focus on
Reading
Planning Retirement
Income
Read to Learn
• How to describe the role
of Social Security in plan- Public Pension Plans
ning for retirement. Who receives benefits under Social Security?
• How to discuss the ben-
efits offered by employer You learned in Chapter 2 that a pension plan is a retirement
pension plans. plan that is funded, at least in part, by an employer. Public pension
• How to explain various plans are established by states and municipalities. Social Security is
personal retirement plans. a public pension plan established by the United States government
in 1935. The government agency that manages the program is called
Main Idea the Social Security Administration.
Various types of retirement
plans are suited to different Social Security
financial situations and per-
sonal needs. Social Security is an important source of retirement income for
many Americans. The program covers 97 percent of all workers, and
Key Terms almost one out of every six Americans currently collects some form
• defined-contribution plan of Social Security benefit. Social Security is a package of protection
• 401(k) plan that provides benefits to retirees, survivors, and disabled persons.
• vesting
You should not rely on Social Security to cover all of your retirement
• defined-benefit plan
• individual retirement expenses. Social Security was not designed to provide 100 percent of
account (IRA) retirement income. In addition, current and future revisions to the
• Keogh plan program may reduce retirement benefits in years to come.
• annuity (insurance)
• heirs Who Is Eligible The amount of Social Security retirement benefits
you receive is based on your earnings over the years. The more you
earn, the greater your benefits will be, up to a maximum amount.
Each year the Social Security Administration will send you a his-
Before tory of your earnings and an estimate of your future monthly ben-
You Read efits. The statement includes an estimate, in today’s dollars, of how
much you would get each month if you retired at different ages. For
PREDICT example, your statement might list benefits for retirement at age 62,
Besides Social Security, 67, and 70, based on the year you were born, your earnings to date,
what other retirement and your projected future earnings.
plans might be available? To qualify for retirement benefits, you must earn a certain num-
ber of credits. These credits are based on the length of time you work
and pay Social Security tax, or contributions, on your earnings. Your
credits are calculated on a quarterly basis. The number of quarters
needed to qualify depends on your year of birth. For example, people
born after 1928 need at least 40 quarters to qualify for benefits.
486 Unit 4 Protecting Your Finances
Dependent Eligibility Certain dependents of a worker may also
receive benefits under the Social Security program. They include a
As You
spouse age 62 or older; unmarried children under 18 (or under 19 if
Read
they are full-time students no higher than grade 12); and unmarried RELATE
individuals with disabilities aged 18 or older. Widows and widowers
can receive Social Security benefits before age 62. If you currently hold a job,
look at a recent paycheck
Social Security Retirement Benefits Most people can begin stub. Are you paying into
collecting Social Security retirement benefits at age 62. However, the Social Security?
monthly amount at age 62 is less than it would be if the person waited
until full retirement age. This initial amount becomes the permanent
base amount.
In the past people could receive full retirement benefits at age 65.
However, the full retirement age is being increased in gradual steps.
For people born in 1960 and later, the full retirement age is 67. If you
postpone applying for benefits when you are eligible, your monthly
payment amount will increase slightly for each year you wait, but
only up to age 70.
Social Security Information For more information about Social
Security, you can visit the Social Security Web site. It provides access to
forms and publications and gives links to other valuable information.
To learn more about the taxability of Social Security benefits, contact
the Internal Revenue Service (IRS) and ask for Publication 554, Older
Americans’ Tax Guide, and Publication 915, Social Security and
Equivalent Railroad Retirement Benefits. These publications can also
be found on the IRS Web site.
SOCIAL SECURITY BENEFITS Social Security is an important source
of income for many retired people. How are Social Security benefits
calculated?
Chapter 15 Retirement and Estate Planning 487
Other Public Pension Plans
TechByte
Calculate Your
Besides Social Security, the federal government provides other
special retirement plans for federal government workers and rail-
Benefits It is never road employees. These employees are not covered by Social Security.
too early to start think- The Veterans Administration provides pensions for survivors of peo-
ing about how you will ple who died while serving in the armed forces. It also offers disabil-
fund your retirement. ity pensions for eligible veterans. In addition, many state and local
One source of retirement
governments provide retirement plans for their employees.
income will probably be
your Social Security ben-
efits. The Social Security
administration will help
Employer Pension Plans
you calculate how much What is one of the benefits of having
your Social Security ben- an employer pension plan?
efits will be. A good way
Another possible source of retirement income is an employer pen-
to start planning for your
retirement is to make sion plan offered by the company for which you work. With this type
some reasonable guesses of plan, your employer contributes to your retirement benefits, and
about what your yearly sometimes you contribute, too. These contributions and their earnings
earnings will be when you remain tax-deferred until you withdraw them during retirement.
are in your mid-20s. Private employer pension plans vary. If the company you work for
Use the Social Secu- offers one, find out what benefits you will receive and when you will
rity Administration’s become eligible to receive those benefits. Most employer plans are one
special calculator to plug of two basic types: defined-contribution plans or defined-benefit plans.
in your best guesses
and see how much you
could receive upon your Defined-Contribution Plan
retirement through
A defined-contribution plan, sometimes called an individ-
finance07.glencoe.com.
ual account plan, is an individual account for each employee. The
employer contributes a specific amount to the account annually. This
type of retirement plan does not guarantee any particular benefit.
When you retire and become eligible for benefits, you receive the
total amount of funds (including investment earnings) that is in your
account. Several types of defined-contribution plans exist.
Money-Purchase Plans With a money-purchase plan, your em-
ployer promises to set aside a certain amount of money for you each
year. That amount may be a percentage of your earnings.
Stock Bonus Plans Under a stock bonus plan, your employer’s con-
tribution is used to buy stock in the company for you. The stock is held
in trust until you retire. Then you can keep your shares or sell them.
Profit-Sharing Plans Under a profit-sharing plan, your employer’s
contribution depends on the company’s profits each year.
401(k) Plans A 401(k) plan, or salary-reduction plan, is a type
of retirement savings plan funded by a portion of your salary that is
deducted from your gross paycheck and placed in a special account.
Many employers match their employees’ 401(k) contributions up to
a specific dollar amount or percentage of salary.
488 Unit 4 Protecting Your Finances finance07.glencoe.com
The funds in 401(k) plans can be invested in stocks, bonds, and
mutual funds. As a result, you can accumulate a significant amount of
money in this type of account if you begin contributing to it early in
your career. In addition, the money that accumulates in your 401(k) Making the Most
plan is tax-deferred, which means that you do not have to pay taxes of a 401(k) Plan
on it until you withdraw it. 1. Begin contributing
as soon as your
403(b) Plans If you are employed by a tax-exempt institution, company allows.
such as a hospital or a nonprofit organization, the salary-reduction 2. Contribute the
plan is called a Section 403(b) plan. The funds in this plan are also maximum amount.
tax-deferred. The 401(k) and 403(b) plans are known as tax-sheltered 3. Learn as much as
annuity (TSA) plans. The amount that can be contributed each year you can about the
to 401(k) and 403(b) plans is limited by law, as is the amount of investment options
contributions to other types of defined-contribution plans. offered.
4. Review your invest-
Vesting Employee contributions to a pension plan belong to you, ments periodically.
the employee, regardless of the amount of time that you are with a 5. Make adjustments
particular employer. But what happens to the contributions that the to your investments
employer has made to your account if you change jobs and move to as needed.
another company? One of the most important aspects of these plans
is vesting. Vesting is the right of an employee to keep the company’s
contributions from company-sponsored plans, such as pensions, even
if the employee no longer works for that employer. Vesting occurs
at different points in time, depending on company policy. After a
certain number of years with a company, you become fully vested, or
entitled to receive 100 percent of the company’s contributions to the
plan on your behalf. Under some plans, vesting may occur in stages.
For example, you might become eligible to receive 20 percent of your
benefits after three years and gain another 20 percent each year until
you are fully vested.
Defined-Benefit Plan
A defined-benefit plan is a retirement plan that specifies the
benefits an employee will receive at retirement age, based on total
earnings and years on the job. The plan does not specify how much
the employer must contribute each year. Instead, your employer’s
contributions are based on how much money the fund will need for
each participant in the plan who retires. If the fund is inadequate, the
employer will have to make additional contributions.
Moving to Another Plan
Some pension plans allow “portability,” which means that you
can carry earned benefits from one pension plan to another when you
change jobs. Workers are also protected by the Employee Retirement
Income Security Act of 1974 (ERISA), which sets minimum standards
for pension plans. Under this act, the federal government insures part
of the payments promised by defined-benefit plans.
Chapter 15 Retirement and Estate Planning 489
As You Personal Retirement Plans
Read What is the biggest benefit of an IRA?
QUESTION In addition to public and employer retirement plans, many peo-
ple choose to set up personal retirement plans. Such plans are espe-
What type of IRA seems
cially important to self-employed people and other workers who are
more flexible—traditional
or Roth? not covered by employer pension plans. Among the most popular
personal retirement plans are individual retirement accounts (IRAs)
and Keogh accounts.
Individual Retirement Accounts
An individual retirement account (IRA) is a special account
in which a person saves a portion of income for retirement. Figure 15.5
on page 492 summarizes the various types of IRAs.
Regular IRA A regular IRA, which is a traditional or classic IRA,
allows you to make annual contributions until age 70½. In the
year 2004, you could contribute up to $3,000 per year. From 2005
to 2007, the limit was set at $4,000. From 2008 and on, you can
contribute up to $5,000 per year. Depending on your tax filing
status and income, the contribution may be fully or partially
tax-deductible. The tax deductibility of a traditional IRA also
depends on whether you belong to an employer-provided retire-
ment plan.
Roth IRA Annual contributions to a Roth IRA are not tax-deductible,
but the earnings are tax-free. You may contribute the same amounts as
allowed for a regular IRA if you are a single taxpayer with an adjusted
gross income (AGI) of less than $95,000. For married couples, the
combined AGI must be less than $150,000.
You can continue to make annual contributions to a Roth IRA
even after age 70½. If you have a Roth IRA, you can withdraw money
from the account without paying taxes or penalities after five years if
you are at least 59½ years old or if you are using the money to help
buy your first home. You may convert a regular IRA to a Roth IRA.
Depending on your situation, one type of account may be better for
you than the other.
Simplified Employee Pension (SEP) Plan A Simplified Employee
Pension (SEP) plan, also known as a SEP-IRA, is an individual
retirement account that is ideal for small businesses or for self-
employed individuals. For a small-business SEP-IRA, each employee
sets up an IRA account at a bank or other financial institution. Then
the employer makes an annual contribution up to a maximum set
by law. The employees’ contributions, which can vary from year to
year, are fully tax-deductible, and earnings are tax-deferred. The SEP-
IRA for a self-employed individual works much the same way. An
individual could contribute up to $42,000 a year in 2005. The limits
increase yearly until 2010.
490 Unit 4 Protecting Your Finances
Spousal IRA You can make contributions to a Spousal IRA on
behalf of your nonworking spouse if you file a joint tax return. The
contributions are the same as for the traditional and Roth IRAs. This
contribution may be fully or partially tax-deductible.
Rollover IRA A rollover IRA is a traditional IRA that allows roll
over, or transfer of, all or a portion of your taxable distribution from
one retirement plan to another IRA without paying taxes on it.
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis-
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals
to help them guide their financial decisions. -EXICO #ITY
MEXICO
According to the U.S. Embassy, a growing num-
ber of American citizens are finding Mexico an attrac-
tive place to spend their golden years. Americans are
drawn to Mexico’s warm climate, easygoing lifestyle, DATABYTES
and lower cost of living. Since the average Social
Security benefit is only about $1,000 a month, many Capital Mexico City
retirees cannot afford to stay in the United States.
Population 106,202,903
In Mexico, however, they can live comfortably. San
Languages Spanish, Mayan, and Nahuatl
Miguel is a favorite place for many of the older gener-
ation. The city is designated as a national monument Currency Mexican peso
and offers culture, fine restaurants, and an easy drive Gross Domestic
to the warm waters of the Gulf of Mexico. Product (GDP) $1.006 trillion
GDP per capita $9,600
Industry: Food and beverages, tobacco, chemicals, iron
and steel, petroleum, mining, textiles, clothing, motor
vehicles, consumer durables, and tourism
Agriculture: Corn, wheat, soybeans, rice, beans,
cotton, coffee, fruit, tomatoes, beef, poultry, dairy
products, and wood products
Exports: Manufactured goods, oil and oil products,
silver, fruits, vegetables, coffee, and cotton
Natural Resources: Petroleum, silver, copper, gold,
lead, zinc, natural gas, and timber
Think Globally
What services needed by retirees might be lacking in a
foreign country?
Chapter 15 Retirement and Estate Planning 491
&IGURE 4YPES OF )2!S
4YPE OF )2! )2! &EATURES
2EGULAR )2! s 4AX DEFERRED INTEREST AND EARNINGS
s !NNUAL LIMIT ON INDIVIDUAL CONTRIBUTIONS
s ,IMITED ELIGIBILITY FOR TAX DEDUCTIBLE
CONTRIBUTIONS
s #ONTRIBUTIONS DO NOT REDUCE CURRENT
TAXES
2OTH )2! s 4AX DEFERRED INTEREST AND EARNINGS
s !NNUAL LIMIT ON INDIVIDUAL CONTRIBUTIONS
s 7ITHDRAWALS ARE TAX FREE IN SPECIFIC CASES
s #ONTRIBUTIONS DO NOT REDUCE CURRENT
TAXES
3IMPLIFIED %MPLOYEE s h0AY YOURSELF FIRSTv PAYROLL REDUCTION
0ENSION 0LAN 3%0 )2! CONTRIBUTIONS
s 0RE TAX CONTRIBUTIONS
s 4AX DEFERRED INTEREST AND EARNINGS
3POUSAL )2! s 4AX DEFERRED INTEREST AND EARNINGS
s "OTH WORKING SPOUSE AND NONWORKING
SPOUSE CAN CONTRIBUTE UP TO THE ANNUAL
LIMIT
s ,IMITED ELIGIBILITY FOR TAX DEDUCTIBLE
CONTRIBUTIONS
s #ONTRIBUTIONS DO NOT REDUCE CURRENT
TAXES
2OLLOVER )2! s 4RADITIONAL )2! THAT ACCEPTS ROLLOVERS OF
ALL OR A PORTION OF YOUR TAXABLE
DISTRIBUTION FROM A RETIREMENT PLAN
s 9OU CAN ROLL OVER TO A 2OTH )2!
%DUCATION )2! s 4AX DEFERRED INTEREST AND EARNINGS
s EARLY WITHDRAWAL PENALTY IS WAIVED
WHEN MONEY IS USED FOR
HIGHER EDUCATION EXPENSES
s !NNUAL LIMIT ON INDIVIDUAL CONTRIBUTIONS
s #ONTRIBUTIONS DO NOT REDUCE CURRENT
TAXES
0LANNING !HEAD )2!S CAN BE A GOOD WAY TO SAVE MONEY FOR RETIREMENT
7HAT ARE THE FEATURES OF THE %DUCATION )2!
Education IRA An Education IRA, also known as a Coverdell
Education Savings Account, is a special IRA with certain restrictions.
It allows individuals to contribute up to $2,000 per year toward the
education of any individual under age 18. The contributions are
not tax-deductible, but they do provide tax-free distributions for
education expenses.
Even if you are covered by another type of pension plan, you
can make IRA contributions that are not tax-deductible. All of the
income your IRA earns will compound, tax-deferred, until you begin
making withdrawals. Remember, the biggest benefit of an IRA lies in
its tax-deferred earnings growth. (See Figure 15.6.)
492 Unit 4 Protecting Your Finances
IRA Withdrawals When you retire, you can withdraw the money
from your IRA by one of several methods. You can take out all of the
money at one time, but the entire amount will be taxed as income. If
you decide to withdraw the money from your IRA in installments, you
will have to pay tax only on the amount that you withdraw. You might
also place the money that you withdraw in an annuity that guarantees
payments over your lifetime. See the discussion on annuities later in this
section for further information about this option.
Keogh Plans
A Keogh plan, which is also an H.R.10 plan or a self-employed
retirement plan, is a retirement plan specially designed for self-
employed people and their employees. Keogh plans have various
restrictions, including limits on the amount of annual tax-deductible
contributions you can make. You should get professional tax advice
before using this type of personal retirement plan.
Limits on Retirement Plans
When must you begin to withdraw your money?
With the exception of Roth IRAs, you cannot keep money in
most tax-deferred retirement plans forever. When you retire, or by
age 70½ at the latest, you must begin to receive “minimum lifetime
distributions.” These are withdrawals from the funds you have accu-
mulated through your plan. The amount of the distributions, or with-
drawals, is based on your life expectancy at the time the distributions
begin. If you do not withdraw the minimum distributions from a
retirement account, the IRS will charge you a penalty.
&IGURE "ENEFITS OF 3TARTING A 2ETIREMENT 0LAN %ARLY
.ET EARNINGS
#ONTRIBUTIONS EXCLUDING CONTRIBUTIONS
!GE
YEAR NO
3AVER !
FOR YEARS CONTRIBUTIONS
NO YEAR
3AVER "
CONTRIBUTIONS FOR YEARS
!SSUMES PERCENT FIXED RATE OF RETURN COMPOUNDED MONTHLY WITH NO CHANGE IN THE PRINCIPLE
3TART %ARLY )F YOU START INVESTING IN THEM EARLY TAX DEFERRED INVESTMENTS SUCH AS
)2!S CAN GROW CONSIDERABLY BY THE TIME YOU RETIRE
)N THIS FIGURE WHICH PERSON CONTRIBUTED MORE MONEY TO THE
RETIREMENT PLAN 7HICH ONE EARNED MORE BY AGE 7HY
Chapter 15 Retirement and Estate Planning 493
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: A Projected Retirement Your Motive: The best time to plan for
Budget Worksheet your retirement is when you are young.
A projected retirement budget worksheet You will need to save money each month
contains the following information: during your working career to provide you
• Your current annual income and with enough money to live on when you
projected income stop working.
• Your current annual expenses and
projected expenses
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Key Points: A Projected Retirement Find the Solutions
Budget Worksheet helps you calculate 1. What are the current annual expenses?
the difference between your projected 2. Why would they not list a mortgage or rent
retirement income and your projected payment as an expense in retirement?
expenses. This worksheet will help you 3. Why might food and vehicle expenses go
down when they retire?
determine how much money you will
4. Why might the Rathcliffs not have a life
need to save for retirement years.
insurance expense in retirement?
5. Do they have enough projected income?
494 Unit 4 Protecting Your Finances
Annuities
Why do people purchase annuities in addition to
other retirement plans?
What do you do if you have funded your 401(k), 403(b), Keogh,
or profit-sharing plans up to the allowable limits and you want to put LANGUAGE ARTS
away more money for retirement? The answer may be an annuity. An Employer pension plans
annuity is a contract purchased from an insurance company that can be beneficial not
only to employees but
guarantees a future fixed or variable payment to the purchaser for a
to employers as well. For
certain number of years or for life. example, employers may
You might also want to purchase an annuity with the money receive a tax credit for
you receive from an IRA or company pension. You can buy an annu- part of the costs of start-
ity to supplement the income you will receive from these other types ing up a retirement plan.
of retirement plans. You can choose to purchase an annuity that has a They may also receive a
tax deduction for any plan
single payment or installment payments. You will also need to decide
contributions they make.
whether you want the insurance company to send the income from Write an essay explain-
your annuity to you immediately or begin sending it to you at a later ing why a retirement plan
date. The payments you receive from an annuity are taxed as ordi- is beneficial to employ-
nary income. However, the interest you earn from the annuity accu- ers and how that benefits
mulates tax-free until payments begin. employees.
GOLDEN TIME With continuing
revisions in the Social Security system,
many people are thinking ahead and
making arrangements for supplemen-
tal income in their golden years. What
advantage does an annuity offer?
Chapter 15 Retirement and Estate Planning 495
Types of Annuities
Annuities may be fixed or variable. Fixed annuities provide a
certain amount of income for life. Variable annuities provide pay-
ments guaranteed above a minimum amount, depending on the rate
of return on your investment. Either way, the rate of return on an
annuity is usually tied to overall interest rates.
Immediate Annuities People approaching retirement age can
purchase immediate annuities. These annuities provide income
payments at once. They are usually purchased with a lump-sum
payment. When you are 65, you may no longer need all of your life
insurance coverage—especially if you have grown children. You may
decide to convert the cash value of your insurance policy into a lump-
sum payment for an immediate annuity.
Deferred Annuities With deferred annuities, income payments
start at some future date. Meanwhile, interest accumulates on the
money you deposit. Younger people often buy such annuities to
save money toward retirement. A deferred annuity purchased with
a lump-sum payment is known as a single-premium deferred annuity.
A “premium” is the payment you make. These annuities are popular
because of the greater potential for tax-free growth. If you are buying
a deferred annuity on an installment basis, you may want one
that allows flexible premiums, or payments. That means that your
contributions can vary from year to year.
Costs of Annuities
Common There are various choices regarding the type of annuity and the
CENTS annuity income it will generate. The costs, fees, and other features
of annuities differ from policy to policy, so you should discuss all
of the possible options with an insurance agent. Ask about charges,
Time to Save
fees, and interest-rate guarantees. Also, be sure to check the financial
Saving money in a savings
or retirement account is health of the insurance company that offers the annuity.
the simplest way to build
assets for retirement. Start-
ing to save while you are
Living on Retirement Income
young may even allow What are some things you can do to stretch
early retirement. However, retirement income farther?
if you have 30 or 40 years
until retirement, every year As you plan for retirement, you will estimate a budget or spend-
without saving can sub- ing plan. When the time to retire arrives, however, you may find that
tract from one to five years your expenses are higher than you had expected. If that is the case,
off retirement. At what age you will have to make some adjustments.
will you want to retire? First, make sure that you are getting all the income to which
you are entitled. Are there other programs or benefits for which
you might qualify? You will also need to think about any assets
or valuables you might be able to convert to cash or into other
sources of income.
496 Unit 4 Protecting Your Finances
In addition, retirees can re-examine the trade-off between spend-
ing and saving. For example, instead of taking an expensive vacation,
they can take advantage of free and low-cost recreation opportunities,
such as public parks, museums, libraries, and fairs, which are enjoy-
able options. Retirees can also receive special discounts at movie
theaters, restaurants, stores, and more.
Working During Retirement
Retirees can use their skills and time instead of spending money.
Some people decide to work part-time after they retire. Some even
take new full-time jobs. Many people prefer to keep active and pursue
new careers. Work can provide a person with a greater sense of useful-
ness, involvement, and self-worth. It is also a good source of supple-
mentary retirement income.
RETIREMENT INCOME The income needed during retirement can come from various
sources. What are some possible sources of income you might find?
Chapter 15 Retirement and Estate Planning 497
Using Your Nest Egg
When should you take money out of your “nest egg,” or savings,
during retirement? The answer depends on your financial circum-
stances, your age, and how much you want to leave to your heirs.
Your heirs are the people who will have the legal right to your assets
when you die. Your savings may be large enough to allow you to live
comfortably on just the interest earned by your savings. On the other
hand, you may need to make regular withdrawals to help finance
your retirement. However, do so with caution.
If you dip into your retirement funds, you should consider: how
long your savings will last if you make regular withdrawals? For exam-
ple, if you have $10,000 in savings that earns 5.5 percent interest,
compounded quarterly, you could take out $68 every month for 20
years before reducing those savings to zero. Whatever your situation,
you should try to conserve your retirement fund to make it last.
Section 15.2 Assessment
QUICK CHECK Calculate How much money will
1. What are the eligibility requirements to Jamal have in his IRA at the end of
receive Social Security retirement benefits? ten years, assuming that the interest rate
2. What is the difference between defined-con- remains the same and that he does not
tribution plans and defined-benefit plans? deposit any additional money? Show your
3. What is the difference between regular IRAs calculations in the form of a chart.
and Roth IRAs?
SOLVE MONEY PROBLEMS
THINK CRITICALLY 6. Making Decisions Mike Johnson has
4. Describe the trade-offs that you would need worked for the same company for 45 years.
to consider if you reached retirement age Now, at age 67, he is about to retire. When
and realized that your expenses were higher he does, he will be entitled to receive the
than you could afford. $600,000 that has accumulated in his 401(k)
plan. Now Mike has to decide what to do
USE MATH SKILLS with the money. If he manages it wisely, it
5. Growing a Nest Egg When Jamal gradu- can help make his retirement years comfort-
ated from college recently, his parents gave able and rewarding.
him $1,000 and told him to use it wisely. Analyze Use what you have learned
Jamal decided to use the money to start in this section to help Mike decide
a retirement account. After doing some what to do with his 401(k) funds. Consider
research about different options, he put the options available to him, such as roll-
the entire amount into a tax-deferred IRA over IRAs and annuities. Explain why your
that pays 11 percent interest, compounded recommendation would make the best use
annually. of Mike’s money.
498 Unit 4 Protecting Your Finances
Section 15.3
Estate Planning Focus on
Reading
and Taxes
Read to Learn
• How to identify various
The Importance of types of wills.
• How to discuss several
Estate Planning types of trusts.
Why is it important to have an estate plan? • How to describe common
Many people think of estates as belonging only to the rich or characteristics of estates.
elderly. However, the fact is that everyone has an estate. An estate is • How to identify the types
of taxes that affect estates.
all property and assets owned by an individual or group. During your
working years, your financial goal is to build your estate by acquiring
Main Idea
and accumulating money for your current and future needs. How-
Different types of wills and
ever, as you grow older, your point of view will change. Instead of
trusts protect your financial
working to acquire assets, you will start to think about what will hap- interests and those of your
pen to your hard-earned wealth after you die. In most cases, people family. Applying strategies
want to pass that wealth along to their loved ones. That is why estate for paying estate taxes can
planning becomes important. help limit expenses for
your heirs.
What Is Estate Planning? Key Terms
Estate planning is the process of creating a detailed plan for • estate
• estate planning
managing personal assets to make the most of them while you are
• beneficiary (estate)
alive and to ensure that they are distributed wisely after your death. • will
It is not pleasant to think about your own death, but doing so is a • intestate
necessary part of estate planning. Without a good estate plan, the • trust
assets you accumulate during your lifetime might be greatly reduced • probate
by various taxes when you die. • executor
• guardian
Estate planning is an essential part of retirement planning and
• codicil
financial planning. It has two stages. The first stage involves building • living will
your estate through savings, investments, and insurance. The second • power of attorney
stage consists of making sure that your estate will be distributed as
you wish at the time of your death. If you get married, your estate
planning should take into account the needs of your spouse and
children, if you have any. If you are single, your financial affairs Before
should be in order for your beneficiaries. A beneficiary (estate) is a You Read
person who is named to receive a portion of someone’s estate.
When you die, your surviving spouse, children, relatives, and/or PREDICT
friends will face a period of grief. One or more of these people will What is your definition of
probably be responsible for settling your affairs. This will be a diffi- a will?
cult time, and so your estate plan should be clear and well-organized.
Chapter 15 Retirement and Estate Planning 499
Otherwise, the people you have left
behind may encounter problems
settling your estate, and your inten-
tions may not be carried out accord-
ing to your wishes. One way to avoid
these problems is to make sure that
important documents are acces-
sible, understandable, and legal.
Legal Documents
An estate plan involves vari-
ous legal documents such as a will,
which is a legal declaration of a per-
son’s wishes regarding disposal of
his or her estate after death. When
you die, the person who is respon-
sible for handling your affairs will
need access to your will and other
important documents. The docu-
ments must be reviewed and veri-
fied before your heirs can receive
the money and other assets to
which they are entitled. If no one
can find the necessary documents,
your heirs may experience difficult
delays. They could even lose a por-
tion of their inheritance as a result.
You should collect and organize
various important papers:
ASSETS AND POSSESSIONS • Birth certificates for you, your spouse, and your children
Most people have various • Marriage certificates and divorce papers
assets and possessions that • Legal name changes (especially important for protecting
make up their estate. What adopted children)
does your estate consist of at • Military service records
this point in your life? • Social Security documents
• Veteran’s documents
• Insurance policies
• Transfer records of joint bank accounts
• Safe-deposit box records
• Automobile registrations
• Titles to stock and bond certificates
Have several copies of the documents needed for processing
insurance claims and settling your estate. In some cases, children
whose parents have died may need to have documents proving their
parents’ births and marriage and/or divorce. Surviving spouses, chil-
dren, and other heirs may also be required to show proof of death in
the form of a death certificate.
500 Unit 4 Protecting Your Finances
Wills
Why is a will such an important document?
One of the most important documents that every adult should
have is a written will. If you die intestate—which is the status
of not having a valid will—your legal state of residence will step
in and control the distribution of your estate without regard for
your wishes. Make sure that you have a written will. An attorney
with estate planning experience can draft a will, which can help
your heirs avoid many difficulties. Legal fees for drafting a will vary
with the size of an estate and particular family situation. A standard
will costs between $200 and $500.
Types of Wills
You have several options in preparing a will. The four basic
types of wills are the simple will, the traditional marital share will,
the exemption trust will, and the stated dollar amount will. The dif-
ferences among the types of wills can affect how your estate will
be taxed.
All types of wills usually designate a beneficiary, the person who
is named to receive a portion or all of an estate after your death.
A beneficiary can be a spouse, relative, friend, or organization. In
the following discussions, the beneficiary will be referred to as
the spouse.
Simple Will A simple will leaves everything to the spouse. Such a
will is generally sufficient for people with small estates. However, for
a large or complex estate, a simple will may not meet objectives. This
type of will may also result in higher overall taxation, since everything
left to the spouse will be taxed as part of his or her estate.
Traditional Marital Share Will The traditional marital share
will leaves one-half of the adjusted gross estate (the total value of
the estate minus debts and costs) to the spouse. The other half of the
estate may go to children or other heirs. It can also be held in trust for
the family. A trust is an arrangement in which a designated person
known as a trustee manages assets for the benefit of someone else. A
trust can provide a spouse with a lifelong income and would not be
taxed at his or her death.
Exemption Trust Will With an exemption trust will, all assets go
to the spouse except for a certain amount, which goes into a trust.
This amount, plus any interest it earns, can provide the spouse with
lifelong income that will not be taxed. In 2004 and 2005, the tax
exemption amount was $1.5 million. That amount increased to
$2 million for the years 2006 through 2008. In 2009, the amount
increases to $3.5 million. The tax-free aspect of this type of will may
become important if property values increase considerably. This type
of will is beneficial for large estates.
Chapter 15 Retirement and Estate Planning 501
Stated Dollar Amount Will The stated dollar amount will allows
you to pass on to your spouse any amount that satisfies your family’s
financial goals. For tax purposes, you could pass on the exempted
amount of $1.5 million (in 2004 and 2005). However, you might
decide to pass on a stated amount related to your family’s future
income needs or related to the value of personal items.
State law may dictate how much you must leave to your spouse.
Most states require that the spouse receive a certain amount, usu-
ally one-half or one-third of the value of an estate. States also have
laws regarding when and how portions of an estate must pass to
beneficiaries.
The stated dollar amount will has one major drawback. Suppose
that you leave specific dollar amounts to your listed heirs and the bal-
ance to your spouse. Although these amounts may be fair and reason-
able when the will is drafted, they can soon become outdated. What
if the value of the estate decreases because of a business problem or
a drop in the stock market? That decrease will not affect heirs who
are left specific dollar amounts, but it will affect the value of your
spouse’s inheritance. For this reason, most experts recommend using
percentages rather than specific amounts.
PEACE OF MIND Preparing a will can make things easier for your family and can ensure that your
estate is distributed according to your wishes. What would happen if an adult were to die without preparing
a will?
502 Unit 4 Protecting Your Finances
Wills and Probate As You
The type of will that is best for your particular needs depends on Read
many factors, including the size of your estate, inflation, your age, and RELATE
your objectives. No matter what type of will you choose, it is best to
avoid probate. Probate is the legal procedure of proving that a will What situations might
is valid or invalid. It is also the process by which your estate is man- motivate you to change
your will?
aged and distributed after your death, according to the provisions of
your will. A special probate court validates wills and makes sure that
your debts are paid. You should avoid probate because it is expensive,
lengthy, and public. As you will read later in this chapter, a living trust
avoids probate and is also less expensive, quicker, and private.
Formats of Wills
Wills may be either holographic or formal. A holographic will is
a handwritten will that you prepare yourself. It should be written,
dated, and signed entirely in your own handwriting. No printed or
typed information should appear on its pages. Some states do not rec-
ognize holographic wills as legal.
A formal will is usually prepared with the help of an attorney. It
may be typed, or it may be a preprinted form that you fill out. You
must sign the will in front of two witnesses; neither witness can be a
beneficiary named in the will. Witnesses must sign in front of you.
A statutory will is prepared on a preprinted form, which is avail-
able from lawyers, office-supply stores, and some stationery stores.
There are serious risks in using preprinted forms to prepare your will.
The form may include provisions that are not in the best interests of
your heirs. If you change the preprinted wording, part or all of the
will may be declared invalid. Furthermore, the form may not remain
up-to-date with current laws regarding wills. For these reasons, it is
best to seek a lawyer’s advice when you prepare your will.
Writing Your Will
Writing a will allows you to express exactly how you want your
property to be distributed to your heirs. It is the only way to make
sure that all of your property will end up where you want it. Some
guidelines for writing a will include:
1. Work closely with your spouse or partner to prepare your will.
2. Write your will to conform to your current wishes.
3. Do not choose a beneficiary as a witness.
4. Consider signing prenuptial agreement if you are remarrying.
5. Consider using percentages instead of dollar amounts.
6. If you are married, your spouse should also write a will.
7. Be flexible.
8. Keep your original will in a safe place and a copy at home.
9. If you alter your will, prepare a new one or add a codicil.
10. Select an executor who is willing to do the needed tasks.
Chapter 15 Retirement and Estate Planning 503
Selecting an Executor An executor is a person who is willing
and able to perform the tasks involved in carrying out a will. These
tasks include preparing an inventory of assets, collecting any money
due, and paying off debts. An executor must also prepare and file
all income and estate tax returns. In addition, he or she will be
responsible for making decisions about selling or reinvesting assets
to pay off debts and provide income for your family while the estate
is being settled. Finally, an executor must distribute the estate and
make a final accounting to beneficiaries and to the probate court. An
executor can be a family member, a friend, an attorney, an accountant,
or the trust department of a bank. You may also name a beneficiary as
the executor. State law sets fees for executors. If you do not name an
executor in your will, the court will appoint one. Naming your own
executor eliminates that possibility and helps prevent unnecessary
delay in the distribution of your property. It will also minimize estate
taxes and settlement costs.
Selecting a Guardian If you have children, your will should name
a guardian to care for them in the event that you and your spouse
die at the same time and the children cannot care for themselves. A
guardian is the person who accepts the responsibility of caring for
the children of the deceased and managing an estate for the children
until they reach a certain age. Many states require a guardian to post
a bond (several hundred dollars) with the probate court. The bonding
company will reimburse the minor’s estate the amount of the bond
if the guardian uses the minor’s property for his or her own gain.
When you name a guardian for your children, choose someone you
know who loves them and shares your beliefs about raising children.
Of course, the person must also be capable and willing to accept the
responsibilities associated with the role of being a parent.
Altering or Rewriting Your Will There may be times when you
wish to change the provisions of your will because of changes in your
life or in the law. After you have made a will, review it frequently so
that it remains current. Here are some reasons to review your will:
• You have moved to a new state that has different laws.
• You have sold property that is mentioned in the will.
• The size and composition of your estate have changed.
• You have married, divorced, or remarried.
• Potential heirs have died, or new ones have been born.
Do not make any written changes on the pages of an existing will.
Additions, deletions, or erasures on a will that has been signed and wit-
nessed can invalidate the will. If you want to make only a few minor
changes, adding a codicil may be the best choice. A codicil is a docu-
ment that explains, adds, or deletes provisions in an existing will. To
be valid, it must meet the legal requirements for a will. If you want to
make major changes in your will, or if you have already added a codi-
cil, it is best to prepare a new will. In the new will, be sure to include a
clause that revokes, or cancels, all earlier wills and codicils.
504 Unit 4 Protecting Your Finances
A Living Will
Why is it important to have a living will?
At some point in your life, you may become physically or men-
tally disabled and unable to act on your own behalf. If that happens,
a living will can help ensure that you will be cared for according to
your wishes. A living will is a legal document in which you state
if you want to be kept alive by artificial means if you become termi-
nally ill and are unable to make such a decision. Many states recog-
nize living wills. Figure 15.7 illustrates a typical living will. Sign and
date the document before two witnesses. Review your living will from
time to time to update your decisions.
&IGURE ! ,IVING 7ILL
Living Will Declaration
Declaration made this _____ day of ______ (month, year)
I, _________________________, being of sound mind, willfully and voluntarily make
known my desire that my dying shall not be artificially prolonged under the circumstances
set forth below, do hereby declare: if at any time I should have an incurable injury, disease,
or illness regarded as a terminal condition by my physician and if my physician has
determined that the application of life-sustaining procedures would serve only to artificially
prolong the dying process and that my death will occur whether or not life-sustaining
procedures are utilized, I direct that such procedures be withheld or withdrawn and that I be
permitted to die with only the administration of medication or the performance of any
medical procedure deemed necessary to provide me with comfort care.
In the absence of my ability to give directions regarding the use of such life-sustaining
procedures, it is my intention that this declaration shall be honored by my family and
physician as the final expression of my legal right to refuse medical or surgical treatment
and accept the consequences from such refusal. I understand the full import of this
declaration, and I am emotionally and mentally competent to make this declaration.
Signed _________________________
City, County, and State of Residence_________________________
The declarant has been personally known to me, and I believe him or her to be of sound mind.
Witness_________________________
Witness_________________________
-AKING #HOICES ! LIVING WILL ENSURES THAT A PERSONS PREFERENCE ABOUT MEDICAL CARE IS
HONORED IF HE OR SHE BECOMES TERMINALLY ILL OR FALLS INTO A COMA
7HAT IS THE BASIC PURPOSE OF A LIVING WILLS
Chapter 15 Retirement and Estate Planning 505
You might consider writing a living will when you draw up a tra-
ditional will. Most lawyers will prepare a living will at no cost if they
are already preparing a traditional will or your estate plan. You can
also get the necessary forms for a living will from nonprofit groups
such as Aging With Dignity.
Power of Attorney
A power of attorney is a legal document that authorizes some-
one to act on your behalf. If you become seriously ill or injured, you
will probably need someone to take care of your needs and personal
affairs. This can be done through a power of attorney.
You can assign a power of attorney to anyone you choose. You
can give that person power to carry out only certain actions or trans-
actions, or you may allow the person to act on your behalf in all mat-
ters, including your living will.
Letter of Last Instruction
In addition to a traditional will and a living will, it is a good
idea to prepare a letter of last instruction. This document is not
legally binding, but it can provide heirs with important informa-
tion. It should contain preferences for funeral arrangements as well
as the names of the people who are to be informed of the death.
With a letter of last instruction, you can also let people know the
locations of your bank accounts, safe-deposit box, and other impor-
tant items.
Trusts
Why is it important that trusts avoid probate?
Basically, a trust is a legal arrangement that helps manage the
assets of your estate for your benefit or that of your beneficiaries.
The creator of the trust is called the trustor, or grantor. The trust is
administered by the trustee, which can be a person or an institution,
such as a bank. A bank charges a small fee for its services in admin-
istering a trust. The fee is usually based on the value of the assets in
the trust.
Individual circumstances determine whether it makes sense to
establish a trust. Some of the common reasons for setting up a trust
are to:
• Reduce or provide for payment of estate taxes.
• Avoid probate and transfer your assets immediately to your
beneficiaries.
• Free yourself from managing your assets while you receive a
regular income from the trust.
• Provide income for a surviving spouse or other beneficiary.
• Ensure that your property serves a desired purpose after your
death.
506 Unit 4 Protecting Your Finances
IN WHOM WE TRUST For some people, setting up a trust is an effective way to organize and
manage an estate. What are some of the main reasons to establish a trust?
Types of Trusts
There are many types of trusts, including a credit-shelter trust, a
disclaimer trust, a living trust, and a testamentary trust. Choose the
type of trust that is most appropriate for your situation. An estate
attorney can advise you about the right type of trust for your needs.
Trusts can be either revocable or irrevocable. A revocable trust is
one in which you have the right to end the trust or change its terms
during your lifetime. Revocable trusts avoid the lengthy process of
probate, but they do not protect assets from federal or state estate
taxes. An irrevocable trust is one that cannot be changed or ended.
Irrevocable trusts avoid probate and help reduce estate taxes. How-
ever, by law you cannot remove any assets from an irrevocable trust,
even if you need them at some later point in your life.
Credit-Shelter Trust A credit-shelter trust is a trust that enables the
spouse of a deceased person to avoid paying federal taxes on a certain
amount of assets left to him or her as part of an estate. As of 2004,
the exemption amount was $1.5 million. It increased to $2 million in
2006 and continues to increase to $3.5 million in 2009. As the most
common estate-planning trust, the credit-shelter trust has many other
names: bypass trust, residuary trust, A/B trust, exemption equivalent
trust, and family trust. A single person does not need to set up a
credit-shelter trust because assets passing to someone other than a
spouse automatically qualify for the estate exemption amount.
Chapter 15 Retirement and Estate Planning 507
Disclaimer Trust A disclaimer trust is appropriate for couples
As You who do not have enough assets to need a credit-shelter trust but who
Read may in the future. With a disclaimer trust, the surviving spouse is
QUESTION left everything, but he or she has the right to disclaim, or deny, some
portion of the estate. Anything that is disclaimed goes into a credit-
What are the advantages of shelter trust. This approach allows the surviving spouse to protect
creating a trust?
wealth from estate taxes.
Living Trust A living trust, also known as an inter vivos trust, is
a property management arrangement that you establish. It allows
you, as trustor, to receive benefits during your lifetime. To set up
a living trust, you simply transfer some of your assets to a trustee.
Then you give the trustee instructions for managing the trust while
you are alive as well as after your death. A living trust has several
advantages:
• It ensures privacy. A will is a public record; however, a trust is
not a public record.
• The assets held in trust avoid probate at your death. This
eliminates probate costs and delays.
• It is advantageous if you own property in more than one state.
• It enables you to review your trustee’s performance and make
changes if necessary.
• It can relieve you of management responsibilities.
• It is less likely than a will to create arguments between heirs
upon your death.
• It can guide your family and doctors to follow your wishes if
you become terminally ill or if you become unable to make
your own decisions.
Setting up a living trust costs more money than creating a will.
However, depending on your particular circumstances, a living trust
can be a good estate planning option.
Testamentary Trust A testamentary trust is established by your
will and becomes effective upon your death. Such a trust can be
valuable if your beneficiaries are inexperienced in financial matters.
It may also be the best option if you expect your estate taxes will be
high. A testamentary trust provides many of the same advantages as
a living trust.
Your Estate
How does the type of joint ownership affect the
distribution of an estate?
As you learned earlier in this chapter, your estate consists of
everything you own. Therefore, an important step in estate planning
is taking inventory of your assets. Do not forget to include in your
inventory jointly owned property, life insurance policies, employee
retirement benefits, money owed to you by others, and all of your
personal possessions.
508 Unit 4 Protecting Your Finances
Some states are known as community-property states. Community
Put on
property is any money earned by either spouse during the marriage
and any property or possessions purchased with that money. It does Your
not include assets received as gifts or through inheritances. In com- Financial
munity-property states, each spouse owns 50 percent of the property. Planner’s
Thus, half of the couple’s assets are included in each spouse’s estate.
In non-community-property states, property is included in the
Cap
estate of the spouse who owns it. The way you own property can If your clients just got mar-
make a significant tax difference. ried and you were planning
their estate, why would you
tell them to own property as
Joint Ownership “tenants in common”?
Joint ownership of property between spouses is very common.
Joint ownership may also exist between parents and children or other
relatives. Joint ownership may help avoid probate and inheritance
taxes in some states. However, it does not avoid federal estate taxes. It
may, in fact, increase the amount of federal estate taxes.
There are three types of joint ownership, each of which has dif-
ferent tax and estate-planning consequences.
1. You and your spouse may own property as “joint tenants
with the right of survivorship.”
• The property is considered to be owned 50–50 for estate
tax purposes and will automatically pass to one spouse at
the other’s death.
• No estate tax is paid at the first death. However, when the
surviving spouse dies, more estate taxes may be due than
with a traditional marital share will.
2. You and your spouse may own property as “tenants in
common.”
• Each individual is considered to own a certain share of
property for tax purposes, and only your share is included
in your estate.
• Your share does not go to the other tenant in common at
your death. Instead, it is included in your probate estate,
and you decide who gets it.
• Gift and estate taxes do not apply to property that belongs
to spouses.
3. Married couples may own property under the form of
“tenancy by the entirety.”
• Both spouses own the property.
• When one spouse dies, the other gets the property
automatically.
• Neither spouse may sell the property without the consent
of the other.
Joint ownership is a poor substitute for a will because it provides
less control over how property is distributed and taxed after death.
State laws govern the types and effects of joint ownership. An attor-
ney should be consulted on these matters.
Chapter 15 Retirement and Estate Planning 509
Life Insurance and Employee Benefits
If you have life insurance, the benefits of that insurance will be
counted among the assets in your estate. Life insurance benefits are
Avoiding Financial free of income tax, and they do not go through probate. They are also
Fraud partially exempt from most state inheritance taxes. However, they
Many people with assets are subject to federal estate taxes under certain circumstances, such
protect their heirs from as when you change beneficiaries, surrender the policy for cash, or
estate problems by setting make loans on the policy.
up trust funds. However,
Death benefits from qualified employer pension plans or Keogh
since trusts are so popular,
trust preparation is a ser- plans are usually excluded from an estate. One exception is if the
vice targeted by a number benefits are payable to the estate. Another exception is if the benefi-
of sophisticated con-artists. ciary chooses a special provision for averaging income tax in lump-
Learn how to avoid estate- sum distributions.
planning fraud.
To continue with
Task 5 of your Lifetime Gifts and Trusts
WebQuest project, visit
You may give part of your estate as a gift or set up a trust for your
finance07.glencoe.com.
spouse or a child. Under certain conditions, such gifts and trusts are
not included as part of your estate upon your death. However, if you
keep any control or use of the gift or trust, it remains part of your estate
and is subject to taxes. For example, if you transfer title of your home
to a child but continue to live in it, the value of the home is taxed as
part of your estate. Similarly, if you put property in a trust but keep
some control over the income or principal, the property is included in
your estate even though you may not be able to obtain it yourself.
Taxes and Estate Planning
Which government, state or federal, imposes
inheritance taxes?
Federal and state governments impose various types of taxes
that you must consider in estate planning. The four major types of
taxes are estate taxes, estate and trust federal income taxes, inheri-
tance taxes, and gift taxes.
Estate Taxes
After You An estate tax is a federal tax collected on the value of a person’s
Read property at the time of his or her death. The tax is based on the
REACT fair market value of the deceased person’s investments, property, and
bank accounts, less an exempt amount.
Has the information in this As of 2006, the exempt amount was $2 million. This means that
chapter convinced you to the “first” $2 million is not used to compute the estate tax. Only
start your retirement plan-
the amount in excess of $2 million can be considered. The exempt
ning sooner than you may
have originally planned? amount is $3.5 million in 2009. The tax rate applied to the remaining
Why or why not? amount is 48 percent. With careful planning, federal estate taxes can
be avoided for estates over $2 million.
510 Unit 4 Protecting Your Finances finance07.glencoe.com
DEATH AND TAXES
Dealing with the financial
aspects of a person’s death
can be a difficult burden for
the heirs. What are the various
types of taxes to consider for
estate planning?
Estate and Trust Federal Income Taxes
In addition to the federal estate tax return, owners of estates and
certain trusts must file federal income tax returns with the IRS. Tax-
able income for estates and trusts is computed in the same manner as
taxable income for individuals. Taxes must be paid quarterly on both
trusts and estates.
Inheritance Taxes
Your heirs might have to pay a tax for the right to acquire the
property that they have inherited. An inheritance tax is a tax col-
lected on the property left by a person in his or her will.
Only state governments impose inheritance taxes. Most states
collect an inheritance tax, but state laws differ widely as to exemp-
tions and rates of taxation. A reasonable range for state inheritance
taxes would be 4 to 10 percent of whatever the heir receives.
Gift Taxes
Both the federal and state governments impose a gift tax, a tax
collected on money or property valued at more than $11,000 given
by one person to another in a single year. One way to reduce the tax
liability of your estate is to reduce the size of the estate while you are
alive by giving away portions of it as gifts. You are free to make such
gifts to your spouse, children, or anyone else at any time. However,
when doing this, be careful that you do not give away assets that you
may need in your retirement.
Chapter 15 Retirement and Estate Planning 511
According to federal law, you may give up to $11,000 per person
per year free of any gift tax. A married couple may give up to $22,000
per person per year without paying the tax. Gifts that exceed those
amounts are subject to the tax. Gift tax rates are currently the same as
estate tax rates, and they are called unified transfer tax rates. However,
gifts might be considered as part of your estate and be taxed if they
were given within three years of your death. Many states have other
gift tax laws as well.
Paying the Tax
After doing everything possible to reduce your estate taxes, you
may still find that taxes are due. In that case, you will have to think
about the best way to help your heirs pay the taxes. The federal estate
tax is due nine months after a death. State taxes, probate costs, debts,
and other expenses are also usually due within that same period.
These costs might result in a real financial problem for your survi-
vors. Finding enough cash to pay taxes, debts, and other costs with-
out causing financial hardship can be very difficult.
There are a number of ways this problem can be handled.
1. Obtain life insurance. A life insurance policy may be the best
way to provide your heirs with the tax-free cash that they
will need to settle your estate.
2. Save enough cash ahead of time to pay taxes and expenses
when they are due. However, the cash may be subject to
income tax during your lifetime and also subject to estate tax
at your death.
3. Your heirs could sell assets to pay
taxes. However, this could result
in the loss of important sources of
income.
4. Your heirs might borrow money.
However, it is unusual to find a
commercial lender that will lend
money to pay taxes. Besides, bor-
rowing money only prolongs the
problem and adds interest costs in
the process.
FOR LIFE Considering the expense of
estate taxes can mean more money or
assets for your family or heirs. What are at
least two sources of funds to pay for taxes and
debts when settling an estate?
512 Unit 4 Protecting Your Finances
5. If your family members or beneficiaries can show they have
a reasonable cause, the IRS may allow them to make deferred
or installment payments on taxes that are due. However, like
borrowing, making payments may prolong the problem.
Planning for the Future
Estate planning is essential not only to ensure that your assets
are distributed in the way you choose, but also to make sure that your
loved ones are not left with difficult or costly problems.
Planning for your estate and taxes as well as writing a will are
just a few of the steps you can take to have a secure financial future
for yourself and others. In addition, planning and saving for your
own retirement will help ensure that your needs are met in your later
years. Remember that the trade-offs, decisions, and goals that you
make for yourself today affect your personal finances, which will con-
tinue to affect your life now and in the future.
Section 15.3 Assessment
QUICK CHECK Analyze If Joel or Rachel dies in
1. What are the four basic types of wills? between 2006 and 2008, how much
2. What is a credit-shelter trust, a disclaimer federal estate tax would the surviving
trust, and a living trust? spouse have to pay, assuming that the estate
3. What are several strategies that you might is taxed at the 48 percent rate?
use to arrange for paying estate taxes?
SOLVE MONEY PROBLEMS
THINK CRITICALLY 6. Cost versus Satisfaction Irving and
4. Which format of a will—holographic or Irma Lansing are making plans for the dis-
formal—is the best from a legal point of tribution of their assets after they die. They
view? Why? have wills, but they want to make sure
that they are using the right type of will
USE MATH SKILLS to maximize the benefits for the surviving
5. Too Much Money Joel and Rachel Simon spouse and their four grown children. The
are both retired. They have been married for estimated value of their estate is currently
50 years and have amassed an estate worth $1.4 million. However, most of their assets
$2.4 million. If either of them dies between are in high-risk stocks, which can vary
the years 2006 and 2008, the surviving greatly in value depending on economic
spouse can receive $2 million tax-free. The conditions and the stock market.
amount over that exemption will be sub- Write About It Help Irving and
ject to federal estate tax. The couple has no Irma by writing a summary of the
trusts or other types of tax-sheltered assets. benefits and drawbacks of the four main
types of wills. Identify which type would be
best for them.
Chapter 15 Retirement and Estate Planning 513
Chapter 15 Review & Activities
CHAPTER SUMMARY
• The sooner you start planning and • Personal retirement accounts include
saving for retirement, the faster your regular IRAs, Roth IRAs, SEP plans,
assets will accumulate. Spousal IRAs, Rollover IRAs, Education
• Estimating your living expenses is IRAs, and Keogh plans.
the first step of retirement planning. • The various types of wills include
Housing needs will depend on your simple wills, traditional marital share
desires and your health. wills, exemption trust wills, and stated
• Social Security provides a regular dollar amount wills.
monthly income payment but is not • The several types of trusts include
meant to cover all retirement expenses. credit-shelter trusts, disclaimer trusts,
• Employer pension plans include two living trusts, and testamentary trusts.
types: A defined-contribution plan is an • One common characteristic of many
individual account for each employee estates is joint ownership of property
into which an employer contributes between spouses.
a specific annual amount; a defined- • Estates are taxed with estate taxes,
benefit plan specifies benefits based on estate and trust federal income taxes,
total earnings and years on the job. inheritance taxes, and gift taxes.
Communicating Key Terms
Imagine you are a financial planner for a company. Prepare text for a PowerPoint presentation
using as many of these terms as possible to introduce the employees to estate planning.
• assisted-living facility (ALF) • annuity (insurance) • trust
• defined-contribution plan • heirs • probate
• 401(k) plan • estate • executor
• vesting • estate planning • guardian
• defined-benefit plan • beneficiary (estate) • codicil
• individual retirement account (IRA) • will • living will
• Keogh plan • intestate • power of attorney
Reviewing Key Concepts
1. Identify three ways expenses decrease at retirement.
2. Describe alternative living and housing arrangements for retirement.
3. Identify two reasons Social Security should not be a primary source of retirement funds.
4. Define employer-sponsored defined-contribution plans and defined-benefit plans.
5. Explain the advantages of the Roth IRA over a regular IRA.
6. Explain why creating a living will is an important part of estate planning.
7. Describe the major advantages of trusts.
8. Explain what it means to be an executor of an estate.
9. List some estate planning methods to reduce inheritance taxes.
514 Unit 4 Protecting Your Finances
Chapter 15 Review & Activities
Science The need for retirement planning is greater in the 21st century
because more people are living longer lives.
Research Find out the life expectancy for people born in the United States
in each decade of the 20th century: 1900, 1910, 1920, 1930, 1940, 1950,
1960, 1970, 1980, 1990, and 2000. Then find out how long someone born
today is expected to live. Make a timeline illustrating the life spans. Then list
several reasons why people are living longer lives.
Cost of Living in Retirement Pretend you are in your late 60s.
With careful planning, you have about $35,000 per year for living expenses
after taxes. Find a Web site that compares the cost of living in different cities.
1. Calculate how much you would need if you lived in U.S. cities that are
attractive to retirees, such as West Palm Beach, Florida; Phoenix, Arizona;
and Dallas, Texas.
2. Compute by using spreadsheet or presentation software to develop charts
and/or graphs comparing the cost of living in different cities.
Connect with Economics and Social Studies Because of
longer life expectancies and declining birth rates, fewer workers are currently
paying into the Social Security system than previously, and more people are
in retirement for more years.
1. Research Find out what the American Association of Retired Persons
(AARP) thinks about Social Security and various ideas to reform it.
2. Think Critically Is it “fair” for younger workers to fund current
retirees’ benefits? Do you believe you will receive Social Security benefits
when you retire? Why or why not?
Wills and Trusts You need a lawyer to help you draw up wills and
trusts. However, you can minimize the amount of time a lawyer will have to
spend preparing the will or trust by organizing your documents and doing
some research on your own first.
Log On Use an Internet search engine to find Web sites showing
sample will and trust documents. Answer the following questions:
1. Under what circumstances is a trust essential? Do you need one currently?
2. What are some of your state’s requirements for a will or trust to be valid?
Newsclip: Social Security Reform Social Security reform has
been highly debated in the news for years. Many politicians aim to change
O N L I N E
the system.
Log On Go to finance07.glencoe.com and open Chapter 15.
Learn more about retirement saving options. Write a list of ways to
help save seniors from financial hardships. Also write a list of ways to help
younger people prepare for retirement.
finance07.glencoe.com Chapter 15 Retirement and Estate Planning 515
Chapter 15 Review & Activities
WHAT IS YOUR PERSONALITY?
Part of the fun of planning a successful future is considering your per-
sonal preferences. The closer you can match your activities with your
personality, the more likely you are to enjoy your life. Read through
the following list and write your top three characteristics on a sepa-
rate sheet of paper.
____ 1. I am steady and reliable.
____ 2. I tend to think a lot.
____ 3. I enjoy being by myself.
____ 4. I almost always plan before I do something.
____ 5. I am very emotional.
____ 6. I love being the center of attention.
____ 7. I enjoy drama.
____ 8. I like to express what I feel.
____ 9. I am always ready to get up and go.
____ 10. I like to participate in high-action sports.
____ 11. I am happiest when doing physical activities.
____ 12. I find it hard to keep still.
Thinker: If all of your selections were from numbers 1–4, consider activities that use your
ability to think.
Heartfelt/Feeler/Enthusiast: If all of your selections were from numbers 5–8, you are
probably happiest when doing something that gives you an emotional lift.
Doer: If all of your selections were from numbers 9–12, you enjoy being active.
Adapter: If your selections were from more than one of the three sections ( 1–4, 5–8, or
9–12), you are versatile and could choose activities that require thinking, involve emotions,
or are active.
Continue to think about the different aspects of your personality and consider what types of
activities you like to do. Thinking about these things now will help you better plan for your
retirement years.
516 Unit 4 Protecting Your Finances
Chapter 15 Review & Activities
Your Financial Portfolio
Saving for Retirement
Henri has become eligible to participate in his company’s 403(b) program. He can
invest from 2 to 15 percent of his salary, which is $20,000 a year. The company matches
the first 5 percent at a rate of 50 percent, or 50 cents for every dollar he invests. Henri
has decided to save 5 percent of his salary. Based on the current investment return of
10 percent compounded annually, Henri has calculated how much he would be able to
save over 10 years, including company-matching contributions.
Contributions Interest Total
Henri’s contribution of 5 percent of his
$20,000 salary $1,000/year 10%
Company contribution matching
50 percent of 5 percent of his salary $500/year
1st Year $1,500 $150.00 $1,650.00
2nd Year 1,500 315.00 3,465.00
3rd Year 1,500 496.50 5,461.50
4th Year 1,500 696.15 7,657.65
5th Year 1,500 915.77 10,073.42
6th Year 1,500 1,157.34 12,730.76
7th Year 1,500 1,423.08 15,653.84
8th Year 1,500 1,715.38 18,869.22
9th Year 1,500 2,036.92 22,406.14
10th Year 1,500 2,390.61 26,296.75
Total $15,000 $11,296.75 $26,296.75
Calculate
On a separate sheet of paper, calculate how much you would have in ten years
if you saved $2,000 a year at an annual interest rate of 10 percent, with the company
contributing $500 a year.
Chapter 15 Retirement and Estate Planning 517
Unit 4 LAB
Get a Financial Life!
Making Retirement Procedures
Plans STEP A Step A The Process
If you were Carrie or David,
how would you spend your retirement years?
Overview
1. Write a short story (one or two pages)
Carrie and David have been working and describing how Carrie and David will spend
saving for their retirement for many years. their retirement years. Where will they
Soon it will become a reality. They are look- live? Will they travel? Will they work? Do
ing forward to spending time with their future they have hobbies? Use your creativity and
grandchildren, developing hobbies, traveling, imagination.
volunteering, and maybe even working part- 2. Research long-term care insurance. Then
time, without having to worry about earning help Carrie and David decide whether they
full-time wages. Their goal is to retire within the should purchase it or invest their money in
next five years. They need to develop a clear and another way.
organized plan for how they will spend their 3. Watch a movie or TV show about people
days, how much money their activities will cost, who are retired or nearing retirement age.
and where they will live. You might rent a video or DVD of Grumpy
Old Men, Cocoon, Space Cowboys, or a more
recent film. Make a list of the hobbies and
Resources & Tools activities of the characters. Write one or
two paragraphs comparing the characters’
• Internet (optional) hobbies and activities to those of people
• Math textbook (for reference) you know who are teens or young adults.
• Portfolio (ring binder or file folder) 4. In 2004, about 12 percent of the American
• Public or school library population was 65 or older. By 2050, that
• Word processor number will increase to 21 percent. Many
of these Americans are or will be living in
retirement communities, assisted-living facil-
ities, or nursing homes. As a service project,
plan an activity for a group of senior citi-
zens in your community. You might develop
a craft project, a music festival, or a game
day. Use your imagination. Then contact a
local center and ask if you can present your
activity there.
518 Unit 4 Protecting Your Finances
STEP B Create Your Portfolio
As you work through the pro- STEP C Mathematics
Math skills are essential for
cess, save the results so that you can refer, managing your own finances and planning for
review, and refine. Create a portfolio to show- retirement. Also, employers look for employees
case the information you collected in Step A. who have math skills. Adding, subtracting, mul-
tiplying, dividing, working with fractions and
1. Include your short story about Carrie and
decimals, and using algebra are the basic math
David’s retirement years.
skills used in the workplace.
2. Present your recommendations and reason-
ing on whether or not Carrie and David 1. Create ten word problems using basic math
should purchase long-term care insurance. skills to solve financial problems from
3. Write a summary of the movie or TV show this unit. For example: David’s employer
you watched. Include the list of hobbies and matches David’s contributions to his 401(k)
activities you created and the comparison retirement savings plan. If David contrib-
paragraph you wrote. utes $250 per month to the plan, how many
4. Present your plan for the senior citizens’ years must David continue to save to accu-
activity. If you are able to implement it, mulate $90,000 without interest? ($250 ⫹
survey the participants to find out if they $250 ⫽ $500; $500 ⫻ 12 ⫽ $6,000; $90,000
enjoyed the activity. Ask how you might ⫼ $6,000 ⫽ 15 years)
improve it for another time. 2. Form groups of three, and as a team, solve
the word problems.
3. Compile the problems and their answers
into a classroom notebook. Label the note-
book “Math Problems in Personal Finance.”
If possible, categorize the problems accord-
ing to the skill (adding, subtracting, frac-
tions, and so on).
519
Unit 5
Business
Ownership
and
Planning
Internet
Project
Be Your Own Boss
Have you ever thought that you would like to be
your own boss? Would you like to own your own
spa, restaurant, or gas station? Business ownership
is the dream of all entrepreneurs, and it is never too
early to explore the opportunities. In this project,
you will think about how to start or acquire your
own business. You will also find out more about what
entrepreneurs do, and learn where to get help on the
road to success.
Log on to finance07.glencoe.com. Begin
by reading Task 1. Then continue on your
WebQuest as you study Unit 5.
Section 16.1 17.2 18.3
Page 539 559 588
520 finance07.glencoe.com
FINANCE FILE
Good Works—
with a Business Plan
Just a decade ago, there were virtu-
ally no B-school courses or student proj-
ects on social entrepreneurship. Today
most top business schools have both.
But before such a subject can be
taught, it must be defined. A social
entrepreneur is one driven by a social
mission, a desire to find innovative
ways to solve social problems that are
not being or cannot be addressed by
the market or the public sector. How to
Change the World: Social Entrepreneurs
and the Power of New Ideas by David
Bornstein adopts this broad definition.
Well-documented cases of grassroots
entrepreneurial activities to tackle such
diverse social problems as child abuse,
disability, illiteracy, housing, and envi-
ronmental degradation give life to it.
The search for financing has sparked
a wave of entrepreneurship within the
field of social investment, including
firms dedicated to investing in businesses
that deliver solutions to social problems.
Let’s hope that in the process, they help
restore the public’s trust in the business
community.
—By Laura D’Andrea Tyson
Write About It What are
some examples of successful
businesses that help society?
Log On To read the complete
BusinessWeek article and do the
BusinessWeek Extension activity to
learn more about business ownership
and financial management, go to
finance07.glencoe.com.
finance07.glencoe.com 521
16
CHAPTER
Types of Business
Ownership
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 16.1
• Identify the advantages
and disadvantages of a sole
proprietorship.
• Explain the differences between
general and limited partners.
• Identify the advantages and
disadvantages of a partnership.
Section 16.2
• Describe two types of
corporations.
• Summarize the process of
forming a corporation.
• Discuss the advantages and
disadvantages of a corporation.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
522
In the Real World . . .
M ichaela Garnett began pet-sitting in high school. She had
good instincts for dealing with animals, so her father suggested she get
a part-time job at a pet store while going to college. Main Street Pet Empo-
rium needed extra help and hired Michaela to work three days a week. However,
the owner was about to retire and sell the store. So Michaela approached her bank,
and with her father’s help, made a deal to buy the store. She knew that custom-
ers loved the cats and dogs offered, but they also wanted exotic fish and parrots.
With these new pets, the store’s profits increased. The business is a partner-
ship, but friends have encouraged her to incorporate it. Michaela needs
to find out more about the types of business ownership.
As You Read Consider what type of ownership
would best suit a small business.
Business Ownership
ASK Q: In a sole proprietorship, you get to keep all the
profits for yourself. Why would I want to have all
the hassles of setting up a corporation?
A: Each type of business structure offers advantages and disadvantages. The net
income from a sole proprietorship is taxed at personal income tax rates, but a corpo-
ration’s profits are taxed at lower, corporate tax rates. However, a sole proprietorship
is easier to set up, so you could be in business more quickly.
Ask Yourself Why might you set up a business as a sole proprietorship?
Go to finance07.glencoe.com to complete the Standard and Poor’s
Financial Focus activity.
finance07.glencoe.com Chapter 16 Types of Business Ownership 523
Section 16.1
Focus on
Reading
Sole Proprietorship
and Partnership
Read to Learn
• How to identify the
advantages and dis-
Business Ownership
advantages of a sole
proprietorship.
Organization
Are there different kinds of business ownership?
• How to explain the dif-
ferences between general Understanding how to handle your personal finances can help
and limited partners. prepare you for managing your own business. The abilities to plan,
• How to identify the manage, and keep track of your own money can be applied to han-
advantages and dis- dling a business. If you decide to start a business and manage its
advantages of a
finances, it is important to become familiar with the different types
partnership.
of ownership.
Main Idea When you start a business, you have a choice as to how the
ownership is legally organized. Business ownership can take one of
Understanding and select-
ing the proper form of three legal forms: sole proprietorship, partnership, or corporation. It
organization for your busi- is important to select the most appropriate form of ownership that
ness can be an essential best suits your needs and the needs of your business. This section will
factor in its success. examine the first two forms of business ownership—sole proprietor-
ship and partnership.
Key Terms
• sole proprietorship
• Employer Identification Sole Proprietorship
Number (EIN) What are the characteristics of a sole proprietorship?
• unlimited liability
• limited life The word sole means “single” or “one.” The word proprietor
• partnership means “owner.” A sole proprietorship, therefore, is a business
• partnership agreement owned by one person. The sole proprietorship is the oldest and most
• general partner common form of business ownership. Approximately 75 percent of
• limited partner
all businesses in the United States today are organized as sole propri-
etorships. Although many people think of corporations when they
think about business in the United States, the sole proprietorship is
the backbone of American business.
Before Most sole proprietorships are small-business operations, each
You Read owned by an individual. An individual who starts a business is known
PREDICT as an entrepreneur. Many of these businesses provide services, such as
auto repair, house cleaning, carpentry, or plumbing. They generally
What might be an advan-
operate out of homes, small offices, or storefronts. Some sole propri-
tage of owning your own
business? A disadvantage? etorships become quite successful, but many go out of business. In all
cases, however, the owners of sole proprietorships are pursuing their
dreams of running their own businesses.
524 Unit 5 Business Ownership and Planning
For example, Debbi Fields had a dream of
selling cookies. She created a highly successful
business called Mrs. Fields Cookies. John Johnson
wanted to start a magazine. So he borrowed $500
from his family and created the successful maga-
zine Ebony. Even some major corporations began
as risky ventures by entrepreneurs. The company
Corning would not exist without Amory Hough-
ton, and there would be no Colgate-Palmolive
without the determination of William Colgate.
Advantages of Sole
Proprietorship
Organizing a business as a sole proprietor-
ship has several advantages. The most important
advantage is having the freedom to make all the
decisions. This form of business organization also
has other advantages. You receive all profits and
pay tax once a year as an individual. This type
of business has easy set-up, simple licensing and
paperwork, and few government regulations.
Easy Set-Up A sole proprietorship is the easiest form of business 䊱 SMALL BUSINESS IS BIG
organization to set up. Although local and state governments require Small businesses have tradi-
some paperwork, you can usually complete this without much tionally been the backbone
difficulty. Starting a sole proprietorship does take some effort, but of the American economy.
because a minimal amount of documentation is required, the cost of What small businesses have
organizing a sole proprietorship is relatively low. started in your area recently?
Licensing In many cases, you can organize a sole proprietorship
by simply obtaining a license to do business from your local or state
government. You might also need to obtain a state sales tax number
because you may be required to collect sales tax on any products you
sell to customers.
Business Name If you are planning to operate under a business
name other than your own name, you must apply for a Certificate
of Doing Business Under an Assumed Name. This is also referred to as
a DBA, which stands for “Doing Business As.” For example, Celia
Jontos wants to start a personalized wedding planning service, Time
to Remember. In order to operate legally under this business name,
Ms. Jontos will need to get a DBA certificate.
Employees If you intend to hire one or more employees to work in
your business, you will need an Employer Identification Number. An
Employer Identification Number (EIN) is a number assigned by
the Internal Revenue Service, which is used for income tax purposes.
Many sole proprietors hire managers and several employees. Some
large companies, which are also organized as sole proprietorships,
have hundreds of employees.
Chapter 16 Types of Business Ownership 525
Careers in Finance
CREDIT ANALYST
GENERAL Carolyn King
CONTRACTOR Self-Employed
Carolyn is a natural planner and leader. As a general contractor, she helps homeowners, landlords,
and businesses construct, remodel, or repair their buildings. She may bid to take part of a job—for
example, fixing a kitchen—or oversee an entire project. Carolyn must know prices and plan for
expenses. Whether she handles the entire job or subcontracts parts of the job to electrical, heating,
and plumbing specialists, Carolyn is responsible for the job being done on time and according to the
budget. General contractors enjoy the challenge of working on different types of jobs and the satis-
faction of putting together teams that are right for each project.
SKILLS: Accounting, communication, decision-making, management, math,
negotiation, organization, problem-solving, and time-management skills
PERSONAL TRAITS: Highly motivated, leadership, able to work independently as well as with
others
EDUCATION: High school diploma or equivalent; or bachelor’s degree in construction
science; experience in the field; and contractor’s license exam
ANALYZE Why would a general contractor need to have good money-management skills?
To learn more about career paths for general contractors, visit finance07.glencoe.com.
Total Control As a sole proprietor, you can run your business as you
wish. This is a great advantage because you do not have to convince
partners, stockholders, or other people that your business decisions
are sound. You can choose what merchandise to sell or services to
provide, what prices to charge, and what hours you will work. As
the sole owner of your own business, you make all management and
financial decisions.
Profits to Owner With a sole proprietorship, when your business
makes a profit, you can keep all of it (after you pay taxes). As your
business grows and becomes more successful, you will receive larger
profits. A sole proprietorship allows the owner to reap the rewards of
hard work and determination.
Profits Taxed Once A business organized as a sole proprietorship
does not pay income taxes as a company. You as the owner must
declare the profits of the business on your personal income tax
return. Tax is computed on your total income for the year. If you
operate your business full-time, any profits you make will be counted
as taxable income. If your business operates part-time and you also
have a full-time job, your taxable income will include income from
your job as well as the net income from your business.
526 Unit 5 Business Ownership and Planning finance07.glencoe.com
Few Government Regulations Another benefit of operating as a
sole proprietorship is that you do not have to complete and file many
forms and reports with the state and federal governments. There may
be some government regulations regarding the particular business, Checking Account
but most sole proprietors experience little government red tape. Questions
1. How much money
do I need to open
Disadvantages of Sole Proprietorship a personal or small
business checking
With most choices people make, there is a positive side and a
account?
negative side. Though organizing your business as a sole proprietor-
2. What are the
ship has definite advantages, this form of business organization also
monthly service
has several drawbacks: charges?
• Limited capital 3. Do I need to
• Unlimited liability keep a minimum
amount of money
• Limited human resources
in my account?
• Limited life
4. Will my check-
ing account earn
Limited Capital When you start a sole proprietorship, the only interest?
source of working capital, besides money you borrow, is your own 5. Can I sign up
money. Generally, no one else helps you finance the business. for overdraft
Moreover, the amount of cash available to you may be limited. protection?
Adequate funding and a positive cash flow are essential for a business.
Without a sufficient amount of money to establish the business,
begin operations, and expand, you could have serious difficulties. See
Chapter 19 for a detailed discussion on sources of funding.
Unlimited Liability A major disadvantage of a sole proprietorship
is that if your business is not successful, you are responsible for all
losses. Unlimited liability is a situation in which the owner of
the business is responsible to pay the business debts out of personal
assets. In other words, if your business is unsuccessful, you could lose
your car, home, savings, and other assets. If your business’s financial
situation is bad, you might have to declare personal bankruptcy.
Starting a new business involves a high risk. More than half of
all new businesses fail within five years after being established. If your
business fails, your personal financial position and credit rating could
be seriously damaged.
Limited Human Resources An advantage of a sole proprietorship
is that you are the only decision maker in the business. However, being
the only person in charge can also be a disadvantage. When you are
the sole owner of a business, you cannot rely on other individuals to
help carry the load.
Most people have limited knowledge and talents. Perhaps you
know a lot about certain goods or services, but your basic business
skills are weak. For example, if you start a painting business, you may
have skills in painting, be able to identify different types of paint, and
know the proper way to apply paint to different surfaces. At the same
time, you may have limited business experience in pricing, record-
keeping, or advertising and marketing.
Chapter 16 Types of Business Ownership 527
Poor decisions in purchasing, accounting, or marketing could
As You ruin your business, even when you have a lot of knowledge about your
Read product or service. A sole proprietor must be willing to hire the services
RELATE of people whose different talents and skills will enhance the business.
With the skills you have Limited Life A sole proprietorship has a limited life, a situation
now, do you think you in which a business’s life span or existence is determined by the
would be able to start owner’s life span or the owner’s decision to terminate the business.
a sole-proprietorship The business may also legally end if sold to someone else. In that
business?
case, the new owner creates a new business in his or her name.
The Partnership
What are the characteristics of a partnership?
Some people choose to form a partnership when starting a busi-
ness. A partnership is a business owned by two or more persons.
Partners as co-owners agree voluntarily to operate the business for
profit. When a partnership is formed, the partners sign a special legal
agreement: A partnership agreement is a written document that
states how the partnership will be organized. The agreement includes
the following basic information:
• Names of the partners
• Name and nature of the business
• Amount of investment by each partner
• Duties, rights, and responsibilities of each partner
• Procedures for sharing profits and losses
• How assets will be divided when and if the partnership is
dissolved
In a partnership you and your co-owners decide how to divide
profits and losses from the business. You also outline the duties and
responsibilities of each partner. All partners must agree to the condi-
tions stated in the partnership agreement. The purpose of this written
document is to prevent later disagreements among the partners.
About 5 percent of all businesses in the United States today are
partnerships. However, some large companies began as partnerships
before becoming corporations. For example, in 1876, an icebox maker
named Abram Anderson started a partnership with a fruit merchant
named Joseph Campbell. Their small partnership eventually grew to
become a corporation, the Campbell Soup Company.
General Partners and Limited Partners
Within the category of partnerships, there are two basic types
of partners: general partners and limited partners. In many partner-
ships, all partners are general partners. A general partner is a busi-
ness partner who has decision-making authority, takes an active role
in the operation of the business, and has unlimited liability for all
losses or debts of the partnership. Every partnership has at least one
general partner.
528 Unit 5 Business Ownership and Planning
All general partners have what is known as agency power. Agency
power, also known as mutual agency, is the right to sign contracts that
are legally binding on the partnership. For example, suppose that
Dylan, Juanita, and Charles form a partnership to make bookcases.
Dylan goes to Clinton Wood Products and signs a contract to pur-
chase wood from that company. Dylan acted on behalf of the busi-
ness with agency power, and so the partnership is legally obligated
under the contract.
A partnership can also add limited partners. A limited partner
is a business partner who does not take an active role in decision
making or in running the business. A limited partner’s liability in
the partnership is limited to the amount of his or her investment in
the business. For example, Christa Clark, a limited partner in Low
Country Furniture, invested $25,000 in the business. Christa is not
involved in running the business. Moreover, her financial liability is
limited to her $25,000 investment. That means if the business fails,
the most she can lose is $25,000.
Advantages of the Partnership
Many of the advantages of a partnership are similar to the
advantages of a sole proprietorship. However, instead of being the
only decision maker in a business, you would share decision making
with your partners. More people can generate more ideas and possi-
bly more money. There are several advantages of a partnership:
• Easy set-up
• More skills and knowledge
• Available capital
• Total control by partners
• Profits taxed once
䊴 YOU ARE THE BOSS In
a sole proprietorship,
the owner makes all the
decisions and takes all the
responsibility. However, it
is impossible for one person
to be knowledgeable and
skilled in all areas. What
skills and knowledge might a
sole proprietor owner lack?
Chapter 16 Types of Business Ownership 529
Easy Set-Up A partnership is also relatively easy
to set up. Although some paperwork is required,
it is generally minimal. You may need to obtain
certain local or state business permits or licenses.
For some types of business operations, you
must also know and follow various government
regulations.
The most important legal document of a
partnership is the partnership agreement. All the
terms and conditions of the partnership must be
clearly stated in this written document. Taking
care to make the agreement as complete and clear
as possible can help you to avoid misinterpreta-
tions and misunderstandings between partners as
the partnership and business grow.
More Skills and Knowledge The skills and
knowledge needed to operate the business in
a sole proprietorship are the responsibility of
just one person. In a partnership, however, the
various partners can contribute different skills
and experience. One person may have previous
experience running a similar type of business.
Another partner might have extensive business
or accounting experience. A third partner might
have excellent sales and marketing skills. The
䊱 PROFESSIONAL pooling of talent and knowledge is an advantage that partnerships
PARTNERSHIPS have over sole proprietorships.
Partnerships are common
Available Capital Several individuals in a business partnership
among groups of profes-
can contribute more money to a business venture than one person
sionals, such as architects,
acting alone with only personal assets. Moreover, if additional cash is
lawyers, and accountants.
needed to maintain or expand business operations, it can be easier to
Can you name groups of people
raise capital when several people are working to do so.
in other occupations that might
For example, in 1872, dry goods merchant Levi Strauss received
form partnerships?
a letter from one of his customers, a Nevada tailor named Jacob
Davis. Davis had been making overalls for miners and had come up
with a way to strengthen the pants by adding rivets to the seams. He
wanted to patent his idea but could not afford the $68 he needed to
file the papers. He wrote to Strauss to suggest that they hold the pat-
ent together. When Strauss teamed up with Davis in 1873, Levi’s®
jeans became a reality.
As You Obtaining bank financing may be more feasible when more than
Read one individual is responsible for the loan. Banks may also be more
willing to loan greater sums of money to a partnership than to a sole
QUESTION proprietorship because the risk is shared among the partners.
What are two advantages
The partners’ credit ratings are very important. Avoid entering
of a partnership over a sole a partnership agreement with anyone who has a questionable credit
proprietorship? rating. The ability of all partners to borrow money can be an impor-
tant factor in the success or failure of a business.
530 Unit 5 Business Ownership and Planning
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: An Application for Your Motive: You may decide in the
Employer ID Number future to start your own business. When
An IRS Form SS-4 contains the following you establish a business, you are required
information: by law to apply to the federal government
• Name and address of the business for an employer identification number.
• Type of business
• Date the business started
• Principal activity of the business
--
Key Points: An employer sends an IRS Find the Solutions
Form SS-4 to the federal government. 1. Who should use the Form SS-4?
When received, the government assigns 2. What is the purpose of this form?
the employer a number. The Employer 3. What was the date that this business started?
Identification Number (EIN) helps the 4. In what state was this business incorporated?
government monitor taxes that a business 5. What is the principal activity of the business?
is required to pay. Whenever taxes are paid,
a business must provide its identification
number.
Chapter 16 Types of Business Ownership 531
Total Control by Partners In a partnership the operation of the
Put on
business is the sole responsibility of the general partners, who can
Your do as they want. However, the partners are also responsible for the
Financial success or failure of the business.
Planner’s Profits Taxed Once Like a sole proprietorship, a partnership is
Cap not taxed as a business. Therefore, it is not subject to state or federal
income taxes. The partnership agreement states how the profits of
After working for two years
the partnership should be divided. Each partner must pay personal
as a financial planner, you
have decided to go out on income taxes to the state and federal government, based on his or her
your own. Determine how share of the profits received from the business. Thus, business profits
you want to establish your are taxed only once.
business: as a sole proprietor-
ship, with a partner or as a
limited partnership. Create a Disadvantages of the Partnership
chart for each business type, While a partnership can offer many advantages, a number of
comparing start-up funds,
problems can arise when several people own and operate a busi-
insurance needed, supplies
needed, and type of advertis- ness. This form of business ownership can avoid some of the
ing needed. problems associated with sole proprietorships, but it also has dis-
advantages:
• Unlimited liability
• Possible disagreement among partners
• Shared profits
• Limited life
In 1975, two young men named Bill Gates and Paul Allen formed
a partnership to produce computer software. Today their company,
Microsoft, is a major corporation, and Bill Gates and Paul Allen are
two of the wealthiest people in the world. Microsoft is a partnership
that turned into one of America’s greatest success stories. However,
most people never come close to this level of achievement. Many part-
nerships have very little success or eventually fail. Entering a partner-
ship involves large financial risks.
Unlimited Liability Earlier in this section, you learned that the
owner of a sole proprietorship has unlimited liability. The same
is true of the general partners in a partnership. If the partnership
loses money or has financial problems, each co-owner is personally
responsible for all of the debts of the business. In other words, if your
partnership fails and the debts of the business cannot be covered by
its assets, you and your partners are responsible for paying the bills
out of your own personal assets.
For example, two friends ask you to join them in forming a part-
nership. You have a large amount of personal assets. Your two partners
have very few assets. If the business fails, you could end up being per-
sonally responsible for the majority of the business debts. You could
even lose everything you own. It is very important to choose your
business partners carefully. Know the personal financial position and
credit ratings of each partner. Remember, each general partner has
unlimited liability for the entire business, not just part of it.
532 Unit 5 Business Ownership and Planning
Disagreement among Partners When several people manage a
business, they may not always agree on important business decisions.
A common reason for failed partnerships is that the partners have
serious conflicts about how the business should operate, and they
allow the business to suffer financially from these conflicts.
Shared Profits Hard work on your part may be the crucial factor
in the success of the business. Nevertheless, you still must share
the profits with your partners. The way in which the profits of the
business are divided is outlined in the partnership agreement.
Limited Life The life of a partnership depends on the willingness
and ability of the partners to continue in business together. A
partnership has a limited life, and partnerships can end for a number
of reasons. Perhaps a partner dies or decides to retire or withdraw
from the partnership due to illness. The partners may disagree and
decide to end their partnership, or they may decide to add new
partners. In these situations, the original partnership dissolves. The
remaining partners and any new partners should then draw up a new
partnership agreement, which will create a new business.
Section 16.1 Assessment
QUICK CHECK Write About It What advice
1. What is an advantage of being a sole would you offer Lawrence and Tyrell
proprietor? to help them work out their differences?
2. What is the difference between a general What solutions would you suggest? Write
partner and a limited partner? down your suggestions for them.
3. What are several disadvantages of a
SOLVE MONEY PROBLEMS
partnership?
6. Business Ownership Decisions
THINK CRITICALLY Pamela owns a pet-sitting business. People
4. In your opinion, what is the most impor- hire her to take care of their pets when
tant element of a partnership agreement? they go out of town. As part of her service,
Explain your answer. Pamela also brings in her clients’ mail and
waters their plants. Her business is boom-
USE COMMUNICATION SKILLS ing, and she needs to make some critical
5. Perturbed Partners Lawrence and decisions about its future.
Tyrell are partners in a small retail business. Analyze Help Pamela decide what
They sell hats and T-shirts from a kiosk in to do now. Should she expand her
a shopping mall. Recently they have been business? Add employees? Take on a part-
thinking about selling other items as well, ner? Make sure that you evaluate the
but they cannot agree on what items to advantages and disadvantages of each
add to their product line. Their disagree- suggestion you offer as you outline your
ments have caused the business to suffer suggestions on paper.
financially.
Chapter 16 Types of Business Ownership 533
Section 16.2
Focus on
Reading
The Corporation
Read to Learn
What Is a Corporation?
What is the difference between a corporation and
• How to describe two
other businesses?
types of corporations.
• How to summarize the You have probably heard the word corporation. A number of
process of forming a large corporations exist nationally and globally, such as IBM, General
corporation. Motors, Hershey Foods, Sony, Hewlett-Packard, Motorola, Xerox, and
• How to discuss the Goodyear. A corporation is another form of business ownership that
advantages and
is different from a sole proprietorship or a partnership.
disadvantages of
a corporation. A corporation is a business organization that operates as a
legal entity that is separate from its owners and is treated by law as if
Main Idea it were an individual person. A corporation can do everything that a
A typical form of business sole proprietorship or a partnership can do—own property, buy and
organization is the corpora- sell merchandise, pay bills, and make contracts. It can also sue and
tion, which is in operation be sued in the court system. About 20 percent of businesses in the
all over the world. United States are organized as corporations, but they produce about
90 percent of the total business revenue in the United States.
Key Terms
• corporation
• articles of incorporation Starting a Corporation
• corporate bylaws What is the process of forming a corporation?
• corporate charter
• board of directors When you form a corporation, you create a legal entity. This process
• limited liability company is more complex than starting a sole proprietorship or a partnership.
(LLC)
• franchise
Paperwork and Documents
To create a corporation, you must file an application with the
state for permission to operate. The application to operate as a cor-
Before poration is called the articles of incorporation. The application
You Read includes information such as the corporate name and the type of
business in which the corporation will be involved.
PREDICT
In addition to the articles of incorporation, you must write a
What might be an advan- set of corporate bylaws. Corporate bylaws are the rules by which
tage of a corporation? a corporation will operate. Items in the bylaws may include how
the company will elect directors of the corporation and when stock-
holders will meet.
When the state approves the application, it issues a corporate
charter. A corporate charter is a license to operate a corporation.
It states the purpose of the business and spells out the laws and guide-
lines under which the business will operate.
534 Unit 5 Business Ownership and Planning
Issuing Stock
The ownership of a corporation is divided into units, which
are shares of stock. These shares of stock are bought by people who
TechByte
Virtual Consultants
become known as stockholders. Stockholders are the legal owners of Using technology can
the corporation. If you buy even one share of stock in Xerox, for help you plan your busi-
example, you are legally an owner of the company and have all the ness strategy. Smart
rights of ownership. Each stockholder receives a stock certificate, software allows you to
strategize about how to
which is a document that is proof of ownership. Small corporations
build your business. For
usually have only a few stockholders. Larger corporations, such as example, the MBA Wiz-
Kodak and Verizon, have thousands of stockholders. ard is intelligent software
created with the capacity
Closely Held Corporations A closely held, or private, corporation
to learn. It has accurately
is one whose shares are owned by a relatively small group of people. In evaluated over 20,000
many cases, there are only three or four stockholders. The shares are business plans, and thus,
not traded openly in stock markets. Many small and family businesses its expanding knowledge
are organized as closely held corporations. is accessible to the user.
Publicly Held Corporations A publicly held corporation is one Read more about
the MBA Wizard
that sells its shares openly in stock markets, where anyone can buy
and write a paragraph
them. Most of these corporations trade their stock on an exchange, about how smart soft-
such as the New York Stock Exchange or the American Stock Exchange. ware might help an
Almost all major corporations, such as Black & Decker, Intel, and entrepreneur write a
American Express, are publicly held. business plan through
finance07.glencoe.com.
Going Public A closely held corporation can be opened to the
general public if the stockholders decide in favor of this move. When
a corporation decides to sell its stock on the open market, the decision
is known as going public.
䊴 CORPORATE POWER
Corporations produce about
90 percent of all U.S. busi-
ness revenue. Why do you
think this is the case?
finance07.glencoe.com Chapter 16 Types of Business Ownership 535
As You Advantages of the Corporation
Read What are the benefits of forming a corporation?
RELATE Establishing your business as a corporation has a number of
advantages over a sole proprietorship and a partnership:
Imagine you and a few
friends decide to start a • Ability to raise capital
business making and sell- • Limited liability
ing cookies decorated to
• Continued life
order. What type of busi-
ness organization would • Separation of ownership and management
suit you best?
Ability to Raise Capital
A major advantage of a corporation is the ability to sell its stock
and generate capital, or money. If the corporation needs money for
growth, expansion, or other purposes, the company can sell addi-
tional shares of stock to raise the necessary funds. If a large amount
of capital is needed to start a business, the company may begin as a
closely held corporation rather than as a partnership. Examples of
this kind of corporation might include an automobile dealership, a
restaurant, and an amusement park.
Limited Liability
A great advantage to the stockholders, or owners, of a corpora-
tion is that they have limited liability. This means that if the corpora-
tion has debts or financial problems, the owners may lose only the
amount of their investment—the price they paid for their stock.
䊱 WHO OWNS THAT TEAM? Professional sports teams are operated
under all forms of business ownership. Some teams are public corpo-
rations. What would happen if a publicly owned sports team experienced a
change in owners?
536 Unit 5 Business Ownership and Planning
Consider the following example: You own $20,000 worth of stock
in the Family Fun Restaurant. The restaurant is not successful and goes
out of business while owing $150,000 dollars to its creditors. As a stock-
holder, you can lose only up to $20,000, or the amount of your invest-
ment, to help repay these debts. You are not personally responsible for
any debt beyond that amount. Unlike a sole proprietorship or a general
partnership, a corporation leaves your personal assets protected. You
are not legally responsible for all the debts owed by the corporation.
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis- !MSTERDAM
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals
to help them guide their financial decisions.
NETHERLANDS
Energy engineers have said that harnessing
only 1 percent of the wind’s force could produce
enough electricity to run the world. By 2020, both the
American and European Energy Associations predict
that wind will supply 12 percent of the world’s power. DATABYTES
The Netherlands is off to a good start. A pioneer
of wind energy, the country has granted licenses for Capital Amsterdam
the development of wind parks on its coast. The parks Population 16,237,000
will include at least 2,000 turbines, which are the
Languages Dutch and Frisian
modern-day versions of traditional windmills, familiar
Currency euro
sights of the Dutch countryside. To help eliminate
polluting fossil-fuel emissions, the Netherlands plans Gross Domestic
to use these powerful turbines to generate 6,000 mega- Product (GDP) $461.4 billion (2003 est.)
watts of wind energy. (Nine megawatts can provide GDP per capita $28,600
electricity for about Industry: Agro-industries, metal and engineering
5,000 houses.) products, electrical machinery and equipment, and
Centuries ago chemicals
there were as many Agriculture: Grains, potatoes, sugar beets, fruits, and
as 9,000 traditional livestock
windmills in the
Exports: Machinery and equipment, chemicals, fuels,
Netherlands. Wind
and foodstuffs
energy was used to
Natural Resources: Natural gas, crude oil, and fertile
pump ocean water
soil
away from the Dutch
land. Today it can help
Think Globally
to light streets and
If a corporation used alternative sources of energy, do
power computers.
you think stockholders might have more or less
confidence in the company? Why or why not?
Chapter 16 Types of Business Ownership 537
As You Continued Life
Read When a sole proprietor retires, dies, or sells his or her business to
QUESTION someone else, that business ceases to exist. Each time partners enter
or leave a partnership, a new partnership must be created. In a corpo-
What is the advantage of ration, however, a change of owners does not end the legal operation
separating ownership and of the business. Stockholders may enter or leave at any time without
management?
affecting the existence of the corporation. Its legal status as a business
continues indefinitely.
Separation of Ownership and
Management
The owners do not run the business in most publicly held cor-
porations. Instead, they elect a board of directors, a group of indi-
viduals who are responsible for overseeing the general affairs of the
corporation. Corporate officers and professional managers are hired
to make day-to-day decisions in running the business. Other special-
ists, such as lawyers and accountants, advise the professional manag-
ers. By separating management from ownership, the corporation can
take advantage of the skills, knowledge, and experience of various
individuals to ensure that the business will run successfully. (See
Figure 16.1 for corporate advantages.)
&IGURE #ORPORATE !DVANTAGES
D
ON IT E T Y
#
I M
,IFTINOUS , BILI
E ,IA
#ORPORATION
3EP
/WN ARATE
-AN ERS
AGE HIP
L M
P ITA EN
T
A
#
)NCORPORATING "USINESS ÛiÊÃiÊÃ>ÊÃiÊ«À«ÀiÌÀà «ÃÊ>`Êv>ÞÊLÕÃiÃÃiÃÊ`iV`iÊÀ
VÛiÀÌÊÌÊVÀ«À>ÌÃÊÌÊ}>ÊÌ iÊLiivÌÃÊvÊVÀ«À>Ì°
7 >ÌÊÃÊ>ÊVÃiÞÊ i`ÊVÀ«À>̶
£È ä£ nÈnÇ£Ó
538 Unit 5 Business Ownership and Planning
In smaller, closely held corporations, the owners often act as the
managers who run the business. The separation of ownership and
management usually does not occur until a company grows large
and goes public. For example, Apple Computer was established origi-
nally as a partnership managed and run by its co-owners, Steve Jobs Be Your Own Boss
and Steve Wozniak. To expand, they formed a closely held corpora- When you are a business
tion. After it became a publicly held corporation, the company hired owner, you may need to
consider incorporating.
professional managers and other specialists to run the business. (See
Learn about the differ-
Figure 16.2 on pages 540–541 for an example of a publicly held cor- ent types of corporations
poration as well as other forms of business ownership.) from which to choose and
how to incorporate your
business.
Disadvantages of a Corporation
What are the drawbacks of corporate ownership? To continue with
Task 2 of your
Though the corporate form of ownership has a number of advan- WebQuest project, visit
tages, it also has several disadvantages: finance07.glencoe.com.
• Complex and expensive set-up
• Slow decision-making process
• Taxes
Complex and Expensive Set-Up
You have learned that sole proprietorships and partnerships are
fairly easy to set up. In contrast, a great deal of work is required to cre-
ate a corporation. You must complete many forms, file reports, and
Common
adhere to many laws and regulations. CENTS
As a result of the great amount of work and organization required,
forming a corporation costs a large amount of money. Some costs of Shop by Phone
creating a corporation include legal fees, licensing costs, filing fees, Instead of driving from
costs of issuing stock certificates, and administrative costs. store to store, use your
telephone to see if a store
has the item that you want
Slow Decision-Making Process and compare prices. You
will save gas and time.
A major disadvantage of the corporation is the slowness of the Also, use the Internet to
decision-making process. In sole proprietorships and partnerships, see if the store sells mer-
only a few people determine how the business is run. As a result, deci- chandise online. What type
sions may be made quickly. However, in corporations, especially large of business ownership might
an e-tail store have? What
ones, many different people study the issues and discuss and debate
would be the advantage of
them before making a decision. The process can take even more time this type of ownership for
if disagreements occur. Thus, corporations may not respond quickly the store?
to issues or situations that affect business.
Taxes
Another major disadvantage of a corporation concerns taxes.
Because a corporation is a separate legal entity, it must pay state
and federal income taxes on its profits. Dividends that stockholders
receive are then taxed again.
finance07.glencoe.com Chapter 16 Types of Business Ownership 539
Figure 16.2 Forms of Business Ownership
Perhaps you have wanted to
open a business one day that
would allow you to combine
your love of a sport, interest,
or hobby with a business
opportunity.This kind of
business can take different
forms of ownership.
1 Sole Proprietorships
A hobby such as fly-fishing
could turn into an ideal sole
proprietorship. An avid fisher-
man could offer his or her
services as a fishing guide
or instructor.
2 Partnerships
Some businesses may
be too large for one
person to operate.
For example, a floral-
design business
that specializes in
events might be a
good enterprise for
a partnership whose
owners contribute
different talents.
540 Unit 5 Business Ownership and Planning
3 Closely Held Corporations Some busi-
nesses are organized as closely held corporations.
The owners could be a group with a common
interest, such as kayaking.
4
Publicly Held
Corporations
Walt Disney World
is part of the
The Walt Disney
Company, a publicly
held corporation
with thousands of
stockholders.
Chapter 16 Types of Business Ownership 541
Limited Liability Company
What is another type of ownership?
The federal government also allows another form of business
MARKETING ownership—a limited liability company (LLC), which is a busi-
ness that operates and pays taxes as a partnership but has limited
Businesses spend billions
of dollars on advertising. liability for the owners. It combines some advantages of both the
The most common types partnership and the corporation. In an LLC, the liability of the own-
of advertising media ers is limited to their investments. The profits are taxed only once.
include newspapers, This form of business is intended for smaller businesses.
magazines, direct mail, Most states allow the creation of LLCs, and they are becoming
billboards, television,
very popular. The Internal Revenue Service approves of this new form
and radio. Select two busi-
nesses in your community— of business organization if the company is small. This form of owner-
a sole proprietorship or ship is not intended for large business operations.
partnership and a corpora-
tion. For each business, find
an example of an adver- Franchise
tisement for the business. Is a franchise a form of business ownership?
Compile the ads as a class
according to the type of A franchise is not a form of business ownership, but it is impor-
media represented. Discuss tant to understand its legal status. A franchise is a contractual
how each form of business agreement to sell a company’s products or services in a designated
ownership affects the busi- geographic area. Franchises are very popular in fast-food businesses,
ness’s choice of advertising
such as McDonald’s, Subway, Burger King, Wendy’s, and Taco Bell, all
media.
of which have franchises.
If you start a franchise, you first organize your business as a sole
proprietorship, partnership, corporation, or LLC. You then purchase
a franchise from a corporation, such as Burger King. This corporation
is known as a parent corporation. You are now licensed, and the fran-
chise is an asset of your business.
䊱 OWNING A FRANCHISE Many businesses are franchises. What are
some advantages of purchasing a franchise from a corporation?
542 Unit 5 Business Ownership and Planning
Smaller franchises may cost only a few thousand dollars, but
large ones, such as McDonald’s and Midas Muffler, cost hundreds
After You
of thousands of dollars. The next time you dine under McDonald’s
Read
golden arches, remember that the establishment is actually a busi- REACT
ness organized under one of the three forms of business owner-
ship. The business is also a franchise and has paid a franchise fee What are four types of busi-
ness ownership?
to McDonald’s.
Choosing the Form of Ownership
Which form of business ownership is best?
No magic formula exists for deciding which form of ownership
is the best. You must carefully consider the advantages and disad-
vantages of each. Then you can decide which one is best for your
particular business and personal needs. Many people feel that a small
start-up business is best established as a sole proprietorship or a part-
nership. These forms of ownership are easy to establish. If the busi-
ness is successful, you can consider creating a corporation to gain
increased capital and limited liability.
Section 16.2 Assessment
QUICK CHECK Calculate If the initial offering of
1. What are the articles of incorporation, a their stock sells for $29.50 per share,
corporate charter, and corporate bylaws? how many shares of stock will they have to
2. What is a closely held corporation? sell to raise $1 million?
3. What are advantages of a corporation?
SOLVE MONEY PROBLEMS
THINK CRITICALLY 6. Limited Liability? Beverly Echo-Hawk
4. What effect might an increase of stock- is the sole proprietor of All Wet, a raft
holders have on a corporation? rental company that operates on the Colo-
rado River. She saved $35,000 to establish
USE MATH SKILLS the business. However, competition from
5. Issuing Stock Terrance and several other companies with better equipment
partners own a dry cleaning business that has caused losses for All Wet. Beverly also
operates as a closely held corporation. They owns $33,000 worth of stock in a corpo-
want to go public and sell stock, hoping ration that is being managed poorly. She
to raise enough capital to expand the fears that the corporation will go out of
business. business.
Analyze Which investment poses a
greater financial risk? Why?
Chapter 16 Types of Business Ownership 543
Chapter 16 Review & Activities
CHAPTER SUMMARY
• Sole proprietorships are easy to set up; • Closely held corporations have shares
the owner retains control and profits; held by a few individuals, and shares
there are few government regulations; are not traded in stock markets.
and profits are taxed once as personal Publicly held corporations sell shares
income. The disadvantages include on stock exchanges, and shares are held
limited capital, unlimited liability, limited by many individuals and institutions.
human resources, and a limited life. • To form a corporation, you must file
• In partnerships, general partners have articles of incorporation with the state
decision-making authority, are active in which you incorporate, and you
in the business, and have unlimited must write corporate bylaws. The state
liability. Limited partners rarely take issues a corporate charter.
an active role in the business, and their • Corporations operate as legal entities
liability is limited to their investment. separate from owners and continue no
• Partnerships are easy to set up and matter who owns them. Corporations
bring more skills, knowledge, and issue stock; stockholders have limited
capital to the business. Partners retain liability. However, corporations are
control, and profits are taxed once difficult and expensive to establish;
as personal income. Disadvantages decision making can be slow; and
include unlimited liability; potential profits are taxed twice.
disagreements; shared profits; and
limited life of the business.
Communicating Key Terms
Imagine that you are a lawyer specializing in business law. Use the terms below to explain to
a new client the different forms of ownership. Role-play this meeting with a partner.
• sole proprietorship • partnership agreement • corporate charter
• Employer Identification • general partner • board of directors
Number (EIN) • limited partner • limited liability
• unlimited liability • corporation company (LLC)
• limited life • articles of incorporation • franchise
• partnership • corporate bylaws
Reviewing Key Concepts
1. Explain why most new businesses begin as sole proprietorships.
2. Describe the roles of general and limited partners in a business.
3. Discuss the advantage of starting a business as a partnership versus a sole proprietorship.
4. Identify the advantages and disadvantages of a closely held versus publicly held corporation.
5. List the contents of articles of incorporation.
6. Explain why current stockholders might oppose a corporation’s decision to issue more stock.
544 Unit 5 Business Ownership and Planning
Chapter 16 Review & Activities
Geography Three friends who majored in biology together in college
want to open up a medical laboratory. They would like to work in a smaller
city to service the medical community there.
Research Look at a map of the United States as you search online for
growing communities in smaller cities. Pick three possibilities for the new
laboratory and choose the best form of business for this group.
Initial Public Offerings (IPOs) “Going public” and issuing stock
is neither simple nor inexpensive. Go online or use other sources to find out
the average cost of an initial public offering. A stockbroker may be able to
help you.
1. Calculate If a medium-sized software development company with a
current annual net income of $10 million wants to “go public” and raise
$75 million for growth and expansion, determine the total worth of stock
it will have to sell to net this amount.
2. Analyze What factors will be involved in setting the initial stock price?
Connect with Economics and Social Studies After being
downsized from her job at a corporation, Mia decides to start her own business
as a technical writer and editor. Her accountant thinks she should “set up
shop” as a limited liability corporation. Mia decides to research this further.
1. Research Investigate the advantages and disadvantages of limited
liability companies for someone in Mia’s situation.
2. Role-Play With a partner, take the roles of Mia and her accountant.
Prepare a list of questions for Mia to ask and answers for the accountant.
Running the Show Although many people feel that “being your own
boss” is something they really would like to do, not everyone can handle the
risks associated with entrepreneurship and sole proprietorship.
Log On Access the Small Business Administration Web site through
finance07.glencoe.com and research the personality characteristics
an entrepreneur needs to survive and thrive.
Write About It Prepare an article for the school or class newsletter
describing these characteristics.
Newsclip: The New Entrepreneurship There are more
entrepreneurs today than there were 20 years ago.
O N L I N E
Log On Go to finance07.glencoe.com and open Chapter 16.
Learn more about what steps you need to take to build your own
enterprise. Write a few sentences about what kind of business you would like
to run.
finance07.glencoe.com Chapter 16 Types of Business Ownership 545
Chapter 16 Review & Activities
WHAT KIND OF BUSINESS?
You could start a business for virtually any activity. As you take this
quiz, use your imagination. Just for fun, review the following list of
businesses and choose five that you could imagine owning. Write
your answers on a separate sheet of paper.
______ a. car repair
______ b. photographic studio
______ c. veterinary clinic
______ d. rock group
______ e. gourmet coffee shop
______ f. graphic artist studio
______ g. newsletter or other publishing enterprise
______ h. computer software
______ i. biotechnology lab
______ j. bed-and-breakfast inn
______ k. architectural firm
______ l. medical care
______ m. hair salon
______ n. tutoring service
______ o. detective
What do your choices say about you?
• If you selected b, d, f, g, or k, you are probably artistic. Your strongest interests are in
the creative arts or working in a field that requires originality and imagination.
• If you selected e, j, l, m, or n, you are probably social. You enjoy helping others and
working closely with people.
• If you selected a, c, h, i, or o, you are probably investigative. You like the challenge of
making decisions and coming up with innovative solutions.
Were your selections from one category—artistic, social, or investigative—or from a combina-
tion of categories? Look to see if you have stronger interests in one area over another. Which
types of daily activities do you prefer—artistic, social, or investigative?
546 Unit 5 Business Ownership and Planning
Chapter 16 Review & Activities
Your Financial Portfolio
Setting Up a Partnership
Mary has been teaching yoga classes at a gym for the past three years. She feels she
now has enough experience to open her own yoga studio. Since she is concerned about
costs and responsibilities, she spoke with one of the other yoga instructors, Tony, about
starting a yoga business together. Tony thinks it is a great idea. Together, they outlined
their partnership plan:
Location: One of Tony’s friends works at an art gallery, which has a peaceful environment and ample floor
space. Mary spoke with the owner of the gallery and negotiated using the gallery weekday evenings and
Saturday and Sunday mornings. Mary and Tony agreed to pay the gallery owner 25 percent of all class fees.
Competition: The only yoga classes presently being offered in the area are at the health club where they
both work.
Start-Up Costs: Mary and Tony must purchase 25 yoga mats at $20 per mat. They also will have insurance
costs of $1,200 per year, plus $150 in fees and licenses. They will each contribute an equal amount of
money from their personal savings to open the business.
Schedule: They will begin their business with eight classes per week: one each weekday evening, two
classes on Saturday morning, and one on Sunday morning. Each class will be one hour in length. They agree
that each person will teach four classes a week and cover for the other during illness or vacation.
Responsibilities: Mary is responsible for maintaining accounting records and paying bills. Tony is
responsible for advertising and promotion.
Revenue: They decide to charge $15 per class. They project the weekend classes might bring in 25 students
at each class ($375). Weekday classes might average 5 to 10 students ($75–150). Mary and Tony agree to
share revenue and expenses equally.
Creating the Partnership: To establish a legal partnership, they write a document that outlines the
organization of the business, the responsibilities of each partner, and the division of profits and losses.
Analyze
What kind of business would you start with a partner? With another student,
choose a business and discuss how you would share responsibilities if you started a
partnership together. Ask: What ways might you finance the business? What skills and
traits do each of you have that might complement each other in a partnership? On a
separate sheet of paper, outline your plan, using Mary and Tony’s outline as a model for
your business partnership.
Chapter 16 Types of Business Ownership 547
17
CHAPTER
Developing a
Business Plan
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 17.1
• Discuss the importance of finan-
cial management for a business.
• Explain the components of a
business plan.
• Describe the aspects of a
financial plan.
Section 17.2
• Explain the importance of account-
ing in financial management.
• Identify the primary functions of
accounting.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
548
In the Real World . . .
John Irvin loves sports. When he was a high school student,
he started selling sports cards because he had collected a lot of doubles
and triples. Eventually, he opened a stand at a local swap meet and at collect-
ibles shows on weekends. Now John wants to open a sports memorabilia store.
What could be better than running a business he loves?
After talking to the advisors at SCORE and the Small Business Association, he
realized that his knowledge about autographs, bobblehead dolls, and limited-
edition trading cards would not be enough for his store to be a winner. He
would need to learn how to start and operate a real business. Making a
plan would be a good first step to make his dream a reality.
As You Read Consider what steps are involved in
planning a business.
Business Plan
ASK Q: My older sister and I are running a very success-
ful business making children’s birthday cakes. Since
we are already doing well, why do we need a business plan?
A: Just because your business is successful now does not mean that it will remain
successful. By creating a business plan, you can define clear goals for things like sales
and profitability that will help you keep your business on track. Your business plan
can help you to assess how inflation may affect your business over time.
Ask Yourself Can you think of any other advantages that writing up a busi-
ness plan would provide?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com Chapter 17 Developing a Business Plan 549
Section 17.1
Focus on
Reading
A Plan for Business
Read to Learn
The Business Environment
What do all businesses have in common?
• How to discuss the impor-
tance of financial man- When you hear the word “business,” do you think of large busi-
agement for a business. nesses, such as Microsoft, Ford, Coca-Cola, Disney, or IBM? Maybe
• How to explain the com- you think of smaller businesses, such as your neighborhood conve-
ponents of a business plan.
nience store, flower shop, or hardware store. All of these businesses,
• How to describe the large and small, are part of the free enterprise system, which is an
aspects of a financial plan.
economic system in which people can choose what they buy, what
they produce and sell, and where they work. Businesses in such a sys-
Main Idea
tem must compete to attract customers.
For a business to thrive, a
One of the main measurements of success for a business is the
sound business plan and an
understanding of financial amount of profit it generates. Profit is the amount of money earned
management are essential. over and above the amount spent to keep the business operating.
Profit motivates most people to take the risk of starting a business.
Key Terms Large and small businesses must do two things to survive: 1) operate
• free enterprise system at a profit with effective financial management and 2) attract and
• profit keep individuals who will run the business.
• business plan
• strategic plan
• marketing plan Developing a Business Plan
• financial plan What is a business plan?
Whether you are starting your own business or taking over
a family business, you must first develop a business plan. A
Before business plan is a written proposal that describes a new business
You Read and strategies to launch that business. It helps you focus on exactly
what you want to do, how you will do it, and what you expect to
PREDICT accomplish. It sets goals for the business just as you set goals for
What might be included in yourself. A business plan is an important part of a proposal to secure
a business plan? funding from investors. Before they invest or loan money, they want
to see that prospective owners have fully developed ideas.
Components of a Business Plan
A business plan can have as many as 15 components: an executive
summary, mission statement, company description, product and ser-
vice plan, management team plan, industry overview, market analysis,
competitive analysis, marketing plan, operational plan, organizational
plan, financial plan, growth plan, contingency plan, and supporting
documents, as well as a cover page, title page, and table of contents.
550 Unit 5 Business Ownership and Planning
Three basic parts of a business plan, that can include many of
the 15 components, focus on a strategic plan, a marketing plan, and
a financial plan. The overall strategic plan is a written outline of
the business goals and the steps to take to achieve them. The second
part is the marketing plan, a written outline of how the business
will be promoted to increase customers and sales. The third part is the
financial plan, which is a written outline of how the business will
get money to start up and operate, and how the business will main-
tain financial operations and business records. Basically, the financial
plan determines how you will keep track of your money. Figure 17.1
illustrates the components of a business plan.
The Strategic Plan
Both new and ongoing businesses must have sound strategic
plans to be successful. In the classic novel, Alice in Wonderland, Alice
asks the Cheshire Cat which way she should walk. The Cheshire Cat
replies, “That depends a good deal on where you want to get to.” This
is an appropriate observation about decision making and planning.
Every person and every business needs goals and a specific course of
action to achieve those goals.
&IGURE "USINESS 0LAN #OMPONENTS
4HE #OMPLETE 0LAN
#OVER 0AGE 4ITLE 0AGE
4ABLE OF #ONTENTS
4HE "ASIC 0ARTS
%XECUTIVE 3UMMARY
-ISSION 3TATEMENT 3TRATEGIC 0LAN
#OMPANY $ESCRIPTION 9OUR BUSINESS GOALS AND
0RODUCT AND 3ERVICE 0LAN HOW YOU WILL ACHIEVE THEM
-ANAGEMENT 4EAM 0LAN
)NDUSTRY /VERVIEW -ARKETING 0LAN
-ARKET !NALYSIS (OW YOU WILL PROMOTE YOUR
#OMPETITIVE !NALYSIS BUSINESS AND INCREASE SALES IN
-ARKETING 0LAN ORDER TO MAKE IT PROFITABLE
/PERATIONAL 0LAN
/RGANIZATION 0LAN &INANCIAL 0LAN
&INANCIAL 0LAN (OW YOU WILL FUND THE CREATION
AND OPERATION OF YOUR BUSINESS
'ROWTH 0LAN
MAINTAIN FINANCIAL OPERATIONS
#ONTINGENCY 0LAN AND KEEP BUSINESS RECORDS
3UPPORTING $OCUMENTS
4HE %SSENTIAL "USINESS 0LAN 7HETHER YOU ARE STARTING A BUSINESS OF YOUR OWN PURCHASING AN EXISTING
BUSINESS OR TAKING OVER A FAMILY BUSINESS IT IS A GOOD IDEA TO DEVELOP A
BUSINESS PLAN
7HAT IS THE PURPOSE OF A BUSINESS PLAN
Chapter 17 Developing a Business Plan 551
WORKING TOGETHER If you are a business owner, your ultimate goal is to have a suc-
Both large and small busi- cessful and profitable business. In order to realize that objective, you
nesses can prosper and grow must first determine the strategic plan you will follow to keep the
as neighbors. Can you think business growing and moving in the right direction.
of some large and small busi- A strategic plan is similar to a game plan you might have for your
nesses in the same mall in sports team. Simply saying “We want to win!” will not bring a victory.
your town? The coach must devise a plan that outlines how the team will achieve
the big win. The team must work together to apply the strategies that
the coach has developed. Similarly, a business owner or operator may
say that he or she wants the business to succeed, but without a sound
business plan, it probably will not happen. The first step in writing a
strategic plan is to set goals.
Setting Goals Businesses set both short-term and long-term goals.
In the business world, short-term goals are goals you expect to reach
within one or two years. Long-term goals are those that may take three
As You or more years to reach. Because long-term goals require a considerable
Read amount of time, they may be less specific than short-term goals. You
will probably revise them as you go.
RELATE
Goals for businesses have the same guidelines as goals you might
What are your financial establish for your personal finances:
goals for the future? List at
least two short-term goals • They should be realistic.
that will help you reach • They should be specific.
your long-term goals. • They should have a clear time frame.
• They should help you decide what type of action to take.
552 Unit 5 Business Ownership and Planning
Whether you own a small convenience store in the city or run
a multinational corporation such as Kodak, the goals can be similar.
Common objectives might include increasing sales, adding new cus-
tomers, or updating equipment.
However, goals can also differ, depending on the size of the busi-
ness. For example, the goals of a small business might include buying
a computer system, introducing a new line of merchandise, or mov-
ing to a better location. Medium-sized businesses may want to open
more stores or begin operating online to increase sales. Larger cor-
porations have more complex goals. They may want to expand their
international markets, change distribution systems, or acquire other
smaller corporations.
Businesses should design goals according to the basic guidelines,
regardless of the size of the business. Goals should be well thought
out and compatible with the philosophy of the business. In all cases,
a business needs to determine if its goals are financially possible.
Identify Steps to Achieve Your Goals When you studied per-
sonal finance in earlier chapters, you learned that people set financial
goals and then decide on ways to achieve those goals. For example,
suppose that you have a short-term personal goal of making the
honor roll. This is an admirable goal, but how do you accomplish it?
You analyze the situation and plan your course of action. You identify
specific actions you can take, such as taking better notes, doing your
homework more carefully, and asking more questions in class.
AIMING FOR GOALS
Businesses and individuals
need financial goals. Can
you name three goals that a
small business such as this one
might have?
Chapter 17 Developing a Business Plan 553
MARKETING SELLS With so many brands of carpet on the market, a good marketing plan will give one
company an edge over the others. Can you name some of the ways carpet companies market their products?
Long-term goals involve more steps over a longer period of time.
Suppose that your long-term goal is to become a successful graphic
designer. What must you do to become a designer? You will need a
career plan. Then you will have to identify short-term steps, such as
taking related courses in high school, selecting schools or colleges
you want to atend to attend, and completing the application process.
Later you will probably focus your attention on long-term steps, such
as graduating, getting a job, and acquiring professional experience.
Hopefully, by taking these short-term and long-term steps, you will
achieve your goal of becoming a designer.
When developing a strategic plan for your business, you should use
the same technique. First, identify your short-term and long-term goals.
Then create a plan that consists of specific steps toward each goal.
A Strategic Plan Case Study Mike and Erin have plans to start
up an eco-friendly landscape business. They realize the importance
of setting realistic, achievable goals. Because their business would be
new, their short-term goals include getting a new business loan with
a low interest rate, purchasing basic equipment, locating suppliers for
plants and flowers, and purchasing a low-cost phone system. Long-
term goals include acquiring a storage facility, purchasing a hybrid
(gas/electric) vehicle to transport equipment, and increasing the
number of customers by 20 percent each year.
554 Unit 5 Business Ownership and Planning
Steps to Achieve Business Goals Mike and Erin recently graduated
from high school and want to start a landscaping business. They have
worked with other landscapers and have experience taking care of a
variety of flowers, plants, and trees. They plan to start their business as
a service, and then open a retail nursery as well.
In their strategic plan, Mike and Erin identify the steps they will
take to achieve each of their goals. One of their short-term goals is to
show a profit after two years. To reach that goal, they plan to increase
the number of customers and keep expenses low.
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis-
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals
to help them guide their financial decisions.
!THENS
GREECE
Surrounded by the crystal-clear waters of the
Aegean and Ionian Seas, Greece is one of the world’s
most popular travel destinations. Many tourists come
for the sun and surf. Others come to see the birthplace DATABYTES
of the Olympics and democracy, and to explore the
ancient ruins that stand as tributes to the past. Dat- Capital Athens
ing back more than 2,500 years, Greece’s glory days
Population 10,988,000
have become a major industry and source of income.
Athens attracts the most tourists. Few could leave Language Greek
the capital city Currency euro
without visiting Gross Domestic
the Parthenon, Product (GDP) $212.2 billion (2003 est.)
the country’s GDP per capita $19,900
most famous
Industry: Tourism, food and tobacco processing,
national trea-
textiles, and chemicals
sure. Dedicated
to the Greek Agriculture: Wheat, corn, barley, sugar beets, and beef
goddess Athena, Exports: Food and beverages, manufactured goods,
the white mar- petroleum products, and chemicals
ble temple sits Natural Resources: Bauxite, lignite, magnesite,
majestically on crude oil, and marble
top of a rocky
Think Globally
hill called the
Athens is a major tourist destination. What businesses
Acropolis.
might be successful there?
Chapter 17 Developing a Business Plan 555
As You The Marketing Plan
Read A marketing plan outlines the ways in which you will promote
QUESTION your business. Promotional activities include advertising and promo-
tions. Advertising is any paid message that a business sends about
Why is a good marketing its products. Promotion is any form of communication a business
plan necessary for any uses to inform, persuade, or remind people about its products or to
business?
enhance its image. You will show a profit or expand your operations
by increasing customers. Therefore, you want to communicate with
as many potential customers as possible to tell them about your goods
or services. For example, Mike and Erin plan to place ads with photo-
graphs of their projects in a local newspaper.
As with the creation of a strategic plan, you have to address some
specific questions. If you have something to sell, how do you sell it?
How do you reach people in an efficient manner? What promotions
or advertising can you afford? To begin to answer these questions,
you should research the existing market for your goods or services.
See Figure 17.2 for an illustration of this process.
Larger corporations may hire private marketing firms to assist
them in developing marketing plans. Some corporations, such as
Levi-Strauss, McDonald’s, and Ford, have been very successful over
the years. Effective marketing plans have allowed these corporations
to introduce new products, maintain sales of existing products, and
keep their names in the public eye.
The Financial Plan
You have probably noticed that the elements in the strategic
plan and the marketing plan involve the need for the efficient man-
agement of money. In order to make intelligent financial decisions
regarding the direction and future of your business, you must record
and report your finances in an orderly, consistent manner. Many peo-
Common ple consider a financial plan to be the most important document for
CENTS a successful business venture.
Sound financial decisions provide the opportunity for:
The Advertising • Sales to rise • Liabilities to be paid
Dollar • Expenses to fall • Credit to expand
Many businesses, large and
• Profits to increase • Customers to increase
small, plan to spend a cer-
tain amount of their bud- • Assets to be acquired • New products to develop
gets (about 5 percent or
more of their net sales) on Aspects of a Financial Plan A financial plan outlines the
promotional activities, such essential financial elements for starting and running a business. An
as advertising promotions. effective plan addresses three aspects of operating your business:
This expense pays off with
assets needed, purchasing methods, and daily financial operations.
more customers and profits.
If a surf and skateboard shop (See Figure 17.3 on p. 558.)
earns $35,000 a month in First, it identifies the assets you will need to purchase in order to
net sales, what might be a begin or continue operating the business. Assets are property or items
good annual advertising bud- of value owned by a business. These might include products to sell or
get for the store? machines, supplies, office equipment, and transportation necessary
for operations.
556 Unit 5 Business Ownership and Planning
Figure 17.2 Steps to Prepare a Marketing Plan
1
To prepare a marketing plan, you first
Assess the competition.
need to research the existing market.
By seeing what is out there, you can
better develop an effective marketing
plan. This plan will become your road
map for reaching new customers and
expanding your business. Take these
steps to prepare your marketing
plan, an important component of
your overall business plan.
2 Identify services offered.
4 Identify potential
customers.
3
Research the current
pricing and advertising.
Chapter 17 Developing a Business Plan 557
Second, your financial plan should address the method that you
TechByte
Business Planning
will use to acquire or purchase these items. How will your business
pay for the things it needs? Do you have sufficient cash available?
Should you borrow money from a bank or credit union?
Software There is a The third and most important aspect of the financial plan
lot of software available to involves the daily financial operations of the business. This feature
help the budding entre- addresses the recording, summarizing, reporting, and analyzing of
preneur write a business
your business’s finances.
plan. These programs,
such as Business Plan Pro, Identifying Needed Assets The first aspect of creating a financial
help you develop a pro-
plan is to identify the assets that are necessary to start the business
fessional business plan for
any size or type of busi- and then to make it grow and increase its profits. Suppose that the two
ness. Many of these pro- entrepreneurs, Mike and Erin, want to buy a computer system. The
grams also provide sample system should be able to handle their present business operations as
business plans that you well as increased business activity in the future. They should consider
can review for ideas. features such as processing speed, memory capacity, upgradeability,
Before you write and the software that is included.
your own business After Mike and Erin have determined the computer components
plan, listen to planning
that their business needs, they should analyze the prices of different
expert Tim Berry discuss
the planning process and systems. They will need to purchase the best system for the best price.
how Business Plan Pro When their analysis is complete, Mike and Erin can decide what com-
can help you through puter system to buy. This research process should be a part of buying
finance07.glencoe.com. any major asset.
Purchasing Assets The second step of a financial plan is to
determine the method to use to purchase the items. Mike and
Erin need to ask several specific questions: Can they purchase the
computer system with their available cash—or should they get a loan?
&IGURE 4HE &INANCIAL 0LAN
4HE &INANCIAL 0LAN
!SSETS .EEDED 0URCHASING -ETHODS $AILY &INANCIAL /PERATIONS
0RODUCTS TO SELL !VAILABLE CASH 2ECORDING
%QUIPMENT %XISTING CREDIT 3UMMARIZING
3UPPLIES .EW LOAN 2EPORTING
4RANSPORTATION '!!0
&UNDING 9OUR "USINESS -OST LENDERS AND INVESTORS REQUIRE A WELL ORGANIZED AND FEASIBLE FINANCIAL
PLAN BEFORE THEY WILL PROVIDE THE MONEY TO START A BUSINESS
7HY MIGHT A FINANCIAL PLAN BE THE MOST IMPORTANT ASPECT
OF A BUSINESS PLAN
558 Unit 5 Business Ownership and Planning finance07.glencoe.com
PRODUCT RESEARCH
Good research leads to
appropriate purchases for
your company. Can you name
at least five items that business
owners might purchase that
require product research?
Will they be able to get a reasonable interest rate? Can they take
advantage of alternatives to purchasing, such as leasing? Can they
get a better deal if they wait? In answering these questions, Mike and
Erin will have to perform a careful analysis of their existing finances
regarding their debts, available cash, and future expenses.
They must also investigate all sources of credit. Will the com- Be Your Own Boss
pany that is selling them the computer extend credit to them? Should The Small Business
Administration (SBA) is
they apply for a short-term loan from a bank? By examining these
an agency of the federal
and other questions, Mike and Erin are practicing effective financial government that helps
management. entrepreneurs. Find out
As a high school student, you make similar decisions about your if you are ready to be an
personal finances. If you want to buy an inexpensive item, such as entrepreneur by taking
a CD, you might pay cash. You will give the purchase little finan- the SBA’s Are You Ready?
quiz, and learn more
cial consideration. However, if it is a more expensive item, such as
about what it takes to
a sound system or a used car, you should examine your situation start up a business.
more carefully. Consider some of the following questions: Do you To continue with
really need it? What is the most you can spend? How much money Task 4 of your
do you have now? Is there anything else you might need? By con- WebQuest project, visit
sidering these questions, you are performing a financial analysis of finance07.glencoe.com.
your purchase—and practicing effective financial management.
finance07.glencoe.com Chapter 17 Developing a Business Plan 559
As a business owner or operator, you might find that some items
you want to purchase are beyond your means. You may not have
enough cash. Especially when you are starting a business, you will
have to accept the fact that you will not be able to obtain every-
thing that you want immediately. You will have to work within your
SOCIAL STUDIES/
MARKETING financial resources until your business begins to make a profit and
Small businesses recognize you can afford to expand your assets. If you are working with limited
that they need to sell to a resources, you must make decisions based on your need for the items
broad market to expand. and your ability to pay for them, whether with cash or credit.
Imagine you are starting
a business to sell a spe- Recording and Reporting Business Finances The third aspect
cific product or service. of a financial plan involves the financial operation of a business. How
Choose one. As part of will Mike and Erin keep daily financial records? Will sales cover their
your marketing plan, you expenses and produce a profit? Will cash be available for unexpected
need to know more about
costs? Will they be able to pay their bills on time?
who will buy your prod-
uct or service. Consider Mike and Erin must know where their business stands financially
what cultures will provide at all times. The recording and handling of financial information,
good markets for you. Do in an accurate and efficient manner, is essential. It includes using
research on the Internet to accepted accounting procedures, analyzing financial statements, con-
find three countries or cul- trolling cash, and paying debts. If data is not recorded in a timely
tures offering such markets.
manner, or if the information is not analyzed correctly, inappropri-
Then present your findings
to the class explaining why ate financial decisions can result. For a new business or a small exist-
you selected those three. ing business, this could be disastrous. Thousands of small businesses
close each year due to poor financial decisions.
Section 17.1 Assessment
QUICK CHECK Present Help Carol and Blanca
1. Describe the three main parts of a business market their jewelry by creating an
plan. advertising flyer. The flyer should be infor-
2. Explain why financial management is an mative and persuasive.
important aspect of a successful business.
SOLVE MONEY PROBLEMS
3. Identify three aspects of a financial plan.
6. Financial Plan Development Santiago
THINK CRITICALLY and his classmates want to raise money for
4. What might happen to a business that ana- Habitat for Humanity. Santiago plans to sell
lyzes its finances only twice a year? doughnuts and hot chocolate three morn-
ings a week at school to raise funds. His
USE COMMUNICATION SKILLS teacher asks for a list of assets he will need.
5. Marketing Your Product Carol and Write About It Help Santiago
Blanca have been operating their own jew- make a list of the assets he will need
elry-making business for three months. to run his doughnut stand. Indicate which
During that time they have sold their cre- assets he might borrow and which ones he
ations to friends and relatives. However, must buy.
they now want to market their products to
a larger customer base.
560 Unit 5 Business Ownership and Planning
Section 17.2
Financial Focus on
Reading
Management
Read to Learn
• How to explain the impor-
Aspects of Financial Management tance of accounting in
What economic theories and principles should you financial management.
know for effective financial management? • How to identify the
primary functions of
As you learned in the first section of this chapter, sound finan- accounting.
cial management is critical to the survival of any business. Finan-
cial management includes all aspects of operating a business. It is the Main Idea
glue that holds the business together. At the same time, it is the oil To ensure effective financial
that helps it run smoothly. Many business functions and procedures management, knowledge
are based on economic theories and principles. Supply and demand, and skills in accounting are
pricing, market segments, and competition are just a few of the eco- essential.
nomic principles you need to know about. An understanding of basic
accounting principles and procedures is also useful. You should have Key Terms
the financial knowledge and skills to be able to collect, summarize, • accounting
• transaction
and analyze financial data.
• generally accepted
accounting principles
Accounting: The Backbone of (GAAP)
• budget
Financial Management • merchandise
• inventory
What is accounting? • cash flow
Accounting is the systematic process of recording and reporting • negative cash flow
the financial position of a business. The financial position depends on
the transactions that occur in the daily operation of the business. A
transaction is any activity that has an effect on the financial situa-
tion of a business. Every time you buy supplies, sell merchandise, buy Before
a photocopier, or pay utility bills, your business is making a transac- You Read
tion. Accounting records and reports can help a business operate effi-
ciently—and profitably—by keeping track of how much the business PREDICT
earns and spends.
Accounting is often referred to as the “language of business.” What do you think the
term cash flow means?
Accounting plays a vital role in the day-to-day activities of every busi-
ness. The influence of accounting is demonstrated by the fact that
many of its terms have become commonplace. You have probably
heard terms such as “assets,” “liabilities,” “expenses,” “revenue,” and
“inventory.” These are all accounting terms. Business owners use this
language to communicate with other owners of the business, their
creditors, and customers. They do this by issuing financial statements.
Chapter 17 Developing a Business Plan 561
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: A Job Description Your Motive: When you write a business
A job description contains the following plan, it is important to think about how
information: you will build a staff of employees. You
start by defining the positions and listing
• Job title
the qualifications of the people who will
• Description of responsibilities
fill those positions.
• List of required skills and education
0REMIER "UILDING #OMPANY
4ITLE#OMPENSATION $ESCRIPTION *OB 3PECIFICATIONS
%NTREPRENEUR/WNER s /VERSEES ALL OPERATIONS s %XCELLENT COMMUNICATION SKILLS
s &ULL TIME s 2ESPONSIBLE FOR SETTING UP ALL s !BILITY TO MOTIVATE AND LEAD
s 3ALARY7AGE 6ARIES BASED POLICIES PROCEDURES AND
ON REVENUES OF SALES GUIDELINES
s %STIMATED AFTER YEAR ONE s 0ERFORMS ALL HIRING AND
EMPLOYEE EVALUATION FUNCTIONS
s 2ESPONSIBLE FOR SETTING LONG AND
SHORT TERM ORGANIZATIONAL GOALS
s !LLOCATES RESOURCES
!CCOUNTANT s 2ESPONSIBLE FOR SUPERVISING s %XCELLENT VERBAL AND WRITTEN
s 0ART TIME CONTRACT PAYROLL ACCOUNTS PAYABLE AND COMMUNICATION SKILLS
PROFESSIONAL HOURS PER ACCOUNTS RECEIVABLE FUNCTIONS s !BILITY TO WORK WITH OTHERS
WEEK s 2ESPONSIBLE FOR AND COORDINATES s !T LEAST YEARS EXPERIENCE IN
s 0RO RATED SALARY WITH VENDORS AND SUBCONTRACTORS CONSTRUCTION OR A RELATED
s 7ORKS WITH OWNER TO OBTAIN SERVICE OR MANUFACTURING
FINANCING AND LINES OF CREDIT INDUSTRY
s 2ESPONSIBLE FOR PAYMENT AND s #ERTIFICATION AS A #0!
COMPLIANCE WITH LOCAL STATE AND
FEDERAL REQUIREMENTS
$IRECTOR OF /PERATIONS s $EVELOPS OPERATIONAL PROCEDURES s !BILITY TO WORK WITH PEOPLE OF
s &ULL TIME s 2ESPONSIBLE FOR IMPLEMENTING ALL ALL BACKGROUNDS AND SKILLS
s 3ALARY PER YEAR POLICIES PROCEDURES AND s !BILITY TO MOTIVATE AND LEAD
GUIDELINES s !T LEAST YEARS EXPERIENCE IN
s -ANAGES ALL OPERATIONS AND THE CONSTRUCTION INDUSTRY OR
ASSISTS WITH HIRING AND YEAR DEGREE IN MANAGEMENT
EMPLOYEE EVALUATION s ! MINIMUM OF YEARS
s 4ROUBLESHOOTS ALL PROBLEMS MANAGEMENT EXPERIENCE
CUSTOMER SERVICE ISSUES AND
EMPLOYEE COMPLAINTS
Key Points: Job descriptions are an Find the Solutions
important part of a business plan because 1. How will the owner be compensated?
investors will want to know how you will 2. What skills and background are required
staff your organization. The descriptions for the job of accountant?
can be advertised in the classified section 3. What are the job functions of the director
of operations?
of a newspaper or magazine, or posted on
4. Why is the accountant’s salary pro-rated
Internet job sites.
over the year?
5. How much experience does the director of
operations need?
562 Unit 5 Business Ownership and Planning
GAAP Put on
When recording and reporting financial changes in a business, Your
owners, bookkeepers, and accountants must use a standard set of Financial
guidelines, which are referred to as generally accepted accounting
principles (GAAP) (pronounced “gap”). If General Motors, Ford,
Planner’s
and DaimlerChrysler all prepared their financial reports in different Cap
ways, no one could compare the three corporations financially. Using
Seven months ago your client
the GAAP guidelines allows investors, banks, suppliers, and govern- opened a small business, and
ment agencies to make comparisons of the financial condition of var- it is already showing a reason-
ious companies. They can determine which businesses are financially able profit. She is tempted to
stable, which ones have the highest percentage of profit, and which take all the profits and have a
ones are growing the fastest. little fun, but she knows this
might not be a good idea.
Every business must have an accurate accounting system, either
Think of three ways she could
manual or computerized. Computer software programs can handle handle the profits.
much of the basic accounting work for most businesses. By using this
modern technology, owners and managers can spend more time ana-
lyzing their finances and planning for the future, and spend less time
doing monotonous paperwork.
The accounting system has many functions and procedures.
However, some of the most essential functions of accounting that
most businesses use include budgeting, inventory, payroll, cash flow,
and investments.
Budgeting
One important function of accounting is budgeting. A budget
for a business is a formal, written statement of expected income and
expenses for a future period of time. For example, the entrepreneurs
Mike and Erin can write a budget to project, or predict, the amount
of money they think they will earn through sales or other income
in their landscaping business. They also project their production
or operating costs (expenses) for the same period. The difference
between these two amounts will be their projected profit or loss for
the period. This gives them a glimpse into the financial future of
their business. It provides the information they will need to make
decisions.
To be practical, you should regularly compare a budget with
actual income and expenses. If you are working with a yearly
budget, you should make monthly comparisons of the budgeted As You
amounts to the actual amounts. If the actual amounts are not rea- Read
sonably close to the budgeted figures, you need to make adjust- RELATE
ments. If the actual amounts are far greater than the projected
figures, you must take immediate action to avoid further financial Businesses need well-
planned budgets—and
problems. An important aspect of financial management is to rec-
so do individuals. What
ognize a problem and take action to remedy it. Accurate, current income and expenses
accounting statements and reports allow you to recognize a prob- would be included in your
lem when it first develops so that you can make financial decisions personal budget?
and take corrective measures.
Chapter 17 Developing a Business Plan 563
CONTROLLING INVENTORY
Proper levels of inventory are
essential for a profitable
business operation. As a
business owner, what might you
do if you had too many of one
model of television in stock?
Inventory
The largest asset of many businesses is the merchandise they
have on hand to sell. Merchandise is the goods retailers buy with
the intent to resell to customers. The inventory is the merchandise
retailers have for sale. Most cash transactions involve the purchase,
control, and sale of merchandise. Therefore, it is essential that inven-
tory be carefully maintained and examined. By tracking inventory,
businesses know the following facts about their merchandise:
• Amount of merchandise sold
• Merchandise that is selling well
• When to reorder merchandise
• Merchandise that should not be reordered
Amount of Inventory The wrong level, or amount, of inventory
can be costly for a business. Having too little inventory means that the
business may not be able to satisfy its customers’ wants. For example,
when you go to a store to buy CDs, and they have very few on the
shelves, you might not bother to look around the store. Instead, it is
As You likely you will go to another store to make your purchase. Lost sales
Read mean lower profits for the store.
If inventory is too high, too much money has been spent on
QUESTION inventory and is not available for other things, such as a new com-
puter system, because cash is not available. Inappropriate inventory
Why is having proper
inventory levels an impor- levels, either too high or too low, are signs of poor management.
tant aspect of financial Most stores use computer programs to monitor inventory. These
asset management? programs provide daily reports that detail what items have been sold,
what is still available, and what must be reordered.
564 Unit 5 Business Ownership and Planning
Payroll
While merchandise is usually the largest asset of a business,
payroll is usually the largest expense of a business. Large companies Cutting Office
such as AT&T, Coca-Cola, and American Airlines employ thousands Expenses
of people. Weekly payrolls are in the millions of dollars. Some small 1. Write or print on
businesses employ fewer than a hundred people, and some very small the backs of used
businesses might employ fewer than ten people. Whether your busi- paper for inter-
office notes.
ness is large or small, payroll is usually your greatest expense.
2. Buy refilled ink car-
Because payroll involves so much cash, it is regulated by state
tridges instead of
and federal laws and must be prepared according to generally accepted new ones (savings
accounting principles (GAAP). Most businesses use computer pro- up to $30 each).
grams to process payroll checks, to complete payroll reports, and to 3. Do not use dispos-
examine payroll information. Efficient payroll management involves able coffee cups.
two important activities. Buy ceramic mugs
for everyone.
Determining Number of Employees First, you must determine 4. Do advertising
whether you have the proper number of employees working at the swaps for your ser-
proper times. Having too many employees or employees working at the vices or products.
wrong times means that you are paying more in wages and salaries than 5. Buy used office
you should. Your payroll expense must be reduced. If you do not have equipment and
enough employees or are understaffed at certain times, your company furniture.
risks losing sales. Both situations are indicators of poor management.
Using GAAP The second activity that ensures efficient payroll
management is using generally accepted accounting principles
(GAAP) to prepare payrolls. Paychecks must be issued on time. All
payroll taxes must be paid, and voluntary deductions must be taken.
All payroll records should also be available for managers and owners
to evaluate immediately. Accurate, complete, and readily available
payroll information is essential. Chapter 21 explains more about
payroll procedures and regulations.
Cash Flow
Every person needs cash. Every business needs cash. Available
cash often determines what a business can or cannot do. An adequate
amount of available cash allows your business to pay its debts, take
advantage of discounts, and pay for expansion.
In personal finance, “cash flow” refers to the amount of money
that actually goes into and out of a person’s wallet or bank accounts.
For a business, cash flow is the amount of cash that is available at any
given time. Money comes in, and money goes out—this is cash flow. A
goal of effective financial management is to maintain a constant flow
of cash through the business. This is easy to say, but it is not always easy
to do. Economic and financial conditions constantly change. Some-
times sales are high, and then they may suddenly drop off. Expenses
may also vary. When a business spends more money than it receives, it
experiences a condition known as a negative cash flow, also called a
cash crunch. When your cash flow is negative, your business suffers.
Chapter 17 Developing a Business Plan 565
As a student, you have probably experienced similar cash
crunches. For example, suppose that you want to go to the movies on
Friday night with your friends, but on Wednesday you buy the wool
sweater you want. So, on Friday night, you discover that you do not
have enough money to go out. For you, this is a short-term disap-
pointment. For a business, however, a shortage of money could mean
serious problems. Without a sufficient flow of cash, merchandise can-
not be replaced, bills cannot be paid, and funds for future growth and
expansion cannot be invested. Maintaining a positive cash flow is a
primary goal of financial management.
Investments
Successful businesses invest for the future. As profits increase,
money should be set aside or invested for future business needs. This
reserve cash may be needed to purchase new equipment, relocate the
business operation, or sell a new line of merchandise. For example,
suppose that Mike and Erin form a business partnership. Their goal is
to purchase a building for their landscaping business within the next
five years. They should set aside a certain amount of money each year
to ensure that sufficient funds will be available to buy the building or
make a down payment.
Careers in Finance
CREDIT ANALYST
BOOKKEEPER Brad Chapman
Longs Drugs
After moving from his hometown, Brad found it easy to find another bookkeeping job. He has
always enjoyed the challenge of balancing ledgers and creating spreadsheets. The skills and experi-
ence he picked up while keeping books for a local music store seem to apply everywhere. At Longs
Drugs, he balances cash registers, determines if registers are over or short, completes daily reports,
and counts and deposits daily receipts. He also handles payroll, tags and logs invoices and claims,
and forwards pertinent paperwork to the general offices. Other tasks of a bookkeeper might include
preparing weekly gross profit study surveys and following up on returned checks.
SKILLS: Accounting, computer, math, organizational, customer-service,
and problem-solving skills
PERSONAL TRAITS: Detail-oriented, discreet, honest, and likes working with numbers
EDUCATION: High school diploma or equivalent; associate degree or technical training at
a college; on-the-job training
ANALYZE Why would most businesses need a bookkeeper?
To learn more about career paths for bookkeepers, visit finance07.glencoe.com.
566 Unit 5 Business Ownership and Planning finance07.glencoe.com
Investments and Reserve Funds After You
Businesses need reserve cash for emergencies or unexpected Read
costs. If equipment breaks and needs repair, sales take an unexpected REACT
drop, or a natural disaster hits your area, you will need cash. Cash
reserves, also called reserve funds, could save your business when any Is having a reserve fund as
type of disaster strikes. important as having a reg-
ular savings account? Why
Cash should be carefully invested and closely monitored. Invest-
or why not?
ments by businesses are similar to personal savings. You should save
money for unexpected bills or events, such as a broken water heater
or a medical bill. You would also need to save for a new car, summer
vacation, or computer for your personal needs.
The Importance of Financial
Management
What are some aspects of financial management?
Businesses must make a profit and invest part of that profit for
future use. Making and monitoring investments is an important
aspect of financial management. In addition to investments, sound
financial management relies on accounting. You will learn more
about accounting functions and managing a business’s finances in
the remaining chapters of this book.
Section 17.2 Assessment
QUICK CHECK Analyze Did the toy store have a
1. Define the term accounting. positive or negative cash flow?
2. What are five of the most essential funtions
SOLVE MONEY PROBLEMS
of accounting?
3. Explain why it is important for a business 6. Accounting Statements Vince and
to maintain and examine its inventory his sister Kim own a pool cleaning ser-
carefully. vice. Kim analyzes the financial statements
and reports each month. Recently she has
THINK CRITICALLY noticed that sales are slipping and that
4. Explain why a business should have enough expenses seem to be out of control. They
cash reserves. need to take corrective measures as soon as
possible.
USE MATH SKILLS Group Analysis In small groups,
5. Accounting Basics You are the book- work together to help Vince and Kim
keeper at a toy store. Last month the figure out what might be happening to
following transactions occurred: their business. Come up with three sug-
Sales: $62,500 gestions for correcting the situation and
Payroll, rent, utilities: $16,000 present them to the class.
Merchandise purchased: $25,000
Chapter 17 Developing a Business Plan 567
Chapter 17 Review & Activities
CHAPTER SUMMARY
• One of the measures of success for The three basic parts of a business plan
a business is the amount of profit it focus on a strategic plan, a marketing
earns. Businesses must do two things plan, and a financial plan.
to survive: operate at a profit with • The financial plan identifies the assets
effective financial management and you need, how you will acquire these
attract customers. assets, and how you will handle daily
• The components of a business plan financial operations.
include: executive summary, mission • Accounting is the systematic process
statement, company description, of recording and reporting a business’s
product and service plan, management financial position, including all
team plan, industry overview, market transactions involving money.
analysis, competitive analysis, • Accounting functions include the
marketing plan, operational plan, preparation of financial statements,
organizational plan, financial plan, auditing, budgeting, payroll, inventory,
growth plan, contingency plan, and cash flow, and investments.
supporting documents—plus a cover
page, title page, and table of contents.
Communicating Key Terms
What sort of a business would you like to start someday, perhaps after working for an employer
in your chosen field to gain some experience? If you were meeting with a bank loan officer to
apply for a commercial loan to start your business, what would you say? Use as many terms below
as you can to develop some points to discuss with the loan officer.
• free enterprise system • financial plan • budget
• profit • accounting • merchandise
• business plan • transaction • inventory
• strategic plan • generally accepted • cash flow
• marketing plan accounting principles • negative cash flow
(GAAP)
Reviewing Key Concepts
1. Explain how financial management is the basic foundation for business success.
2. Describe specific items you would include in your business’s strategic, marketing, and finan-
cial plans.
3. Identify the three aspects of a financial plan.
4. List three examples of accounting transactions.
5. Explain why a business needs to follow generally accepted accounting principles (GAAP).
568 Unit 5 Business Ownership and Planning
Chapter 17 Review & Activities
Language Arts One of the main measurements of success for a
business is the amount of profit it earns.
Write About It Write a paragraph explaining what is meant by this
statement.
Business Capital A primary concern of a business is its “working” capi-
tal, which is the current assets minus current liabilities. It is all assets that
can be turned into cash quickly, reduced by all liabilities that must be paid
within the year.
1. Calculate From the following partial balance sheet, calculate the
company’s working capital:
Assets Liabilities
Cash $17,500 Current liabilities $114,000
Marketable securities 93,000 Long-term debt 216,000
Accounts receivable 87,455 Partnership equity 176,955
Inventories 162,000
Fixed assets 147,000
Net of depreciation
2. Compute Use spreadsheet software to make this calculation.
Connect with Economics and Law In the late 20th and early
21st centuries, the stock value of Enron Corporation seemed to go up. However,
Enron’s earnings were overstated because the company used illegal accounting
practices that removed negative cash flow items from the income statement.
Investors lost a great deal of money when the problem was discovered.
1. Research Access an Internet search engine and find out how Enron hid
its money-losing operations from public view.
2. Think Critically As a result of Enron and a few other large companies’
overstatements of earnings, the federal government passed the Sarbanes-
Oxley Act. Find out the requirements of the Sarbanes-Oxley Act. Do you
think this Act will prevent another Enron-like scandal?
Web Site: Do You Need One? The successful sales of your home-
baked goods through diners and coffee shops have led you to consider filling
orders for custom cakes. You are considering the creation of a Web site to
promote and sell your products.
Log On Use an Internet search engine to find Web sites of similar
businesses. Then answer these questions: What are the advantages and
disadvantages of producing and maintaining a Web site?
Newsclip: A Shaky Ship? Despite a weak economy, a company can
succeed if it adheres to a comprehensive business plan.
O N L I N E
Log On Go to finance07.glencoe.com and open Chapter 17.
Learn all of the elements of a business plan. Choose a corporation
featured in the news. Write a sample business plan for it.
finance07.glencoe.com Chapter 17 Developing a Business Plan 569
Chapter 17 Review & Activities
WHAT’S YOUR BUSINESS
PERSONALITY?
Businesses need employees who have all types of personalities. Which
four of the following statements best describe your personality? Write
your answers on a separate sheet of paper, and then add up the
number of points.
_____ I prefer activities that allow me to tell other people what to do. (5 points)
_____ I can delegate responsibility. (3 points)
_____ I prefer a clear definition of my responsibilities. (1 point)
_____ I am very good at brainstorming ideas. (5 points)
_____ I am good with details. (1 point)
_____ I like to do things exactly right. (1 point)
_____ I enjoy persuading others. (5 points)
_____ I am good at planning. (3 points)
_____ I like to be in charge. (5 points)
_____ I am good at organizing. (3 points)
_____ I prefer to follow others’ instructions. (1 point)
_____ I know how to give clear directions. (3 points)
Support staff: If you scored 4–8 points, you are a real team player and can provide
essential support to any business enterprise.
Manager: If you scored 10–14 points, you may be on track for a management career.
Entrepreneur: If you scored 16–20 points, you may succeed by running your own business
when you are ready.
570 Unit 5 Business Ownership and Planning
Chapter 17 Review & Activities
Your Financial Portfolio
Planning for Success
For several years Tom has been going with his father to yard sales. His father buys old
clocks and radios. He fixes them if they need repairs and sells them at the Millerton Flea
Market. Tom wants to start his own business and organize his plans.
Oldies but Goodies
Type of business: Selling used CDs, DVDs, videos, and video games
Location: Millerton Flea Market
Target customers: All ages, but mainly ages 10 to 35 for the CDs, DVDs, and
videos; and ages 10 to 25 for the video games
Potential number of customers: About 300 to 800 people visit the flea market each day, which is
open Fridays through Sundays.
Competition: No one has been selling these products at the flea market since
the Albertsons moved away.
Other competition: The nearest place to buy used CDs is about 10 miles away; three
local video stores sell used DVDs, videos, and video games.
Challenges: Getting enough products to sell: Jaimie McKerry buys surplus
stock for Franklin’s Discounts, and he will sell me used CDs for
about $2.50 each if I buy at least 100 at a time.
Costs: Purchasing the products, Dad will share expenses with me for
renting the table ($50 for the weekend), and gas for when we
go look at garage sales.
Potential profit: I used to look at all the DVDs, CDs, and videos when Vin Albertson
had his table, and he seemed to move a lot of merchandise. I think
I can make a profit of $3 a unit and sell 30 to 50 units a weekend.
Background and special skills: I have been going to garage sales with Dad for several years.
There are always old DVDs, CDs, videos, and video games that I
can pick up at low prices. I like negotiating when I buy and sell,
and I like helping Dad at his table. I also know popular titles.
Prepare a Plan
Select a merchandising business that you think you would like to own. On a sepa-
rate sheet of paper, describe the type of business, the product(s) involved, and the
factors you think would make it successful. Explain why you think you could make this
business a success.
Chapter 17 Developing a Business Plan 571
18
CHAPTER
Developing a
Financial Plan
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 18.1
• Explain start-up capital.
• Identify start-up costs.
• Describe operating capital.
• Explain projected income
statements.
• Discuss the role of reserve
capital.
Section 18.2
• Identify the elements of a
financial plan.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
572
In the Real World . . .
Y ears of ballet, jazz, and tap dancing have stressed Teri
Kim’s feet, and she has found that she cannot wear shoes if they do
not have proper cushioning and arch support. Unfortunately, most shoe
stores do not carry stylish shoes that fit her requirements. After discovering that
others share her frustration, Teri has decided to open a boutique that sells sensible
but stylish footwear. She has contacted several companies that manufacture shoes
that meet her standards and has found a perfect location for her store. Her next
tasks are to figure out how much start-up capital is required and to create a
strategy to make the store profitable. She realizes that developing a finan-
cial plan will help her dream become a reality.
As You Read What elements of a financial plan are
necessary to create a successful business?
Financial Plan
ASK Q: Since the projections in a financial plan are just
guesses, why is the plan so important? Why should
I bother spending time making financial predictions that might not come true?
A: A financial plan is essential to understanding what will make your business profit-
able, how much cash you will need to operate the business, and the future value of
the business. Even though your financial plan will need to be updated regularly, it still
provides you with a solid idea of where your business should be headed.
Ask Yourself Why is it important to be able to figure out how much cash
you will need to operate your business?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com Chapter 18 Developing a Financial Plan 573
Section 18.1
Focus on
Reading
Identifying Required
Capital
Read to Learn
• How to explain start-up
capital. Elements of a Financial Plan
• How to identify start-up Why is a financial plan an important part of a
costs. business plan?
• How to describe operat-
A financial plan is often considered the most important part of
ing capital.
an overall business plan. Without adequate planning and cash, your
• How to explain projected
business may not survive. Figure 18.1 on page 576 shows how wise
income statements.
financial planning can help you make your business dream a reality.
• How to discuss the role
of reserve capital. An effective financial plan enables you to determine required
capital. Capital is the money you will need to establish a business,
Main Idea operate it for the first few months, and expand it once it stabilizes.
The first step in developing The process of determining required capital will include identifying
a financial plan is deter- and analyzing the assets and costs that are involved in starting a new
mining how much capital business. Once you have identified these items, you will assign an
you will need. The next estimated dollar value to each one.
step involves creating a A financial plan also addresses the various sources of funding
future financial picture of
you will use to acquire or purchase the needed items. In addition,
your business by devel-
oping projected financial the plan outlines how you will record, summarize, and report the
statements. finances of your business. This section will examine the process of
determining required capital.
Key Terms
•
•
capital
start-up capital
Determining Required Capital
• start-up costs Why is it necessary to have a clear, concise, and
• operating capital realistic financial plan?
• financial forecasting
The first aspect of a financial plan is to determine how much
• projected financial
statements capital you will need. You may be shocked at the amount of money
• fixed expenses that is required to start a business and ensure its success. The purpose
• variable expenses of a financial plan is to give you a realistic idea of what you will need.
• reserve capital The quality of your financial plan will affect not only the success of
your business, but also your ability to qualify for financing. A clear,
concise, and realistic financial plan will give lenders confidence in
your business knowledge and skills.
There are three types of required capital: start-up capital, oper-
ating capital, and reserve capital. To begin a financial plan, you will
need to analyze carefully all three types of required capital and esti-
mate the amount of each needed to start up your business.
574 Unit 5 Business Ownership and Planning
Start-Up Capital Before
Why do many start-up businesses fail within the first You Read
five years of operation?
PREDICT
The first type of required capital is start-up capital—the
What is the difference
money required to start your business. Sufficient start-up capital is between start-up capital
essential to the survival of a new business. and operating capital?
Establishing a business is an expensive and risky venture. The
U.S. Small Business Administration reports that most small businesses
fail in the first one to five years of operation. One of the reasons these
businesses fail is that they lack sufficient start-up capital. If money
is not available to purchase necessary merchandise or to pay current
bills, a business will not survive.
Start-up capital is divided into two basic categories. The first cat-
egory is the capital required to purchase the assets you will need to
start your business. Before you can open the doors of your business,
you will need to buy various items. These items may include equip-
ment, display racks, and inventory.
The second category of start-up capital is start-up costs—the
costs or fees involved in establishing your business. Start-up costs
may include permits, legal and accounting fees, and security depos-
its. Some start-up costs are one-time expenses, such as permits, legal
fees, and deposits for telephone service. Other costs are continuing
expenses, such as rent, maintenance, and insurance.
Identifying Required Assets
Some assets are common to all businesses, both new and estab- Shopping for a
lished. These are the items that most businesses need in order to oper- Used Car or Van
ate. Other assets are unique to specific types of businesses or to certain 1. Test-drive the car
geographic areas. on streets as well
When preparing a financial plan, you will need to identify both as highways.
common and unique assets. Be sure to record the types and quanti- 2. Have a reputable
ties of items that you will need. To start, list the assets that are com- mechanic inspect
the car.
monly needed by businesses. Assets might include office furniture,
3. Make sure the oil
such as desks and file cabinets; computer hardware and software; dis-
and other fluids
play cases or shelves; store equipment, such as copiers and cash reg- are clean.
isters; merchandise inventory; transportation or delivery equipment,
4. Compare the ask-
such as cars or vans; store and office supplies; carpeting and lighting; ing price with
and security and communication systems. prices in news-
Next, list the assets you will need that may be unique to your paper ads and in
particular type of business or to your geographic area. Such assets Kelley Blue Book.
might include unique pieces of production or repair equipment; spe- 5. If you want a
cial types of display equipment; special electronic, security, or main- warranty, buy the
car from a dealer
tenance equipment; or required health or safety equipment.
instead of an
When you make these lists, it is a good idea to observe estab- individual seller.
lished businesses that are similar to your business, to read trade jour-
nals, and to consult with vendors in the industry. This will give you a
better idea of what assets you will need for your business.
Chapter 18 Developing a Financial Plan 575
Figure 18.1 Creating a Business
Creating a new business
requires lots of preparation
and hard work. By creating a
thorough and realistic financial
plan, you will ensure that your
business has the money it
needs to prosper and grow.
1
Analyze your needs and costs. Research the
supplies your business will need and the fees and
costs that you will have to pay to get started.
2 Secure funding. Your plan will describe
how each business expense will be paid.
Financial institutions will consider the
accuracy of your financial plan before
agreeing to lend money to your business.
576
3 Plan your process. In your financial plan, you will
show how you will record, summarize, and report
your business’s finances once you get started.
Unit 5 Business Ownership and Planning
4 Prepare for opening. A good financial
plan will ensure that you have money to
cover all the supplies and preparation
necessary to open your business.
䊴 LARGE CAPITAL
INVESTMENTS Some
businesses, such as patio
and garden supply stores,
require a great deal of
start-up capital. Can you
name other types of businesses
that require large amounts of
capital to begin operating?
Identifying Start-Up Costs
Next, identify and list the start-up costs for your business in
your financial plan. This can be a complex task. You have to iden-
tify common start-up costs and determine which of those costs you
should include in your financial plan. You must also become familiar
with required local and state licenses, permits, and fees. Local trade
associations, banks, and the U.S. Small Business Administration can
help you identify these costs. Some common start-up costs include
business insurance; legal and professional fees; licenses and permits;
banking and credit card fees; marketing and advertising costs; rent
and utilities security deposits; remodeling and renovation costs; and
maintenance and repair expenses.
Unidentified costs are a serious problem for entrepreneurs who
are beginning new businesses, so be sure to include any type of cost
that you feel you may encounter in starting up your business. Too
often, unexpected or hidden costs consume start-up funds. If that
happens, money may not be available for other needed items.
Assigning Costs to Identified Items As You
Read
Once you have identified your required assets and start-up costs,
you must estimate how much you will have to pay for each item. RELATE
Be careful to assign a realistic dollar value to each required asset and Think about a job you or a
start-up cost. If you underestimate, you may have to reduce costs in friend have had. What were
other areas, and then you may not have enough cash to pay for essen- some assets unique to that
tial items. If this occurs often, your business may face a serious cash business?
flow problem.
Chapter 18 Developing a Financial Plan 577
Play it safe by estimating on the high side. For example, suppose
that your business will need a photocopier machine. You determine
that it will cost between $1,400 and $1,800. When you assign costs
to your required assets, you should use the higher estimate, $1,800.
If you pay only $1,600 for the photocopier, you can apply the addi-
tional budgeted amount ($200) to other costs.
The final step in calculating how much money you will need to
launch your business is to prepare a statement of required start-up
capital. For example, Amanda Woodland is opening a new business
called “The Silver Lining Gift Shop.” She has developed a state-
ment of required start-up capital. Amanda’s statement is shown in
Figure 18.2.
Amanda realizes that there will be unexpected costs and small
items that she will need to purchase, which are not on this statement.
But she thinks that she has identified all major required assets and start-
up costs. After listing the items, she realizes that she will need approxi-
mately $90,000 in start-up capital. If Amanda had not researched and
analyzed all her costs carefully, she probably would have guessed that
she could start her gift shop with much less than $90,000.
&IGURE 3TATEMENT OF 2EQUIRED 3TART 5P #APITAL
3
, 4(% 3),6%2 ,).).' ')&4 3(/0
3TATEMENT OF 2EQUIRED 3TART 5P #APITAL
)TEM #OST
!33%43
$ISPLAY EQUIPMENT
/FFICE FURNITURE
#OMPUTER SYSTEM
0HOTOCOPIER
-ERCHANDISE
3UPPLIES
!LARM SYSTEM
#ARPET LIGHTS FANS
-AINTENANCE EQUIPMENT
4OTAL !SSETS
34!24 50 #/343
)NSURANCE
0ROFESSIONALLEGAL FEES
"USINESS PERMITSLICENSES
5TILITY DEPOSITS
!DVERTISING
2EPAIRS-AINTENANCE
"ANKING FEES
4OTAL 3TART 5P #OSTS
4OTAL 2EQUIRED 3TART 5P #APITAL
#OUNTING #OSTS 4HIS STATEMENT CAN HELP ENSURE THAT NO START UP COSTS ARE FORGOTTEN
7HY IS IT IMPORTANT TO KNOW START UP COSTS BEFORE OPENING A BUSINESS
578 Unit 5 Business Ownership and Planning
䊴 HIT OR MISS? It is
impossible to know for sure
how successful your busi-
ness venture will be. What
individuals or groups might
you consult for reliable advice?
Operating Capital
Why should you predict the amount of operating
capital you will need?
After you determine how much capital you will need to start
your business, you must focus on the second type of required capital.
This is called operating capital—the amount of capital needed to
operate a business for the first few months or years.
Although the sale of your products or services will generate rev-
enue, this money is often not enough to cover business expenses and
expansion plans. You will need money to purchase additional mer- TechByte
Easy Planning Many
chandise and increase sales to keep your business running. Cash must
also be available to carry out your strategic plan and marketing plan. entrepreneurs are skilled
at sales and promot-
As part of your financial plan, you must do financial
ing their businesses but
forecasting, which is the process of estimating a business’s operat- have trouble applying
ing capital. This future financial picture of your business is reported financial math. However,
in projected financial statements—statements that predict the when you must create
financial position of a business in the months and years to come. a financial plan to start
The projected financial statements will include income statements, or expand a business,
technology is available
balance sheets, and statements of cash flows.
to help. Financial plan
software can analyze a
Projected Income Statement financial situation, make
projections, and create
An income statement for a merchandising business will report financial statements for a
revenue, cost of merchandise sold, gross profit on sales, operating financial plan.
expenses, and net income (or loss). This type of financial statement Read more about
usually reports what happened in the previous accounting period. financial plan
In contrast, a projected income statement is an estimate of the software and list three
types of statements that
way in which income amounts will change over the next few months
it can create through
or years. You create this statement before you begin business opera- finance07.glencoe.com.
tions. This statement reveals where you expect your business to be in
the future.
finance07.glencoe.com Chapter 18 Developing a Financial Plan 579
Estimating figures for a pro-
jected income statement can be
a challenge. You must analyze all
information regarding revenue and
expenses for your type of business.
You can obtain this information
from trade associations, vendors,
local business organizations, and
government agencies such as the
U.S. Small Business Administration
and the Bureau of the Census. The
information from these sources is
based on facts and averages. How-
ever, to create figures for your pro-
jected income statement, you will
have to apply that information to
your business and make educated
guesses.
It is better to estimate pro-
jected revenues on the low side and
to estimate projected expenses on
the high side. This approach will
allow some flexibility if sales do
not reach your expectations or if
expenses are higher than you had
originally estimated. If you project
yearly sales of between $130,000
and $150,000, use the lower esti-
mate of $130,000. If you estimate
your heating bill might be between
$3,000 and $4,000, use the higher
amount of $4,000.
䊱 PRICEY PROMOTIONS It is important to determine the correct amount for a start-up
Promotions are a variable company’s expenses. Expenses are often classified as fixed or variable.
marketing expense that
Fixed Expenses Fixed expenses are expenses that remain
increases or decreases
the same regardless of business activity. These might include rent,
depending on the success of
insurance, or interest on a loan. Fixed expenses are fairly easy to
the business. Can you name
project because they remain constant, or fixed, for a stated length of
a promotional activity that
time. For example, no matter how much your business earns from
recently took place at a store
sales in a particular month, you will still pay the same amount in rent
near you?
for the duration of your lease.
Variable Expenses Variable expenses are expenses that may
change. Sometimes variable expenses can be adjusted depending
on sales. Such expenses might include supplies, advertising, wages,
and sometimes utilities. For example, if sales are lower than you
had predicted, you could purchase fewer supplies or reduce your
employees’ hours. It is more difficult to project variable expenses.
580 Unit 5 Business Ownership and Planning
Some variable expenses, such as maintenance and repairs, have
nothing to do with sales. These also cannot be projected accurately.
As You
When your computer or cash register no longer works, you must have
Read
it repaired or replaced. The principal characteristic of variable expenses QUESTION
is that they change with business conditions and other situations.
Figure 18.3 shows a projected income statement for Skelly’s In what way is a projected
income statement different
Craft Shop for the first four months of operation. You can see that from other income
the statement is projecting losses in each month. This is not unusual statements?
for a new business. In fact, it is common for a new business to go
for several months or even a year without reporting a profit. Notice,
however, that the estimated loss for Skelly’s Craft Shop decreases each
month. With continued good financial management, it is likely that
profits will be reported in the near future.
&IGURE 0ROJECTED )NCOME 3TATEMENT
3+%,,93 #2!&4 3(/0
0ROJECTED )NCOME 3TATEMENT
-/.4(
2%6%.5%
3ALES
#OST OF -ERCHANDISE 3OLD
'ROSS 0ROFIT ON 3ALES
%80%.3%3
2ENT
%LECTRICITY
(EAT!#
4ELEPHONE
)NSURANCE
-AINTENANCE2EPAIRS
-ISCELLANEOUS
7AGES
4AXES
3UPPLIES
)NTEREST
!DVERTISING
4OTAL %XPENSES
.ET )NCOME ,OSS
&ORECASTING 0ROFIT ! PROJECTED INCOME STATEMENT CAN HELP DETERMINE WHETHER A COMPANY WILL
BECOME PROFITABLE WITHIN A REASONABLE AMOUNT OF TIME
7HY IS CREATING SUCH A STATEMENT AN IMPORTANT PART OF DEVELOPING
A FINANCIAL PLAN
Chapter 18 Developing a Financial Plan 581
Figure 18.4 shows a projected income statement for Skelly’s
Craft Shop for the first five years of operation. It provides a long-range
view of business activity. Although the amounts are only estimates,
if they are projected realistically, they may indicate the potential suc-
cess of the business.
Notice that by the end of the second year, the craft shop antici-
pates a profit. If all goes according to projections, the business should
be doing quite well within five years. This is good news for the business
owners. It is also important information to include in a financial plan
for banks or other financial institutions that might provide funding
to the owner.
&IGURE 0ROJECTED 9EAR )NCOME 3TATEMENT
3+%,,93 #2!&4 3(/0
0ROJECTED 9EAR )NCOME 3TATEMENT
9%!2
2%6%.5%
3ALES
#OST OF -ERCHANDISE 3OLD
'ROSS 0ROFIT ON 3ALES
%80%.3%3
2ENT
%LECTRICITY
(EAT!#
4ELEPHONE
)NSURANCE
-AINTENANCE2EPAIRS
-ISCELLANEOUS
7AGES
4AXES
3UPPLIES
)NTEREST
!DVERTISING
4OTAL %XPENSES
.ET )NCOME ,OSS
)NCOME /VER 4IME 4HIS STATEMENT PROVIDES IMPORTANT INFORMATION FOR FINANCIAL INSTITUTIONS
WHICH MAY PROVIDE FUNDING
7HAT WOULD IT MEAN IF A COMPANYS PROJECTED YEAR INCOME
STATEMENT SHOWED LOSSES THROUGH ALL FIVE YEARS
582 Unit 5 Business Ownership and Planning
Projected Balance Sheet
Financial institutions will also want to see a forecast of the overall
financial position of your business. You provide this with a projected
balance sheet. On a projected balance sheet, you estimate the future
assets, liabilities, and net worth of your business one year, three years,
or five years from now. A projected balance sheet for Ramos T-Shirts
is shown in Figure 18.5.
Review the projected balance sheet for Ramos T-Shirts, and you
can see that the shop seems to be headed in the right direction. The
net worth of the business is projected to increase over the next three
years, with the owner’s equity increasing from $37,600 at the end
of the first year to $50,600 at the end of the third year. You will also
notice that in this same three-year period, assets are projected to
increase ($71,200 to $83,100), and liabilities are projected to decrease
($33,600 to $32,500).
&IGURE 0ROJECTED 9EAR "ALANCE 3HEET
2 2!-/3 4 3()243
0ROJECTED 9EAR "ALANCE 3HEET
9%!2
!33%43
#ASH IN "ANK
!CCOUNTS 2ECEIVABLE
3TORE %QUIPMENT
/FFICE %QUIPMENT
-ERCHANDISE )NVENTORY
3UPPLIES
#OMPUTER %QUIPMENT
4OTAL !SSETS
!CCOUNTS 0AYABLE
.OTES 0AYABLE
4OTAL ,IABILITIES
/7.%23 %15)49
*ON 2AMOS #APITAL
4OTAL ,IABILITIES
!SSETS AND %XPENSES ! PROJECTED BALANCE SHEET SHOWS ESTIMATES OF THE ASSETS LIABILITIES AND NET
WORTH OF A START UP BUSINESS
7HY IS IT IMPORTANT THAT THE PROJECTED BALANCE SHEET SHOWS AN
INCREASE IN ASSETS
Chapter 18 Developing a Financial Plan 583
Projected Statement of Cash Flows
A statement of cash flows reports how much cash a business has
taken in and where the cash has gone. This document shows how the
cash position of a business changed during an accounting period.
Many consider the projected statement of cash flows to be the
most important projected financial statement. When you prepare a
projected statement of cash flows, you analyze the amount of cash
that you anticipate will be available for your business in the future.
Will you have sufficient cash if your business operates on its projected
path? Remember, success and growth depend on available cash.
Figure 18.6 shows a projected statement of cash flows for West-
port Sporting Goods for a period of three months. You can see that
the business predicts a positive cash flow for the three-month period.
In other words, more money is shown coming into Westport Sporting
Goods each month than is shown going out. Realize that these three
months—April, May, and June—are probably a particularly high sales
period for a sporting goods store. Therefore, the business might not
have such a positive cash flow throughout the entire year.
&IGURE 0ROJECTED 3TATEMENT OF #ASH &LOWS
7%340/24 30/24).' '//$3
0ROJECTED 3TATEMENT OF #ASH &LOWS
!02), -!9 *5.%
#!3( 2%#%)6%$
#ASH 3ALES
)NTEREST )NCOME
4OTAL #ASH )NFLOW
#!3( $)3"523%$
2ENT
5TILITIES
3UPPLIES
!DVERTISING
"ANK #HARGES&EES
)NTEREST %XPENSE
4ELEPHONE
-AINTENANCE
#REDIT #ARD &EES
0AYROLL
4AXES
$ELIVERY #HARGES
-ISCELLANEOUS
)NSURANCE
4OTAL #ASH /UTFLOW
.%4 /0%2!4).' #!3( &,/7
"%')..).' #!3( "!,!.#%
%.$).' #!3( "!,!.#%
-ONEY TO /PERATE 5SING THIS STATEMENT WILL HELP TO DETERMINE THE FUTURE HEALTH OF A COMPANY
7HY DO SOME PEOPLE THINK THIS STATEMENT IS ONE OF THE MOST
IMPORTANT FINANCIAL STATEMENTS FOR A START UP BUSINESS
584 Unit 5 Business Ownership and Planning
䊴 CASH ONLY When you
pay for pizza to be delivered
to your home, you probably
pay in cash. Likewise, when
merchandise is delivered
to a store, the store may be
required to pay for the items
in cash. What types of small
businesses might have deliver-
ies every day that require cash
payments?
Reserve Capital
Why is it important for a start-up business to have
reserve capital available?
Put on
The third type of capital is called reserve capital—money that Your
is set aside for unexpected costs or opportunities. Reserve capital is
like cash in a personal savings account. If and when you need money, Financial
it is there. Planner’s
When emergencies arise, reserve capital can be a lifeline for Cap
small businesses. Unexpected costs can occur at any time and usually
require immediate attention. Examples of unexpected costs include Congratulations! You are
successfully operating your
repair bills and the expense of replacing broken equipment or lost or
own financial management
damaged merchandise. Without immediate access to cash to pay such company. A new client,
costs, your business could face a serious financial problem. Mrs. Brent, wants to open
Reserve capital is also needed to take advantage of business an old-fashioned ice cream
opportunities. Suppose that a competitor is going out of business and parlor and seeks your help in
has offered you inventory at a great price if you pay for it in cash. You preparing a projected income
statement for the bank. What
can use cash from your reserve fund to take advantage of the oppor-
questions will you need to ask
tunity. In this situation cash must be available immediately, or the her in order to prepare such
opportunity is lost. Good financial planning includes taking advan- a statement?
tage of business opportunities when they arise.
Chapter 18 Developing a Financial Plan 585
In addition, business owners use reserve capital to expand and
grow their businesses. For example, you might use cash from the
reserve fund to buy new lines of merchandise, to expand or reno-
vate your facilities, or to purchase more up-to-date equipment. Such
forward-thinking investments allow your business to develop and
become financially successful.
The amount of capital set aside in a reserve fund will vary from
business to business. Many businesses set up this fund as a line of credit
at the bank. This money can also come from your personal funds.
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis-
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals
to help them guide their financial decisions. -OSCOW
RUSSIA
Although oil is Russia’s major natural resource,
students may be its most important one. Each year
Russia produces more than 200,000 graduates who
receive degrees in the sciences. Schooled in computer DATABYTES
science, physics, math, and engineering, they provide
a foothold for Russia’s economic future. However, Capital Moscow
the problem may be getting them to stay in Russia.
Population 145,546,000
Other countries can offer Russian scientists the power-
Language Russian
ful incentive of good salaries, something that is hard
to find in Russia. For example, a professional with a Currency Russian ruble
postsecondary degree in Japan may earn up to $3,700 Gross Domestic
a month, whereas Product (GDP) $1.28 trillion (2003 est.)
in Russia the same GDP per capita $8,900
person would only Industry: Mining and extractive industries, machine
make about $100 a building, shipbuilding, road and rail transportation
month. In response equipment, and communications equipment
to this trend, the
Agriculture: Grain, sugar beet, sunflower seed,
Russian govern-
vegetables, and beef
ment has increased
Exports: Petroleum and petroleum products, natural
its monetary contri-
gas, wood and wood products, metals, and fur
butions to the field
of science by 90 per- Natural Resources: Oil, natural gas, coal, and timber
cent in an effort to
boost salaries. Think Globally
If you were a Russian graduate and had to choose
between a good salary in a foreign country or a low
salary at home, which would you choose and why?
586 Unit 5 Business Ownership and Planning
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: A Personal Your Motive: When you apply for a loan,
Financial Statement you must present an accurate personal
This form lists the following information: financial statement so that banks and
• Name and contact information lenders can review your current financial
• Assets and income status. They want to be sure that you have
• Liabilities and loans resources to pay off a loan.
• Source of income
• Noteholder contact information
0ERSONAL &INANCIAL 3TATEMENT
53 3MALL "USINESS !DMINISTRATION "QSJM
!S OF ???????????? ???????
#OMPLETE THIS FORM FOR EACH PROPRIETOR OR EACH LIMITED PARTNER WHO OWNS OR MORE INTEREST AND EACH GENERAL PARTNER OR EACH STOCKHOLDER OWNING OR MORE
OF VOTING STOCK OR ANY PERSON OR ENTITY PROVIDING A GUARANTY ON THE LOAN
.AME 4BSBI%FBO "USINESS 0HONE
2ESIDENCE !DDRESS8FTU$MFWFMBOE3E 2ESIDENCE 0HONE
5XJOTCVSH 0)
#ITY 3TATE :IP #ODE
*OUFSJPSTCZ%FTJHO
"USINESS .AME OF !PPLICANT"ORROWER
!SSETS /MIT #ENTS ,IABILITIES /MIT #ENTS
#ASH ON HAND IN "ANKS
????????????? !CCOUNTS 0AYABLE
?????????????
3AVINGS !CCOUNTS
????????????? .OTES 0AYABLE TO "ANKS AND /THERS o
?????????????
)2! OR /THER 2ETIREMENT !CCOUNT
????????????? $ESCRIBE IN 3ECTION
!CCOUNTS .OTES 2ECEIVABLE o
????????????? )NSTALLMENT !CCOUNT !UTO
?????????????
,IFE )NSURANCE #ASH 3URRENDER 6ALUE /NLY
????????????? -O 0AYMENTS ???????????
#OMPLETE 3ECTION )NSTALLMENT !CCOUNT /THER o
?????????????
3TOCKS AND "ONDS
????????????? -O 0AYMENTS ??????????
$ESCRIBE IN 3ECTION ,OAD ON ,IFE )NSURANCE o
?????????????
2EAL %STATE
????????????? -ORTGAGES ON 2EAL %STATE
?????????????
$ESCRIBE IN 3ECTION $ESCRIBE IN 3ECTION
!UTOMOBILE 0RESENT 6ALUE
????????????? 5NPAID 4AXES
?????????????
/THER 0ERSONAL 0ROPERTY o
????????????? $ESCRIBE IN 3ECTION
$ESCRIBE IN 3ECTION /THER ,IABILITIES o
?????????????
/THER !SSETS o
????????????? $ESCRIBE IN 3ECTION
$ESCRIBE IN 3ECTION 4OTAL ,IABILITIES
?????????????
.ET 7ORTH
?????????????
4OTAL
????????????? 4OTAL
?????????????
3ECTION 3OURCE OF )NCOME #ONTINGENT ,IABILITIES
3ALARY
????????????? !S %NDORSER OR #O -AKER ?????????????
.ET )NVESTMENT )NCOME ????????????? ,EGAL #LAIMS *UDGMENTS ?????????????
2EAL %STATE )NCOME ????????????? 0ROVISION FOR &EDERAL )NCOME 4AX ?????????????
/THER )NCOME $ESCRIBE BELOW ????????????? /THER 3PECIAL $EBT ?????????????
3ECTION .OTES 0AYABLE TO "ANKS AND /THERS
.AME AND !DDRESS OF .OTEHOLDERS
Key Points: The Small Business Find the Solutions
Administration (SBA) developed a personal 1. What is the purpose of a personal financial
financial statement for loan applicants to statement?
complete when applying for an SBA loan. 2. What is Sarah’s net worth?
Similar to a personal balance sheet, the 3. How was her net worth calculated?
4. What is Sarah’s salary?
form details a person’s assets, liabilities,
5. Why would the SBA want to know the
and net worth.
names and addresses of noteholders?
Chapter 18 Developing a Financial Plan 587
You should not use your reserve capital for the normal opera-
tion of your business. It should be used only for unexpected costs and
worthwhile business opportunities.
By keeping a reasonable amount of money in your reserve fund,
Be Your Own Boss you will be able to take care of your business even in crisis situations.
Learn all you can about Also, you will be able to take advantage of business opportunities that
the different ways entre- require money above and beyond the income from your business.
preneurs finance their
start-up businesses. What
you know about how to
obtain financing will make
Using Technology
the difference between How can technology assist in preparing
the success or failure of financial information?
your business.
Recording, summarizing, and reporting financial information
To continue with can be an extremely time-consuming activity. Computers offer small
Task 5 of your business owners the ability to automate all the accounting functions.
WebQuest project, visit Daily, weekly, monthly, and annual reports can be generated quickly
finance07.glencoe.com.
and accurately. With software and hardware being very affordable,
most small businesses use some form of automated accounting.
Section 18.1 Assessment
QUICK CHECK Write About It Write a paragraph
1. What are two categories of start-up capital? that will help Theo convince Cole
2. How do you estimate the amount of oper- that developing a written financial plan
ating capital needed to run a business? and creating projected financial statements
3. Where is the financial information needed will help their business succeed.
to create a projected income statement?
SOLVE MONEY PROBLEMS
THINK CRITICALLY 6. Identify Start-Up Costs Jana plans
4. Explain why a sound financial plan is to turn her love of basketball into a busi-
critical to the success of a business. ness by offering summer basketball camps
for children, one-on-one training for high
USE COMMUNICATION SKILLS school players, and skills assessment for
5. Projected Financial Statements college players. Jana is ready to create a
Theo and Cole have an opportunity to start financial plan for her business.
a business selling sunglasses at the beach. Analyze Help Jana identify the
Theo knows it is very important to develop required assets and start-up costs for
a written financial plan for the new busi- her business.
ness. Cole, however, says that as long as
they know what is going on, they do not
need projected financial statements.
588 Unit 5 Business Ownership and Planning finance07.glencoe.com
Section 18.2
Case Study: Focus on
Reading
A Financial Plan
Read to Learn
• How to identify the ele-
Starting a Business ments of a financial plan.
What are some requirements to start a business?
Main Idea
For the past five years, Molly Singer has worked at King Point Flo-
A good financial plan
rist, a local flower and garden store. During that time Molly learned reflects your knowledge
to create fresh flower arrangements, fruit and gourmet baskets, and and skills and projects a
dried flower displays. She has read several books on floral design and picture of the potential
has received numerous compliments on her arrangements. financial success of your
Because of her work at the florist shop, Molly has experience in business.
purchasing flowers and arrangements, advertising, pricing, sales pro-
cedures, and recordkeeping. She has taken several business courses at
Key Term
the local community college and has attended two seminars on run- • chart of accounts
ning a small business.
Molly now feels that she is ready to open her own florist busi-
ness. She realizes that running her own business will be very different
from working for someone else. She is a little nervous about the chal- Before
lenges she will face as a business owner. However, she is confident You Read
that she has the knowledge and skills she needs to operate a success- PREDICT
ful flower shop.
Molly has decided to call her business “Cricket Lane Flowers.” What is the advantage of
having a thorough and
After researching locations and potential markets for a shop, she has
solid financial plan?
found a small store that will fit her needs. It is located on a main
street with a steady traffic flow and high visibility. No other flower
shops are in the area, but there are several small businesses nearby
that seem to attract customers. The store is in good condition, the
monthly rent is reasonable, and the required painting and decorating
should be affordable.
A Business Plan for
Cricket Lane Flowers
What is an example of a business plan?
With some preliminary research completed, Molly is ready to cre-
ate her business plan for Cricket Lane Flowers. Her overall business
plan consists of three parts: a strategic plan, a marketing plan, and a
financial plan. This section provides brief summaries of Molly’s strate-
gic and marketing plans as well as all elements of her financial plan.
Chapter 18 Developing a Financial Plan 589
䊳 IN FULL BLOOM Molly
will need more than a good
location to make her dream
of a thriving flower shop
come true. What else will
Molly need to build a successful
new business?
The Strategic Plan
For her strategic plan Molly researched the local flower market,
identified the competition, and decided on the line of flowers and
services that her shop will provide. After careful analysis, she set the
following short-term and long-term goals.
Short-Term Goals:
• Rent a store in a good location.
• Secure a good telecommunication system.
• Computerize all accounting functions.
• Increase sales by 5 percent or more each month during the
first year.
• Utilize all local advertising outlets.
As You Long-Term Goals:
Read • Increase sales by 30 percent or more in each of the first
RELATE three years.
• Show a profit by the end of the second year.
Which one of Molly’s long- • Expand inventory to include fruit and gift items.
term goals do you think • Develop business clients.
will be the most difficult to
reach? Why? Molly’s strategic plan also outlines the steps that she will take to
achieve each of her short-term and long-term goals.
590 Unit 5 Business Ownership and Planning
The Marketing Plan
In her marketing plan, Molly analyzed the competition, identi-
fied advertising outlets, developed promotional activities, and estab-
lished an advertising and promotion budget for Cricket Lane Flowers.
The success of her sales goals depends on an effective marketing plan. LANGUAGE ARTS
At her previous job, Molly purchased advertising space in local and A marketing plan helps a
business owner to predict
regional newspapers and magazines. Molly has decided to spend
the cost of promoting and
$2,000 in each of the first three months on advertising. marketing his or her new
company. An important
The Financial Plan part of developing a mar-
keting plan is analyzing
What must Molly do before she prepares her the competition. By doing
financial plan? so, the business owner
can determine the com-
With her strategic and marketing plans completed, Molly is petition’s strengths and
ready to develop her financial plan. As you may recall, the success of weaknesses and plan his
her strategic and marketing plans depends on the quality and accu- or her marketing strategy
racy of her financial plan. accordingly. Write a short
Before preparing a financial plan, Molly must be sure that she essay outlining the process
for evaluating potential
has set realistic goals for herself and her business. She knows that
business rivals.
although her figures are only estimates, they must be attainable. Also,
Molly realizes that it will take time to earn a profit.
Background Information
To help start her business, Molly has saved money over the past
five years, and her brother and sister will lend her some money. She
needs to borrow additional funds, but she is confident that she will
qualify for loans because of her well-established credit history. She
has financed two cars and repaid her student loans. In addition, Molly
uses her credit cards wisely and makes payments on time.
Molly has decided to organize her new business as a sole pro-
prietorship. Although she will have unlimited liability, this form of
ownership is easier and less costly to establish than others. She has
consulted with an attorney and an accountant. Molly will continue
to work with her accountant throughout the life of her business. She
will need to consult him in the future regarding issues such as busi-
ness expansion, tax filing, and the possibility of hiring employees.
Elements of the Financial Plan
As You
Molly’s financial plan includes the following reports: Read
• Statement of Required Start-Up Capital QUESTION
• Projected 12-Month Income Statement
• Projected 12-Month Statement of Cash Flows What are Molly’s alter-
• Projected 3-Year Income Statement natives to setting up
a business as a sole
• Projected 3-Year Statement of Cash Flows
proprietorship?
• Projected 3-Year Balance Sheet
Chapter 18 Developing a Financial Plan 591
Molly’s complete financial plan for Cricket Lane Flowers appears
on the following pages. By reading and analyzing her six projected
financial statements in Figures 18.7 through 18.12 (pages 592–597),
you will see how she expects her business to develop over time.
Cricket Lane Flowers
Financial Plan
Prepared by Molly Singer
Business Objective: To open and operate a financially
successful flower shop.
Required Capital:
Start-Up Capital $89,000
Operating Capital 12,000
Reserve Capital 15,000
Total Required Capital $116,000
Figure 18.7 Cricket Lane Flowers—Statement of Required Start-Up Capital
CRICKET LANE FLOWERS
Statement of Required Start-Up Capital
Item Cost
ASSETS
Refrigeration equipment $9,600
Display equipment 8,100
Maintenance equipment 2,900
Delivery van 19,000
Office furniture 1,900
Rugs, lights, ventilation 5,200
Computer system 3,500
Phone systems 750
Photocopier 1,800
Merchandise 17,000
Supplies 1,100
Alarm system 900
Total Assets $71,750
START-UP COSTS
Rent deposit 3,500
Insurance 1,400
Building signs 3,000
Artists‘ fees 150
Professional/legal fees 2,200
Business permits/licenses 250
Stationery/business cards 400
Flowers/wire fees 500
Utility deposits 700
Phone lines 450
Advertising 2,000
Repairs/fix-up costs 1,800
Banking fees 200
Other 500
Total Start-Up Costs 17,050
Total Required Start-Up Capital $88,800
Starting the Business With this statement, Molly will not forget any important start-up costs.
Do you think Molly’s list of required start-up capital is accurate? Why?
592 Unit 5 Business Ownership and Planning
Sources of Capital:
Cash from Owner $30,000
Personal Loans 6,000
Short-Term Commercial Loan 30,000
Common
(SBA Guaranteed) CENTS
Home Equity Loan 50,000
Total Available Capital $116,000 Saving Is Better
Spending money is easy,
especially when you have
Molly will invest the funds from the first three sources of capital
a credit card. Resist the
(cash from owner, personal loans, and short-term commercial loan) temptation to use your
in the business immediately. To cover the initial operation costs of card to buy something
the business, Molly has elected to use a home equity loan. As you you want but cannot really
learned in Chapter 7, a home equity loan is a loan based on the dif- afford. Instead, be patient
ference between the current market value of a home and the amount and save your money for
that special item. Why is it
still owed on the mortgage. Home equity loans are an easy source of
important to use your credit
extra cash, but they must be used carefully. For example, if Molly’s cards wisely for business or
business were to fail, she would have difficulty repaying the loan. personal expenses?
Careers in Finance
CREDIT ANALYST
CONTROLLER Glenn Danforth
Lovoltech
Business math and problem solving have always interested Glenn. As the controller for a start-up
semiconductor manufacturer, Glenn is responsible for all aspects of the corporation’s finances. He
handles banking, profit and loss statements, balance sheets, payroll, accounts payable, accounts
receivable, collections, cost accounting, inventory valuation, and government filing. He also pre-
pares and analyzes weekly cash management reports, monthly expense reports, and quarterly finan-
cial statements complete with management analysis. Because the company works with a plant in
Taiwan, Glenn is in the process of learning Mandarin Chinese. He enjoys studying the different parts
of the business and seeing how he can help them “add up” to a more profitable company.
SKILLS: Accounting, analytical, communication, computer, decision-making,
management, math, organizational, and problem-solving skills
PERSONAL TRAITS: Discreet, flexible, good judgment, likes working with people and numbers,
and tactful
EDUCATION: High school diploma or equivalent; bachelor’s or master’s degree in
accounting, finance, or business; Certified Public Accountant certification;
master’s degree in business administration also recommended
ANALYZE Why would a controller need to be a good team player?
To learn more about career paths for controllers, visit finance07.glencoe.com.
finance07.glencoe.com Chapter 18 Developing a Financial Plan 593
&IGURE #RICKET ,ANE &LOWERS0ROJECTED -ONTH )NCOME 3TATEMENT
#2)#+%4 ,!.% &,/7%23
0ROJECTED -ONTH )NCOME 3TATEMENT
-/.4(
2%6%.5%
3ALES
#OST OF -ERCHANDISE 3OLD
'ROSS 0ROFIT ON 3ALES
%80%.3%3
2ENT
%LECTRICITY
(EAT!#
4ELEPHONE
)NSURANCE
-AINTENANCE2EPAIRS
-ISCELLANEOUS
7AGES
4AXES
3UPPLIES
)NTEREST
!DVERTISING
/THER
4OTAL %XPENSES
.ET )NCOME ,OSS
&IGURE #RICKET ,ANE &LOWERS0ROJECTED -ONTH 3TATEMENT OF #ASH &LOWS
#2)#+%4 ,!.% &,/7%23
0ROJECTED -ONTH )NCOME 3TATEMENT
-/.4(
#!3( 2%#%)043
#ASH 3ALES
4OTAL #ASH 2ECEIPTS
#!3( 0!9-%.43
0URCHASE OF -ERCHANDISE
/PERATING %XPENSES
)NTEREST %XPENSE
4AXES
4OTAL #ASH 0AYMENTS
.%4 #!3( &,/7
594 Unit 5 Business Ownership and Planning
Figure 18.8 Cricket Lane Flowers—Projected 12-Month Income Statement (cont’d)
CRICKET LANE FLOWERS
Projected 12-Month Income Statement
MONTH 7 8 9 10 11 12
REVENUE
Sales $17,000 $17,800 $18,700 $20,400 $22,300 $24,000
Cost of Merchandise Sold 7,900 8,300 9,100 9,900 11,400 12,000
Gross Profit on Sales $9,100 $9,500 $9,600 $10,500 $10,900 $12,000
EXPENSES
Rent 3,500 3,500 3,500 3,500 3,500 3,500
Electricity 185 190 190 190 200 200
Heat/AC 370 350 340 340 350 360
Telephone 225 240 240 250 250 250
Insurance 480 480 480 480 480 480
Maintenance/Repairs 160 160 160 175 175 175
Miscellaneous 180 190 190 190 190 190
Wages 600 700 700 800 800 900
Taxes 525 595 615 640 660 675
Supplies 660 670 670 670 680 680
Interest 680 680 680 680 680 680
Advertising 1,200 1,200 1,200 1,400 1,500 1,500
Other 125 125 125 125 100 130
Total Expenses $8,890 $9,080 $9,090 $9,440 $9,595 $9,720
Net Income/<Loss> <$210> <$420> $510 $1,060 $1,305 $2,280
Monthly Income This statement shows the progression of Cricket Lane Flowers’ income.
Is there a reasonable progression of income over the 12 months?
&IGURE #RICKET ,ANE &LOWERS0ROJECTED -ONTH 3TATEMENT OF #ASH &LOWS CONTD
#2)#+%4 ,!.% &,/7%23
0ROJECTED -ONTH )NCOME 3TATEMENT
-/.4(
#!3( 2%#%)043
#ASH 3ALES
4OTAL #ASH 2ECEIPTS
#!3( 0!9-%.43
0URCHASE OF -ERCHANDISE
/PERATING %XPENSES
)NTEREST %XPENSE
4AXES
4OTAL #ASH 0AYMENTS
.%4 #!3( &,/7
.EGATIVE #ASH &LOW FOR THE -ONTH 0ERIOD
-ONTHLY #ASH &LOW ! NEGATIVE CASH FLOW SHOULD PROGRESS TO A POSITIVE ONE WITHIN A YEAR OR SO
3HOULD -OLLY EXPECT A POSITIVE CASH FLOW BY THE TH MONTH 7HY
Chapter 18 Developing a Financial Plan 595
&IGURE #RICKET ,ANE &LOWERS0ROJECTED 9EAR )NCOME 3TATEMENT
#2)#+%4 ,!.% &,/7%23
0ROJECTED 9EAR )NCOME 3TATEMENT
9%!2
2%6%.5%
3ALES
#OST OF -ERCHANDISE 3OLD
'ROSS 0ROFIT ON 3ALES
%80%.3%3
2ENT
%LECTRICITY
(EAT!#
4ELEPHONE
)NSURANCE
-AINTENANCE2EPAIRS
-ISCELLANEOUS
7AGES
4AXES
3UPPLIES
)NTEREST
!DVERTISING
/THER
4OTAL %XPENSES
.ET )NCOME ,OSS
0REDICTING 3UCCESS -OLLY PROJECTS THE FIRST THREE YEARS OF HER COMPANYS INCOME
7HAT IS THE NET INCOME INCREASE BETWEEN THE FIRST AND SECOND YEARS
&IGURE #RICKET ,ANE &LOWERS0ROJECTED 9EAR 3TATEMENT OF #ASH &LOWS
#2)#+%4 ,!.% &,/7%23
0ROJECTED 9EAR 3TATEMENT OF #ASH &LOWS
9%!2
#!3( 2%#%)043
#ASH 3ALES
4OTAL #ASH 2ECEIPTS
#!3( 0!9-%.43
0URCHASE OF -ERCHANDISE
/PERATING %XPENSES
)NTEREST %XPENSE
4AXES
4OTAL #ASH 0AYMENTS
.%4 #!3( &,/7
&UTURE #ASH &LOW -OLLY HAS PREDICTED POSITIVE CASH FLOWS IN THREE YEARS
(OW DO YOU CALCULATE NET CASH FLOW
596 Unit 5 Business Ownership and Planning
&IGURE #RICKET ,ANE &LOWERS0ROJECTED 9EAR "ALANCE 3HEET
#2)#+%4 ,!.% &,/7%23
0ROJECTED 9EAR "ALANCE 3HEET
9%!2
!33%43
#ASH IN "ANK
!CCOUNTS 2ECEIVABLE
$ISPLAY %QUIPMENT
2EFRIGERATION %QUIPMENT
$ELIVERY %QUIPMENT
/FFICE %QUIPMENT
#OMPUTER %QUIPMENT
-ERCHANDISE )NVENTORY
3UPPLIES
4OTAL !SSETS
,)!"),)4)%3
!CCOUNTS 0AYABLE
.OTES 0AYABLE
4OTAL ,IABILITIES
/7.%23 %15)49
-OLLY 3INGER #APITAL
4OTAL ,IABILITIES /%
#2)#+%4 ,!.% &,/7%23
4HE &IRST 9EARS -OLLY HAS USED THIS SHEET TO PREDICT THE HEALTH OF HER COMPANY IN THE
FIRST THREE YEARS OF BUSINESS
$OES IT LOOK LIKE #RICKET ,ANE &LOWERS WILL SURVIVE THE FIRST DIFFICULT
YEARS OF OPERATION
Chapter 18 Developing a Financial Plan 597
Accounting Procedures
Molly’s accountant has set up a chart of accounts—a list of all
the general ledger accounts that a business will use. (See Chapter 20
for more information on accounting.) This chart of accounts will pro-
vide Molly with a framework for recording and reporting her business
transactions. Figure 18.13 shows the accounts she will use.
Molly’s accountant also recommended purchasing a software
program to maintain Cricket Lane Flowers’ accounting records, so all
accounting procedures will be computerized. By using a software pro-
gram, Molly will spend less time maintaining her accounting records
and will have more time to run her business.
Molly will be responsible for entering all business transactions
into the program. At the end of every month, the computer system
will generate a trial balance, financial statements, and reports. Molly
and her accountant will analyze Cricket Lane Flowers’ monthly
income statement, statement of cash flows, and balance sheet.
&IGURE #RICKET ,ANE &LOWERS#HART OF !CCOUNTS 3HEET
#2)#+%4 ,!.% &,/7%23
#HART OF !CCOUNTS
!33%43 2%6%.5%
#ASH IN "ANK 3ALES 2EVENUE
!CCOUNTS 2ECEIVABLE 3ALES 2ETURNS
-ERCHANDISE )NVENTORY
3UPPLIES #/34 /& -%2#(!.$)3%
0REPAID )NSURANCE 0URCHASES
$ISPLAY %QUIPMENT 0URCHASES 2ETURNS
2EFRIGERATION %QUIPMENT
/FFICE %QUIPMENT %80%.3%3
#OMPUTER %QUIPMENT !DVERTISING
$ELIVERY %QUIPMENT "ANK #ARD &EES
$ELIVERY
,)!"),)4)%3 )NSURANCE
!CCOUNTS 0AYABLE )NTEREST
.OTES 0AYABLE -AINTENANCE
-ISCELLANEOUS
/7.%23 %15)49 2ENT
-OLLY 3INGER #APITAL 3UPPLIES
-OLLY 3INGER 7ITHDRAWALS 5TILITIES
)NCOME 3UMMARY 4AX
)N /NE 0LACE 4HIS CHART OF ACCOUNTS WILL HELP -OLLY KEEP TRACK OF ALL TRANSACTIONS
7OULD A SOFTWARE PROGRAM HELP -OLLY KEEP TRACK OF HER ACCOUNTS
598 Unit 5 Business Ownership and Planning
By comparing these financial statements with statements from
previous months, Molly and her accountant will be able to evalu- After You
ate the financial progress and position of her business. If a financial Read
problem is identified, her accountant will make recommendations as REACT
to what Molly needs to do to correct the problem. It is only by careful
and constant financial analysis that Molly can be assured her busi- Do you think that you
could develop a reasonable
ness is growing according to the projections outlined in Cricket Lane
financial plan for a business
Flowers’ financial plan. using the information pro-
At the end of each quarter or year, her accountant will also see vided in this chapter?
that all required local, state, and federal reports are submitted to the
appropriate agencies.
Section 18.2 Assessment
QUICK CHECK Calculate Using Figure 18.10 on
1. What reports did Molly include in her page 596, calculate what Molly’s pro-
financial plan? jected sales would be in the second and
2. Refer to Molly’s projected 12-month third year if they increased 35 percent from
income statement in Figure 18.8 on each previous year. How might a 35 per-
pages 594–595. When does Molly predict cent increase in sales impact Molly’s pro-
that she will begin to show a positive net jected expenses?
income?
SOLVE MONEY PROBLEMS
3. As you can see from Figure 18.9 on
pages 594–595, Molly is projecting a 6. Start-Up Capital According to
negative cash flow of $6,120 for the first Figure 18.7 on page 592, Molly will need
12-month period during which she is $71,750 to purchase assets for Cricket Lane
in business. How did she arrive at this Flowers. If the bank denies her applica-
conclusion? tion for the short-term commercial loan of
$30,000, she will not have enough money
THINK CRITICALLY for all the assets that she has identified as
4. Summarize the steps that Molly has taken necessary to begin operations.
to ensure that her financial plan will be Analyze How might Molly revise
efficient and effective. her list of assets and still have what
she will need to begin to operate her busi-
USE MATH SKILLS ness? Explain your reasoning.
5. Positive Predictions One of Molly’s
long-term strategic goals is to increase sales
by 30 percent or more in each of the first
three years of business. As Molly reviews
her projected income statements for the
next three years, she knows that she made
the “best guess” estimates for both revenue
and expenses. Molly believes that she will
meet or maybe even exceed her goals.
Chapter 18 Developing a Financial Plan 599
Chapter 18 Review & Activities
CHAPTER SUMMARY
• Start-up capital includes money required • Projected income statements are an
for the purchase of assets needed to estimate of the way in which income
run a business, including inventory, amounts will change over the next
equipment, furnishing, supplies, and few months or years. Estimates of
utilities, plus start-up costs. fixed expenses and variable expenses
• Start-up costs include legal, profes- are included in the projected income
sional, and banking fees, licenses, statement. Lending institutions see
permits, insurance, marketing costs, these statements when you apply for
and remodeling and maintenance costs. commercial loans.
Estimates of these start-up costs should • Reserve capital is money set aside for
be on the high side, as new business unexpected costs or opportunities,
owners often underestimate or miss similar to an emergency fund.
some of these costs. • The elements of a financial plan include
• Operating capital is the money needed a statement of required start-up capital,
to operate the business for the first few a projected 12-month income statement,
years. Often, revenue generated from a projected 12-month statement of
the business is not enough to meet cash flows, a projected 3-year income
these costs in the first few years of statement, a projected 3-year statement
business. of cash flows, and a projected 3-year
balance sheet.
Communicating Key Terms
Imagine that you are planning to open a new business. Using the terms below, prepare some
notes for a meeting with a commercial loan officer at your bank regarding a business line of credit.
• capital • financial forecasting • variable expenses
• start-up capital • projected financial • reserve capital
• start-up costs statements • chart of accounts
• operating capital • fixed expenses
Reviewing Key Concepts
1. Explain the three steps in estimating start-up capital needs.
2. List the start-up costs of a business you would like to start someday.
3. Explain why operating capital estimates should be made “on the high side.”
4. Describe some ways of estimating income and expenses in order to prepare projected
income statements.
5. Explain how reserve capital will enable you to take advantage of business opportunities.
6. Explain why the projected statement of cash flows is considered the “most important
financial statement” in the financial plan.
600 Unit 5 Business Ownership and Planning
Chapter 18 Review & Activities
Economics After visiting the wholesale flower mart, Molly, the owner
of Cricket Lane Flowers, discovered that prices are going up on many of the
flowers that the shop regularly purchases to sell to customers.
Plan and Budget Imagine you are the owner of Cricket Lane Flowers.
Brainstorm some ways to reduce variable expenses to offset the rise in
wholesale prices.
Projecting Income As you can see on page 593, Molly, the owner of
Cricket Lane Flowers, has the following sources of capital:
Cash from Owner $30,000
Personal Loans $6,000
Short-Term Commercial Loan $30,000
Home Equity Loan $50,000
Total Available Capital $116,000
1. Calculate the percentage of the total available capital Molly is paying
from her personal savings.
2. Compute using spreadsheet software to determine the percentage of total
available capital from the other sources of capital.
Connect with Economics In every financial undertaking, there are
risks that can be controlled, and risks that cannot be controlled.
1. Research Go back through the chapter and look over Cricket Lane
Flowers’ sources of start-up and operating capital (page 592).
2. Think Critically What are some risks over which Molly, the company
owner, has no control? How would you respond if Molly asked you for
financial assistance with start-up costs? Why?
Round Up Your Consultants Everyone who runs a small business
needs consultants to help him or her deal with various issues. A business
owner may need a computer-support service or a promotional specialist.
Log On Use an Internet search engine to find several sources of such
services in your town. Answer the following questions:
1. How much would it cost to obtain services from these sources?
2. Molly has $2,200 for professional and legal fees (see Figure 18.7 on
page 592). If she needs $1,000 for legal fees, would the remaining $1,100
cover the cost of hiring a computer-support service?
Newsclip: Lacking Capital Many start-up companies make
investments in their businesses but lack start-up capital.
O N L I N E
Log On Go to finance07.glencoe.com and open Chapter 18.
Learn more about how to write a financial plan for your business.
Explain the consequences of lacking capital.
finance07.glencoe.com Chapter 18 Developing a Financial Plan 601
Chapter 18 Review & Activities
ARE YOU A PERSUADER?
Your personality can help guide your future. On a separate sheet
of paper, write down ten of the following character traits that best
describe you and find out if you are a persuader, a communicator,
or an individualist.
______ a. I like meeting people.
______ b. I am friendly.
______ c. I try to avoid conflict.
______ d. I like to spend time alone.
______ e. I like to talk.
______ f. I am sensitive.
______ g. I am interested in other people.
______ h. I am upbeat.
______ i. I am enthusiastic.
______ j. I like to be active.
______ k. I have perseverance.
______ l. I am persuasive.
______ m. I let other people do what they want.
______ n. I am cautious.
______ o. I am ambitious.
______ p. I like to feel in control.
______ q. I like to plan.
______ r. I like organization.
______ s. I like to be the center of attention.
Score 3 points for each of these character traits: a, b, e, g, h, i, j, k, l, o, or s.
Individualist: If you scored 6–12 points, you might enjoy a career and hobbies that gives
you independence.
Communicator: If you scored 15–21 points, you enjoy activities in which you are a team
player working toward a common goal.
Persuader: If you scored 24–30 points, consider a career in sales or another field in which
you can influence people.
602 Unit 5 Business Ownership and Planning
Chapter 18 Review & Activities
Your Financial Portfolio
Start with a Plan
Three brothers, Collin, Kyle, and J.C., plan to start a house painting business. All of them
have experience painting, and they have identified plenty of work in an area downtown
that is being renovated. They want to know how much start-up capital they will need
to get their business going and to keep it going until it is solidly established.
Start-Up Costs
One-time costs:
Equipment: 3 ladders $305
Paint sprayers 120
Rollers, brushes, drop cloths, and other supplies
(ongoing supplies will be expensed per job) 250
Down payment for van $3,000
Total one-time costs $3,675
Continuing costs (monthly):
Insurance $120
Cell phone 25
Van loan 625
Van maintenance and gas 100
Total monthly costs $870
Total monthly costs ⴛ 12 months 10,440
Total start-up costs $14,115
Identify
Start-up costs depend on the type of business, the size of the business, and the
amount and kind of inventory and operating expenses. Give an example of the follow-
ing types of businesses: service, retail, and manufacturing. Which might have the most
expensive start-up costs? Why?
Chapter 18 Developing a Financial Plan 603
Unit 5 LAB
Get a Financial Life!
A Business Is Born Procedures
Overview STEP A The Process
Eva and Jack are aware that
having a strong business and financial back-
Carrie and David Lanier have two children: ground will be crucial to the success of their
Eva, age 23, and Jack, age 22. Eva and Jack business. Therefore, they have asked you for
graduated from college with a low amount of some advice and assistance with writing a rough
student loan debt, thanks to smart planning, draft of the first two main sections of their busi-
saving, and investing by their parents. While ness plan.
Eva and Jack were in college, they worked and
started saving their own money for a retail store 1. Eva and Jack are ready to hire a bookkeeper.
they plan to open some day. They need help They have asked you to help them choose
writing a business plan for Party Town. They will the right employee. Make a list of the skills
hire a bookkeeper to complete a financial plan. and characteristics the new employee should
Their store will offer party decorations, paper have. Write a newspaper ad for the position.
goods, balloons, and games. Now it is time to 2. a) Set up the first main section of the busi-
begin finalizing their plan. They hope to earn ness plan—the strategic plan for Party Town.
money from the store profits to expand their Include the mission statement of the com-
business in the future. pany, a description of the business and prod-
uct, a product plan with their short-term
and long-term goals, and list the manage-
ment team and their roles.
Resources & Tools b) Set up the second main section of the
• Assorted magazines and newspapers business plan—the marketing plan for Party
• Internet Town. Include research and information
• Portfolio (ring binder or file folder) on the target customers, the competition,
• Public or school library advertising outlets, and ideas for promo-
• Word processor tional activities as well as a budget for adver-
tising and promotion.
3. Write a list of the elements of a financial
plan as a guide for the bookkeeper to use.
4. Identify several books, magazines, news-
papers, and Web sites that could be used by
someone interested in starting and manag-
ing a business.
604 Unit 5 Business Ownership and Planning
STEP B Create Your Portfolio
As you work through the pro- STEP C Applying Technology
The globalization of the
cess, save the results so that you can refer, marketplace, advances in technology, and the
review, and refine. Create a portfolio with four downsizing of the workforce are trends that are
sections to showcase the information that you transforming the workplace and the worker.
collect in Step A. Technology is providing ways for people to work
anytime and anyplace. The successful workers
1. Section 1 should include the newspaper ad
and entrepreneurs of tomorrow must have strong
you created for the bookkeeper position.
technical skills and be willing to update those.
2. Section 2 should include the strategic
plan document and the marketing plan 1. Research an emerging technology and its
document with any supporting research impact on the workplace and retailing. Some
materials. topics include: computers, artificial intelli-
3. Section 3 should list all the elements of a gence, e-books, video telephones, video con-
financial plan in outline form. ferencing, and voice and eye recognition.
4. The last section will be a bibliography of the 2. Contact a vendor who sells the products you
resources that you identified. selected. Find out how much they cost and
next year’s projected sales.
3. Create a poster, brochure, or other visual aid
about your selected technology. Include the
features and benefits of the product. Also,
note how one type of technology could be
applied to Party Town.
4. Write a two-page paper outlining your pre-
dictions for the ways in which technology
will affect the workplace and the economy.
605
Unit 6
Business
Finance
Basics
Internet
Project
Franchise Ownership
Buying a franchise business offers people a chance
to own their own business. Franchise owners have
the advantage of offering goods or services that
have instant name recognition. But purchasing a
franchise does not guarantee success. In this project
you will investigate franchise opportunities to
decide whether owning a franchise is right for you.
You will learn about your obligations as a franchise
owner, how to shop for opportunities, and how to
ask the right questions before you invest.
Log on to finance07.glencoe.com. Begin
by reading Task 1. Then continue on your
WebQuest as you study Unit 6.
Section 19.1 20.1 21.1 22.1
Page 614 639 682 705
606 finance07.glencoe.com
FINANCE FILE
Cycling Back to the
Future
When Gary Boulanger decided to
open an independent bike shop in Day-
ton, Ohio, he sought inspiration from
hometown heroes: Orville and Wilbur
Wright. The famous brothers had built
a bicycle company there in the 1890s
before garnering greater fame as avia-
tion pioneers.
So in January 2003, timed to coin-
cide with the 100th anniversary of the
Wright brothers’ first flight, Boulanger
introduced modern versions of the
Wrights’ Van Cleve and St. Clair models,
opening Cycles Gaansari in downtown
Dayton. Instead of going head-to-head
with big manufacturers and retailers,
Boulanger [created] his own niche with
a retro line of cycles.
Boulanger says [his] shop brought
in $140,000 in sales during its first year,
$250,000 last year, and he expects rev-
enue to double this year.
Boulanger stresses customer ser-
vice. In turn, he says “our customers are
brand loyal.” To that end, he has begun
selling a line of clothing and accesso-
ries with the Gaansari logo. And he
began marketing a signature brand of
coffee. Like the Wright Brothers before
him, Gary Boulanger’s business has def-
initely taken flight.
—By Rod Kurtz
Write About It How has
Gaansari’s inventory helped the
business succeed?
Log On To read the complete
BusinessWeek article and do
the BusinessWeek Extension activity
to help you learn more about inven-
tory, go to finance07.glencoe.com.
finance07.glencoe.com 607
19
CHAPTER
Sources of
Funding
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 19.1
• Explain the role of entrepreneurs.
• Differentiate between start-up
costs, operating costs, and
reserve funds.
• Identify sources of personal and
private financing.
• Discuss the options available
through bank funding.
• Identify the factors banks consider
to approve commercial loans.
Section 19.2
• Describe the function of the
Small Business Administration.
• Identify alternative sources of
funding for a business.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
608
In the Real World . . .
Clive Lee has dreamed of opening a bicycle shop that serves
amateur and professional cyclists. He has found a good location, distri-
butors who can provide him with specialized supplies, and a great mechanic.
He has also determined how much money it will take to get the business off the
ground. Clive saved money from his current job for many years and has good credit.
However, this will not be enough for him to open the shop he has planned. Clive will
need to get a loan from a bank or work with an outside investor. To obtain money
from a bank, the Small Business Administration, private investors, commercial
financing, or other sources of funding, Clive will need a good business plan.
As You Read Consider some some sources and organizations
that might agree to lend start-up capital to an
entrepreneur?
ASK Fast Cash
Q: My family runs a small business. Recently a
lot of unexpected expenses came up, and now we
need $4,000 in a hurry. We just expanded our business, so we have no cash in re-
serves. How can we obtain the money?
A: If you have outstanding (unpaid) invoices from customers whom you have billed
for your products, you can take those invoices to a bank and borrow against those
receivables. If you have orders to fill but need money for supplies, you can speak to a
lender about a short-term commercial loan.
Ask Yourself How can a business prepare for unexpected expenses?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com Chapter 19 Sources of Funding 609
Section 19.1
Focus on
Reading
Analyzing Financial
Needs
Read to Learn
• How to explain the role
of entrepreneurs. Starting a New Business
• How to differentiate What do you need to start a new business?
between start-up costs,
operating costs, and Jenny, age 8, and Matt, age 7, are going into business. They are
reserve funds. going to set up a lemonade stand—called J & M Lemonade—in front
• How to identify sources of Matt’s house. A lot of people walk down that street, which is close
of personal and private to a school and a park. Jenny and Matt figure that their location will
financing. provide plenty of customers. It is summer, and people are thirsty.
• How to discuss the Cold lemonade will be in demand.
options available through Before they begin selling lemonade, however, Jenny and Matt
bank funding. must decide what things they will need to get their business started.
• How to identify the factors In addition to lemonade, Jenny says they will need a large pitcher, a
banks consider to approve stand or table, and some cups. Matt adds a large sign, a box for their
commercial loans.
money, and some ice cubes to the list. They agree that they will also
need coins to make change for customers.
Main Idea
As with all business operations, Jenny and Matt will need cash,
To start or expand a busi-
ness, you must accurately
equipment, and supplies, as well as goods or services to sell. How do
estimate the amount of you think they will get these items? They will probably do what you
funding you will need. did when you were their age: They will go home and see what they
can find. Their families may help them find a pitcher, a table, and
Key Terms some cardboard to make a sign. They may give them some coins to
• entrepreneur use for change and buy the lemonade and cups.
• operating costs Soon Jenny and Matt have all the items they need, and they set
• reserve fund up their stand. J & M Lemonade is now an active player in the free
• private financing enterprise system.
• commercial debt
financing
•
•
commercial loan
line of credit
Business Entrepreneurs
• secured loan What does it take to become an entrepreneur?
• unsecured loan
When you were younger, you may have had a small business
similar to Jenny and Matt’s lemonade stand. Like Jenny or Matt,
you were an entrepreneur. An entrepreneur is an individual who
takes the risk of starting a new business. Entrepreneurs are highly
motivated people who transform ideas for products or services into
real-world businesses. About 80 percent of the 23 million business
operations in the United States are run by one owner. Entrepreneurs
are the backbone of the American economy.
610 Unit 6 Business Finance Basics
High School Entrepreneurs Before
Would you like to be an entrepreneur? Most high school students You Read
would. In a recent Gallup poll, seven out of every ten high school stu- PREDICT
dents said that they would like to start a business. It is possible for a
high school student to start his or her own business. For example, Is every business owner an
entrepreneur?
Fred DeLuca is one successful entrepreneur who started his business
shortly after graduating from high school. In 1965, DeLuca borrowed
$1,000 from a friend and opened Pete’s Super Submarines, a sandwich
shop in Bridgeport, Connecticut. Today you may know DeLuca’s busi-
ness as Subway. As of June 2005, Subway had over 23,000 restaurants
in 82 countries.
Funding a Business
Why do many entrepreneurs need to find outside
sources for funding?
One of the major concerns when starting a business is how it
will be financed. People who take on new business ventures usually
need far more money than they realize.
Jenny and Matt started their lemonade stand with nothing. They
had no lemonade, supplies, or cash. They funded their business with
cash and other assets that their families provided. They hoped to sell
several cups of lemonade and take in some money. Do you think that
they made a profit? Chances are that the money they took in did not
cover the cost of the lemonade and other supplies.
THE AMERICAN DREAM
Anyone can start a small
business. What do you think
you would need to start your
own business?
Chapter 19 Sources of Funding 611
FUNDING CONCERNS Successful busi-
nesses such as this one needed money to start
their operations. Where do you think you might be
able to obtain money for a new business venture?
Family members supported J & M Lemonade financially, but
they did not expect to make a profit on their investment. They just
wanted to help provide an educational and fun experience for Jenny
and Matt. If it were not for their financial support, Jenny and Matt
could not have started their business because other sources of funds
were not available.
As a young adult, you would require funding if you decided to
start your own business. Unfortunately, it is not easy to get funding
for a new business from an outside source. Banks and other financial
institutions are very selective about who receives loans. They also
expect to get a good return on their investment.
As You Determining Needed Capital
Read Why is it so important to know how much money is
needed to start up a business?
RELATE
When you are starting a business, the first thing you must do is
Do you or your friends
make a realistic estimate of how much capital you will need. As you
dream of owning your own
business? What steps will it know, capital is the money you need to establish a business, to oper-
take to make those dreams ate it for the first few months, and to expand the business. Determin-
come true? ing the capital needed to start up your business is one of the steps of
developing a financial plan.
612 Unit 6 Business Finance Basics
Start-Up Costs
The first goal in determining needed capital is to identify start-
up costs. Start-up costs usually require a large amount of cash. If you
attempt to estimate the costs without careful analysis, your estimate
will probably be too low.
To analyze your costs, you should list everything you will require to
begin to operate. Most businesses have some common start-up costs:
• Inventory needed to open the business
• Equipment, fixtures, and display cases
• Security deposit for rented space
• Advertising and promotions
• Insurance
• Professional fees (such as lawyers’ fees)
• Remodeling costs (such as creating office space)
• Legal permits and licenses
• Supplies
Your next task is to assign an estimated cost to each item. Unless
you list every anticipated cost, your total estimate will not be realistic.
Landscaping firms and convenience stores are different types of
businesses, and each has different requirements for operating. Start-
up costs vary among businesses and industries. Make sure that you
research and explore the industry you are entering.
Careers in Finance
CREDIT ANALYST
COMMERCIAL Jenny Tanner
LOAN OFFICER Scott Watson & Associates, Inc.
Jenny Tanner gains satisfaction from helping small businesses and corporations become big ones.
She tends to businesses and corporations that need to borrow money for new equipment or to buy
property. She meets with the customers to explain the different types of loans available. After receiv-
ing a loan application from a business, she requests a credit report from a credit bureau, consults
with her manager, and decides whether or not to approve the loan. As a commercial loan officer,
Jenny is expected to seek out new customers.
SKILLS: Sales, presentation, communication, math, problem-solving, and
organizational skills
PERSONAL TRAITS: Likes working with people and numbers, detail oriented, and self-motivated
EDUCATION: High school diploma or equivalent; bachelor’s degree in finance, economics,
business, or accounting; a minimum of three years’ experience in a banking
environment
ANALYZE How might a commercial loan officer’s job differ from a personal loan officer’s job?
To learn more about career paths for commercial loan officers, visit finance07.glencoe.com.
finance07.glencoe.com Chapter 19 Sources of Funding 613
Operating Costs
Besides determining your start-up costs, you must also estimate
your operating costs for the first 90 to 120 days. Operating costs are
Franchise Ownership the ongoing expenses for operating a business.
Evaluate your personality Start-up costs and operating costs are separate cost categories. It
and find out if owning a is critical that you estimate both types of costs as accurately as pos-
franchise business makes sible. If you use all of your money for start-up costs, then you will not
sense for you.
have any money available to pay your operating costs. When you
To continue with
start a new business, the amount you earn usually will not be enough
Task 2 of your
WebQuest project, visit to cover your expenses. If you cannot pay your suppliers, rent, or util-
finance07.glencoe.com. ity bills, your business will be in serious trouble.
When you prepare your budget for the first 90 to 120 days of
business, you will include your expected income as well as your esti-
mated monthly costs. Businesses have a number of common operat-
ing costs:
• Payroll • Office expenses
• Rent • Advertising
• Insurance premiums • Delivery charges
• Utility bills • Bank charges and other fees
Reserve Fund
Before starting a business, you will also have to estimate the amount
of money you may need at a later date for growth. A reserve fund
is money that can be made available for the future expansion of a
business. You may need additional money to purchase merchandise
or equipment, or perhaps to lease a truck. This money will allow for
growth and help you avoid having to borrow additional capital.
Jenny and Matt’s lemonade stand stayed in business for only two
hours. They did not plan to operate an ongoing business. Of course,
you hope that your business will have a much longer life. Therefore,
careful financial planning for the future is critical. Consider other
expenses when looking ahead and estimating a reserve fund:
• Additional equipment for increased business
• Advertising and other promotional costs
• Capital for any unexpected costs or decreased sales
• Maintaining a positive cash flow
• Expansion of facilities
• Getting and keeping the right amount of inventory
When you have estimated the amounts of your start-up and
operating costs and your reserve fund, you will have a good idea of
your business’s financial needs. You will see what your cash flow will
look like during the first months of operation. Then you can estimate
the total amount of capital you will need to establish your business
and begin to operate.
614 Unit 6 Business Finance Basics finance07.glencoe.com
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: An Application for Your Motive: By applying for a loan
Business Loan through the SBA, you will have a better
An application for a loan from the Small chance of receiving the funding you need
Business Administration (SBA) contains: to start your business.
• Name and contact information
• Amount requested
• Intended use of loan
• Other outstanding federal loans or debt
U.S. Small Business Administration
APPLICATION FOR BUSINESS LOAN
Individual Full Address
Jason True 1647 west Alvarez, Phoenix, AZ 85001
Name of Applicant Business Tax I.D. No. or SSN
True Business Forms
Full Street Address of Business Tel. No. (inc. A/C)
5743 Sun Palm Lane 480-672-1853
City County State Zip Number of Employees (Including
Phoenix Maricopa AZ 85001 subsidiaries and affiliates)
Type of Business Date Business Established At Time of Application 14
Business to Business If Loan is Approved 22
Bank of Business Account and Address
First Merit 5812 Tuskan Lane Subsidiaries or Affiliates
# 3006482-1 Phoenix, AZ 85001 (Separate for above)
Use of Proceeds Use of Proceeds
(Enter Gross Dollar Amount Loan Requested (Enter Gross Dollar Amount Loan Request
Round to the Nearest Hundreds) Round to the Nearest Hundreds)
Land Acquisition $ 150,000 Pay off SBA Loans
New Construction/ Pay off Bank Loans (Non
Expansion Repair $ 250,000 SBA Associated)
Acquisition and/or Repair Other Debit Payment (Non
Machinery and Equipment SBA Associated)
Inventory Purchase All Other
Working Capital (including
Accounts Payable) Total Loan Requested $ 400,000
Acquisition of Existing
Business
Term of Loan (Requested Mat.) 10 Yrs.
PREVIOUS SBA OR OTHER FEDERAL GOVERNMENT DEBT: If you or any principles or affiliates have 1) ever requested Government Financing or 2 ) are delinquent on the
repayment of any Federal Debt complete the following:
Original Amount Date of Approved or Current or
Name of Agency of Loan Request Declined Balance Past Due
$ $
SBA 100,000 6/28/20-- Approved 12,500 Current
$ $
Key Points: In order to be granted a Find the Solutions
loan by the SBA, you need to provide 1. How many employees will this company
a personal financial history, inform have if the loan is approved?
them of the amount of the loan you are 2. How will this company utilize the funds?
requesting, and describe how you intend 3. What is the total amount of the loan?
4. How much does this company owe the SBA
to use the funds. The example represents
for a previous loan?
just a small portion of the full Application
5. What is the requested term of the loan?
for Business Loan.
Chapter 19 Sources of Funding 615
LOCATION, LOCATION
Besides having a great idea
for a business, you must also
find somewhere to operate it.
What features would you look
for when choosing a location
for a local business?
Personal and Private Financing
What is the difference between personal
Business Credit and private financing?
Cards Tips
After you have determined the amount of money you require,
1. Choose a credit card
with no annual fee you will need to figure out how you will get it. Getting affordable
and low interest and sufficient financing is often a major problem when starting or
rates. expanding a business. However, there are many sources of funding
2. Do not mix your available for businesses. Initially, you will probably explore the pos-
business and person- sibility of personal financing.
al purchases on your
business credit card.
3. Use your year-end
Personal Financing
statements from Many people begin small businesses with funds from their own
your credit card
personal assets. In fact, personal assets make up a large part of the start-
company that track
and categorize your up funding for most new business ventures in the United States.
business expenses The primary reason for using this method is that new small busi-
for the year. nesses often have difficulty getting affordable funding. Banks and
4. Take advantage of other financial institutions are not interested in risky or unproven
special rewards and business ventures. You cannot just walk into a bank and tell them
discounts for office that you have a great idea for a new business and expect the loan
supplies and travel officer to hand you money.
if available.
Banks are more interested in funding existing businesses that
5. Avoid using cash
have reported profit over a period of time. These businesses are safer
advance options
because interest investments and provide banks and other financial institutions with
rates are higher. the assurance of a good return on their money.
When starting a small business, you may have to rely on your
own assets to finance the start-up and operating costs. You might use
your personal savings or investments such as stocks or bonds.
616 Unit 6 Business Finance Basics
You might also use loans from family members and friends to
help finance the business. However, with these sources of capital, you
may not have enough cash to get the business going.
Consumer Loans In order to get the funds you need, consider
applying for a consumer, or personal, loan. Most financial institutions
require that consumer loans be secured with collateral. Collateral is
a form of security (usually an asset such as a car or home) that helps
guarantee that a loan will be repaid.
When you pledge collateral for a loan, the risk to the bank is
reduced. As a result, you have a much better chance of getting fund-
ing and can receive better interest rates. If you cannot pay back the
loan, the financial institution can take the property that you have
pledged as collateral.
Home Equity Loans A home equity loan is a loan based on the
difference between the current market value of a home and the
amount still owed on the mortgage. A home equity loan may also
be called a second mortgage. Home equity loans are fairly safe for
financial institutions because they are secured by property. As a result
these loans are usually easier to get than consumer loans, and some
entrepreneurs who own homes use this source.
To determine the maximum amount of this type of loan, the finan-
cial institution will find out the current market value of a home and its
equity. Equity is the value of the home less the current balance on the
home’s mortgage loan.
Suppose a house has a present market value of $175,000, and the
mortgage has a balance of $65,000. The equity in the house is $110,000
($175,000 − $65,000 = $110,000).
Banks will usually allow an owner to borrow up to 80 percent of
the current market value of the home. In this example, the maximum
amount the bank would loan on a home worth $175,000 would be HOME SWEET HOME A
$140,000 ($175,000 × .80 or 80% = $140,000). However, there is an home equity loan can be an
existing mortgage with a current balance of $65,000. Therefore, to fig- easy source of financing for
ure out the amount that the bank would loan, subtract the mortgage an entrepreneur. What risk is
balance from $140,000. In this example, the loan cannot exceed $75,000 involved in using a home equity
($140,000 − $65,000 = $75,000). loan to finance a business?
This type of loan is available only
if there is a substantial amount of equity
in the property. In other words, a home
must be worth a lot more than the
amount owed on the mortgage.
The negative aspect of a home
equity loan is that if the business fails,
the owner could lose his or her home.
A recent study found that more than
one-half of new businesses fail during
the first five years. Considering this
high failure rate, you should think seri-
ously before you finance your business
with a home equity loan.
Chapter 19 Sources of Funding 617
GO FIGURE FINANCIAL MATH
A HOME EQUITY LOAN Market Value ⫻ .80 or 80% ⫽
Adjusted Market
Value of Home
Synopsis: Home equity loans are based on the differ- $160,000 ⫻ .80 or 80% ⫽ $128,000
ence between the current market value of a home and
The adjusted market value of the home is $128,000.
the amount still owed on the mortgage.
B. Find the maximum amount of the home equity loan.
Example: Drew wants to apply for a home equity
loan at Wilton Bank to start his new Internet com- Adjusted ⫺ Existing ⫽ Home
pany. He presently owns a home that has a market Market Value Mortgage Equity Loan
of Home Balance
value of $160,000. He has an existing mortgage bal-
$128,000 ⫺ $90,000 ⫽ $38,000
ance of $90,000. What is the maximum amount the
bank will lend to Drew for a home equity loan? Wilton Bank will lend Drew up to $38,000 for a
home equity loan.
Formula:
Adjusted Market ⫺ Existing Mortgage ⫽ Home Equity
Value of Home Balance Loan
YOU FIGURE
If the adjusted market value of your home is
Solution:
$220,000 and the existing mortgage balance
A. Find the adjusted market value of the home.
is $142,000, how much would you be allowed
to borrow for a home equity loan?
Private Financing
If you cannot get enough capital through personal financing,
you must look to other sources. The next option might be private
financing. Private financing is borrowing money from family or
friends. This type of funding is attractive because it involves little
paperwork and often requires no collateral and low, or no, interest
payments. The disadvantage is that it can lead to personal conflicts if
the business is unsuccessful, and you are unable to repay a loan.
Bank Funding
What is the difference between a secured
and an unsecured loan?
If personal and private financing are insufficient, you may have
to apply for a business loan to get additional money. One of your first
sources for such financing is your local bank.
Commercial debt financing is borrowing money from
a bank or other financial institution to fund a business. Another
option is a commercial loan, which is a loan that finances a new
or ongoing business. Larger banks give out commercial loans, but
they are often interested in larger, more established business oper-
ations with revenues of millions of dollars. Therefore, when small
businesses need money, smaller, local banks are their logical source.
618 Unit 6 Business Finance Basics
A small bank can better relate to small business needs, and it can offer
advice and assist you with other services.
Getting funding from local banks has both advantages and dis-
advantages. Advantages might include:
• They are highly experienced in dealing with small businesses.
• They offer a wide variety of loan plans.
• They offer advice and other business services.
• They are community-oriented and are interested in seeing local
businesses succeed.
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
4ALLINN
S&P 500® financial index. It also gathers financial statis-
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals
to help them guide their financial decisions.
ESTONIA
After enduring Viking occupation in the 10th
century and gaining independence from Russia in
1991, Estonia has come into its own. Only twice the
size of the state of New Hampshire, this small coun- DATABYTES
try boasts one of the fastest-growing economies in
Europe. An independent spirit sets the stage for suc- Capital Tallinn
cess, as indicated by the fact that more than 90 per-
Population 1,353,000
cent of Estonia’s businesses are privately owned.
One area of business that is experiencing rapid Languages Estonian, Russian, and Ukrainian
growth in Estonia is information technology. Govern- Currency Estonian kroon
ment support has helped to encourage entrepreneurs Gross Domestic
to start businesses in this industry. In fact, the gov- Product (GDP) $17.3 billion (2003 est.)
ernment has created a GDP per capita $12,300
program called “Tiger Industry: Engineering, electronics, wood and wood
Leap” that has con- products, and textiles
nected every school in
Agriculture: Potatoes, vegetables, livestock, dairy
Estonia to the Inter-
products, and fish
net. The government
has also funded hun- Exports: Machinery and equipment, wood and paper,
dreds of public Internet textiles, food products, and furniture
access points to make Natural Resources: Oil, shale, peat, and phosphorites
sure its citizens are Think Globally
“plugged in.” How does government funding of telecommunication
services benefit the entire country of Estonia?
Chapter 19 Sources of Funding 619
BANK ON IT A local bank may be the
source of funding your business needs.
Why might a small local bank be better
prepared to help a new business than a
larger bank?
Disadvantages might include:
• They are closely regulated by the government. As a result, there
is extensive paperwork, investigation, and documentation
involved in the loan process.
• They are conservative by nature and may reject your loan if
your business appears too risky.
If you and your local bank are interested in establishing a work-
ing relationship, you should know what loan options are available.
All banks offer a wide variety of loans, and a good banker will recom-
mend the loan that is best for you and your business.
Short-Term Commercial Loans
A short-term commercial loan is a business loan that is usually
As You made for a term of one year or less. Most are written for 30-, 60-, or
Read 90-day periods. These loans are typical for small businesses. They are
QUESTION designed to help the business meet short-term financial obligations
and help with cash flow during a specific time or season. You could
What is the purpose of a use the money for purchasing merchandise before a peak sales period,
short-term commercial
loan?
acquiring equipment, or paying unexpected bills.
For example, during the summer months, Durango’s Ski Shop
begins to prepare its inventory for the upcoming winter season. The
owner, Sabrina, decides that she needs a large quantity of new skis.
Because the ski shop’s sales are typically low in the summer, she has
to apply for temporary financing. With a short-term commercial
loan, Sabrina can purchase the inventory she needs now and repay
the loan with the profits from winter ski sales.
620 Unit 6 Business Finance Basics
Long-Term Commercial Loans
A long-term commercial loan is a business loan that is made for
a term of one to five years. These loans are normally used by larger,
TechByte
Internet Finance
established businesses that require great amounts of funding. Because Education In order to
these are large loans, the businesses will need more time to pay them take advantage of the
back. They may use the funds for expensive equipment, the relocation many loans available
of facilities, the expansion of storage areas, or other major expenses. to entrepreneurs, you
need some basic finan-
New or smaller businesses might have trouble getting these loans.
cial management skills.
Banks consider such businesses to be less stable. Therefore, banks do There are many books
not want to take the risk that the loan will not be repaid. and resources available.
You can also sign up for
online courses and com-
Lines of Credit plete them in your spare
A line of credit is an arrangement in which bank customers time. Each online course
can borrow a certain amount of money from the bank immediately. is sent to you via e-mail
on a daily or weekly basis
This makes funds available for unexpected costs or routine expenses.
and is designed to help
A store owner can borrow all or part of that money at any time and you learn a specific skill
for any purpose. For example, if the plumbing breaks and costs $8,000 or solve a particular prob-
to repair, money is available. lem. There are no grades
The main advantage of this type of funding is that you do not or degrees, but many
pay any interest unless you access the funds. But once you borrow an courses are free.
amount from the line of credit, the bank will charge you interest. View a list of money-
and business-related
The bank will review your available credit every so often. Based
courses and list those you
on your history of accessing the account and on your repayment pat- would like to take through
tern, the bank may increase or decrease the amount of credit. This finance07.glencoe.com.
type of funding is intended for short-term costs that your business
may not be able to handle. For this reason, the bank also expects you
to repay the money in a short period of time.
FULL INVENTORY A
business that depends on
seasonal sales will prepare
its inventory in advance of
the busy season. What type
of loan might such a business
require?
finance07.glencoe.com Chapter 19 Sources of Funding 621
Secured and Unsecured Loans
A secured loan is a loan that is backed by collateral. Most
short-term and long-term loans must be backed by collateral. Banks
LANGUAGE ARTS will hold the title to the equipment, facility, or merchandise used as
Successful entrepreneurs collateral until the loan is repaid. Because banks must be conservative
are risk takers, are goal in their loan policies, most business loans are secured. Only a well-
oriented, and are inde- established, profitable business that has a good relationship with a
pendent. They also know bank can obtain unsecured loans. An unsecured loan is a loan that
how to secure financing does not require collateral from the borrower. If an unsecured loan is
to transform their ideas
approved, it is usually short-term. Because of the increased risk to the
into products or services
that will sell. Imagine you creditor, the interest rate on an unsecured loan is usually higher than
are ready to open your busi- on a secured loan.
ness and you need to bor-
row $10,000 to get started.
Write a letter requesting the Commercial Loan Applications
funding from either your What are the five C’s of credit?
parents, a friend, or a bank.
Be sure to describe the type New and expanding small businesses often have difficulty get-
of business you are going to ting necessary funding. Banks use certain standards to judge a compa-
open and why you think it ny’s financial position and determine how much risk to accept. Banks
will be successful. are conservative and selective as to which businesses they approve for
financing.
You have already learned about the criteria banks and credit card
companies use to determine your creditworthiness (see Chapter 6).
When you fill out an application for credit, you must answer questions
regarding your credit history, your annual income, and your valuable
assets. These institutions want a complete financial picture of you.
When evaluating commercial loan applications, banks will
examine these same factors as well as other information. They want a
financial picture of both you and your business.
THE FIVE C’S A loan
officer will look carefully at
the information you provide
before deciding to grant you
a commercial loan. What
criteria does a bank use to
evaluate a loan request?
622 Unit 6 Business Finance Basics
The Five C’s of Credit
If you apply for a commercial loan, the bank will first examine
the five C’s of credit: character, capacity, capital, collateral, and credit Common
history. (See Figure 19.1.) CENTS
Character Banks want to make sure that you are capable of paying
off the loan on time. They will consider your business experience Paid in Full
When you get your first
and your dealings with other local businesses. Your prior history
credit card, use it wisely.
with the bank, your reputation in the local business community, and Decide how much you
comments from your creditors will also be important. In addition, can afford to charge
proof of your skills as a manager will be essential. each month and stick to
that budget. Be sure to
Capacity The bank will determine whether your business has or pay your bill in full every
will have enough cash to repay the loan on time. It will also examine month. If you do, you will
your sales history, statements of cash flow, and profits reported by avoid high interest charges
your business. and save. How would good
use of personal credit cards
Capital The bank will look to see whether you have invested a help you in starting up a
considerable amount of your personal assets in the business. Some business in the future?
financial institutions require that you use your personal assets for at
least 30 percent of the capital needed to start your business.
Collateral The bank will make sure that you have enough business
assets to secure the loan. Does your business own office equipment,
machinery, delivery equipment, or real estate? Good collateral is also
an important element for approval.
Credit History The bank will review both your personal credit his-
tory and your business credit history. It will also consider your payment
history on any consumer and commercial loans you may have.
&IGURE &IVE #S OF #REDIT
#HARACTER #APITAL
#APACITY
#OLLATERAL
#REDIT (ISTORY
!SSESSING #REDIT 2ISK "ANKS LOOK AT YOUR FIVE #S OF CREDIT TO DETERMINE WHETHER THEY SHOULD GRANT
YOU A LOAN
(OW WOULD YOU RATE EACH ONE OF YOUR OWN FIVE #S
Chapter 19 Sources of Funding 623
Business Plan
The bank will also examine your business plan to make sure that
your business is financially sound. It looks to see whether you have a
clear vision of where you want your business to go and whether you
have identified the necessary steps to achieve your goals. Then the
bank can better measure your financial needs.
Banks often base loan decisions on the business plan. It is vital
that your plan be clear, accurate, and well planned. Include the three
basic parts of a business plan that focus on a strategic plan, a market-
ing plan, and a financial plan. As you learned in Chapter 17, a busi-
ness plan can include a variety of components, such as an executive
summary, mission statement, company description, product and ser-
vice plan, management team plan, industry overview, market analysis,
competitive analysis, marketing plan, operational plan, organization
plan, financial plan, growth plan, contingency plan, and support-
ing documents, as well as a cover page, title page, and table of con-
tents. Spending extra time to make sure that your business plan has
accurate information could mean the difference between getting the
money you need or not.
Section 19.1 Assessment
QUICK CHECK Calculate How much money will
1. What is the difference between start-up Mario need to borrow? What percent-
costs and operating costs? age of his total costs will he borrow?
2. What are several sources of personal
SOLVE MONEY PROBLEMS
financing?
3. What are two ways in which a small busi- 6. Sources of Funding Christa has oper-
ness might use a line of credit? ated a résumé writing service out of her
home for the past two years. Because she
THINK CRITICALLY has many new customers, her added equip-
4. Choose the best source of funding for a ment and supplies will no longer fit in her
new business owner: a consumer loan, a extra bedroom. Christa is looking for a new
home equity loan, or private financing. location for the business, but she realizes
Explain your reasoning. that the change will bring additional costs.
Analyze Identify sources of fund-
USE MATH SKILLS ing that Christa may be able to access.
5. Cost of Borrowing Mario has estimated Which sources of funding do you think she
start-up costs for a cappuccino stand to be should avoid? Which sources do you think
$8,900. He projects that his operating costs would be best?
for the first six months will be $6,300. He
also wants to have $10,000 in his reserve
fund. Mario has saved $20,000 for his new
business.
624 Unit 6 Business Finance Basics
Section 19.2
Sources of Funding Focus on
Reading
Small Business Administration Read to Learn
What kinds of services does the Small Business
• How to describe the
Administration provide? function of the Small
No matter how good your business may look on paper, banks Business Administration.
might not provide necessary financing. This is especially true for • How to identify alterna-
new or start-up businesses. As a new or start-up business owner, you tive sources of funding
for a business.
may not have a sound credit history or enough collateral, managerial
experience, or profit from operations. Therefore, you will need some
Main Idea
help to get your loan. To whom do you turn? Your best alternative
Entrepreneurs can get fund-
may be the federal government. ing through the help of the
The federal government recognizes the importance of small Small Business Administra-
businesses in the American economy and, therefore, provides assis- tion and other sources.
tance to them. The Small Business Administration (SBA) is an
independent agency of the federal government that offers assistance Key Terms
to people who are starting small businesses and to those who want • Small Business
to expand existing businesses. Its services include management train- Administration (SBA)
ing, organizational guidance, and assistance in getting funding. • LowDoc Program
• business credit card
Almost 99 percent of American business operations are consid-
• private investor
ered “small businesses” under the SBA guidelines. Thousands of busi- • commercial finance
nesses take advantage of services offered by the SBA every year. If the company
SBA did not exist, many small businesses would never get the money • venture capital firm
they need. • Small Business Invest-
The SBA offers many loan programs to small businesses that have ment Companies
(SBICs)
a hard time getting the funding they need through other methods.
If you cannot convince the bank that you are a good loan candidate
and that your business will be successful, you might try one of the
SBA loan programs.
Before
You Read
SBA Guaranteed Loans PREDICT
What is the benefit of receiving an SBA
guaranteed loan? What advantages might
the federal government
The most common type of SBA loan is obtained through the receive by operating the
Guaranteed Loan Program. To get an SBA guaranteed loan for your Small Business Administra-
small business, you apply to a bank or other financial institution for a tion (SBA)?
commercial loan. If the bank denies your request, you can then com-
plete an application for an SBA loan. Your bank submits your applica-
tion to the SBA under the Guaranteed Loan Program.
Chapter 19 Sources of Funding 625
FEDERAL ASSISTANCE
The federal government pro-
vides help for entrepreneurs
through the Small Business
Administration (SBA). How
does the SBA’s Guaranteed
Loan Program work?
The SBA examines your application. If it approves the loan, it
authorizes the bank to give you the funding. The SBA then guaran-
tees a major portion of the loan. At present the SBA will guarantee up
to 85 percent of a bank loan for $150,000 or less and 75 percent of a
loan for more than $150,000. The repayment period usually cannot
exceed seven years.
With this guarantee by the federal government, banks are more
willing to grant funding to a small business. The bank knows that if
you default on the loan, the SBA will repay the majority of the money
you owe. Remember, you do not borrow money from the SBA. You
get your loan from a bank or some other financial institution, but the
SBA guarantees a large portion of the loan.
In the past many people were frustrated by the amount of paper-
work and the time it took to process loan applications through the
SBA. In response, the SBA introduced the LowDoc (Low Documenta-
tion) Program in 1993. The LowDoc Program is a government loan
program that allows businesses applying for loans of less than $150,000
to submit a one-page application with a small amount of documenta-
tion. They receive a reply within 36 hours. This program also features
electronic loan processing. Loan maturity is usually 5 to 10 years or up
to 25 years.
The SBA also offers a variety of other loans for specific groups or
business endeavors. It has special guaranteed loan programs for inter-
national trade, pollution control, exporters, and businesses entering
markets in economically depressed areas. Today the SBA is still the
primary source of assistance in getting small business funding. Every
year banks and other financial institutions lend billions of dollars to
small business operations with SBA guarantees.
626 Unit 6 Business Finance Basics
Other Sources of Funding As You
Why might a new business need to obtain Read
funding from other sources?
RELATE
Some business owners use personal resources or funds from fam-
Would you consider apply-
ily members or friends to expand their businesses. Many others use
ing to the SBA for assis-
short-term commercial loans, which are often guaranteed by the SBA. tance if you were starting a
However, you can also get funding through a business credit card, pri- business? Why, or why not?
vate investors, commercial finance companies, venture capital firms,
and state and local governments.
Business Credit Card
In recent years financial institutions have developed alterna-
tive funding options to try to meet the needs of a wide variety of
businesses. One of these options is to offer a line of credit through a
business credit card. A business credit card is a credit card that is
issued to a business rather than to an individual. The use of business
credit cards has become a major source of short-term financing for
small businesses. Commercial loans from financial institutions are
another common source of funding.
Business credit cards require the business to have a good credit
history. They are suitable for businesses that want to expand or
cover unexpected costs, but they are generally not issued for start-
up financing. A credit limit on a business credit card is usually under
$15,000. The disadvantage of this quick source of funding is high
interest rates, similar to those on personal credit cards. Business credit
cards are good for emergencies, but balances should be paid as quickly
as possible.
Visa, MasterCard, and American Express all offer small busi-
ness credit cards. These cards provide discounts on travel, car rentals,
and insurance. Credit card issuers also provide advice and assistance
through small business publications.
Private Investors
A private investor is a person outside an entrepreneur’s cir-
cle of friends and relatives who provides funding because he or she
is interested in helping a new business to succeed. Typically called
“angels,” private investors will usually leave the management of the
business to the owner. However, they are also interested in getting a
good return on their money. This means that you may have to give
them a share of ownership.
If you cannot locate private investors in your area, you can turn
to the SBA. The SBA has set up the Angel Capital Electronic Network
(ACE-Net), which is a Web site that lists small businesses that are
looking for investors. The SBA screens both entrepreneurs and inves-
tors to assure reliability. Approved investors can access information
on thousands of businesses. An investor chooses a business, and then
the business owner and the investor can negotiate a deal.
Chapter 19 Sources of Funding 627
As You Commercial Finance Companies
Read A commercial finance company is a firm that lends money
QUESTION only to businesses. Commercial finance companies insist that all
loans be secured with collateral, such as equipment or inventory.
What are the disadvantages These companies are helpful to existing businesses that need short-
of borrowing money from term financing.
a commerical finance
The government does not regulate commercial finance compa-
company?
nies as closely as it does banks, so these companies accept more risk
in granting loans. However, if a finance company grants you a riskier
loan, it will charge you a higher interest rate. It is easier to get this
kind of loan, but you will pay more for it.
Venture Capital Firms
A venture capital firm is a company that provides private
funding for small businesses that need a substantial amount of imme-
diate cash. Because these small businesses are high-risk in terms of
ability to repay loans, they cannot always get adequate funding from
lenders such as banks and commercial finance companies. Venture
capital firms take the risk, but in turn, they often expect a large return
of 25 to 40 percent on their investment.
Venture capital firms usually seek to make investments of at least
$500,000. Keep in mind that the venture capital firm is not merely
lending money; it is also investing in your business. Therefore, ven-
ture capital firms expect to have a voice in major business decisions
and will examine a business’s financial position carefully throughout
the year.
Put on Most venture capital firms are private, but the SBA created a pub-
lic venture capital program—the Small Business Investment Com-
Your
pany Program. Small Business Investment Companies (SBICs)
Financial are private investment firms that work with the SBA to provide
Planner’s longer-term funding for small businesses. The advantage in dealing
Cap with the SBIC program is that the SBA regulates lenders, and financ-
ing terms must meet SBA guidelines. If small businesses need venture
Imagine you have successfully capital, they usually go to SBIC firms first.
started your new business,
and you have completed six
months of operations with State and Local Funding
a respectable profit. Conse-
Why do state and local governments provide
quently, you have decided
funding opportunities for small businesses?
to expand your business, but
you will need an additional Many states provide opportunities for small businesses to get
$125,000 in capital. Would
funding through a variety of programs. These funding programs are
you choose to seek this fund-
ing through a commercial available in cities where local and state governments are encouraging
finance company, a venture individuals to open businesses in economically depressed neighbor-
capital firm, or an SBIC? hoods. Local chambers of commerce or regional offices of the SBA
can assist you.
628 Unit 6 Business Finance Basics
Funding Your Dreams After You
Why are small businesses essential to Read
the American economy?
REACT
The American economy has been built by entrepreneurs who
were willing to take risks and explore new ventures. Ray Kroc was Based on what you have
learned in this chapter,
52 years old when he purchased the rights to a hamburger stand how would you raise start-
owned by the McDonald brothers in San Bernardino, California. up capital for a new
His venture would revolutionize the food industry. Robert Pittman business?
was only 26 years old when he combined video and music and
created MTV.
The funding of small businesses is essential to the American
economy. Almost all of the nation’s Fortune 500 companies started
as small businesses. They began with little capital and obtained addi-
tional funds by using creativity. Today you can get funds through a
variety of sources. Through private and public funding, you can pur-
sue your dreams and own your own business.
Section 19.2 Assessment
QUICK CHECK Write About It Write a paragraph
1. What is the primary function of the Small telling Ashley about alternative means
Business Administration? of getting approval for a commercial loan.
2. What are some alternative sources of fund- Also explain how the federal government
ing for business owners? might be able to help her.
3. How might you find venture capital for
SOLVE MONEY PROBLEMS
your business?
6. Financing Options Kimo owns a print
THINK CRITICALLY shop. He offers a variety of services, includ-
4. For what types of expenses do you think a ing printing brochures and letterheads. He
business should use a business credit card? wants to expand his business by offering
For what expenses should a business not use multimedia services. To do this, he needs
a credit card? Explain. $50,000 to $60,000. Kimo has decided to
investigate a bank loan guaranteed by the
USE COMMUNICATION SKILLS SBA, private investors, and venture capital
5. Loan Questions Your friend Ashley is firms as sources of money for his expansion.
having trouble getting a loan to finance the Write About It In a small group,
start-up costs of her collectibles shop. Her analyze Kimo’s prospects of receiv-
local bank turned her down because her ing funding from a bank, a private investor,
business idea seemed too risky. and a venture capital firm. Write a one-page
report to help Kimo decide which funding
source to explore further.
Chapter 19 Sources of Funding 629
Chapter 19 Review & Activities
CHAPTER SUMMARY
• An entrepreneur is a person who takes • Some of the options available through
the risk of starting a new business. bank funding are short- and long-term
• Start-up costs include money for commercial loans, lines of credit, and
the purchase of assets needed to secured and unsecured loans.
run a business, including inventory, • The factors banks consider to approve
equipment, furnishing, supplies, and commercial loans include the five C’s:
utilities; costs such as legal, professional, character, capacity, capital, collateral,
and banking fees; licenses; permits; and credit history.
insurance; marketing costs; and • The Small Business Administration
remodeling and maintenance costs. (SBA) is a major source of funding for
Operating capital is the money needed to new small businesses. This agency can
operate a business for the first few years. also help with management training
Reserve capital is money set aside for and organizational guidance.
unexpected costs or opportunities. • Other sources of funding for a business
• Sources of personal financing include include business credit cards, private
personal assets, consumer loans, and investors (angels), commercial finance
home equity loans. Sources of private companies, venture capital companies,
financing include family and friends. and state and local agencies.
Communicating Key Terms
You are an entrepreneur talking with a bank loan officer about a Small Business Administration
loan. Use as many of the terms below as you can to explain why the bank should give you a loan.
• entrepreneur • line of credit • private investor
• operating costs • secured loan • commercial finance
• reserve fund • unsecured loan company
• private financing • Small Business • venture capital firm
• commercial debt Administration (SBA) • Small Business
financing • LowDoc Program Investment Companies
• commercial loan • business credit card (SBICs)
Reviewing Key Concepts
1. Explain why entrepreneurs are considered part of the backbone of the American economy.
2. Identify some differences between start-up costs, operating costs, and reserve funds.
3. Explain the pros and cons of taking out a home equity loan to start a business.
4. List one advantage and one disadvantage of secured loans, unsecured loans, and lines of credit.
5. Describe the five C’s of credit and how they apply to a business loan.
6. List one reason that loans guaranteed by the Small Business Administration are a win-win
situation for the entrepreneur and the lending institution.
7. Explain the role of a venture capital firm.
630 Unit 6 Business Finance Basics
Chapter 19 Review & Activities
Economics Assume you are a trained bookkeeper and you want to start
a home-based business handling bookkeeping and tax preparation for small
companies.
Write About It List the start-up and operating costs you think you will
need to cover your new business.
Start-Up Costs The following is a list of some of the start-up costs for a
new, home-based word-processing business.
Computer $1,200
Printer $700
Office supplies $100
Office furniture $500
1. Calculate the start-up costs for this business. What percentage of the
total start-up costs listed here is the computer?
2. Compute by using spreadsheet software to make these calculations.
Connect with Economics Imagine that you are starting your own
business after working in graphic design for an advertising agency for a
number of years. You must take out a home equity loan to cover the $20,000
of your start-up and initial operating costs.
1. Research Use an Internet search engine to find interest rates for home
equity loans in your area.
2. Think Critically Under what circumstances is a home equity loan the
best choice for funding a new business?
Small Business Administration The Small Business
Administration (SBA) is a government agency that offers assistance to small
start-up businesses.
Log On Use an Internet search engine to find businesses in your
area that are associated with the SBA. Answer the following questions:
1. Why do businesses become associated with the SBA?
2. What is the advantage of securing a loan from a financial source that is
associated with the SBA?
Newsclip: Finding Capital To be your own boss, you need to find
capital for starting up your business. There are more options available to
O N L I N E
entrepreneurs today than in the past.
Log On Go to finance07.glencoe.com and open Chapter 19.
Learn about different options to help you find the funding needed
to start a new business. Write a paragraph about which option you would
choose and why.
finance07.glencoe.com Chapter 19 Sources of Funding 631
Chapter 19 Review & Activities
ARE YOU A GO-GETTER?
Finding the money to start a business and keep it going can seem
like a huge obstacle. Just for fun, take the following quiz to see if
you are a go-getter who can find funding. Write your answers on a
separate sheet of paper.
1. I am willing to defer getting paid in or der to see my vision succeed.
_______ Yes _______ No
2. I am willing to ask everyone I know if they want to invest in my enterprise.
_______ Yes _______ No
3. I am investigating every possibility I can think of for financing.
_______ Yes _______ No
4. I have spoken to at least one person who is a successful entrepreneur.
_______ Yes _______ No
5. I have the perseverance to reach my goals.
_______ Yes _______ No
6. My ideas are so clear that I can convince others to help me make them a reality.
_______ Yes _______ No
7. I am flexible and can readily adapt to change.
_______ Yes _______ No
Scoring:
The more “yes” answers you have, the more likely it will be that you will find funding.
632 Unit 6 Business Finance Basics
Chapter 19 Review & Activities
Your Financial Portfolio
Tanya’s Toys
Tanya’s mother brings home rejects and remnants of towel fabric from the mill where
she works. Tanya’s grandmother taught Tanya how to sew the cloth into animal shapes
and stuff them. Tanya and her family give these little stuffed animals as presents.
She has also sold 25 of them at $8 each to raise money for the high school football
team. Tanya and her friend, Lisa, have decided to start a business making and selling
“Tanya’s Toys.” Tanya has listed the expenses of making 100 stuffed animals and the
sources of funding.
Item Cost Source of Funding
Toweling $25 She spoke directly to the manager at the mill,
who offered a special deal of $25 payable after
the animals were sold.
Sewing machines $430 Tanya was already using the sewing machine she
had at home and located another used industrial
machine. She and Lisa decided they would buy
the second machine after they sold 500 toys.
Other sewing equipment: $45 Tanya’s grandmother offered to loan them the
Sewing shears, tape money to buy good sewing shears.
measure, patterns
Supplies: Thread, eyes, $25 Tanya and Lisa decided to fund the purchase of
buttons, ribbon, and felt supplies from their savings.
to decorate the animals
Wages 0 Tanya and Lisa will not pay themselves wages until
they have all the equipment and supplies.
Research
What kind of business could you launch that would require minimal start-up costs?
On a separate sheet of paper, use the guidelines shown above to describe and name
your business and list what equipment and supplies you would need. Also indicate how
you would fund your enterprise. How much would your equipment and supplies cost?
How could you persuade family or friends to participate in your business?
Chapter 19 Sources of Funding 633
20
CHAPTER
Financial
Accounting
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 20.1
• Describe the accounting system.
• Identify the first five steps of the
accounting cycle.
• Discuss the role of the general
journal.
• Explain the purpose of posting.
• Summarize the purpose of a
trial balance.
Section 20.2
• Identify items included on an
income statement.
• Explain the purpose of a balance
sheet.
• Define and explain the role of a
statement of cash flows.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
634
In the Real World . . .
J essica Scott runs a small bakery. She also caters events. She
has made cupcakes for graduation parties, pastries for picnics, and
cakes for weddings. Her accountant tells her that she should do more cater-
ing because it is more profitable and dependable than her daily business.
Accounting records would help Jessica identify the goods and services to
increase, such as take-and-bake items, biscuits for pets, and catering—as well
as items to discontinue, such as low-carb donuts. Jessica has learned to trust
her accountant’s advice. Though she may have to stop making some of her
favorite items, Jessica wants to remain profitable.
As You Read Consider the types of accounting records a
small store owner would need to understand and use.
The Accounting Cycle
ASK Q: When I start my business, I am going to hire
an accountant to keep my records. So why do I
need to understand the accounting cycle?
A: A professional can help you maintain financial records. However, you still need
to understand what information is represented in your financial statements and its
relevance to the decisions you will need to make. Also, to communicate with your
accountant, you will need to understand what he or she is talking about.
Ask Yourself Can you think of any other reasons why it is important that
you understand the accounting cycle?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com Chapter 20 Financial Accounting 635
Section 20.1
Focus on
Reading
The Accounting
Cycle: The First
Read to Learn
• How to describe the
Five Steps
accounting system.
• How to identify the
first five steps of the
accounting cycle.
The Language of Business
How is accounting used in business?
• How to discuss the role
of the general journal. Have you ever wondered how a rap group or a rock band deter-
• How to explain the pur- mines what cities to play on tour? What determines the price of
pose of posting. tickets, and how much does a national tour cost? These questions are
• How to summarize the all answered by accountants and financial advisers.
purpose of a trial balance. Accounting plays a vital role in the day-to-day activities of your
business—and of every business. Accounting records and reports help
Main Idea a business operate efficiently—and profitably—by keeping track of
All businesses should how much is earned and how much is spent. Accounting is so much
record and summarize their
a part of the business world that it is often called “the language of
financial transactions in
the same way, using the business.”
accounting cycle.
Key Terms The Accounting System
• financial reports What is the purpose of using the accounting system?
• accounting period
Whether you are keeping financial records for a rock band, a
• accounting cycle
• accounting equation neighborhood bike shop, or a major corporation, accounting princi-
• account ples and procedures are universal. All businesses use the same system,
• accounts receivable which follows established accounting guidelines called “generally
• accounts payable accepted accounting principles,” or GAAP. With all businesses using
• double-entry accounting the same system, anyone who is interested in examining the records
• T accounts
of a business will be able to understand its financial reports.
• debit
• credit (accounting) The accounting system is designed to collect, record, and report
• journal on financial transactions that affect a business. Financial reports
• general ledger are written records that summarize the results of financial transac-
• posting tions affecting a business and report its current financial position.
• trial balance They indicate how well your business is doing. There are many groups
and individuals interested in your business’s finances:
• Potential buyers
• Government agencies
• Banks or other financial institutions
• Employees and consumers
636 Unit 6 Business Finance Basics
Accounting Assumptions Before
When you are creating the accounting books for your business, You Read
you make two assumptions about the business. The first assumption PREDICT
is that the business will operate as a separate unit, or business entity.
This means that the records and reports of your business will be kept What is the value of keep-
completely separate from your personal finances. You never mix your ing day-to-day track of
your financial status?
business finances with your personal finances.
The second assumption is that your business will make its finan-
cial reports in specific blocks of time. An accounting period is a
block of time covered by an accounting report. The accounting period
can be one month or one quarter (three months), but the most com-
mon period is one year.
During this accounting period, you record all financial transac-
tions for your business and report the results. You engage in activ-
ities that maintain your accounting records in an orderly manner.
The accounting cycle is the activities, or steps, that help a business
keep its accounting records in an orderly manner.
In this chapter you will learn about the first five steps of the
accounting cycle. In each accounting period—whether a month, a
quarter, or a year—the entire accounting cycle is completed. You prob-
ably have heard news broadcasts such as: “Ford sales are up 4 percent
over last quarter and up 6 percent from the same quarter last year.” By
using a set period of time, such as a quarter, you can compare finan-
cial reports from one period to those from another period.
The Accounting Equation
Property is anything of value that you own or control. Both peo-
ple and businesses have property. You might own a CD player, a com-
puter, clothes, a television set, or maybe a car. For a business, property
could include cash, office equipment, supplies, merchandise, or vehi- Accounting for
cles. When you own an item of property, you have a legal right or Your Money
financial claim to that item. In contrast, when you have control over 1. Put all receipts in
an item, you have only the right to use it. A rented office is property, labeled folders and
but a business does not have a financial claim to it. In accounting, file them in alpha-
property or items of value owned by your business are called assets. betical order.
Your equity in a piece of property is your share of its value, or your 2. Keep a budget and
financial claim to the property. This also applies to businesses. For exam- review it weekly.
ple, suppose that your business owns a truck valued at $16,000. You are 3. Balance your
checkbook
the owner of the business, so your equity in the truck is $16,000. If the
monthly.
truck is completely paid for, you have financial claim to the truck. An
4. Be aware of—and
owner’s claim to the assets of a business is called owner’s equity. meet—all tax-filing
However, what if you still owe $3,000 to the Stratford Savings deadlines.
Bank for the truck? The truck is valued at $16,000, but the creditor (the 5. Use a financial
bank) has $3,000 equity, while your equity is now only $13,000. Both software program
you and the creditor have financial claims to (equity in) the asset. to track your
finances.
Property ⫺ Creditor’s Financial Claim ⫽ Owner’s Financial Claim
$16,000 ⫺ $3,000 ⫽ $13,000
Chapter 20 Financial Accounting 637
䊱 RENTED PROPERTY Many businesses rent space where they run
their operations. Is rented space a business asset?
Creditors’ claims to the assets of a business are called liabilities,
or the debts of a business. The relationship between assets and the
two types of equity (liabilities and owner’s equity) is shown in the
accounting equation:
Property ⫺ Creditor’s Financial Claim ⫽ Owner’s Financial Claim
Assets ⫺ Liabilities ⫽ Owner’s Equity
The accounting equation (Assets ⫺ Liabilities ⫽ Owner’s
Equity) is the basis for keeping all accounting records in balance.
The entire system of accounting is based on this equation. As your
business buys, sells, or exchanges goods and services involving many
business transactions, the numbers may change. However, total assets
will always equal total liabilities plus owner’s equity. As you learn
more, you will understand why this equation is so important.
Establishing Accounts
What are accounts?
When you set up the books of a business, you create accounts for
each of the three categories in the accounting equation:
• Assets
• Liabilities
• Owner’s equity
An account shows the balance for a specific item, such as cash
or equipment. You must look at your business and determine what
accounts your business needs. Businesses create only the accounts
they need for their type of business operation. The accounts used by
one business may differ from the accounts used by another.
638 Unit 6 Business Finance Basics
For example, Chris Archer uses the following accounts for his
business, Archer Delivery Service:
Assets Liabilities Owner’s Equity
Cash in Bank Accounts Payable Chris Archer, Capital Franchise Ownership
Accounts Receivable Everyone loves ice cream.
Office Equipment That is why there are at
Delivery Equipment least 20 different franchise
opportunities involving
the sale of ice cream
cones, dishes, and cakes.
Asset Accounts Learn more about these
Chris has established four asset accounts. The first account opportunities.
shows all of the cash that enters or leaves the business. It is Cash in To continue with
Bank because all cash received by his business is deposited in a bank Task 3 of your
account, and all cash paid out is paid by check. In accounting, both WebQuest project, visit
cash and checks are considered cash transactions. finance07.glencoe.com.
The second asset account for the business is Accounts Receivable.
Accounts receivable is the total amount of money owed to a busi-
ness by customers. Chris completed deliveries for other companies,
and they owe his business money. This account represents a future
value that will eventually bring cash into the business.
Chris will use the two remaining asset accounts, Office Equipment
and Delivery Equipment, when he buys equipment. If he needs other
accounts for other assets, he can create them.
Careers in Finance
CREDIT ANALYST
ACCOUNTING Rich Jackson
TEACHER Portland Unified School District
Rich enjoys explaining, giving instruction, and providing inspiration for others. After working behind
a desk as an accountant for ten years, Rich needed a change of pace. He decided to work as a
teacher. Rich finds it rewarding to help his students master a skill that will be helpful to them pro-
fessionally and personally. He creates lesson plans to help students learn concepts, practice transac-
tions, and test their understanding. Teachers enjoy working with students, other teachers, parents,
and administrators to foster success for students in class and life.
SKILLS: Accounting, communication, computer, math, organizational, and time
management
PERSONAL TRAITS: Works well with people and numbers, patience, and sense of humor
EDUCATION: Bachelor’s degree in education or business education and/or a master’s degree
in accounting, finance, or business; experience in field
ANALYZE What skills might an accounting teacher need that an accountant may not need?
To learn more about career paths for accounting teachers, visit finance07.glencoe.com.
finance07.glencoe.com Chapter 20 Financial Accounting 639
Liabilities Account
Chris listed only one liability account—Accounts Payable.
Common Accounts payable is the amount of money owed, or payable, to
CENTS the creditors of a business. The balance owed will remain in Accounts
Payable until the business pays the debt.
Costly Corrections
When recording trans- Owner’s Equity Account
actions manually, never
erase errors. The erasure The owner’s equity account is identified by the owner’s name,
may look like an illegal Chris Archer, followed by the word Capital. This account will report
cover-up. Instead, cross the owner’s share of assets. Most businesses have more accounts than
out the error and write those presented here for Archer Delivery Service. Businesses often
the correction above
it. Accounting errors can
have many accounts, such as revenue or sales, utilities and other
cost businesses money. In expenses, merchandise, payroll, and many more.
what other ways might a
business suffer as a result T Accounts
of accounting errors?
When accountants analyze and record business transactions,
they use double-entry accounting, which is a system of record-
keeping in which each business transaction affects at least two
accounts. Remember, Archer Delivery Service has six accounts that
can be used.
An efficient way to understand double-entry accounting is to
use T accounts. A T account is a tool to increase or decrease each
account that is affected by a transaction.
Account Name Account Name
Left Side Right Side Left Side Right Side
Debit Credit Debit Credit
As you can see by this illustration, a T account has the account
name at the top and has a left side and right side. An amount entered
on the left side of a T account is called a debit. An amount entered
on the right side of a T account is called a credit.
Rules of Debit and Credit
Debits and credits are used to record the increases or decreases
in accounts affected by a business transaction. Under double-entry
accounting, for each debit in one account (or accounts), there must
be a credit of an equal amount in another account (or accounts).
The rules of debit and credit vary, depending on whether the
account is an asset, a liability, or an owner’s equity account. Regard-
less of the type of account, the left side is always the debit side and
the right side is always the credit side. The general rules are:
• An asset account increases on the debit side and decreases on
the credit side.
• Liability accounts and owner’s equity accounts increase on the
credit side and decrease on the debit side.
640 Unit 6 Business Finance Basics
Using the Five Steps Put on
How do businesses use the first five steps of the Your
accounting cycle? Financial
The accounting cycle consists of ten steps. This section describes Planner’s
how businesses apply and benefit from the first five activities, or Cap
steps, of the accounting cycle:
You are considering enter-
1. Collect and verify source documents. ing a business partnership
2. Analyze each transaction. with an accountant. What
3. Journalize each transaction. might be the advantages and
4. Post to the general ledger. disadvantages of such an
5. Prepare a trial balance. arrangement?
Step 1: Collect and Verify Source Documents
When a business transaction occurs, a paper called a source docu-
ment is prepared. A source document is evidence that a business trans-
action happened. Common source documents include check stubs,
invoices, receipts, and memorandums. Collect and check all source
documents before recording anything in your business’s books.
Step 2: Analyze Each Transaction
Applying the rules of debit and credit to analyze transactions
using T accounts is simple. Remember that every transaction must
have a debit (or debits) and a credit (or credits) of an equal amount of
money. Use these steps to analyze Transaction #1:
1. Identify the two accounts affected.
2. Classify each of the accounts.
3. Decide whether each account is increasing or decreasing.
4. Determine which account is debited and which is credited.
Transaction #1 On May 5, Archer Delivery Service purchased a
photocopier for $900. Check 104 was written for the full amount.
Analysis:
1. The accounts affected are Office Equipment and Cash in Bank.
2. Both are asset accounts.
3. The business is buying office equipment. The balance in
the Office Equipment account is increasing. Cash in Bank
is decreasing.
4. According to the debit-credit rules, increases in asset
accounts are recorded as debits. Office Equipment is debited
$900. Decreases in asset accounts are recorded as credits.
Cash in Bank is credited $900.
Office Equipment Cash in Bank
Debit Credit Debit Credit
⫹900 ⫺ ⫹ ⫺900
Chapter 20 Financial Accounting 641
Here is another example:
As You
Read Transaction #2 On May 7, Archer Delivery Service bought a truck
for $11,000 from Gail’s Auto Land. The entire cost was financed by
RELATE Wilton Bank.
Do you have a checkbook Analysis:
register? Do you have to
stay within a budget? How 1. The accounts affected are Delivery Equipment and Accounts
do you think these activi- Payable.
ties are similar to and/or 2. Delivery Equipment is an asset account. Accounts Payable is
different from keeping
a liability account. In this transaction, the business is buying
books for a business?
a truck.
3. The balance in the account Delivery Equipment is increas-
ing. The balance in Accounts Payable is increasing.
4. The Delivery Equipment account is debited $11,000.
Accounts Payable is credited $11,000.
Delivery Equipment Accounts Payable
Debit Credit Debit Credit
⫹11,000 ⫺ ⫺ ⫹11,000
Notice that both Transactions #1 and #2 have a debit to one account
and a credit to another account. Every business transaction will have
balancing debit and credit entries. This is how the system of double-
entry accounting works.
䊱 EQUIPPED FOR BUSINESS Expensive equipment, such as a truck for
a business, is usually financed rather than paid for in full. What types of
accounts in the accounting equation are affected by financing equipment?
642 Unit 6 Business Finance Basics
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: An Income Statement Your Motive: If you own or work in a
An income statement contains the business, you will want to know if the
following information: business is profitable or not. If you are not
• Income generated bringing in enough income to offset your
• Expenses incurred expenses, you will not make a profit.
• Profit or loss
'ENERAL 0RODUCTS )NCOME 3TATEMENT
9EAR ENDING $ECEMBER
2EVENUE
3ALES
#OSTS OF GOODS SOLD
'ROSS PROFIT
/PERATING %XPENSES
3ALARIES
!DVERTISING
2ENT
5TILITIES
-AINTENANCE
)NSURANCE
-ISC
4OTAL %XPENSES
.ET 0ROFIT
4AXES
.ET 0ROFIT
Key Points: An income statement shows Find the Solutions
how much a company earns after it pays all 1. How is gross profit calculated?
its expenses, such as salaries, advertising, 2. What time period is covered in the statement?
rent, utilities, maintenance, insurance, and 3. What percent of net profit does this com-
other operating expenses. pany pay in taxes?
4. How much did it cost this company to pro-
duce the goods it sold?
5. What could this company do to increase its
profits?
Chapter 20 Financial Accounting 643
Step 3: Journalize Each Transaction
Do you keep a diary or journal? Many people do. They write down
the day-to-day events that they want to remember. Businesses do the
same thing. The financial events of your business are your business
transactions, which you record in a journal. You use T accounts to ana-
lyze the transactions, but to record the transactions, you use a journal.
A journal is a record of all of the transactions of a business. Business
transactions are recorded in the order in which they occur. The process
of recording business transactions in a journal is called journalizing.
A business journal uses accounting stationery. The stationery has
lined columns for recording dollar amounts. You do not use commas,
decimal points, or dollar signs. For example, the amount $1,846.20 is
entered as shown in Figure 20.1.
One of the most common accounting journals is the general
journal. A general journal is an all-purpose journal in which all the
transactions of a business may be recorded. When a business trans-
action occurs, a source document—such as a receipt or invoice—is
created. Then you analyze the transaction, using T accounts, and
enter it in the general journal. You record the date of the transaction,
the accounts affected, and the amount of the debit and credit entries.
Figure 20.2 shows how Transactions #1 and #2 on pages 641 and
642 are entered in a general journal.
Step 4: Post to the General Ledger
By looking at a general journal, you cannot easily see what the
balance is in each of your accounts. You may want to know how
much cash you have, how much your business owes in accounts pay-
able, how much office equipment you have, and most important,
whether your business is making a profit.
&IGURE %NTRY ON !CCOUNTING 3TATIONERY
%ASY %NTRIES !CCOUNTANTS USE A TYPE OF STATIONERY DESIGNED FOR ACCOUNTING PROCEDURES
7HAT IS DIFFERENT ABOUT RECORDING NUMBERS ON THIS STATIONERY
644 Unit 6 Business Finance Basics
&IGURE 4RANSACTIONS IN A 'ENERAL *OURNAL
'%.%2!, */52.!, 0!'%
$!4% $%3#2)04)/. $%")4 #2%$)4
-AY /FFICE %QUIPMENT
#ASH IN "ANK
#HECK
$ELIVERY %QUIPMENT
!CCOUNTS 0AYABLE7ILTON "ANK
0ROMISSORY .OTE
3EEING THE "IG 0ICTURE 4HE GENERAL JOURNAL ALLOWS BUSINESSES TO RECORD ALL BUSINESS TRANSACTIONS
7HAT DO YOU RECORD IN A GENERAL JOURNAL
In order to find the balance of each account, you must trans-
fer the amounts that are in the general journal to a general ledger.
A general ledger is a book or set of electronic files that contains
the accounts used for a business. Each account has its own page. In a
manual accounting system, the accounts used by a business are kept
on separate pages or cards. These pages or cards are kept together in
a book or file, which is the ledger. In a computerized accounting sys-
tem, the electronic files of the accounts comprise the ledger. Keeping
accounts together in a general ledger makes information easy to find.
When you need financial statements, you can take the information
from the ledger and present it as well-organized reports. Figure 20.3
shows a blank ledger page.
&IGURE 4HE 'ENERAL ,EDGER
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7 >ÌÊÌÞ«iÊvÊÜiÀ}>âi`ÊÀi«ÀÌÃÊV>ÊÞÕÊVÀi>ÌiÊvÀ
vÀ>ÌÊÊÌ iÊ}iiÀ>Êi`}iÀ¶
Chapter 20 Financial Accounting 645
&IGURE 0OSTING TO THE 'ENERAL ,EDGER
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7 >ÌÊÃÊÌ iÊ`ivÌÊvÊ«ÃÌ}¶
Making Entries The manual accounting system uses a ledger
account form, which is accounting stationery for recording financial
information about specific accounts. There are several common ledger
account forms. These forms are described by the number of amount
columns they have. For example, the ledger page in Figure 20.3 on
page 645 is a four-column ledger account form. The four-column
account form has spaces to enter the account name, the account number,
the date, a description of the entry, and the posting reference.
To make entries, next to the title Account, you enter one of your
business’s account names, such as Cash in Bank. As you can see, the
page has four amount columns. You use the first two amount col-
umns to enter the debit or credit amounts from the general journal.
You use the last two amount columns to enter the new account bal-
ance after you make an entry from the general journal.
The type of account determines which balance amount column
As You you will use. For example, asset account balances are recorded on the
Read debit side. Liability and owner’s equity account balances are recorded
on the credit side.
QUESTION Posting is the process of recording transfers of amounts from
What balances are the general journal to individual accounts in the general ledger.
recorded on the debit side? Figure 20.4 shows how you would post the general journal entry
for May 5 to the corresponding accounts in the general ledger.
646 Unit 6 Business Finance Basics
The date you record on the account in the general ledger is the
date on which the transaction occurred. You may also enter a brief
description of the transaction. You then transfer the debit entry of
$900 from the general journal to the account in the general ledger
account called Office Equipment. Because this account had a previous
balance of $1,600, it now has a new balance of $2,500. Remember
that debit entries increase the balance in asset accounts.
You then record the credit entry to the general ledger account
Cash in Bank. This amount is entered in the credit column. Cash
in Bank is an asset account. Remember that credit entries decrease
asset account balances. Thus, the balance in the Cash in Bank
account decreases by $900. The new debit balance for Cash in Bank is
$6,418.40. Both account balances are recorded on the debit side.
Final Balances At the end of an accounting period, you will post
the figures from the general journal to the appropriate accounts in
the general ledger. After all entries have been posted, the final balance
for each account will appear on the general ledger. For example, at the
end of the accounting period, the general ledger account for Office
Equipment may look like Figure 20.5.
This account had a beginning balance of $1,600. Three debit
entries were made: $900, $2,350, and $3,680. Each of these entries
increased the account balance. On May 18, a credit entry of $400
decreased the balance. So, the account called Office Equipment has a
final debit balance of $8,130.
Time to Post The size of the business, the number of transactions,
and whether the business uses a manual accounting system or a
computerized accounting system will affect how often posting
occurs. Ideally, businesses should post daily to keep their accounts
up to date.
&IGURE *OURNAL %NTRIES 0OSTED TO A 'ENERAL ,EDGER
, Ê ,
!##/5.4 "vvViÊ µÕ«iÌ !##/5.4 ./
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3AMPLE %NTRIES Ê}iiÀ>Êi`}iÀÊà ÜÃÊ`Û`Õ>ÊiÝ«iÃiÃÊ>`ÊÌÌ>ÃÊvÀÊi>V ÊÌÞ«iÊvÊ>VVÕÌ°
7 >ÌÊÜ>ÃÊÌ iÊL>>ViÊvÊÌ ÃÊ>VVÕÌÊ>vÌiÀÊÌ iÊVÀi`ÌÊvÊf{ää
Ü>ÃÊ`i`ÕVÌi`¶
Chapter 20 Financial Accounting 647
&IGURE ! #OMPLETED 4RIAL "ALANCE
!RCHER $ELIVERY 3ERVICE
4RIAL "ALANCE
&OR THE -ONTH %NDED -AY
#ASH IN "ANK
!CCOUNTS 2ECEIVABLE
/FFICE %QUIPMENT
$ELIVERY %QUIPMENT
!CCOUNTS 0AYABLE
#HRIS !RCHER #APITAL
4OTALS
3TAYING 7ELL "ALANCED ! TRIAL BALANCE STATEMENT LISTS ALL THE SEPARATE ACCOUNTS FOR A BUSINESS
7HY SHOULD THE TOTALS FOR THE DEBIT AND CREDIT COLUMNS BE EQUAL
Step 5: Prepare a Trial Balance
When you have journalized all your business transactions and
posted each of them to the accounts in the general ledger, you need
to know if the account balances are correct. Did you post all the
amounts from the general journal to the general ledger accounts? Is
the accounting equation still in balance?
&IGURE 4HE &IRST &IVE 3TEPS OF THE !CCOUNTING #YCLE
*OURNALIZE EACH
TRANSACTION
!NALYZE EACH 0OST TO THE
TRANSACTION GENERAL LEDGER
#OLLECT AND VERIFY 0REPARE A
SOURCE DOCUMENTS TRIAL BALANCE
4HE "ACKBONE 4HE ACCOUNTING CYCLE IS THE BASIS OF ALL ACCOUNTING PROCEDURES
7HY SHOULD ALL BUSINESSES USE THE SAME ACCOUNTING SYSTEM
648 Unit 6 Business Finance Basics
To answer these questions, you will prepare a trial balance. A
trial balance is a list of all the account names for a business and
their current balances. After you complete all posting, the total of all
the debit balances should equal the total of all the credit balances.
If the debit and credit totals are the same, then the general ledger is
balanced. You can assume that the posting is complete and that the
math is correct. Figure 20.6 shows an example of a trial balance for
the month of May 20 - - .
You will notice that the accounting equation is still balanced:
Assets ⫽ Liabilities ⫹ Owner’s Equity
Keeping Records
To summarize, you have learned that businesses keep financial
records according to an established set of principles and procedures.
Every effective business, large and small, follows GAAP guidelines.
The steps of the accounting cycle are universal. Figure 20.7 illus-
trates the first five steps of the accounting cycle that were introduced
in this section. Businesses generate their financial statements by fol-
lowing the steps of the accounting cycle.
Section 20.1 Assessment
QUICK CHECK Write About It Write a paragraph
1. What are the first five steps of the explaining the first five steps of the
accounting cycle? accounting cycle that would help Dione
2. What is recorded in a general journal? begin a course outline.
3. How does a general ledger help you keep
SOLVE MONEY PROBLEMS
your business records organized?
6. Account Names Jake Adams recently
THINK CRITICALLY started Jake’s Janitor Services. He cleans
4. Suppose that you prepare a trial balance several office buildings in town. He
and discover that total debits do not equal borrowed money from two creditors to
total credits. What are some of the errors purchase his cleaning equipment.
that you might have made? Write About It Make a list of the
account names that Jake might use
USE COMMUNICATION SKILLS for his cleaning business.
5. The Accounting Cycle Dione teaches
computer classes at a local senior citizen
center. He has just been asked to teach
a course on the basics of accounting for
small businesses.
Chapter 20 Financial Accounting 649
Section 20.2
Focus on
Reading
Financial Statements
for a Business
Read to Learn
• How to identify items
included on an income Financial Statements
statement. Why are financial statements important for
• How to explain the pur- operating a business?
pose of a balance sheet.
To operate a business profitably, you need to have up-to-date
• How to define and
explain the role of a financial information. You cannot make decisions if you do not have
statement of cash flows. the current facts. Financial statements provide this information.
Financial statements are reports that summarize changes that
Main Idea result from business transactions during an accounting period. By
You need current financial preparing and analyzing these statements, you can see if your busi-
statements that analyze ness is on course, having difficulty, or headed for serious trouble. Pre-
your financial position in paring financial statements is another step in the accounting cycle.
order to make sound finan- The primary financial statements are the income statement (or
cial decisions about your
the statement of operations or statement of earnings) and the balance
business.
sheet. A third statement, the statement of cash flows, is also used. The
sources of information for your financial statements are the final bal-
Key Terms
ances in the general ledger accounts. When you prepared your trial
• financial statements
• income statement balance, you proved that the posting from the general journal to the
• cost of merchandise sold general ledger was correct and complete. Now you have to report
• gross profit on sales what happened during this accounting period.
• net income You will now examine financial statements from a small mer-
• balance sheet chandising business—Happy House Card Shop. A merchandising
• statement of cash flows
business is a business that buys goods, marks them up, and sells them
to customers. Happy House Card Shop sells a variety of cards, gift
wrapping, and small gifts bought from wholesalers or distributors.
Before
You Read Income Statement
PREDICT At the end of an accounting period, you want to know how much
money your business made or lost. You also want to know how much
What do you think finan- money you took in from sales and where the money went. You report
cial statements might tell a
this information on your income statement, which is a report of
business owner?
the net income or net loss for an accounting period. An income state-
ment for a merchandising business has five sections: revenue, cost
of merchandise sold, gross profit on sales, operating expenses, and
net income (or loss). The amounts entered on the income statement
will be the ending balances in the accounts in the general ledger.
Figure 20.8 shows an income statement.
650 Unit 6 Business Finance Basics
Revenue You will notice that the beginning of the statement
reports the total sales (A), or revenue, for the period. Happy House
earned $292,619 in sales for the year ending December 31, 20--. This
is the total amount of money that the business earned from selling
merchandise to customers.
Cost of Merchandise Sold Next, the cost of the merchandise sold
(B) is calculated and reported. The cost of merchandise sold is
the amount of money the business paid for the goods that it sold
to customers. To arrive at this amount, Sheila first determines the
cost of merchandise in the store at the beginning of the accounting
period. In this case, $83,744 was on hand. Then she adds the cost of
the additional merchandise that Happy House purchased during the
year, which was $205,813. This means that the store had a total of
$289,557 in merchandise available to be sold.
After counting her inventory, Sheila determines that she still has
$93,281 in merchandise in the store. This means that the cost of the
merchandise sold is $196,276.
&IGURE )NCOME 3TATEMENT
(!009 (/53% #!2$ 3(/0
)NCOME 3TATEMENT
&OR THE 9EAR %NDED $ECEMBER
2EVENUE
3ALES !
#OST OF -ERCHANDISE 3OLD
-ERCHANDISE ON (AND *AN
0LUS -ERCHANDISE 0URCHASED
-ERCHANDISE !VAILABLE FOR 3ALE
-INUS -ERCHANDISE 3TILL ON (AND
4OTAL #OST OF -ERCHANDISE 3OLD "
'ROSS 0ROFIT ON 3ALES #
/PERATING %XPENSES
!DVERTISING %XPENSE
)NSURANCE %XPENSE
-AINTENANCE %XPENSE
-ISCELLANEOUS %XPENSE
2ENT %XPENSE
3ALARIES %XPENSE
3UPPLIES %XPENSE
5TILITIES %XPENSE
4OTAL /PERATING %XPENSES $
.ET )NCOME %
6ITAL 2ECORDS !N INCOME STATEMENT IS AN IMPORTANT FINANCIAL DOCUMENT FOR ANY BUSINESS
TO SHOW INVESTORS
7HAT AMOUNT ON AN INCOME STATEMENT IS ALSO USED IN THE GENERAL LEDGER
Chapter 20 Financial Accounting 651
&IGURE #OMPARISON OF )NCOME 3TATEMENTS
(!009 (/53% #!2$ 3(/0
#OMPARATIVE )NCOME 3TATEMENT
&OR THE 9EAR %NDED $ECEMBER
0REVIOUS 9EAR #URRENT 9EAR $OLLAR #HANGE 0ERCENT #HANGE
3ALES
#OST OF -ERCHANDISE 3OLD
'ROSS 0ROFIT ON 3ALES n n
4OTAL /PERATING %XPENSES n n
.ET )NCOME
!NALYZING 0ROGRESS "Y COMPARING INCOME FROM YEAR TO YEAR A BUSINESS CAN EVALUATE ITS PROGRESS
OR ITS DECLINE
$ID THE OPERATING EXPENSES INCREASE OR DECREASE DURING THE
CURRENT YEAR OF OPERATION FOR THIS BUSINESS
Gross Profit Sheila then subtracts the cost of the merchandise sold
($196,276) from the amount earned from sales ($292,619) to arrive
at (C), the gross profit on sales ($96,343). The gross profit on sales
is the profit made from selling merchandise before operating expenses
INTERNATIONAL are deducted. This is the profit Sheila made by marking up her
FINANCE/MATH merchandise and selling it.
The Internet has spurred
Net Income Net income is the amount of revenue that remains
an increase in globaliza-
tion. Even small companies after expenses for the accounting period are subtracted from the gross
can now market goods profit on sales. To calculate the net income for the period, Sheila
worldwide. Business peo- subtracts the total operating expenses (D⫽$58,096) from the gross
ple need to understand profit on sales (C⫽$96,343). For this period, Happy House Card Shop
how different currencies reported a net income (E) of $38,247.
work and how to deter-
mine exchange value. The
United States uses the Analyzing the Income Statement
dollar, much of Europe
uses the euro, and Great You can see that Happy House made a profit. It is a good idea to
Britain still uses the pound. compare the figures on this income statement to those on last year’s
Using the Internet, track the statement. A comparison of condensed income statements for Happy
exchange rate of the euro House is shown in Figure 20.9. By reviewing the changes, Sheila will
and the pound for three have an idea of how well her business is doing.
days, recording how many
In Figure 20.9, you can see that sales increased by 3.10 percent
of each will equal $100.
from last year. Depending on where the business is located and on
general economic conditions, this may be good. Notice that the net
income rose by 5.44 percent. This could be because the business
reduced total operating expenses by 5.19 percent. Sales increased, but
the net income increased at a greater rate. This is an example of good
financial management.
652 Unit 6 Business Finance Basics
䊴 MAKING GOOD
DECISIONS Having current
financial information about
total sales is essential to
making sound business deci-
sions. What kinds of financial
statements would you examine
to analyze a business?
Another common method of analysis is to show figures on
an income statement as a percentage of sales. Based on the present
income statement and last year’s statement from Happy House, a par-
tial analysis is shown in Figure 20.10.
Last year the cost of merchandise sold was 65.63 percent of total
sales. This year it increased to 67.08 percent of total sales. Sheila
Henry paid more for her merchandise, but her sales did not increase
at the same rate.
The gross profit on total sales decreased from 34.37 percent to
32.92 percent. Happy House sold more merchandise but lowered its
percentage of gross profit. If it were not for a drop in expenses this
year, the business would have reported a lower net income. This anal-
ysis provides the owner of Happy House with some of the informa-
tion that she needs to make decisions regarding the store’s pricing.
&IGURE #OMPARISON 5SING 0ERCENTAGE OF 3ALES
0REVIOUS 9EAR #URRENT 9EAR
!MOUNT IN $OLLARS 0ERCENT !MOUNT IN $OLLARS 0ERCENT
3ALES
#OST OF -ERCHANDISE 3OLD
'ROSS 0ROFIT ON 3ALES
!NOTHER 7AY TO !NALYZE &INANCIAL FIGURES CAN ALSO BE EXPRESSED AS PERCENTAGES AND A BUSINESS
CAN ASSESS AND EXPRESS ITS PROGRESS ON A PERCENTAGE BASIS
&OR THIS BUSINESS WHAT WAS THE GROSS PROFIT ON SALES PERCENT
DURING THE PREVIOUS YEAR 7AS THAT MORE OR LESS THAN THE
CURRENT YEARS PROFIT
Chapter 20 Financial Accounting 653
As You The Balance Sheet
Read The other primary financial statement of a business is a balance
RELATE sheet. A balance sheet is a report of the balances of all asset, liability,
and owner’s equity accounts at the end of an accounting period. The
Do you think Happy House main purpose of the balance sheet is to present a business’s financial
should raise its prices next position by reporting the assets of a business and the claims against
year? Explain your answer.
those assets (creditor’s claims and owner’s claims). It reports what the
business owns, owes, and is worth on a specific date. It is like taking
a financial photo of your business on the last day of the accounting
period. This is your present financial situation. The balance sheet for
Happy House Card Shop is shown in Figure 20.11.
You learned in Section 20.1 that the basic accounting equation
must always be in balance. The balance sheet represents the basic
accounting equation.
Assets ⫽ Liabilities ⫹ Owner’s Equity
Notice that a balance sheet consists of three sections: an asset sec-
tion, a liability section, and an owner’s equity section. On the Happy
House balance sheet, the total assets ($211,209) equal the total lia-
bilities ($49,092) plus the owner’s equity ($162,117). This means the
accounting equation is still in balance.
&IGURE "ALANCE 3HEET
(!009 (/53% #!2$ 3(/0
"ALANCE 3HEET
$ECEMBER
!33%43
#ASH IN "ANK
!CCOUNTS 2ECEIVABLE
-ERCHANDISE )NVENTORY
3UPPLIES
/FFICE %QUIPMENT
$ISPLAY %QUIPMENT
4/4!, !33%43
,)!"),)4)%3
!CCOUNTS 0AYABLE
3ALES 4AX 0AYABLE
0AYROLL 4AXES 0AYABLE
4/4!, ,)!"),)4)%3
/7.%23 %15)49
3HEILA (ENRY #APITAL
4/4!, ,)!"),)4)%3 /7.%23 %15)49
3TAYING !FLOAT 4HE BALANCE SHEET FOR A BUSINESS MUST SHOW A BALANCED EQUATION IN WHICH THE
ASSETS EQUAL LIABILITIES AND OWNERS EQUITY IN ORDER TO STAY IN BUSINESS
)S THIS PARTICULAR BUSINESS IN BALANCE 7HY OR WHY NOT
654 Unit 6 Business Finance Basics
Analyzing the Balance Sheet As You
To analyze these figures, you would compare the current Read
amounts on the balance sheet with figures from last year, as shown QUESTION
in Figure 20.12.
By examining the numbers and percentages, you can see that What sections are included
changes have taken place. Happy House bought various assets during on a balance sheet?
the year. This is shown in various increased balances:
• Supplies
• Office Equipment
• Display Equipment
The business also has more cash and inventory on hand, and
higher accounts receivable, than last year.
The balance sheet is an important financial statement, but to
make wise decisions, you should always compare the financial data to
a previous year’s balance sheet. Remember, the financial statements
provide the information about assets, liabilities, and owner’s equity,
but you must analyze and interpret it to make recommendations
based on that information.
&IGURE #OMPARISON OF "ALANCE 3HEETS
(!009 (/53% #!2$ 3(/0
#OMPARATIVE "ALANCE 3HEET
$ECEMBER
0REVIOUS 9EAR #URRENT 9EAR $OLLAR #HANGE 0ERCENT #HANGE
!33%43
#ASH IN "ANK
!CCOUNTS 2ECEIVABLE
-ERCHANDISE )NVENTORY
3UPPLIES
/FFICE %QUIPMENT
$ISPLAY %QUIPMENT
4/4!, !33%43
,)!"),)4)%3
!CCOUNTS 0AYABLE
3ALES 4AX 0AYABLE
0AYROLL 4AXES 0AYABLE
4/4!, ,)!"),)4)%3
/7.%2g3 %15)49
3HEILA (ENRY #APITAL
0AST AND #URRENT "USINESSES CAN USE THEIR BALANCE SHEETS TO DO A COMPARISON OF PROFITS AND
0ERFORMANCE EXPENSES OVER THE YEARS 4HIS CAN HELP BUSINESSES PINPOINT PROBLEM FINANCIAL
AREAS AND MAKE IMPROVEMENTS
(AVE THIS BUSINESSS ASSETS INCREASED OR DECREASED )S THIS AN
IMPROVEMENT OR NOT
Chapter 20 Financial Accounting 655
Statement of Cash Flows
TechByte
Computerized
Why are cash flows important?
The income statement and balance sheet provide vital financial
Accounting Software information, but neither financial statement shows how cash came
There are many options into or went out of the business during the period. You will want to
to consider when look-
know how much cash is available during business operations.
ing for computerized
accounting software to You may remember that your personal cash flow is the money
help you run your busi- that actually goes in and out of your wallet and bank accounts. In a
ness. A businessperson’s business, cash flow refers to the sources and uses of cash during an
decision about which accounting period.
one is right for his or her Understanding cash flows will help you in cash management.
needs is an important
Suppose that your school has a big dance coming up on Friday. All of
choice—one that could
mean the difference your friends are going and will probably go somewhere to eat after it
between success and fail- is over. You will need cash for Friday night, but you will not get your
ure. Looking for the right paycheck from your job until Saturday. In this example, money needs
accounting software solu- to go out for the dance before money comes in from your job. You
tion for your business can have a “cash crunch” problem.
be a real challenge.
Businesses often face similar problems. If a small business expe-
You can learn
riences a cash crunch situation, it could have serious problems. Good
about free software
assistance and write a cash control and management means that sufficient cash is available
paragraph explaining the for operating the business on a daily basis and for emergencies.
process used to make
the best choice through
finance07.glencoe.com.
Cash Inflows and Outflows
A statement of cash flows is a financial statement that
reports how much cash a business took in and where the cash went.
It explains changes in the Cash in Bank account during the account-
ing period.
䊳 ENTERTAINMENT
EXPENSES Theatrical com-
panies must pay for produc-
tion costs well before cash
from ticket sales is received.
What kind of cash flow would
a theatre group experience
before ticket sales begin?
656 Unit 6 Business Finance Basics finance07.glencoe.com
&IGURE 3TATEMENT OF #ASH &LOWS
(!009 (/53% #!2$ 3(/0
3TATEMENT OF #ASH &LOWS
&OR THE 9EAR %NDED $ECEMBER
#ASH &LOWS FROM /PERATING !CTIVITIES
#ASH 2ECEIPTS FROM
3ALES TO #USTOMERS
#ASH 0AYMENTS FOR
0URCHASE OF -ERCHANDISE
/PERATING %XPENSES
.ET #ASH &LOWS FROM /PERATING !CTIVITIES
#ASH &LOWS FROM )NVESTING !CTIVITIES
#ASH 0AYMENTS FOR
0URCHASE OF !SSETS %QUIPMENT
.ET #ASH &LOWS FROM )NVESTING !CTIVITIES
#ASH &LOWS FROM &INANCING !CTIVITIES
.ET #ASH &LOWS FROM &INANCING !CTIVITIES
.ET )NCREASE $ECREASE IN #ASH
#ASH AT "EGINNING OF 9EAR
#ASH AT %ND OF 9EAR
3HOW -E THE -ONEY ! BUSINESS MAY LOOK GOOD ON PAPER WITH ASSETS SUCH AS A BUILDING AND
EQUIPMENT BUT INCOME IN THE FORM OF CASH IS NEEDED TO PAY FOR EXPENSES
7HAT ITEMS WOULD BE CONSIDERED CASH INFLOWS FOR THIS BUSINESS
Cash flows include both cash inflows (cash that enters a busi-
ness) and cash outflows (cash that exits a business). Cash inflows may
include sales and interest earned from investments or savings. Cash
outflows may include operating expenses, merchandise purchases,
supplies, and interest and taxes paid.
Figure 20.13 shows the statement of cash flows for Happy
House. Notice that the statement of cash flows has three sections:
• Cash Flows from Operating Activities
• Cash Flows from Investing Activities
• Cash Flows from Financing Activities
Analyzing the Statement of Cash Flows
Happy House has a positive cash flow. During the year, more cash
entered the business than was paid out. The difference is $12,629.
When your business has negative cash flows, you will probably
experience a lack of available cash. You may not be able to pay your
bills or buy goods to resell. The business will not grow. Your state-
ment of cash flows can be a major consideration when you want to
borrow money. Potential investors and lenders want to see cash flow-
ing into your business in a constant, positive manner.
Chapter 20 Financial Accounting 657
Computerized Accounting
How do businesses use accounting software?
Most businesses use some type of accounting software to record
and report their business transactions. Even for an automated sys-
tem, you still need to collect and keep your source documents. Each
business transaction must be separated into its debit and credit parts.
However, you will enter the transaction in the computer system by
using account numbers rather than the account names. You still need
to enter the amounts.
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
0ARIS
S&P 500® financial index. It also gathers financial statis-
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals
to help them guide their financial decisions.
FRANCE
Telecommunication services rank as a major
industry in France. The telecom sector is an important
part of the French economy, making up two-thirds of
French exports in manufacturing goods. These exports DATABYTES
grew by 29 percent during the 1990s and continue to
grow. One of the industry stars, France Telecom, boasts Capital Paris
125 million customers. The company has a global out-
Population 59,771,000
reach to five continents and revenue of nearly $60 bil-
Languages French
lion in U.S. dollars. Headquartered in Paris, France,
Telecom offers the second largest wireless operation and Currency euro
Internet access service (called Wannado) in Europe. Gross Domestic
To reach its goal as Product (GDP) $1.65 trillion (2003 est.)
world leader in telecom- GDP per capita $27,500
munications, France Tele- Industry: Machinery, chemicals, automobiles, metal-
com has taken a page lurgy, aircraft, electronics, and textiles
from its own book. It
Agriculture: Wheat, cereals, sugar, beets, potatoes,
trains its personnel online.
beef, and fish
A computer program,
Exports: Machinery and transportation equipment,
called Train Us, matches
aircraft, plastics, chemicals, pharmaceuticals, and food
the instruction offered
for the jobs within the Natural Resources: Coal, iron ore, bauxite, fish, and
company. Employees can timber
learn new skills or change
Think Globally
career paths without
What types of functions might an accounting student
leaving their desks.
need to learn from an online training course?
658 Unit 6 Business Finance Basics
Computerized Posting After You
When all transactions are entered, you can “tell” the program Read
to post all amounts to the appropriate general ledger accounts. Com- REACT
puterized posting is faster and eliminates accounting errors that you
might make by doing it manually. Why is it important to
understand basic account-
ing procedures, even if you
Using Accounting Principles use accounting software to
What are important financial tools for businesses? manage accounts?
You have learned about several basic financial statements that
are some of the tools used to apply the first five accounting princi-
ples. The basic accounting principles are the backbone of every busi-
ness. Business owners and investors who risk their money and time
depend on accurate accounting records to report the results of the
operation and financial condition of their businesses. All businesses
use the same practices, which help them analyze their financial posi-
tions and make effective business decisions.
Section 20.2 Assessment
QUICK CHECK Calculate What is the gross profit
1. What items are included on an income on sales for each semester? What is
statement of a merchandising business? the percentage of gross profit to sales? Did
2. What is the purpose of a balance sheet? profits improve from the fall semester to
3. Why is the statement of cash flows impor- the spring semester?
tant to a business?
SOLVE MONEY PROBLEMS
THINK CRITICALLY 6. Sharing Financial Information
4. Describe how it is possible for a business to Sylvia worked her way through college at
have made a profit during the most recent a health food store. She learned about the
accounting period but not have enough various aspects of operating a business.
money to pay its employees this week. When she graduated, she opened her own
store, Sylvia’s Smoothies. Now she is ready
USE MATH SKILLS to add a partner to her business.
5. Gross Profit Damien is the student Analyze What type of financial
manager of Panther’s Pen, the student information might Sylvia need to
store on his school campus. During the fall share with potential partners?
semester, sales (or revenue) totaled $5,420,
and the cost of merchandise sold was
$3,500. During the spring semester, sales
were $4,890, and the cost of merchandise
sold was $3,060.
Chapter 20 Financial Accounting 659
Chapter 20 Review & Activities
CHAPTER SUMMARY
• The accounting equation states that • A trial balance is a list of all the
Assets ⫺ Liabilities ⫽ Owner’s Equity. accounts and their current balances.
Accounts show the balance for a All the debit balances should equal the
specific item. Accounts are set up as total of all the credit balances.
needed by a business, and may vary • The income statement is a report
depending on the type of business. of the net income or net loss for an
• The first five steps of the accounting accounting period.
cycle are to collect and verify source • The balance sheet reports balances for
documents, analyze each transaction, all asset, liability, and owner’s equity
journalize each transaction, post accounts at the end of an accounting
transactions to the general ledger, and period. It presents the business’s
prepare a trial balance. financial position.
• Business transactions are recorded in • The statement of cash flows reports
the general journal. how much cash your business took in
• Posting to the general ledger allows you and how it was used.
to see the balances in each account.
Communicating Key Terms
As an independent bookkeeper, you are preparing a presentation about the services you offer
to someone just starting a business. Use as many terms below as you can in the presentation.
• financial reports • T account • income statement
• accounting period • debit • cost of merchandise sold
• accounting cycle • credit (accounting) • gross profit on sales
• accounting equation • journal • net income
• account • general ledger • balance sheet
• accounts receivable • posting • statement of cash flows
• accounts payable • trial balance
• double-entry accounting • financial statements
Reviewing Key Concepts
1. Explain the three parts of the accounting equation.
2. Describe the five steps in the accounting cycle.
3. Explain the rules of debit and credit.
4. Explain how posting to the general ledger can simplify financial reporting.
5. Describe a trial balance.
6. List items included on an income statement.
7. Describe reasons why a business may have a reasonable balance sheet but poor cash flow.
8. Define a statement of cash flows.
660 Unit 6 Business Finance Basics
Chapter 20 Review & Activities
Economics Compare and contrast the steps leading to preparing a trial
balance with balancing your personal checkbook.
Write About It Write an article for your class newsletter explaining the
similarities and differences in the two actions.
Balance Comparison Below is a sample balance sheet that includes two
years:
2003 2004
Assets
Cash 17,500 24,300
Marketable securities 93,000 88,000
Accounts receivable 87,455 68,600
Inventories 162,000 169,000
Fixed assets 147,000 138,000
Liabilities
Current liabilities 114,000 122,000
Long-term debt 216,000 214,000
Partnership equity 176,955 151,900
1. Calculate How have the different items in the balance sheet changed in
percentages between the end of 2003 and 2004?
2. Compute Use spreadsheet software to make these calculations.
Connect with Communication Skills A graphic designer is
starting a business. She has purchased the equipment, furniture, and supplies
needed, and is working for several clients.
Role-Play Set up accounts for the graphic designer. With a partner,
role-play a discussion between you, the bookkeeper, and the designer. The
bookkeeper explains the accounting system set up for the business, and the
designer asks questions about how it will work.
Accounting Software Using software saves time when generating
the financial reports needed for decisions. Some early accounting software,
such as Lotus 1-2-3® and Peachtree®, is still in use today in updated versions.
Log On Search the names of five different accounting software
packages. Go to the Web sites for these packages.
Present How do they differ? Are some designed for particular industries?
Develop a few PowerPoint slides to report the results of your research.
Newsclip: Fuzzy Numbers Many corporations need to improve
their financial reporting and disclosure techniques. Annual and quarterly
O N L I N E
profit figures are frequently inflated and may mislead investors.
Log On Go to finance07.glencoe.com and open Chapter 20. Find
an income statement, balance sheet, and cash flow statement from
any company you choose. Write down any financial inconsistencies (or
“fuzzy numbers”) you might find.
finance07.glencoe.com Chapter 20 Financial Accounting 661
Chapter 20 Review & Activities
DO YOU THINK LOGICALLY
OR INTUITIVELY?
Which type of thinker are you—logical or intuitive? Logical thinking
tends to be analytical, orderly, and consistent, sometimes based on
rules or something exact. Intuitive thinking is based on insight and
tends to be more approximate, symbolic, and capable of dealing with contradiction. You
may have a tendency toward logical or intuitive thinking. In this quiz, there are no “right”
or “wrong” answers. Choose ten of the words below that best describe your thought
processes, and then write them on a separate sheet of paper.
______ abstract ______ dreamy ______ playful
______ ambiguous ______ exact ______ poetic
______ analogous ______ fantastical ______ practical
______ analytic ______ focused ______ precise
______ approximate ______ generalized ______ rational
______ conceptual ______ imaginative ______ reflective
______ constructive ______ impractical ______ specific
______ critical ______ inferring ______ speculative
______ deductive ______ literal ______ symbolic
______ detailed ______ logical ______ visionary
Scoring:
Give yourself 5 points if you wrote down analytic, conceptual, constructive, critical, deduc-
tive, detailed, exact, focused, literal, logical, practical, precise, rational, reflective, or specific.
Give yourself 3 points if you wrote down abstract, ambiguous, analogous, approximate,
dreamy, fantastical, generalized, imaginative, impractical, inferring, playful, poetic,
speculative, symbolic, or visionary.
If you scored 30–38 points, you prefer intuitive thinking.
If you scored 42–50 points, you prefer logical thinking.
Regardless of your tendencies, try alternate types of thinking. Whenever you feel you are
not communicating well, consider that the other person might be using a different way
of thinking.
662 Unit 6 Business Finance Basics
Chapter 20 Review & Activities
Your Financial Portfolio
Income Statements
Dakota’s gardening business now includes gardening for 22 homes and gardening
and planting for three commercial properties. She is considering hiring Rashelle for an
hourly fee to work with her so she can expand the business. To see if she can afford
to hire Rashelle, she has prepared an income statement. In reviewing six months of
income statements, Dakota felt she could afford to pay Rashelle, especially if she picked
up some new accounts.
Dakota’s Gardening
Income Statement for the Month Ended July 31, 20--
Revenue
Regular gardening fees $3,460
Charge for plantings 180
Charge for trimming trees 300
Total revenue $3,940
Operating Expenses
Buying plantings $ 90
Truck loan 150
Equipment: new tree pruner 75
Gas expense 25
Insurance expense 35
Total expenses $ 375
Net Income $3,565
Apply
On a separate sheet of paper, choose a service business that you might like to
operate. Determine what you would charge for your service. Based on your fee and ser-
vices, determine what your monthly revenue and expenses would be. Using the same
guidelines as shown above, prepare an income statement. Would you want to hire and
supervise help or would you prefer to work alone?
Chapter 20 Financial Accounting 663
21
CHAPTER
Managing Payroll
and Inventory
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 21.1
• Identify six steps in managing a
payroll system.
• Describe the common methods
of paying employees.
• Discuss required and voluntary
payroll deductions.
• Identify the accounts used in
recording payroll.
Section 21.2
• Identify information needed for
an inventory control system.
• Summarize methods of
determining inventory quantity.
• Explain methods used to
calculate cost of inventory.
• Discuss how to analyze
inventory turnover.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
664
In the Real World . . .
W endy Jansen runs a vending business, offering snacks made
from potatoes. Her unique idea developed from her love of French fries.
She is very knowledgeable about potatoes—white, russet, red, and more. When
she told her friends about the business, they thought it was clever but impracti-
cal. However, Wendy created recipes for everything from potato-on-a-stick to sweet
potato soufflé. She sells her products at fairs, music festivals, and sporting events.
She does so well that she runs out of certain items. She realizes she must keep track
of her stock and ingredients by using an inventory system. Otherwise, she will
lose sales and the chance to grow her business into something more.
As You Read Consider how using an inventory system makes
good business sense.
Social Security and
ASK Medicare
Q: I am only 16. Why should I pay Social Security and
Medicare taxes? Those programs may not be around when I am old enough to collect.
A: It is true that Social Security programs are projected to run low on funds around
the year 2025. Under the present system, the rate of return on your contributions to
these programs is lower than what you might earn. However, Congress is working to
ensure that Social Security will provide funds for future retirees. Also, Social Security
and Medicare offer many other types of benefits including disability benefits.
Ask Yourself What can you do now to help supplement your retirement income?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com Chapter 21 Managaing Payroll and Inventory 665
Section 21.1
Focus on
Reading
Managing Payroll
Read to Learn
The Importance of Payroll
• How to identify six steps Records
in managing a payroll Why do payroll records need to be accurate?
system.
• How to describe the If you own a business, a large and important part of its account-
common methods of ing system will involve payroll. A payroll is a list of employees and
paying employees. the payments due to each employee for a specific period of time.
• How to discuss required The specific period of time during which you pay your employees
and voluntary payroll is known as a pay period. The two most common pay periods are
deductions. weekly and biweekly (every two weeks). However, some companies
• How to identify the pay their employees only once per month.
accounts used in record-
A good payroll accounting system ensures that employees are
ing payroll.
paid on time and have the correct amounts on their paychecks. The
payroll records and reports need to be very accurate. As with other
Main Idea
accounting functions, when you process payroll information, you
Managing payroll efficiently
and accurately enables a must follow specific guidelines. As discussed in Chapter 20, these
business to run more effec- guidelines are known as generally accepted accounting principles
tively and profitably. (GAAP). In addition to following GAAP procedures, state and federal
governments issue strict guidelines for paying employees and report-
Key Terms ing payroll information.
• payroll A business has two major goals when setting up a payroll system.
• gross earnings The system should perform these functions:
• salary
• hourly wage • Collect and process all information needed to prepare and issue
• overtime rate payroll checks.
• commission • Maintain payroll records needed for accounting purposes and
• deductions for preparing reports to government agencies.
• Federal Insurance
Contributions Act (FICA) Every payroll system has some common tasks or steps. All are
• Social Security tax important and must be done carefully, accurately, and regularly. If
• Medicare tax you pay your employees every week, you will complete all of these
• total gross earnings
tasks weekly:
1. Calculate gross earnings.
2. Calculate payroll deductions.
3. Prepare payroll records.
4. Prepare paychecks.
5. Record payroll information in the accounting records.
6. Report payroll information to the government.
666 Unit 6 Business Finance Basics
Calculating Gross Earnings Before
What is a salary and a wage? You Read
The first step in a payroll system is to calculate the total earnings PREDICT
of all employees for the pay period. The total amount of money an
Why do you think it is
employee earns in a pay period is the gross earnings. Three of the necessary to keep payroll
most common methods of paying employees are by salary, hourly records?
wage, and salary plus commission.
Salary
A salary is a fixed amount of money paid to an employee for
each pay period, regardless of the number of hours worked. For exam-
ple, Catherine Boggs is the manager of the shoe department at Dick-
inson’s Department Store. She earns a fixed weekly salary of $530
even though she may work 40 hours one week and 44 hours another
week. Salaries are paid to managers, supervisors, and others.
Hourly Wage
If you work for a local business after school and on the week-
ends, you probably receive an hourly wage, a specific amount of
money paid per hour to an employee. Most temporary and part-time
jobs pay an hourly wage. Many full-time jobs, such as entry-level
jobs, also pay an hourly wage.
Careers in Finance
CREDIT ANALYST
PURCHASING Angie Strong
AGENT Rogers Corporation
Cultivating business relationships is Angie’s top skill and her favorite part of her job. As a purchasing
agent for a polymer and electronics manufacturer, Angie is responsible for finding good sources for
products, buying the products, and negotiating the purchasing of raw materials, component parts,
equipment, and more. It is Angie’s job to develop relationships with suppliers, determine patterns of
need, and ensure the best quality and cost of items purchased. She must also understand key market
trends and issues that affect the supply of products.
SKILLS: Analytical, communication, computer, decision-making, math,
organizational, negotiation, research, and sales skills
PERSONAL TRAITS: Able to handle stress, honest, likes working with people and numbers, tactful
EDUCATION: High school diploma or equivalent or bachelor’s degree in business
administration; experience in the field
ANALYZE How might good payroll management affect a company’s purchasing abilities?
To learn more about career paths for purchasing agents, visit finance07.glencoe.com.
finance07.glencoe.com Chapter 21 Managing Payroll and Inventory 667
For example, Sean McCormick works at a sporting goods out-
As You let on weekday afternoons for $7.25 per hour. Last week he worked
Read 20 hours, and his gross earnings were $145 ($7.25 20 $145).
RELATE This week he had already worked 20 hours by the end of the day on
Wednesday. Sean’s gross earnings vary from week to week because he
If you are currently em- works different amounts of time each week.
ployed, look at a recent
Employers may have hourly employees use time cards or a time
paycheck stub and com-
pare your gross earnings to clock to keep track of each day. They use this information to deter-
the amount you were actu- mine the total hours each employee worked during a pay period. At
ally paid. What accounts the end of each period, the employer checks the information on time
for the difference? cards or time sheets for accuracy. If the information is incorrect, pay-
checks will be inaccurate. That is a problem for both employees and
employers.
Overtime Pay
According to state and federal laws, hourly-wage employees gen-
erally are paid extra when they work overtime, or more than 40 hours
in a pay week. The overtime rate, the amount paid above the nor-
mal rate, is usually 1.5 times the employee’s regular hourly wage. For
example, Kelly Robinson’s regular hourly wage is $7.40. If she works
more than 40 hours in a given week, her overtime rate for the extra
hours is $11.10 ($7.40 1.5 $11.10).
Suppose that Kelly worked more than 40 hours last week. To
calculate her gross earnings, multiply her regular hourly wage by 40
hours. Then you multiply the overtime rate by the number of over-
time hours. By adding the results of these calculations, you can figure
out her gross earnings for the week.
GO FIGURE FINANCIAL MATH
GROSS EARNINGS AND OVERTIME Formula:
(Hourly Rate Regular Hours) (Overtime Rate
Synopsis: Your gross earnings are the total amount Overtime Hours) Gross Earnings
of money you receive during a given pay period.
Solution:
Overtime, which you receive if you work more than
($7.40 40) ($11.10 3) Gross Earnings
your allotted number of hours, is 1.5 times your $296 $33.30 $329.30
regular hourly rate.
Kelly’s gross earnings for the week are $329.30.
Example: Kelly worked 43 hours this week. If her
regular hourly wage is $7.40 and her overtime
wage is $11.10, what are her gross earnings for
YOU FIGURE
the week? If you earn $8.25 an hour and you work
47 hours in one week, what are your gross
earnings?
668 Unit 6 Business Finance Basics
Typically, employees might
work extra hours during holiday
sales or other busy periods. They
might also work overtime to cover
for other employees who are sick or
on vacation. Remember, controlling
payroll costs is an important aspect
of good financial management.
Commission
A commission is an amount
of money paid to an employee
based on a percentage of the
employee’s sales. The more the
employee sells, the more he or she
is paid. Paying commissions to
sales employees is a way to encour-
age them to increase their sales.
It is very common for employ-
ers to pay sales employees a salary
plus commission. For example,
Olivia Chun is paid a weekly salary of $150 plus a 5 percent com- NINE TO FIVE All employ-
mission on all merchandise she sells. This week she recorded sales of ees are paid but not all in
$3,725. Olivia’s commission for the week is $186.25 ($3,725 .05 or the same manner. Some
5% $186.25). Her gross earnings for the pay week are $336.25 ($150 receive a salary, some are
$186.25 $336.25). paid an hourly wage, and
some earn a salary plus
commission. What does it
Calculating Payroll Deductions mean to work on salary plus
What are some of the deductions that are taken out commission?
of employees’ paychecks?
If you have ever received a payroll check, you were probably
surprised to see that the amount on the check was less than you
expected. Deductions are the various amounts that are subtracted
from an employee’s gross earnings. Some deductions are required by
local, state, or federal law. Others are voluntary deductions. Employ-
ees choose to have these amounts withheld from, or taken out of,
their gross earnings. The calculation of these deductions is the second
step in a payroll system.
Deductions Required by Law
As an employer, you are required by law to deduct certain pay-
roll taxes from the gross earnings of all employees. These include
federal income tax, Social Security tax, and Medicare tax. In many
states additional taxes are withheld for local and state income taxes.
Employers deduct these taxes from employees’ paychecks and send
the amounts to the appropriate government agencies.
Chapter 21 Managing Payroll and Inventory 669
Federal Income Tax Most people pay income tax to the federal
government each year. This tax is based on their total income for the
year. To ensure that people will have the money to pay these taxes,
the government requires employers to withhold an amount of money
from employees’ paychecks each pay period. This money is sent to the
government and is applied to each employee’s federal income tax.
After calculating gross earnings, employers use tax tables sup-
plied by the Internal Revenue Service (IRS) to determine the amount
of federal tax to withhold from each employee’s paycheck. To use the
tables, employers must know how many allowances each employee
is claiming. An allowance is an adjustment to the tax withheld from
your paycheck. The more allowances an employee claims, the less tax
will be withheld. Allowances are based on the employee’s marital sta-
tus and number of dependents. A single person could claim an allow-
ance of zero or one. A married person with two children could claim
an allowance of four. Figure 21.1 shows an IRS tax table.
&IGURE )NTERNAL 2EVENUE 3ERVICE 4AX 4ABLE
3).',% 0ERSONS7%%+,9 0AYROLL 0ERIOD
)F THE WAGES ARE !ND THE NUMBER OF WITHHOLDING ALLOWANCES CLAIMED IS
!T "UT LESS
LEAST THAN 4HE AMOUNT OF INCOME TAX TO BE WITHHELD IS
0AYING 5NCLE 3AM $EPENDING ON THE NUMBER OF ALLOWANCES YOU CLAIM YOUR EMPLOYER WILL
WITHHOLD A CERTAIN AMOUNT FROM YOUR PAYCHECK FOR INCOME TAX
7HAT IS THE PURPOSE OF WITHHOLDING THIS MONEY
670 Unit 6 Business Finance Basics
For example, suppose that Eric Gaus has weekly gross earnings
of $235 and claims one allowance. According to the tax table, the
amount withheld as his federal income tax is $20. If Eric had too
much withheld from his pay, the government would refund him the
excess amount. If Eric had too little withheld, he would have to send
the additional amount he owed to the IRS. LANGUAGE ARTS
Businesses pay their
FICA Taxes In addition to federal income tax, employers also collect employees in different
Social Security taxes for the federal government by deducting them ways and with differing
from their employees’ paychecks. The 1935 Federal Insurance time periods, depending
Contributions Act (FICA) established the present Social Security on several factors. Employ-
ees may be paid salaries,
system. Social Security payments are often referred to as FICA taxes.
hourly wages, or salaries
The FICA taxes pay for programs that provide income to certain plus commissions, and pay
individuals: periods may be weekly,
biweekly, or monthly.
• The old-age and survivors’ benefit programs provide income to
What types of businesses
retired persons and the spouse and dependents of a deceased would use each payment
worker. method and pay period?
• The disability insurance program provides income to people Write a paragraph explain-
with disabilities and their families. ing your answers. Consider
• The Medicare program provides health insurance benefits for factors such as type of work
performed, number of hours
people 65 or older, certain people with disabilities, and people
worked, business cash flow
of any age who have permanent kidney failure. patterns, and any other
FICA includes two types of tax: Social Security tax and Medicare possible factors.
tax. Social Security tax finances the federal programs that provide
retirement, disability, and life insurance benefits. Medicare tax is
the tax that finances part of the Medicare program.
All employees pay FICA taxes based on rates established by the
United States Congress. The rates can change at any time. In 2005,
the FICA tax rates were 6.2 percent for Social Security and 1.45 per-
cent for Medicare. The money from these taxes goes to the Social
Security Administration, where it is put into a trust. It is then distrib-
uted to people collecting Social Security and Medicare benefits.
GO FIGURE FINANCIAL MATH
FICA DEDUCTION Solution:
($380 .062) ($380 .0145) FICA Deduction
Synopsis: FICA taxes include the Social Security tax
and the Medicare tax. These taxes are used to pro- $23.56 $5.51 $29.07
vide income to a variety of people. Alex’s FICA taxes amount to $29.07.
Example: What is the FICA deduction for Alex
Calligros if his gross earnings for the week are $380? YOU FIGURE
If your gross earnings for the month are $550,
Formula:
how much would be deducted from your pay-
(Gross Earnings Social Security) (Gross Earnings
check for FICA taxes?
Medicare Tax) FICA Deduction
Chapter 21 Managing Payroll and Inventory 671
Employers use the FICA rates to calculate how much to with-
TechByte
Managing Cash Flow
hold from the taxable gross earnings of each employee for each pay
period. Multiply gross earnings by the Social Security tax, and then
multiply gross earnings by the Medicare tax. Add these two figures to
Having enough cash on determine the FICA deduction.
hand at the right time
is key when it comes State and Local Income Taxes Many states and cities tax the
to managing a grow- earnings of people who live or work within their boundaries. In
ing company. The lag some states the taxes are simply a percentage of gross earnings. In
between the time you other states, the amount owed is based on tax tables similar to the
have to pay your suppli-
federal withholding tables issued by the IRS. Where employees work
ers and employees and
the time you collect from and live determines how state or local taxes are taken from their
your customers is often a gross earnings.
problem. The solution is
cash flow management.
Cash flow management
Voluntary Deductions
means delaying outlays Many employers deduct other amounts of money from employees’
of cash as long as pos- paychecks. These deductions are voluntary, meaning that the employer
sible while encourag-
will deduct these amounts only if the employee requests it. If the employee
ing anyone who owes
you money to pay it as does not want the money deducted, it remains in his or her paycheck.
quickly as possible. But However, once an employee requests a voluntary deduction, it is withheld
how can you encourage from each paycheck until the employee asks his or her employer to stop
people who owe you taking it out. Some common voluntary deductions include:
money to pay on time?
• Health or life insurance premiums
Learn more about • Union dues
software for cash
flow management and
• Contributions to charities
write a paragraph • Pensions and other retirement plans
about it through • Direct deposits to a credit union or bank
finance07.glencoe.com.
A popular voluntary payroll deduction is a contribution to a 401(k)
plan for retirement, which you learned about in Chapter 15. Many
employees contribute a portion of their gross earnings to accounts in
a company 401(k) plan. The funds in a 401(k) plan are tax-deferred,
meaning that employees do not have to pay taxes on the money that
accumulates in their 401(k) plans until they withdraw it.
Preparing Payroll Records
What information is included on a payroll register?
The third step in a payroll system is to prepare payroll records.
Federal and state laws require all businesses to keep accurate payroll
records. Employers are expected to:
• Calculate earnings and deductions correctly.
• Distribute employee paychecks on time.
• Keep accurate payroll records.
• Pay all taxes owed to government agencies on time.
• File all required payroll reports to government agencies on time.
To fulfill these obligations, your business needs an efficient sys-
tem for collecting, recording, and summarizing payroll information.
672 Unit 6 Business Finance Basics finance07.glencoe.com
Preparing the Payroll Register As You
After collecting information for the pay period, you record the Read
data on a payroll register. The payroll register is a record that summa- QUESTION
rizes information about employee earnings and deductions for each
pay period. Figure 21.2 shows an example of a completed payroll What are the three main
register for Ezra’s Sport Clothes. sections of a payroll register?
A payroll register has three main sections pertaining to money:
earnings, deductions, and net pay. The earnings section records the
regular pay, overtime pay, and gross earnings of each employee for
the pay period. The deductions section of the payroll register lists
and totals the required and voluntary deductions withheld from
each employee. The number of columns varies from business to busi-
ness. The net pay section records the amount that remains after the
total deductions are subtracted from gross earnings. For Ezra’s Sport
Clothes, the total net pay for this week’s payroll is $1,338.31.
Preparing Paychecks
What are some of the benefits of direct deposit?
After checking the accuracy of the payroll register, you prepare
a payroll check for each employee. This is the fourth step in a payroll
system. The amount on each payroll check—often referred to as take-
home pay—should equal the net pay listed for each employee. Along
with the check, each employee receives a written or printed expla-
nation that shows how the net pay is calculated. The stubs attached
to payroll checks provide this explanation and serve as a record for
employees. An example of a paycheck that lists gross earnings, deduc-
tions, and net pay is shown in Figure 21.3 on page 674.
&IGURE #OMPLETED 0AYROLL 2EGISTER FOR %ZRAS 3PORT #LOTHES
--
0REPARING 0AYROLL Ê«>ÞÀÊÀi}ÃÌiÀÊÃÕ>ÀâiÃÊvÀ>ÌÊÊi«ÞiiÊi>À}ÃÊ>`
`i`ÕVÌÃÊvÀÊi>V Ê«>ÞÊ«iÀ`°
7 >ÌÊÌ iÀÊvÀ>ÌÊÃÊÀiVÀ`i`ÊÊÌ iÊÀi}ÃÌiÀ¶
Chapter 21 Managing Payroll and Inventory 673
&IGURE #OMPLETED 0AYROLL #HECK AND 3TUB
%ZRAS 3PORT #LOTHES
'ATEWAY "LVD
3ACRAMENTO #!
$ATE -AY
0AY TO THE
/RDER OF 2YAN $RUMMOND
4WO HUNDRED TWENTY DOLLARS AND $OLLARS
!MERICAN .ATIONAL "ANK
3!#2!-%.4/ #!,)&/2.)!
%MPLOYEE 0AY 3TATEMENT
$ETACH AND RETAIN THIS STATEMENT
%ARNINGS $EDUCTIONS
0ERIOD 3OCIAL &EDERAL 3TATE .ET
%NDING 3ECURITY -ED )NCOME )NCOME (OSP 5NION 0AY
2EGULAR /VERTIME 4OTAL 4AX )NS $UES 4OTAL
4AX 4AX 4AX
n
0AYDAY 4HE AMOUNT ON EACH PAYROLL CHECKOFTEN CALLED hTAKE HOME PAYvSHOULD
EQUAL THE NET PAY LISTED FOR EACH EMPLOYEE ON THE PAYROLL REGISTER
7HAT WERE 2YAN $RUMMONDS GROSS EARNINGS FOR THE PERIOD
ENDING -AY 7HAT WAS HIS NET PAY
Direct Deposit
Instead of issuing paychecks, many businesses offer direct
deposit of employee earnings. With direct deposit, net pay is depos-
ited automatically in an employee’s designated bank account.
Employers do not have to prepare a paycheck if they offer direct
deposit. However, they must give employees a written record of
their payroll information.
Employees and employers generally prefer direct deposit. Employ-
ees do not have to go to the bank to deposit their paychecks; they do
not risk misplacing or losing a check; and funds are usually available
faster. Employers can reduce the expenses of paper and labor for pro-
cessing checks by using direct deposit.
Automated Payroll Preparation
Today almost all businesses use some type of automated system
to prepare payroll records. Computer-generated records provide an
efficient and accurate system. Computers are affordable, and a variety
of software packages is available. The employer enters the number of
hours each employee worked, and the computer produces a payroll
register and the paychecks.
674 Unit 6 Business Finance Basics
Recording Payroll Information
What payroll information is recorded in a company’s
accounting records?
After you complete the payroll register and prepare individual
paychecks, the payroll must be recorded in the accounting system of
your business. This is the fifth step in the payroll process. In record-
ing the payroll, you are recording only the total amounts for the pay
period. The individual amounts for each employee have already been
recorded on the payroll register.
The Salaries Expense Account
Each pay period, you pay out a certain amount of money
to your employees in wages or salaries. The amount you pay
to all employees before any deductions are taken out is called
total gross earnings. This is a basic operating expense of your
business. You record the total gross earnings
in a general ledger account titled Salaries CHECK IT OUT This
Expense. On the payroll register illustrated teacher likes the conve-
in Figure 21.2, on page 673, the total gross nience of being paid by
earnings for the period are $1,719.20. direct deposit. What are
some other reasons that
Deductions to a company might pay its
employees by direct
Liabilities deposit?
The amount you deduct
from employee earnings for
Social Security, Medicare, and
other taxes or payments is sub-
tracted from total gross earn-
ings. This money does not
belong to your company. You
must pay it to the proper agen-
cies or organizations on behalf
of your employees. Therefore, all
deductions taken from employ-
ees’ gross earnings immedi-
ately become liabilities of your
business.
In Chapter 20, you learned
that in setting up your account-
ing system, you create only the
accounts that your business
needs. These accounts are assets,
liabilities, and owner’s equity.
The liabilities of your business
are identified in the account
title by the word payable.
Chapter 21 Managing Payroll and Inventory 675
Based on the deductions shown on its payroll register in
Figure 21.2 on page 673, Ezra’s Sport Clothes has the following liabil-
ity accounts:
• Social Security Tax Payable
• Medicare Tax Payable
• Employees’ Federal Income Tax Payable
• Employees’ State Income Tax Payable
• Hospital Insurance Premium Payable
• Union Dues Payable
These items remain liabilities until the business makes the
required payments to the government, insurance companies, local
unions, and any other agencies or organizations.
Global Financial Landscape
z
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis-
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals
to help them guide their financial decisions. 3INGAPORE
SINGAPORE
Known for centuries as the Lion City, Singapore
might also be known as a “company town.” The gov-
ernment involves itself in every aspect of Singapore’s
commerce. From international trade to trash collec- DATABYTES
tion, the small city-state is a study in efficiency. It is
no wonder that Fortune magazine chose Singapore as Capital Singapore
one of the world’s best places to do business. The gov-
Population 4,372,000
ernment has threatened
employers with punish- Languages Chinese, Malay, Tamil, English
ment if they do not pay Currency Singapore dollar
foreign workers on time. Gross Domestic
Many citizens believe the Product (GDP) $109.1 billion (2003 est.)
government knows what GDP per capita $23,700
it is doing. Others are not Industry: Electronics, chemicals, financial services, oil
so sure. Critics say that too drilling equipment, and petroleum refining
much government con-
Agriculture: Rubber, copra, fruit, orchids, and poultry
trol weakens the country’s
competitive spirit and Exports: Machinery and equipment (including elec-
stifles the creativity of its tronics), consumer goods, chemicals, and mineral fuels
citizens. The concern is Natural Resources: Fish and deep-water ports
that this may hurt the Think Globally
country’s economy. List some of the reasons why too much government
control might have a negative effect on business.
676 Unit 6 Business Finance Basics
Cash in Bank
After salary expenses and deductions have
been recorded, the last account to be affected by
payroll is Cash in Bank. Cash in Bank is the account
that records all of the cash that enters or leaves the
business. For the pay period shown in Figure 21.2
on page 673, the cash account is reduced by the
total amount of net pay, which is $1,338.31. Your
cash account balance will be reduced further as
you make payments on your payroll liabilities.
Employer’s Payroll
Taxes
How do employers help pay for
benefits such as Social Security?
The amounts in the various payroll liability
accounts of a business represent the taxes that
employees paid on their earnings. The state and
federal governments also require employers to pay
additional taxes that are based on the total taxable
gross earnings each pay period. This money goes
toward benefits such as Social Security and unem-
ployment and disability insurance.
KEEPING TRACK A store
Employer’s Share of FICA Taxes such as Borders bookstore
Federal law requires that the employer match the total amount employs many people work-
deducted from employees’ paychecks for Social Security and Medi- ing in many different areas
care. In other words, if your employee pays $25, you must pay an of the business. How might
additional $25. In Figure 21.2 on page 673, the total Social Secu- accurate payroll records help
rity tax deducted from the total gross earnings for the pay period employers manage their busi-
ending May 18 was $106.59. As the employer, Ezra’s Sport Clothes ness expenses?
must match this amount ($106.59) and send the government a
check totaling $213.18 ($106.59 $106.59 $213.18). Employers
also have to match Medicare deductions with an equal amount. An
employer must match and pay Social Security tax and Medicare tax
for every pay period.
Federal and State Unemployment Taxes
The employer pays both federal and state unemployment taxes.
The maximum federal unemployment tax is 6.2 percent on the first
$7,000 of an employee’s annual wages. State unemployment tax rates
and maximum taxable amounts vary among states. Employers may
deduct up to 5.4 percent of the state unemployment taxes from fed-
eral unemployment taxes. Most employers, therefore, pay a federal
tax of 0.8 percent (6.2% 5.4% 0.8%) of taxable gross earnings.
Chapter 21 Managing Payroll and Inventory 677
GO FIGURE FINANCIAL MATH
UNEMPLOYMENT TAXES Solution:
Total
Synopsis: Employers are required to pay federal ($3,000 .008) ($3,000 × .054) Unemployment
and state unemployment taxes. These taxes provide Taxes
income to workers who have lost their jobs. $24 $162 $186
Example: The total gross earnings of Prairie Pet Prairie Pet Store will have to pay $24 to the federal
Store are $3,000 for the pay period. None of the government and $162 to the state government for a
employees has reached the maximum taxable total of $186.
amount. How much money must the owner pay to
the federal and state governments, based on the
unemployment tax rates?
YOU FIGURE
If your company’s total gross earnings for a
Formula:
specific pay period were $4,100, how much
(Total Gross Earnings Federal Tax Rate)
(Total Gross Earnings State Tax Rate) would you have to pay in federal and state
Total Unemployment Taxes unemployment taxes?
To calculate the amount to pay, you multiply the total gross
earnings for the pay period by the federal tax rate. Then multiply the
total gross earnings for the pay period by the state tax rate. Finally,
add the two figures to calculate the total amount of taxes to pay.
Reporting Payroll Information
to the Government
What information is essential in filing reports
to the government?
The amount of money a business owes government agencies must
be paid according to strict guidelines, outlined in the Internal Revenue
Code (IRC). Both the federal and state governments expect prompt
payment along with the proper forms and reports. You must file a vari-
ety of forms to the different government agencies. Reporting informa-
tion about payments to the government is the sixth and last step in the
payroll process. You need current and accurate payroll information for
filing the reports and making the necessary payments.
Employers must comply with employment tax rules and proce-
dures in the IRC or risk civil or criminal penalties. The IRC addresses
a number of issues:
• Determining whether the federal tax coverage rules apply
• Computing an employee’s taxable wages
• Calculating the amount of employment taxes to be withheld
• Depositing the correct amount of taxes with the government
• Filing employment tax returns
678 Unit 6 Business Finance Basics
Payroll Accounting in
Financial Management
Why is it important to analyze payroll
information regularly?
Accurate payroll records are essential for controlling business
expenses. Good payroll records can pinpoint the labor cost for differ-
ent areas of your business. They will also indicate how much of the
total gross earnings was spent on overtime. Although overtime is justi-
fied in many cases, it may also be a sign of a poor use of employees.
Payroll is often the biggest expense of running a business. There-
fore, it is very important to carefully analyze the payroll information
of every pay period. Payroll costs can dramatically reduce profits.
However, payroll is also an area where you can reduce expenses.
Good financial management requires constant review of your pay-
roll system.
Section 21.1 Assessment
QUICK CHECK Calculate Help Danielle with the
1. What are the steps of a payroll system? calculations. Which employee earned
2. What are the three most common methods the most money this week?
of paying employees?
SOLVE MONEY PROBLEMS
3. What are three required payroll deductions
and three voluntary payroll deductions? 6. Growth Spurt Alicia runs a pool clean-
ing service and has almost 200 clients. Her
THINK CRITICALLY business is growing very quickly. Now Alicia
4. Discuss some of the advantages and disad- must decide whether to continue paying
vantages of paying someone a salary instead overtime each week to her employees or
of an hourly wage. to hire another employee or two. Each of
Alicia’s 15 employees earns an hourly wage
USE MATH SKILLS of $7.50 and works an average of 8 hours of
5. Eagle Earnings Danielle is the payroll overtime a week.
manager at Eagle Amos, a retail business that Calculate and Analyze Calculate
specializes in camping and hiking gear. She how much Alicia is paying her current
needs to determine the weekly gross earn- employees in overtime. Calculate how much
ings for several employees. Hourly employ- it would cost for Alicia to hire an additional
ees earn overtime at a rate of 1.5 times the employee at $7.50/hour. Which would be
regular hourly rate and do not receive com- the most cost-effective solution: hiring a new
mission. Salaried employees earn a 4 percent employee or continuing to pay her current
commission on their sales. Danielle knows: employees overtime?
• Shari worked 44 hours at $6.75/hour.
• Rolf worked 40 hours at $7.35/hour.
• Litisha earns a salary of $185/week and
had sales totaling $1,150.
Chapter 21 Managing Payroll and Inventory 679
Section 21.2
a
Focus on
Reading
Managing Inventory
Read to Learn
Establishing an
• How to identify infor- Inventory System
mation needed for an Why is it important to keep close track
inventory control system. of inventory?
• How to summarize
methods of determining Felix Martinez owns a small bookstore in San Diego that special-
inventory quantity. izes in materials about travel in the United States and other countries.
• How to explain methods Business has been very good lately. One of Felix’s most challenging
used to calculate cost of tasks is deciding which books to buy and keep in stock for his cus-
inventory. tomers. He reviews his stock regularly to see which books sell well
• How to analyze inventory and which ones remain on the shelves. The decisions he makes in
turnover. purchasing books can have a significant impact on his business’s cash
flow and profits.
Main Idea When you own a business, one of the major expenses of your
Maintaining adequate company is the purchasing of merchandise, or the items that you
quantities of merchandise
buy with the intent to resell to customers. The amount of merchan-
in inventory enables busi-
nesses to meet the needs dise you have on hand at any particular time is known as inventory.
of customers and manage Inventory for a manufacturing business can include raw materials,
cash flow. goods in process, and finished goods. For a retail business, products
or merchandise in stock, such as books, clothing, or appliances, are
Key Terms also considered to be inventory. Inventory is often the largest asset
• perpetual inventory system of a business.
• point-of-sale terminals In order to control the purchase and sale of merchandise for
• periodic inventory system your business, you must establish an inventory control system.
• specific identification
method
This system tracks the quantity and cost of merchandise purchased,
• first-in, first-out method the merchandise in stock, and the merchandise sold to customers.
(FIFO) Figure 21.4 illustrates the various stages of merchandise in a retail
• last-in, first-out method business. Properly tracking the flow of merchandise gives you the up-
(LIFO) to-date information that you need to make good management deci-
sions. The essential items of information for an inventory control
system include:
Before • The amount of merchandise sold in each accounting period.
You Read • Information about which items are selling well.
• Information about which items are not selling well.
PREDICT
Tracking and controlling inventory is also a major function of
Why should a business an accounting system. You cannot make good financial decisions
manage inventory without accurate and current inventory information.
effectively?
680 Unit 6 Business Finance Basics
Figure 21.4 The Stages of Merchandise
Merchandise is moving from the time
you order it until the time that it is sold
to a customer.
1
Ordering Merchandise
Merchandise must be
reordered when your
inventory runs low in order
to meet customer demand.
2 Storing Merchandise After you
receive merchandise, it must be
stored in a safe, efficient manner.
3 Displaying Merchandise
Merchandise must be displayed in
an appealing way that will attract
customers.
4 Selling Merchandise The sale of
merchandise brings in cash for your
business and also reduces your inventory,
which must be replenished by reordering.
Chapter 21 Managing Payroll and Inventory 681
The Importance of
Controlling Inventory
Why is having too little inventory bad for business?
Franchise
Ownership Because the purchase of merchandise often requires large
When you own a fran- amounts of money, it has a great impact on cash flow. Therefore, it
chise and are in business is essential to maintain the proper level of inventory. Your goal is to
for yourself, you will have have enough merchandise to meet customer demand but not have an
to become a good man- overstock of items.
ager of resources, time,
and people. Learn more
If your inventory is too large, you may have purchased the
about being a good boss wrong items or the wrong quantity of items. As a result, cash may not
and business leader. be available for operating expenses, expansion activities, or emergen-
cies. You will also be paying more than necessary for storage. To get
To continue with
Task 4 of your
rid of excess inventory, you may have to sell it at a loss.
WebQuest project, visit If your inventory is too low, customers will not have enough
finance07.glencoe.com. choices of merchandise. They may shop elsewhere, in which case,
you lose sales. With fewer sales, your business receives less cash.
Have you ever gone to purchase something at a store only to find
out that the item was out of stock? Can you remember how you felt?
Disappointed customers often do not return. Satisfied customers, on
the other hand, go back to businesses where they find the items they
want when they want them. Therefore, maintaining an appropriate
level of inventory is good business management.
Determining Amount
of Inventory
What systems help determine amount of inventory
in stock?
At certain points in each accounting period, businesses need to
determine how much merchandise is in stock. They also need to cal-
culate the value of the merchandise. How do you calculate the quan-
tity of merchandise on hand at a given point?
Two accounting methods are used to determine how much mer-
chandise is in stock: the perpetual inventory system and the periodic
inventory system. Both of these systems report the quantity of mer-
chandise available for sale to customers.
The Perpetual Inventory System
A perpetual inventory system is a system that keeps a con-
stant, up-to-date record of merchandise on hand. Every time an item
is sold, the item is deducted from the inventory. A perpetual inven-
tory system allows you to determine the quantity you have on hand
and the cost of the items at any time. By having current, up-to-date
information, you can reorder and restock items whenever the quan-
tity becomes low. Restocking can help avoid loss of sales.
682 Unit 6 Business Finance Basics finance07.glencoe.com
Before the introduction of computers, this type of inventory sys-
tem was impossible for most businesses to use. It was just too difficult
As You
to keep track of a large quantity of items being bought and sold. Today,
Read
however, many businesses use point-of-sale terminals, which are RELATE
electronic cash registers. These terminals are linked to a centralized
computer system that keeps track of sales. Look at a receipt you
received from a purchase
You have probably bought an item in a store with this kind of
such as clothing or a music
system, where the associate passes an electronic gun or scanner over CD. Is there an item num-
the bar code of the item you are buying. The scanner reads the bar ber listed on the receipt
code, you hear a beep, and the item’s price appears on the screen of for each item? How might
the point-of-sale terminal. Sales tax is automatically calculated when a store owner use these
the items are entered. The sales slip you receive from the store lists numbers?
the items you just purchased along with their prices.
In addition to recording the prices of items, point-of-sale termi-
nals also identify the items and remove them automatically from the
inventory records. When a particular item reaches a predetermined
low point, the purchasing manager reorders the item so that the busi-
ness does not run out of it. With such an automated system, busi-
nesses know the number of items sold and the number still on hand
at all times. An example of a computer printout of a daily inventory
report is shown in Figure 21.5.
&IGURE #OMPUTER 0RINTOUT FROM A 0ERPETUAL )NVENTORY 3YSTEM
7ILTON /UTDOOR #ENTER
$!),9 ).6%.4/29 2%0/24
$EPARTMENT
/CTOBER
5NIT 4OTAL
3TOCK 1UANTITY #OST 6ALUE
)TEM 5NIT
.O
+ILMER 2ODS %ACH
4YON 2ODS %ACH
0ETERSON 2ODS %ACH
%ACH
+ 2 2ODS
%ACH
7EBER 2EELS
%ACH
0RO 2EELS
%ACH
!RTCRAFT 2EELS
"OX
&ISHING (OOK
"OX
&ISHING (OOK
4OTAL
7HATS IN 3TOCK ! PERPETUAL INVENTORY SYSTEM ALLOWS YOU TO UPDATE INVENTORY RECORDS
EVERY TIME AN ITEM IS SOLD
(OW MANY 0ETERSON RODS AND 7EBER REELS DID 7ILTON /UTDOOR
#ENTER HAVE IN STOCK AS OF /CTOBER
Chapter 21 Managing Payroll and Inventory 683
SCAN IT! Many stores
use point-of-sale terminals
and scanners to record sales.
What is the advantage of using
this technology?
It is difficult, but not impossible, for businesses that do not use
computers to use a perpetual inventory system. Usually these busi-
nesses sell large items, such as cars or furniture. They have fewer
items in stock and do not sell many items within a certain time
period. As a result, they can keep track of inventory with index cards
or inventory sheets that list the items in stock. When the business
sells an item, someone pulls the index card for that item from an
inventory box or removes the item from an inventory sheet. Because
Common very few items are sold each day, it is possible to maintain a non-
computerized perpetual inventory system.
CENTS
Inventory Losses
The Periodic Inventory System
Retail businesses must con- Another system used to keep track of merchandise on hand is
sider loss of inventory due a periodic inventory system. A periodic inventory system is a
to human error as they
system in which inventory records are updated only after someone
manage their inventory
levels. The National Secu- makes an actual physical count of the merchandise on hand. You do
rity Survey Final Report not change inventory records every time you purchase or sell some-
found that causes of inven- thing. You count everything you have and update your inventory
tory shortages include only after everything is counted.
employee theft at 48 per- Perhaps you have worked in a store and helped take inventory. If
cent, shoplifting at 32
not, you may have seen a sign in a store window that read “Closed for
percent, vendor fraud at 5
percent, and administrative Inventory.” Businesses take a physical count of merchandise at least
and paper errors at 15 per- once a year. For most businesses, the process of identifying and count-
cent. If a boutique carried ing all items of merchandise is time consuming. Therefore, inventory
100 dresses and 50 designer is usually counted when the quantity of merchandise is at its lowest
handbags, and the store’s point. For a seasonal business, the count occurs after the peak sales
total inventory shortage was
period. In a ski shop, for example, the peak sales period is November
typically 10 percent, how
many of each item were lost through March. You would probably take inventory in May or June,
due to shoplifting? when there is less merchandise to count. After taking the physical
count, you can order new merchandise for the next year.
684 Unit 6 Business Finance Basics
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: A Paycheck Stub Your Motive: When you receive a check
A paycheck stub contains the following from your employer, a statement will be
information: attached to the check. This statement tells
you how your paycheck was calculated.
• Name and Social Security number of
Sometimes employers make mistakes in
employee
their payroll. You can check the paycheck
• Amount earned during the pay period
stub to make sure the amounts are correct.
and year-to-date
• Amount of taxes withheld from wages
during the pay period and year-to-date
'ENERAL 0RODUCTS -ICHELLE ,I
0/ "OX 3ECOND 3TREET
.EW 9ORK .9 !THENS /( 33 NO 88 8888
0ERIOD BEGINNING 0ERIOD ENDING 0AY DATE
0AY 3UMMARY
%ARNINGS
,ESS 4AXES
$EDUCTIONS
.ET #HECK
%ARNINGS TO $ATE 4YPE 2ATE (OURS #URRENT 9EAR TO $ATE
(OLIDAY
3TRAIGHT 4IME
4AXES #URRENT 9EAR TO $ATE
&EDERAL INCOME TAX
3OCIAL 3ECURITY
-EDICARE
3TATE INCOME TAX
#ITY TAX
Key Points: A paycheck stub contains Find the Solutions
information for the current pay period as well 1. How much does Michelle make per hour?
as the cumulative total for the calendar year. 2. Does she make more money per hour on
holidays?
3. When did Michelle receive this pay?
4. How much in taxes was deducted from her
paycheck?
5. What was the total amount Michelle
received?
Chapter 21 Managing Payroll and Inventory 685
Today many businesses use electronic equipment when taking a
As You physical inventory. An employee simply enters the stock number of
Read each item and the quantity in stock into a handheld computer. When
QUESTION the physical count is complete, he or she prints an up-to-date record
of the inventory items.
Even with good inventory Even if a business uses a perpetual inventory system, it must con-
controls in place, why might
duct a periodic physical inventory at least once a year to check the
you still want to do a physi-
cal inventory? accuracy of inventory records. Errors can be made in entering inven-
tory data when purchasing merchandise. Errors can also be made at
point-of-sale terminals when the business sells merchandise. Items
can be lost, stolen, or identified incorrectly. A periodic physical count
ensures that accounting records are accurate and agree with what the
business actually has in stock.
Determining the Cost
of Inventory
Why is it important for a business to
use its chosen costing method consistently?
You have determined the quantity of merchandise on hand.
Now you need to calculate the cost of that merchandise. In other
words, the inventory must be assigned a value. You could do this
fairly easily if the cost of every item were always the same. However,
that is unusual.
For example, Heather Martin buys certain items for her pet store
several times within a single inventory period. Often the cost of these
items changes during that period. Heather might buy a specific brand
and size of dog food for $9 per bag in March. She might pay $12 for
the same dog food in June. How can she appropriately determine the
cost of the remaining bags of dog food she still has on hand? To answer
this question, businesses use one of several inventory costing methods
approved by GAAP guidelines. All of these methods calculate a value
for inventory on hand: the specific identification costing method; the
first-in, first-out method; and the last-in, first-out method.
The Specific Identification
Costing Method
The specific identification method is an inventory cost-
ing method in which the exact cost of each item is determined and
assigned to an item. The actual cost of each item is obtained from the
invoice. This is the most accurate costing method. It is commonly
used by businesses that sell a small number of items at high prices.
These businesses include appliance stores, car dealerships, and fur-
niture stores. Because every item must be researched, this costing
method is not practical for most businesses. You will use it only if
you have few items to track and if the cost is easy to look up.
686 Unit 6 Business Finance Basics
The First-In, First-Out
Costing Method
If you cannot determine the exact cost
of every item in your inventory, you will have
to make a good estimate. One method of esti-
mating cost is the first-in, first-out method.
The first-in, first-out method (FIFO) is
an inventory costing system that assumes the
first items purchased (first in) are the first items
sold (first out). It also assumes that the items
the business purchased most recently are the
ones on hand at the end of the period.
For example, Matthew Lee owns a small
neighborhood grocery store. One of his best-
selling items is milk. Because milk is perish-
able, the employees stock the shelves first
with the milk that was purchased first. As
that milk is sold, later purchases are added
at the back of the shelves. The first in are
the first out.
Here is another example of how the
FIFO inventory method works for Lamar’s
House of Music:
HOW MANY? HOW MUCH?
Troy DVD Player—Model #875 Counting inventory and
Date Description Units Cost Total determining its value is an
important task for all busi-
Feb. 4 Beginning Inventory 9 $250 = $2,250 nesses. Why is it important to
May 12 Purchase 20 253 = 5,060 count merchandise and assign
it a value?
July 7 Purchase 10 258 = 2,580
Sept. 15 Purchase 12 263 = 3,156
Nov. 9 Purchase 10 265 = 2,650
Total 61 $15,696
After taking a physical inventory, the employees at Lamar’s House
of Music discover that there are 12 DVD players still in stock. Using
the FIFO method, they assume that the 12 remaining players are the
last ones the business purchased, because the “first in” are the “first
out.” They calculate the cost of the ending inventory as follows:
Sept. 15: 2 units @ $263 = 526
Nov. 9: 10 units @ $265 = $2,650
Cost of ending inventory = $3,176
Chapter 21 Managing Payroll and Inventory 687
The Last-In, First-Out Costing Method
Another method for calculating the value of your ending
Inventory at inventory is the last-in, first-out method. The last-in, first-out
Home method (LIFO) is a costing method that assumes the last items
1. To keep track of purchased (last in) are the first items sold (first out). It also assumes
your assets, start a that the items purchased first are still on hand at the end of the
list. period.
2. Go room by room For example, Stratford Stone Company sells loose stone to con-
and write a de- tractors. When new stone arrives, it is deposited on top of the exist-
scription of each
ing stone. As the stone is taken from the top of the pile, the first
item and note
serial numbers. stones sold are the last delivered. The physical flow of the company’s
3. Collect a receipt product, therefore, is “last-in, first-out.”
and photo for each If the employees at Lamar’s House of Music use the LIFO method
item. for calculating the cost of DVD players, they would assume that the
4. Collect personal last players purchased were sold first. The earliest players are still in
papers such as stock. This could happen if they pushed older items to the back of
birth certificates. the shelves. Using the LIFO method, they would calculate the cost of
5. Make two copies ending inventory as follows:
of your list to keep
in a safe place. Feb. 4: 9 units @ $250 = $2,250
May 12: 3 units @ $253 = $ 759
Cost of ending inventory = $3,009
Choosing a Costing Method
The cost of the ending inventory will vary, depending on which
costing method you use. Notice that the inventory at Lamar’s House
of Music is valued at $3,176 using the FIFO method but at $3,009
using the LIFO method. Similarly, the inventory would be valued
at a different amount if the store used the specific identification
method.
Put on Businesses choose the inventory costing method that seems
best for their particular type of business. Once a business chooses a
Your
method, however, it must use that method consistently. Consistent
Financial reporting helps owners and creditors compare financial reports from
Planner’s one accounting period to another.
Cap
Imagine that you have a cli- Analyzing Inventory Turnover
ent who is opening a shop Is it better to have high or low inventory turnover?
that will sell kitchen supplies,
from stoves to spoons and In order to evaluate the performance of your business, analyze
everything in between. One current inventory information and compare it to data from previous
of your tasks is to establish accounting periods.
inventory and determine One type of analysis—the inventory turnover—is the number
inventory control and re-
of times you sell your inventory in a given time period. To calculate
porting methods. Would
you suggest inventory con- the inventory turnover, divide the cost of the merchandise sold in a
trol using specific identifica- given time period by the average inventory. (The average inventory is
tion costing, FIFO, or LIFO? the value of beginning inventory plus the value of ending inventory,
divided by two.)
688 Unit 6 Business Finance Basics
GO FIGURE FINANCIAL MATH
AVERAGE INVENTORY Solution:
$65,000 $80,000
$72,500
Synopsis: You need to determine the average 2
inventory for your company in order to calculate the
The store’s average inventory for the year was
inventory turnover for a specific period of time.
$72,500.
Example: Cindy’s Fine China had an inventory val-
ued at $65,000 as of January 1, and an inventory val-
ued at $80,000 as of December 31 of the same year.
What was the store’s average inventory for the year?
YOU FIGURE
If the value of your beginning inventory was
Formula: $72,000 and the value of your ending inven-
Value of Beginning Value of Ending
tory was $100,000, what was your store’s
Inventory Inventory Average
average inventory for the year?
2 Inventory
Average Inventory After you have determined the average
inventory for a particular time period, you can calculate the inventory
turnover. To do so, divide the cost of merchandise sold during that
time period by the average inventory.
Inventory Turnover Levels A high inventory turnover means
that your business has money tied up in inventory for shorter periods
of time. As a result, your financing, storage, and insurance costs are
reduced, which benefits your business. On the other hand, a low
inventory turnover may mean that sales were lower than expected or
that too many items were in stock and remained unsold.
GO FIGURE FINANCIAL MATH
INVENTORY TURNOVER Solution:
$200,000
2.76
Synopsis: Inventory turnover is the number of $ 72,500
times you sell your inventory in a given period of
The inventory turnover for Cindy’s Fine China was
time. High inventory turnover is good.
2.76 times a year.
Example: Cindy’s Fine China sold $200,000 of
merchandise. If the store’s average inventory for
the period was $72,500, what was its inventory
turnover? YOU FIGURE
Formula: If you sold $110,000 of merchandise and your
Cost of Merchandise Sold average inventory was $80,000, what was
Inventory Turnover
Average Inventory your inventory turnover for the year?
Chapter 21 Managing Payroll and Inventory 689
GO FIGURE FINANCIAL MATH
NUMBER OF DAYS IN STOCK Solution:
365 365
Synopsis: Inventory turnover is used to determine about 132 days about 112 days
2.76 3.25
the number of days that you have merchandise in
stock. If merchandise remains in stock for an increas- Merchandise remained in stock for about 132 days
ing amount of time, you may want to rethink your in 2007 and for about 112 days in 2006.
purchasing practices.
Example: Inventory turnover for Cindy’s Fine China
was 2.76 in 2007 and 3.25 in 2006. How many days
did the merchandise remain in stock each year?
YOU FIGURE
Formula:
If you had an inventory turnover of 3.6 for one
365 Days
Number of Days in Stock year, how many days did your merchandise
Inventory
Turnover stay in stock?
Days in Stock Inventory turnover is used to determine the number
of days that merchandise is in stock. You calculate this figure by dividing
the number of days in a calendar year (365) by inventory turnover.
If you find that your merchandise remains in stock for an
increasing amount of time from one year to the next, you should
investigate the reasons and decide whether to change your purchas-
ing practices.
Stock Lists
Another tool that businesses use to plan purchases and manage
inventory is stock lists. There are three types of stock lists: the basic
stock list, model stock list, and never-out list.
Basic Stock List A basic stock list is a form that lists items a
store should always keep in stock. A basic stock list is used for staple
merchandise. For example, the basic stock list for a sporting goods
store might include tennis balls, golf balls, and basketballs. The basic
stock list includes the minimum amount of an item and the quantity
to be reordered.
Model Stock List The model stock list is used for fashion
merchandise. It is not as specific as the basic stock list. Since fashion
merchandise varies more than staple merchandise, the model stock
list is shorter, but it specifies quantities of each item.
Never-Out List The never-out list is used for the most popular
merchandise. This list changes often. Items are added to the list
as their popularity increases, and items are dropped as their sales
decrease; thus, cash flow can remain steady.
690 Unit 6 Business Finance Basics
Payroll, Inventory, After You
and Cash Flow Read
Why should a business closely monitor its cash flow? REACT
Blood flows through your body, keeping you healthy, active, and Why do payroll and inven-
alive. Without a steady flow of blood, your body would not function tory systems require more
properly, and you would eventually die. Cash has a similar effect on careful monitoring and
analysis than other aspects
a business. Cash flows through the business, giving it the financial
of a business?
resources it needs to operate in a healthy and profitable manner. A
negative cash flow might cause difficulty in a business’s daily opera-
tions. A negative cash flow means that cash is not available for paying
bills, restocking merchandise, or expanding the business. If this hap-
pens over an extended period of time, the business may close.
Payroll and inventory are two financial areas that have great
influence on your cash flow and on the life of your business. If the
inflow of cash is not sufficient to meet the demanding needs of pay-
roll and inventory, financial problems may result. Payroll expenses
must be kept to a minimum, and merchandise must be purchased
with careful analysis of present and future sales markets. Careful
recording, monitoring, and analysis of data involving payroll and mer-
chandise is essential for a positive cash flow and the ability to make
sound financial decisions. A successful business carefully monitors its
cash flow and constantly analyzes its payroll and inventory costs.
Section 21.2 Assessment
QUICK CHECK Analyze In groups of two or three,
1. What is the difference between the per- discuss possible causes for the change
petual inventory system and the periodic in Jerry’s inventory turnover. Then offer
inventory system? Jerry some suggestions. What might he
2. What are the various costing methods? do to increase his inventory turnover?
3. Why do payroll and cash flow have such
SOLVE MONEY PROBLEMS
a large influence on a business’s health?
6. Inventory Control Aurora is planning
THINK CRITICALLY to open a small art gallery in New York City,
4. Explain when and why a business should featuring artwork from new and emerging
conduct a physical count of its inventory. artists in Latin America. As she gets ready to
establish her inventory system, she realizes
USE COMMUNICATION SKILLS that she will have many decisions to make
5. Inventory Analysis Jerry’s Junkyard regarding how to track and control her
sells used parts for Japanese cars. Recently inventory.
Jerry hired you to analyze his current inven- Analyze Decide which inventory
tory information. Last year his inventory system Aurora’s art gallery should use.
turnover was 16.67. This year inventory Explain your decision. Also, which costing
turnover has dropped to 12.5. method should Aurora use? Explain why.
Chapter 21 Managing Payroll and Inventory 691
Chapter 21 Review & Activities
CHAPTER SUMMARY
• The six steps in managing a payroll • To establish an inventory control
system are: (1) calculate gross earnings; system, know the amount of
(2) calculate payroll deductions; (3) merchandise sold, what items are
prepare payroll records; (4) prepare selling, and what items are not.
paychecks; (5) record payroll information • Perpetual inventory systems are
in accounting records; and (6) report possible with bar code scanning and
payroll information to the government. point-of-sale terminals. To keep a
• Employees are paid by fixed salary, periodic inventory system up-to-date,
hourly wages, and commissions based regular physical counts are required.
on the value of goods they sell. • The specific identification method works
• Some payroll deductions are required by for businesses that sell few, high-priced
law, such as income and Social Security items. For first in, first out (FIFO) costing,
tax. Others, such as 401(k), are voluntary. the first items sold are the first bought.
• Payroll information is recorded in the For last in, first out (LIFO) costing, the
salaries expense account. Deductions first items sold are the last bought.
become liabilities and are recorded in • Inventory turnover is calculated by
separate accounts as payables. dividing the cost of merchandise sold in
a time period by the average inventory.
Communicating Key Terms
Using the terms below, write questions a store owner would ask a payroll-and-inventory service.
• payroll • Federal Insurance Contri- • periodic inventory
• gross earnings butions Act (FICA) system
• salary • Social Security tax • specific identification
• hourly wage • Medicare tax method
• overtime rate • total gross earnings • first-in, first-out method
• commission • perpetual inventory (FIFO)
• deductions system • last-in, first-out method
• point-of-sale terminals (LIFO)
Reviewing Key Concepts
1. Explain why using computers makes the steps in the payroll system easier.
2. Describe the types of jobs that get paid by salary, wages, and commission.
3. Identify some required payroll deductions.
4. Explain how the rules of debit and credit apply to employee deductions.
5. List information needed for an inventory control system.
6. Explain why the perpetual inventory system is preferable for most businesses.
7. Describe the FIFO costing method and the LIFO costing method.
8. Explain inventory turnover analysis.
692 Unit 6 Business Finance Basics
Chapter 21 Review & Activities
Art The prices of merchandise are advertised on television and in print
ads, and are even painted on store-front windows. Pricing is one of the most
important tools retailers use to promote their businesses.
Design Choose a product that you would like to advertise in a print ad.
Research the typical prices for this product and set a reduced price for a clear-
ance sale at the mall. Using markers, crayons, paint, cut-outs from magazines,
or computer graphics, create an ad displaying the product and its sale price.
Salary vs. Commission Marika is a salesperson who earns the
following amount:
Base salary: $27,000; sales commission: 6.5 percent
Monthly sales reported:
January $10,300 April $42,000
February $17,000 May $53,000
March $35,300 June $72,000
1. Calculate Marika’s gross pay in salary and commissions for January
through June.
2. Compute by using spreadsheet software to make these calculations.
Connect with Government In 2005, the United States federal
government started discussing the option of allowing younger workers to
handle the investment of part of their Social Security contributions.
1. Research Access the Internet and find the reasons different groups,
such as A.A.R.P., are for or against this proposal.
2. Think Critically What is your opinion about this issue? Explain the
reasoning behind your view.
Just-in-Time Inventory (JIT) Industries have reduced the cost of
storing and carrying inventories by requiring just-in-time inventory from
their suppliers.
Log On Use the Internet to research just-in-time inventory systems
and their requirements. Answer the following questions:
1. What industries seem to use this system the most?
2. How does a business’s relationship with suppliers change under this
system?
Newsclip: More Demand There is demand when companies bolster
their assembly lines and inventories, which eventually creates more supply.
O N L I N E
Log On Go to finance07.glencoe.com and open Chapter 21.
Learn more about how companies stock up their inventories. Think
about a product that is in high demand. Write it down and compare your
response with your classmates’ responses.
finance07.glencoe.com Chapter 21 Managing Payroll and Inventory 693
Chapter 21 Review & Activities
STOCKING UP ON KNOWLEDGE
Whether you plan to work for a company or imagine running your
own business some day, here is a chance to test yourself on some
business basics. Write your answers on a separate sheet of paper. After
you finish studying the chapter, take the quiz again to see how much
you have learned.
1. After federal, state, and local taxes are subtracted from a paycheck, the amount of money
left is called __________ .
a. gross pay c. salary
b. net pay d. wages
2. The various amounts of money that are subtracted from an employee’s paycheck are
called __________ .
a. taxable incomes c. withholdings
b. co-payments d. deductions
3. The agency that collects federal taxes and oversees the federal income tax system is
called the __________ .
a. Social Security Administration c. Big Brother
b. Internal Revenue Service d. U.S. Treasury
4. A fixed amount of money that is paid to an employee for each pay period is
called __________ .
a. wage c. commission
b. salary d. allowance
5. The system of physically counting merchandise on hand is called __________ .
a. spot-checking inventory system c. point-of-sale inventory system
b. unit control system d. periodic inventory system
6. The number of times a business sells its inventory in a given period of time is
called __________ .
a. margin c. unit control
b. markup d. inventory turnover
694 Unit 6 Business Finance Basics
Chapter 21 Review & Activities
Your Financial Portfolio
Keeping Track of Inventory
Janine is helping to count inventory at her mother’s jewelry store, The Silver Parrot. She
thas been working on birthstone pendants. After she counted them, she looked up how
many were on order. Then she filled in the number to order, based on the guideline of
always keeping at least five pendants in stock.
Description Number in Stock Number on Order Number to Order
January 2 3 0
February 5 0 0
March 0 3 2
April 0 3 2
May 1 3 1
June 4 3 0
July 3 3 0
August 3 0 2
September 2 0 3
October 4 0 1
November 2 3 0
December 1 3 1
Calculate
Before the new products were ordered, Janine’s mother decided to change the
guideline to “always keep 15 of each pendant in stock,” rather than five. On a separate
sheet of paper, calculate how many additional birthstone pendants Janine should order
for the store.
Chapter 21 Managing Payroll and Inventory 695
22
CHAPTER
Pricing, Costing,
and Growth
$ What You’ll Learn
W hen you have completed this
chapter, you will be able to:
Section 22.1
• Explain how to calculate selling
price.
• Identify variable and fixed costs.
• Discuss effective pricing.
Section 22.2
• Describe different forms of
business growth.
• Discuss profit planning.
• Explain how to calculate target
sales and margin of safety.
• Explain the importance of
planning for growth.
Reading Strategies
To get the most out of your reading:
Predict what you will learn in this chapter.
Relate what you read to your own life.
Question what you are reading to be sure
you understand.
React to what you have read.
696
In the Real World . . .
J anet Manzetti enjoys collecting unique pottery and dishware
and selling them at local fairs. The pieces are very popular, so she ap-
proached a local store about selling them. The store’s buyer was impressed by
the craftsmanship and offered to buy them for resale. Janet hesitated because her
costs of finding and paying for the goods are about what the store’s buyer wanted
to pay. However, she then thought about it and decided to improve the boxed
packaging. With fancy presentation, she could charge a higher wholesale price.
The store’s buyer agreed to pay more for the pottery, and Janet expanded her
business. The right pricing and costing allow Janet to make a profit.
As You Read Consider ways that any business owner
can use pricing to encourage sales.
Selling Price
ASK Q: I started making scarves and hats for my
friends for fun, but demand for them has become
so high that I am thinking of selling them. How much do I charge?
A: Your selling prices should be close to what your competitors charge. Make sure
that your business will be profitable at those prices. For many businesses, profit
margins are only in the 10 to 15 percent range. For each $1 in sales, the business
keeps ten cents—making accurate pricing essential.
Ask Yourself How do you find out what competitors charge?
Go to finance07.glencoe.com to complete the Standard & Poor’s Financial
Focus activity.
finance07.glencoe.com Chapter 22 Pricing, Costing, and Growth 697
Section 22.1
Focus on
Reading
Merchandise Pricing
and Costing
Read to Learn
• How to calculate selling
price. Pricing
• How to identify variable Why is pricing important to a business?
and fixed costs.
Pricing is the process of assigning a selling price to a good or
• How to discuss effective
pricing. service. Price is usually expressed in monetary terms, such as $60 for a
pair of shoes. It can also be expressed in non-monetary terms, such as
Main Idea free goods or services in exchange for the purchase of a product. The
Effective pricing and cost- oldest form of pricing is the barter system, which involves exchang-
ing are essential factors ing a good or service for another good or service without the use of
for a business’s financial money. For a merchandise business, you must price goods and services
success. appropriately for your business to succeed. If you set monetary prices
too high, customers may buy from your competition—or not buy at
Key Terms all. If you set prices too low, you may not be able to cover your costs
• pricing and operating expenses.
• product cost-plus pricing
• markup
• manufacturing business Goals of Pricing
• product costing
• cost behavior Many factors influence the prices of goods and services. Pricing
• variable costs decisions must take into account costs, competition, and economic
• direct materials conditions. To make sound pricing decisions, a business owner must
• direct labor consider the goals of pricing.
• fixed costs
Every business owner wants to set effective prices that yield large
• contribution margin
• break-even point profits. Most businesses have three goals that act as guidelines for
effective pricing:
• To obtain a given share of the market
• To generate sales that produce a specific profit
Before
• To meet competitors’ prices
You Read
In establishing prices, a business may have to prioritize these
PREDICT
three goals. For example, suppose that a primary goal of your new
What factors do you think outdoor sportswear business is to match your competitors’ prices. You
a retailer should consider must remember that if you set your prices too low, you may not gener-
when setting prices for
ate enough profit for your business to succeed. Suppose that the pri-
merchandise?
mary goal of your business is to increase profits. You can achieve your
objective by selling more items at the current price or by selling the
same number of items at a higher price. However, if you raise prices to
increase profits, you may no longer meet competitors’ prices. You must
decide which pricing goals are most important to your business.
698 Unit 6 Business Finance Basics
Merchandise Pricing
How do retail businesses price merchandise they sell?
All the financial procedures you have learned so far have involved
merchandising businesses. A merchandising business buys goods,
marks them up, and sells them to customers, such as retail stores.
Establishing selling prices in this type of business is relatively simple.
Retail Pricing Methods
A retail business sells goods or services to the final user, the con-
sumer. One pricing method commonly used by retail businesses is
product cost-plus pricing. Product cost-plus pricing is the pro-
cess of determining an item’s selling price by adding the invoice cost
of the item (how much the business paid for the item) to a certain
percentage of that cost. This added amount is the markup, which
is the difference between the cost of an item to a business and the
selling price of the item. This markup amount must cover all of the
business’s expenses and allow for a profit.
For example, Luggage World is a retail store that sells a wide vari-
ety of travel bags and suitcases. As merchandise is received, the store
manager prices all bags with a 70 percent markup. Suppose that the
Presidential Bag has an invoice cost of $48. The manager calculates
the selling price as follows:
Purchase cost $48.00
Plus markup ⫹ 33.60 ($48.00 ⫻ .70 or 70%)
Selling price $81.60
䊴 ANNOUNCING PRICES
Newspaper and magazine
advertisements are sources
for information on what
competitors are charging
for goods. Do you think
a business should always
match competitors’ selling
prices? Why?
Chapter 22 Pricing, Costing, and Growth 699
As You Adjusting Prices
Read If you cannot sell an item or a line of merchandise with a partic-
RELATE ular markup, you may have to lower the selling price or discontinue
stocking the item. The decision to mark up items by a certain percent-
Think about sales where age will depend on factors such as economic conditions, competi-
you have “gotten a bar- tion, or the season of the year.
gain.” What do you think
Suppose that you purchase sweatshirts for your outdoor sports-
the retailer reduces to
come up with a sale price? wear shop at $12 per shirt and price each one with a markup of 60
percent ($12 ⫻ .60 or 60% ⫽ $7.20). The retail price of each sweat-
shirt is $19.20 ($12 ⫹ $7.20 ⫽ $19.20). However, if your competitors
are selling the same sweatshirts for $17.99 each, you will probably
have difficulty selling your sweatshirts with a 60 percent markup. If
you lower your price to be competitive, you may not earn enough
profit to cover your expenses. If you cannot purchase the same sweat-
shirts from another supplier at a lower cost, you may have to sell a
different line of sweatshirts.
The percentage of markup will vary depending on the line of
merchandise you are selling. Stores (such as jewelry stores) that sell
very few items in a day have higher markup percentages than stores
(such as music stores) that sell many items in a day. Regardless of the
product, the markup must cover expenses and generate a profit for
the business.
䊱 EXPENSIVE ITEMS A jewelry store may have only a few potential cus-
tomers each day and will sell merchandise to only a small percentage of
them. Why does a jewelry store have to set high prices on its merchandise?
700 Unit 6 Business Finance Basics
Costing and Pricing in a
Manufacturing Business
How does costing affect pricing for
manufacturing businesses?
Not all businesses simply purchase items, mark them up,
and resell them to customers. Some businesses produce new mer-
chandise. These businesses are called manufacturing businesses. A
manufacturing business is a business that buys raw materials or
processed goods and transforms them into finished products.
For example, if Tonya decides to sell hand-decorated hand-
bags to her friends, her business will be a manufacturing business.
She purchased a plain bag and decorated it, using paints, buttons,
and sewing materials to create a desirable new item. Tonya will
have to consider the cost of the materials and labor that go into
the production of her first bag before she can determine an appro-
priate price for similar bags. Determining costs and pricing in a
manufacturing business is more complicated than it is in a retail
business.
Careers in Finance
CREDIT ANALYST
CHIEF FINANCIAL Alberto Saenz
OFFICER Cycle Gear
Alberto loves to make short-term goals that help achieve long-term ones. As the chief financial
officer (CFO) for a chain of motorcycle parts, accessories, and clothing retailers, Alberto is expected
to direct the company’s overall financial policies, procedures, and reporting that are required to con-
tinue a 30 percent per year growth rate with increasing profitability. He manages all financial func-
tions, including accounting, budgeting, cash flow, bank relationships, risk, inventory management,
and taxes. Besides knowledge of accounting, CFOs need to know federal and state laws and regula-
tions as well as international trade.
SKILLS: Accounting, analytical, communication, computer, decision making, math,
problem solving, and long-range planning skills
PERSONAL TRAITS: Able to see the big picture, able to cope with stress, flexible, good judgment,
independent, likes working with people and numbers, and tactful
EDUCATION: High school diploma or equivalent; bachelor’s degree or master’s degree in
accounting, economics, finance, or business administration; Certified Public
Accountant certification
ANALYZE Why would a CFO need to understand pricing principles?
To learn more about career paths for chief financial officers, visit
finance07.glencoe.com.
finance07.glencoe.com Chapter 22 Pricing, Costing, and Growth 701
Product Costing
Product costing is the process of analyzing all costs involved
in creating products. By product costing, you can establish a selling
price that is both competitive and profitable for your business.
Product costing will help Tonya decide whether she can sell hand-
decorated bags for a reasonable price. Her costs for the first bag might
be low. Thus, she could make and sell similar bags at a profit. However,
making the first bag could be expensive. To cover costs, she would have
to set a high price. The price may be so high that no one would buy the
bags. Thus, Tonya could decide that the bags are not worth making.
Global Financial Landscape
Standard and Poor’s publishes the globally recognized
S&P 500® financial index. It also gathers financial statis-
(ANOI
tics, information, and news, and analyzes this data for
international businesses, governments, and individuals
to help them guide their financial decisions.
VIETNAM
The Vietnamese have a saying: “Close the past,
open the future.” When American troops pulled out of
Vietnam at war’s end in 1975, they were the enemy.
Today they are welcomed as friends. The Vietnamese DATABYTES
have opened up former war-related sites as part of The
Vets’ Tour, adding one more market to their soaring Capital Hanoi
economy. In the last decade, the country’s economy Population 80,786,000
has grown 7.4 percent a year. Two of the most famous
Languages Vietnamese, English, French, Chinese,
exhibits include the “Hanoi Hilton,” a war prison, and
Khmer, and local languages
the Cu Chi tunnels. This underground, 75-mile-long
maze hid thousands of guerilla soldiers. Now widened Currency dong
to accommodate tourists, the tunnels display mess Gross Domestic
halls, meeting rooms, Product (GDP) $203.9 billion (2003 est.)
and a small cinema. GDP per capita $2,500
Tourism is a growth Industry: Food processing, garments, shoes, and
industry in Vietnam. machine manufacturing
Many hotels have been Agriculture: Paddy rice, corn, potatoes, rubber, poultry,
rated at three to four and fish
stars, and investors such
Exports: Oil, marine products, rice, coffee, and rubber
as Disney are develop-
ing resorts. Focusing on Natural Resources: Phosphates, coal, manganese,
cultural, ecological, and bauxite, and chromate
business tourism, Viet-
nam may attract 7.5 mil- Think Globally
lion visitors by 2010. How might pricing and costing affect Vietnam’s tourist
industry?
702 Unit 6 Business Finance Basics
䊴 THEY’RE HOT! Items
that are in great demand,
such as barbecues during
warm weather, rarely go
on sale during the summer
months. What might be the
reason for this?
Classifying Costs
What are the different types of costs to consider?
Whether you are the manager of a large business, such as Gen-
eral Electric, or a small business, such as a local bakery, you need com-
plete information about costs to make smart financial decisions. You
must identify your costs and determine what costs will increase, and
what costs will remain the same.
Cost behavior is the way a cost changes in relation to a change
in business activity. For example, as your business makes more items, Common
some costs may increase, such as the costs of additional materials
or labor. Other costs remain constant and are not influenced by the CENTS
number of items you produce or the volume of sales. These costs
could include rent, taxes, and insurance. In analyzing cost behavior, Business Expenses
When planning for
you will usually classify costs as variable or fixed.
expenses that will affect
the prices of the products
Variable Costs you sell, consider your
operating expenses. The
In product costing, variable costs are costs that change in top ten small business
direct proportion to the activity level of production. This means expenses include: health
that if production increases, these costs will increase. If production insurance, DSL or dial-up
Internet fees, cell phone
decreases, your variable costs will decrease.
fees, utilities, advertising,
To understand cost behavior, consider the example of Windy accounting services, voice
River Creations. Wayne and Naomi are Native Americans who want mail, financial planning
to start a small business producing handmade Native American jew- services, and collection
elry. They intend to buy metal bands, beads, leather, and other mate- services. Choose a small
rials and make items to sell to area stores. They have rented a small business that you would like
to own. If you were looking
shop, purchased a few pieces of equipment, bought materials and
for ways to cut back on your
supplies, and hired two local artists to make the jewelry. business expenses, what
Windy River has identified three variable costs. These are areas would you target
(1) direct materials used to make the jewelry, (2) direct labor to create and why?
the jewelry, and (3) supplies used in processing the jewelry.
Chapter 22 Pricing, Costing, and Growth 703
Direct Variable Costs Direct materials are the raw materials
used to make a finished product. For Windy River’s jewelry, these
materials include metal, beads, leather, pins, packaging, and other
items. Wayne and Naomi plan to produce five pieces of jewelry, one of
which is the Sunset Bracelet. The direct materials needed to produce
MATH
each bracelet cost $4.30.
Imagine you have a retail
Direct labor is the work required to convert raw materials into
business selling widgets,
doodads, and thingama- a finished product. To determine the cost of direct labor, multiply
bobs. You want to deter- the amount of time spent to produce the item by the employee’s
mine the selling price for hourly wage. Wayne and Naomi are paying their employees $12 per
each. You have costs, such hour. It takes approximately 15 minutes (0.25 hours) to make the
as rent and labor plus the Sunset Bracelet. Therefore, the cost of direct labor per bracelet is
items’ wholesale costs.
$3 (0.25 ⫻ $12 ⫽ $3).
Figure the markup at 70%
and the price for each item: Wayne and Naomi now know that the cost of materials and
labor needed to make the bracelet is $7.30 ($4.30 direct materials
Item Costs
plus $3 direct labor). They must also take into account the cost of the
Widgets $1.32 supplies that will be consumed in the production process. This cost
Doodads $4.80 could include polish, wire, solder, glue, and finishing spray. Wayne
Thingamabobs $8.74 and Naomi estimate that the cost of the supplies for one bracelet is
$0.35. This brings the total variable cost per bracelet to $7.65, illus-
trated as follows:
Direct materials $4.30
Direct labor 3.00
Supplies 0.35
Total variable cost $7.65
As more units are made, the variable cost assigned to each unit
remains the same, but the total variable cost for the business increases.
When fewer units are made, total variable costs decrease. The table
below shows how the total variable cost for Windy River increases or
decreases depending on the number of Sunset Bracelets made.
Unit Total
Variable Cost Variable Cost
7 Bracelets $7.65 ⫻ 7 ⫽ $53.55
10 Bracelets $7.65 ⫻ 10 ⫽ $76.50
18 Bracelets $7.65 ⫻ 18 ⫽ $137.70
Fixed Costs
Rent, insurance, taxes, salaries, and some utilities are examples
of fixed costs. Fixed costs are costs that remain constant even if
activity or production level changes. The total fixed cost remains the
same regardless of the number of units produced.
For example, Wayne and Naomi pay $700 per month to rent the
shop that Windy River occupies. Regardless of the number of brace-
lets produced in a month, the fixed cost of rent will remain at $700.
Remember, the selling price of the bracelets must exceed all fixed costs
plus all variable costs in order for Windy River to make a profit.
704 Unit 6 Business Finance Basics
䊴 LABOR INTENSE Many
manufacturing companies
use robots to assemble prod-
ucts. What are some advan-
tages of using robots instead of
human beings?
Selling Price
How do businesses determine the selling price for goods?
Wayne and Naomi plan to mark up the variable costs by approxi-
mately 70 percent in order to cover the fixed costs and show a profit.
The total monthly fixed costs for the business are $1,400. Windy River is
selling five types of jewelry, so each type must cover one-fifth, or 20 per-
cent, of the fixed costs per month. Therefore, each type of jewelry must
cover $280 in fixed costs per month ($1,400 ⫻ .20 or 20% ⫽ $280).
If the variable costs total $7.65 for each bracelet and a 70 percent
markup is added, the selling price of the bracelet will be $13 ($7.65 ⫹
[$7.65 ⫻ .70 or 70%] ⫽ $13). Wayne and Naomi must determine whether
this markup is sufficient. To do so, they will have to figure out how
many bracelets they must sell to cover both fixed and variable costs.
The Contribution Margin
What is the contribution margin?
The contribution margin is the amount of money that the
Franchise Ownership
sale of a particular product contributes toward the payment of fixed
What skills and abilities
costs and the profit of a business. The contribution margin equals make a business leader
total sales minus total variable costs. For example, if a product has effective? Learn more
sales of $13,000 and has variable costs totaling $7,000, it has a contri- about leadership and
bution margin of $6,000. This is the product’s contribution to cover imagine yourself as a
the fixed expenses and provide a profit. great business leader.
Sales $13,000 To continue with
Task 5 of your
Minus variable costs ⫺ 7,000
WebQuest project, visit
Contribution margin $ 6,000 (Amount available finance07.glencoe.com.
for fixed expenses)
finance07.glencoe.com Chapter 22 Pricing, Costing, and Growth 705
Learn to identify and understand the standard
financial documents you will use in the real world.
Investigate: A Break-Even Analysis Your Motive: If you manage or own
A break-even analysis contains the a retail store, you need to analyze your
following information: merchandise pricing, costs, and sales to
• Names of the products analyzed determine when you are making a profit.
• Unit pricing and fixed and variable The Break-Even Analysis Worksheet can
expenses help you determine profitability.
• Calculation for number items that must
be sold to break even
"REAK %VEN !NALYSIS 7ORKSHEET
3TORE 3ALLIES !CCESSORIES
,OCATION &ASHION 7AY
3KOKIE )LLINOIS
0RODUCT ,INE *EWELRY
0ERIOD 3IX MONTHS BEGINNING *UNE
)TEM 5NIT 0RICE 0 6ARIABLE #OSTS &IXED #OSTS & 5NITS TO
PER 5NIT 6 "REAKEVEN N
0N 6N &
7ATCHES
.ECKLACES
2INGS
"RACELETS
%ARRINGS
Key Points: Fixed costs can include Find the Solutions
such expenses as rent, utilities, insurance, 1. What are the total fixed costs assigned to
advertising, and administrative expenses. the jewelry department for the six-month
period?
2. What is the break-even point for necklaces?
3. Which item has the highest markup?
4. What would happen to the break-even point
if Sallie raised the price of the bracelets?
5. How much does a ring cost at Sallie’s?
706 Unit 6 Business Finance Basics
The Break-Even Point
Why do businesses that sell products want to know
the break-even point?
TechByte
Pricing Science When
The break-even point is the point at which total sales equal setting the price for a
total costs (variable and fixed costs). The break-even point represents product, some businesses
use product cost-plus
the sales that a business must achieve to break even, or cover all costs.
pricing; some consider
At the break-even point, there is neither a profit nor a loss. how the competition is
Calculating the break-even point helps a business owner predict priced; and some look
how changes in costs and sales will affect the profit earned by the at the break-even point.
business. The break-even analysis can also determine how many units A variety of e-newslet-
of a product must be made and sold to cover expenses. ters provide information
covering case studies,
For example, suppose that you wanted to calculate how many
marketing trends, and
units of the Sunset Bracelet that Wayne and Naomi would have to the latest product news
sell to break even, or cover all costs. Represent the number of units on pricing strategy. This
needed to break even by a variable such as n. On the left side of the research can help busi-
equation, multiply unit sales price by n. On the right side of the equa- nesses determine the
tion, multiply the unit variable costs by n, then add the total fixed best price for a product.
costs. Solve for n. Learn more about
Break-even sales are the sales, expressed as a dollar amount that pricing science
a business must make to cover all costs. Break-even sales for the Sun- and research and list
set Bracelet are $689 (53 bracelets ⫻ $13 ⫽ $689) per month. The fol- resources through
finance07.glencoe.com.
lowing calculations show the accuracy of the math.
GO FIGURE FINANCIAL MATH
BREAK-EVEN POINT Solution:
$13.00n ⫽ $7.65n ⫹ $280.00
Synopsis: By calculating the unit variable cost of
$13.00n ⫺ $7.65n ⫽ $280.00
products to sell with the monthly fixed costs, a busi-
$5.35n ⫽ $280.00
ness can figure out how many units of a product
n ⫽ $280.00 ⫼ $5.35
must sell to break even.
n ⫽ 52.3 or 53 bracelets
Example: Windy River sells each Sunset Bracelet
To break even, Windy River must sell 53 Sunset
for $13. The unit variable cost for the bracelet is
Bracelets each month.
$7.65. The amount of monthly fixed costs that sales
of the Sunset Bracelet are expected to contribute is
$280. How many units of the Sunset Bracelet must YOU FIGURE
Windy River sell to break even? Your sister is selling custom printed T-shirts at
Formula: the beach on weekends. Fixed costs from sales
Break-Even Sales ⫽ Variable Costs + Total Fixed Costs total $345. How many bracelets should she sell
Unit Sales Price ⫻ n ⫽ (Unit Variable Costs ⫻ n) to break even if each T-shirt sells for $20 and the
⫹ Fixed Costs unit variable cost is $11.50 each?
finance07.glencoe.com Chapter 22 Pricing, Costing, and Growth 707
Total Unit
As You
Read Sales (53 ⫻ $13) $689.00 $13.00
Less variable costs (53 ⫻ $7.65) ⫺ $405.45 ⫺ $7.65
QUESTION Contribution margin $283.55 $ 5.35
Define, in your own words, Less fixed costs ⫺ $280.00
fixed costs, variable costs, Net income $ 3.55
and break-even point.
Fortunately for Wayne and Naomi, Windy River has been aver-
aging sales of 70–80 bracelets per month for the past few months,
exceeding their break-even point. At the present rate of sales, the
bracelet’s contribution margin is covering its share of fixed costs and
is contributing to a net income for the business.
By substituting different numbers in the break-even equation,
Wayne and Naomi can analyze how changes in sales price, costs, and
sales volume affect profit. What if only 45 bracelets are sold? What if
the variable costs increase by $2? How much profit is reported if 75
bracelets are sold? Such questions are an important part of financial
analysis. If you are a business owner, you must anticipate changes in
the market and be prepared with alternative plans if the changes actu-
ally occur. Using the techniques to analyze all financial possibilities
and being prepared for change can help keep a business growing.
Section 22.1 Assessment
QUICK CHECK Calculate Help Dani figure out
1. What are the basic goals that businesses use how many mirrors she has to sell to
for setting prices? break even. Dani estimates that her vari-
2. What is the difference between variable able costs are $25 per mirror and her fixed
costs and fixed costs in product costing? costs are $1,000.
3. What is the purpose of calculating the
SOLVE MONEY PROBLEMS
break-even point?
6. Establishing Retail Prices Cookie
THINK CRITICALLY Cutters is a retail store that sells a variety
4. Describe what might happen if a retail of kitchen gadgets and gifts. Today is your
business sold its products to consumers for first day on the job there, and you have
the same price it paid for them. been asked to price the food processors that
have just arrived. The manager has told
USE MATH SKILLS you that all products have a 65 percent
5. Break-Even Point Dani sells mirrors markup. The invoice price of one food pro-
at weekend craft shows for $75 each. She cessor is $72.
makes the mirror frames out of colored Calculate Figure out the selling
pieces of glass and ceramic tile. The mirrors price of each food processor.
are very popular, and Dani has more orders
than she can fill.
708 Unit 6 Business Finance Basics
Section 22.2
Planning for Growth Focus on
Reading
Sources of Business Growth Read to Learn
What are the different sources of business growth?
• How to describe differ-
The key to all successful business operations is growth. Businesses, ent forms of business
whether they are small sole proprietorships or large corporations, are growth.
much like people. They must grow and mature to achieve success. A • How to discuss profit
planning.
business that does not grow can end up far behind its competition.
Business growth can come from many sources and can be mea- • How to calculate
target sales and
sured in many ways. It may develop from an increase in the number
margin of safety.
of customers, sales, share of the market, employees, lines of merchan-
• How to explain the
dise, and (of course) profit. These are important aspects of growth for importance of planning
any business as well as indicators of success. However, growth should for growth.
be carefully planned and directed. Sound financial planning is essen-
tial for making decisions regarding expansion. Main Idea
Not every aspect of your business needs to grow every year. For a To be successful, a business
business, bigger does not necessarily mean better. If a business grows too needs to make a profit but
rapidly or in the wrong area, serious financial problems may result. also must grow.
Planning growth to correspond with the business’s short-term
and long-term goals is essential to financial success. If you have a Key Terms
business, short-term goals for the business reflect the areas to con- • target profit
centrate efforts. One year you may place an emphasis on increasing • target sales
• margin of safety
the number of customers; the following year, you may explore new
lines of merchandise. As one of your target areas grows, others may
also increase and grow. For example, if you concentrate on increasing
your number of customers this year, your sales and profits should also
report increases. Primary growth in one area often leads to secondary
Before
growth in other areas.
You Read
PREDICT
Customers In what ways do you think
Adding new customers usually causes a rise in sales. More sales businesses can grow?
usually result in greater profits. Increasing the number of customers is
always a primary goal in business. Acquiring new customers is often a
result of two factors: effective advertising and promotions and refer-
rals by satisfied customers. Potential customers must know where the
business is located, and they must believe that buying goods and ser-
vices from your business will be a positive experience. Although you
may have control over your advertising and marketing programs, you
have little or no control over customer referrals. Satisfying your cus-
tomers’ needs is the key to building a solid customer base.
Chapter 22 Pricing, Costing, and Growth 709
Sales
Growth in sales is also a source of business growth. When sales
Avoiding Fees increase, however, you must be capable of handling the larger vol-
1. Shop around for ume so that you continue to satisfy your customers. If sales grow too
business checking quickly, and you do not have enough employees, the quality of your
accounts with low customer service may suffer seriously. In addition, you must be sure
or no fees. that you have sufficient merchandise to offer.
2. Pay your credit
card and other
bills in full each Market Share
month on time.
A measurement of growth is the business’s share of the exist-
3. Use a free Internet
ing market. If your business held approximately 15 percent of the
service.
potential market last year, and this year your market share has risen
4. Ask your telephone
company for the
to 19 percent, you have achieved positive growth. This is evidence
best small business that your business is staying competitive, probably through effective
deal. advertising and promotions.
5. Return all equip-
ment rentals on Market Development
time to avoid late
fees. A business can grow and expand its products to reach new loca-
tions locally, nationally, or even internationally. Franchising is one way
to grow. Franchisers sell the right to operate a business under the com-
pany’s name. In exchange for a fee, you the franchiser provide training,
hiring, and other assistance such as manuals and market analyses.
Employees
As your market share grows and your sales increase, you must
maintain an appropriate number of employees to contribute to
growth. The need to hire more employees to accommodate your cus-
tomers is a sign of positive growth. However, the additional employ-
ees should be utilized in the proper manner. Payroll is a major expense
of your business.
As You
Read Product Development
RELATE When expanding with a new line of merchandise, carefully
Can you think of a com- analyze the potential market and estimate the profits to be made.
pany that began offering Expanding for the sake of expansion is not always a source of posi-
more types of products tive growth. The new line should assure a new sales market and good
than it had in the past? profits. Unfortunately, many small businesses experience financial
success only to expand to new areas that prove unprofitable.
Profits
One of the key indicators of the success of your business is the
rate of growth of your profits. Making a profit is crucial to your busi-
ness. Profits must grow for your business to survive. However, plan-
ning for increased profits is often easier said than done. Businesses
may approach profit in several ways.
710 Unit 6 Business Finance Basics
䊴 HOW MANY CAN YOU
SELL? Stores are always
faced with the problem
of realistically predicting
how many items can be
sold. What problem could
result from stocking too many
soccer balls?
Profit Planning
How can a business plan to make profits?
Business managers frequently evaluate cost and profit data to
determine how to maximize profits. They use break-even analysis
to test possible changes and to determine how those changes might
affect future profits. Using the results of their analysis, managers fore-
cast sales and plan financial activities for their business.
Setting a Target Profit
An important part of the planning process is setting goals. One
common goal is to increase the amount of net income, or profit.
Target profit is the amount of net income that a business sets as a
goal. For example, you may want to expand to a new line of merchan-
dise or possibly open another outlet or store. In order to fulfill these
objectives, you will need to generate a given amount of profit.
Suppose that Wayne and Naomi want to earn a profit of $500 As You
per month over the next six months on sales of the Sunset Bracelet. Read
Assuming that the selling price and costs remain constant, how many QUESTION
bracelets would they need to sell to achieve this target profit?
Target sales is the number of units a business needs to sell to What is the difference
reach a target profit. The target sales equation is as follows: between target profit and
target sales?
Target Sales ⫽ Variable Costs ⫹ Fixed Costs ⫹ Target Profit
Chapter 22 Pricing, Costing, and Growth 711
GO FIGURE FINANCIAL MATH
TARGET SALES Solution:
$13.00n ⫽ $7.65n ⫹ $280.00 ⫹ $500.00
Synopsis: Calculating how much product a busi-
$13.00n – $7.65n ⫹ $280.00 ⫹ $500.00
ness must sell to reach a profit is essential for success.
$5.35n ⫽ $780.00
Example: Windy River sells each Sunset Bracelet n ⫽ $780.00 ⫼ $5.35
for $13. The unit variable cost for the bracelet is n ⫽ 145.7, or 146 bracelets
$7.65. The amount of monthly fixed costs that sales
Windy River would have to sell 146 Sunset Bracelets
of the Sunset Bracelet are expected to contribute
to achieve its target profit.
is $280. The target profit is $500 per month. How
many units of the Sunset Bracelet must Windy River
sell to reach its target profit? YOU FIGURE
Formula: You are selling smoothies at school-sponsored
Target Sales ⫽ Variable Costs ⫹ Fixed Costs ⫹ sporting events. You price them at $3.50 each.
Target Profit The unit variable cost is $1.25 each. Your
Unit Sales Price ⫻ n ⫽ (Unit Variable Costs ⫻ n) ⫹ monthly fixed costs by sales should be $150.
Fixed Costs ⫹ Target Profit The target profit is $400 a month. How many
smoothies should you sell?
Using the target sales equation, you can calculate how many
units a business must sell to reach its target profit. Represent the num-
ber of units needed to achieve the target profit by a variable such as n.
On the left side of the equation, multiply the unit sales price by n. On
the right side of the equation, multiply the unit variable costs by n.
Then add fixed costs and the required profit. Solve for n.
Windy River has been selling about 70 to 80 bracelets per month,
and sales have risen approximately 10 percent per month. By increas-
ing current sales by approximately 10 percent a month for the next six
months, Windy River will sell about 124 Sunset Bracelets per month
by the sixth month. Assuming current sales are 70 per month, pro-
jected sales would be as follows:*
Month 1 77
2 85
3 94
4 103
5 113
6 124
(*Assumes 10 percent increase in current sales per month.)
Windy River would have to sell 146 bracelets per month to reach
its target profit of $500. Wayne and Naomi decide that this is an
unrealistic expectation. They conclude that a target profit of $400 is
more realistic. Using the target sales calculation, they determine that
they must sell 128 bracelets each month to achieve the goal of $400
profit per month.
712 Unit 6 Business Finance Basics
Margin of Safety Put on
When you are analyzing target sales and profits, you should con- Your
sider what will happen if you do not reach your target. Your margin of Financial
safety will indicate the amount that sales can drop before the business
Planner’s
experiences a loss. The margin of safety is the target sales minus
the break-even sales, which indicates the amount of risk that sales will Cap
meet the break-even point. A high margin of safety suggests a minimal Imagine you are operating
risk that sales will fall below the break-even point. Wayne and Naomi an athletic shoe store for
calculate the margin of safety for the Sunset Bracelet as follows: teens. You plan to expand
your merchandise lines. You
Target sales $1,664.00 128 bracelets can (a) sell shoes to other age
(to achieve a profit of $400) groups, or b) sell other items
Less break-even sales ⫺ 689.00 ⫺ 53 bracelets to the teen market. Which
expansion plan will you fol-
Margin of safety $975.00 75 bracelets
low and why?
The margin of safety is $975, or 75 bracelets. This means that
sales can drop by this amount below target sales before the business
experiences a loss on this item. For Windy River, this target sales
amount is a fairly safe venture.
䊲 SHORT DEMAND Items such as seasonal clothes and CDs have a
short selling period. Tastes in music and clothes change, and new items
come out every day. Can you name any other products that have a very
short selling period?
Chapter 22 Pricing, Costing, and Growth 713
䊱 CONTROLLED EXPANSION Expanding a small business such as a
restaurant or boutique is good, but you should not expand too rapidly.
Can you name a business in your area that expanded but then had financial
problems?
The Challenges of Growth
What are the factors that might affect a business’s
ability to grow?
If your business is successful, it will probably grow. If you have
planned effectively for growth, you will also experience growth. How-
ever, you should consider whether your business is ready or suited for
growth. Several factors affect the ability of a business to grow:
• Market characteristics—If your niche market is too small,
your business may be unable to grow. To develop further, the
business must expand outside into new market areas.
• Multiple sites—With more than one location, you must
decide where your main operations will be located. You will
also need to staff your other locations.
• Delegation—Many small business owners are successful at
starting their own businesses. However, they may not have
the skills to manage others to do expanded tasks. You might
consider hiring someone as a manager.
• Industry innovation—If your industry’s growth is
dependent upon innovation or constantly changing ideas and
products, you will have to move ahead faster than the trends.
• Systems and controls—Effective systems and controls need
to be in place for management, marketing, finances, and record
keeping.
714 Unit 6 Business Finance Basics
Planning and Growth After You
Why is planning so important? Read
As you project your business’s financial prospects, you must ana- REACT
lyze carefully where you will spend your profits. Growth is important,
How can profits be used?
but only if it is carefully analyzed, planned, and controlled. Good
planning will usually result in successful growth; poor planning could
drive you out of business.
The following guidelines will not guarantee successful decisions,
but ignoring them could result in business failure:
• Make sound financial decisions when setting short-term and
long-term goals.
• Set realistic financial targets.
• Control expenses and costs.
• Analyze financial statements frequently.
• Analyze your competition.
• Evaluate current economic conditions.
• Maintain a reserve fund.
You may always have limited funds to invest for business growth.
However, careful planning and financial analysis should provide you
with the knowledge you will need for intelligent investment deci-
sions and well-planned, controlled growth of your business.
Section 22.2 Assessment
QUICK CHECK Write About It You write an
1. What are the common forms of business advice column for small business
growth? owners. What guidance might you give
2. How is the target sales figure calculated? Lil regarding the goals she has set for The
3. How is margin of safety calculated? Rug Rack?
THINK CRITICALLY SOLVE MONEY PROBLEMS
4. Explain why business growth just for the 6. Achieve Target Profit You have been
sake of growth is not wise. hired by Windy River Creations as a business
consultant. After analyzing the market for
USE COMMUNICATION SKILLS the company’s products, you determine it is
5. Business Growth Lil owns an indepen- possible to earn a profit of $600 per month
dent rug store in a small town. The Rug within the next six months on the Sunset
Rack has been open for about a year, and Bracelet. Assume that the bracelet will con-
business has been very good. Currently she tinue to sell for $13 and that the costs will
sells new and antique rugs as well as home remain constant.
decorating magazines. Lil thinks that it is Calculate Figure out how many
time to add a new line of merchandise and bracelets Windy River will need to
expand her customer base. sell in order to achieve this target profit.
Chapter 22 Pricing, Costing, and Growth 715
Chapter 22 Review & Activities
CHAPTER SUMMARY
• In merchandising businesses, product • Businesses grow by increasing cus-
cost-plus pricing is used: A markup tomers, sales, market share, markets,
based on the cost of the item is added to number of employees, lines of
the actual cost. The markup percentage merchandise, and profits.
covers business expenses plus profit • Profit planning occurs by setting target
margin. In manufacturing businesses, profit goals and estimating a margin of
product costing covers raw materials, safety—target sales minus break-even
plus the cost of processing them into sales.
finished products, plus profit. • Target sales needed to reach a target
• Variable costs, such as direct materials profit is equal to variable costs, plus
and direct labor, change in proportion fixed costs, plus target profits. The
to production levels. Fixed costs remain margin of safety is the amount that
constant despite production level sales can drop before the business
changes. experiences a loss. This is equal to the
• By determining the contribution margin target sales minus the break-even sales.
and break-even point, a business can set • Planning for growth will enable you
attractive prices that also ensure a profit to grow in a controlled way and to be
for the business. prepared and able to take advantage of
growth opportunities when they appear.
Communicating Key Terms
Imagine you are a consultant assisting the owner of a florist shop in pricing her flowers and
floral design services. Use as many of the key terms as you can to write a presentation on pricing.
• pricing • cost behavior • contribution margin
• product cost-plus pricing • variable costs • break-even point
• markup • direct materials • target profit
• manufacturing business • direct labor • target sales
• product costing • fixed costs • margin of safety
Reviewing Key Concepts
1. Explain why product cost-plus pricing would not work in a manufacturing business.
2. Explain why, in some cases, it may be beneficial to have more variable costs and to also
reduce fixed costs.
3. Explain why the contribution margin is so important.
4. Explain why expanding into new lines of merchandise may not lead to business growth.
5. Explain why determining target profits is necessary to plan for business growth.
6. Explain why the margin of safety is so important to a business.
7. Discuss how your reserve fund can affect growth opportunities.
716 Unit 6 Business Finance Basics
Chapter 22 Review & Activities
Economics Clothing is often marked up more than 100 percent.
Write About It Write a paragraph explaining what this means in terms
of the price you pay in the store. Include your analysis of factors that go into
the price determination, other than the cost of the clothing before markup.
Margin of Safety Target sales for Cricket Lane Flowers are $338,000
in its third year of operation. Break-even sales are estimated at $289,000
(estimated cost of goods sold ⫹ expenses for year three).
1. Calculate the margin of safety. Then explain your opinion of this level.
2. Compute as an alternative activity, using spreadsheet software to make
these calculations.
Connect with Economics and Business In economics, demand
for a product usually grows gradually. Unfortunately, a business owner has
to make large investments in lump sums to increase capacity to meet the
growing demand. For example, investment in production facilities is made in
large “jumps” while demand grows gradually.
1. Role-Play Imagine that Electro Toys has experienced great demand for
its products and services, and its owner is thinking about opening two
more stores, a major investment. How can she be sure that demand will
continue to grow and use the additional supply she offers? With a partner,
take on the roles of the shop’s owner and a friend of hers who invested
in her business when she first started it. They are discussing the business
owner’s thoughts about whether to expand.
2. Write About It Write a script about this discussion.
Competition You are considering opening a business providing
home maintenance and “handyman” services. You realize that you will be
competing with large plumbing repair companies and other specialists.
Log On Make a list of services you plan to offer. Then access an
Internet search engine and find sources of such services in your town
to evaluate the competition.
Write About It Write a marketing plan that explains how you will grow
your business by promoting your services so that potential customers can
differentiate you from the competition, and thus, increase your market share.
Newsclip: The Right Price Smart pricing systems are Web-based
systems that adjust prices to changing market conditions.
O N L I N E
Log On Go to finance07.glencoe.com and open Chapter 22.
Learn about the methods companies use to price goods. Write a list of
some of your favorite things to buy and what they cost.
finance07.glencoe.com Chapter 22 Pricing, Costing, and Growth 717
Chapter 22 Review & Activities
CREATIVE THINKING
Successful businesses rely on a constant stream of ideas and people
with the courage to present them. Do you have a lot of good ideas?
Here is an opportunity to test your creative thinking. Write your
answers on a separate sheet of paper.
1. Do you look for ideas?
Often Sometimes Rarely
2. Do you sometimes play “devil’s advocate” as a way to stimulate others?
Often Sometimes Rarely
3. Do you challenge the rules?
Often Sometimes Rarely
4. Do you ask “what if” questions?
Often Sometimes Rarely
5. Can you motivate yourself and do what it takes to set your ideas in motion?
Often Sometimes Rarely
6. Do you use impractical ideas as stepping stones to new ideas?
Often Sometimes Rarely
7. Do you express silly ideas?
Often Sometimes Rarely
8. Do you challenge assumptions?
Often Sometimes Rarely
Scoring: Give yourself 5 points for each “often,” 3 points for each “sometimes,” and 0
points for each “rarely.”
Beginner: If you scored 0–10 points, consider playing around with new ideas and present-
ing them. Ideas can be fun!
Explorer: If you scored 11–20 points, you are willing to stretch yourself.
Creator: If you scored 21–30 points, your input will be welcome on any team.
Brainstormer: If you scored 31–40 points, you take the lead in risky ideas that may result
in big rewards.
718 Unit 6 Business Finance Basics
Chapter 22 Review & Activities
Your Financial Portfolio
Business Expansion Magic
Under the name of Morgan the Magnificent, Victor Morgan has been performing magic
since he was eight years old. Now that he is 16, he wants to branch out from school
events and birthday parties for friends and family to perform professionally. He already
has his own Web site and a performance video. To expand the business, he wrote down
the following strategies and actions he could take:
• Make a flyer and a cover • Contact the human • Contact local stores that
letter I can send out to resources department of sell or rent party supplies.
potential customers. local companies to let them Ask if I can post a flyer and
know I am available to per- if they can recommend me
• Contact a public relations form at employee functions if anybody is looking for an
agency and offer to do free and holiday parties. entertainer.
performances in exchange
for their helping me get • Contact local chambers • Contact wedding planners
publicity. of commerce to find out to see if they would recom-
when they are having street mend me to be part of the
• Call the local newspaper fairs or crafts fairs. wedding entertainment.
and ask if someone could
write an article about me. • Stop by ice cream stores to
find out if I can post a flyer.
Analyze
Pick a business in your town. On a separate sheet of paper, list eight strategies and
actions that could improve or expand the business.
Chapter 22 Pricing, Costing, and Growth 719
Unit 6
# LAB
Titlea Financial Life!
Get
Growing a Business Procedures
Overview STEP A The Process
Eva and Jack need help making
a decision about what merchandise they should
Two years ago, Jack Lanier and his sister carry and the best type of Web site to develop.
Eva opened their retail store called Party Town.
1. Recommend a new product or line of mer-
They sell a wide variety of party decorations,
chandise that you think Party Town should
paper goods, balloons, and games. The business
carry. (Examples might include hard-to-find
has been a success so far. Eva and Jack have been
costumes, piñatas, or party favors.) Create a
able to meet their expenses each month and
flyer, poster, or other visual aid describing
make a modest profit. Now they want to grow
the new product.
their business. They are interested in carrying a
2. Research the competition (other party stores,
new line of merchandise and opening an online
discount stores, toy stores, and Internet sites),
store with expanded inventory. With their
either by looking through the yellow pages
regular customers, in addition to new Web-site
or by visiting stores nearby. Describe Party
customers from outside their area, they hope to
Town’s competition and its merchandise.
gain a greater share of the market and expand
3. Interview a business owner of a similar
their business now and in the future.
business in town.
4. Eva and Jack also plan to sell balloon bou-
quets that they will make. The direct mate-
rials will cost $5.25; the direct labor per
bouquet is $6; and the supply costs will be
Resources & Tools
about $0.85. Assume that Party Town plans
• Crayons, markers, colored pencils to mark up the bouquets by 80 percent.
• Internet (optional) Figure out the selling price of each bouquet.
• Portfolio (ring binder or file folder) If the fixed costs are $300, determine how
• Public or school library many balloon bouquets Eva and Jack must
• Resources
Publication software & Tools
(optional) sell to break even.
• Spreadsheet software (optional) 5. Help Eva and Jack set a target profit for the
• Word processor balloon bouquets. How many bouquets must
they sell to achieve the target profit? Calcu-
late the margin of safety for this product.
6. Research costs of starting a Web site with
e-tail capability, such as costs of Internet
service providers, design, and customer-
service support.
720 Unit 6 Business Finance Basics
STEP B Create Your Portfolio
As you work through the pro- STEP C The Internet
Almost anything you want to
cess, save the results so that you can refer, know can be found on the Internet. It provides a
review, and refine. Create a professional-looking vast communication network for people around
portfolio of the recommendations that you will the world. Students and employees must learn
present to Eva and Jack. to use the available information wisely, ethically,
and legally.
1. The first page should be a title page with the
following information centered: 1. Write a definition for the term ethics.
Business Growth 2. Many employers have a formal policy that
Presented to Eva Lanier and Jack Lanier, defines the acceptable and unacceptable uses
Owners of the Internet in the workplace. Write a
Party Town policy that Eva and Jack might establish for
By (Your Name) their employees.
2. The first section should include your flyer, 3. Research one legal issue that can arise
poster, or other visual material describing when an employee uses the Internet, such
the new merchandise and Web site that you as plagiarism, viruses, employers accessing
have recommended to Eva and Jack. employees’ e-mail, or employees accessing
3. The second section should present your the Internet for personal use. Write a one- to
research about the competition in your com- two-page paper on the issue.
munity and on the Internet. 4. Some people assume that everything appear-
4. The third section should include the selling ing on the Internet is factual. However, this
price, break-even point, target profit, and is not always the case. As a class, develop a
margin of safety for the balloon bouquets. list of ways to check the accuracy of infor-
Include calculations. Also, include costs for mation that you find.
operating a Web-site.
721
Appendix: Math Skills Builder
WRITING NUMBERS AS WORDS AND ROUNDING NUMBERS
ds
san
nds
hou
hs
s
usa
dth
nds
ndt
dt
ds
s
tho
dre
dre
dre
lio n
usa
usa
ths
s
s
hun
hun
hun
one
ten
ten
ten
tho
tho
mil
•
• • • • • • • • • • •
3 2 5 6 3 3 9 4 5 2
The place-value chart shows the value of each digit in the number 3,256,339.452. The place-value
chart can help you write numbers.
EXAMPLE 482 SOLUTION four hundred eighty-two
8.557 eight and five hundred fifty-seven thousandths
$39.45 thirty-nine and forty-five hundredths dollars
or thirty-nine and 45/100 dollars
Place value is also used in rounding numbers. If the digit to the right of the place value you want
to round is 5 or more, round up by adding 1 to the number in the place value. Then change
all the digits to the right of the place value to zeros. If the number is 4 or less, round down by
changing all the numbers to the right of the place value to zeros.
EXAMPLE Round 4765 to the nearest hundred.
SOLUTION 4765 A. Find the digit in the hundred place. It is 7.
➛
4765 B. Is the digit to the right 5 or more? Yes.
➛
4800 C. Add 1 to the hundreds place. Change the digits to the right to zeros.
➛
EXAMPLE Round 0.843 to the nearest tenth.
SOLUTION 0.843 A. Find the digit in the tenth place. It is 8.
➛
0.843 B. Is the digit to the right 5 or more? No.
➛
0.8 C. Do not change the tenths digit. Drop the digits to the right.
➛
722 Appendix
WRITING NUMBERS AS WORDS AND ROUNDING NUMBERS
Dollar and cents amounts are often rounded to the nearest cent, or the hundredths place.
EXAMPLE $26.7443 SOLUTION $26.74
$683.1582 $683.16
PROBLEMS
Write as numbers.
1. three thousand four hundred ninety-nine
2. one hundred eleven and 32/100 dollars
3. two hundred six and eighty-eight thousandths
Write in word form.
4. 572
5. 2.897
6. $325.10
Round to the nearest place value shown.
7. ten thousand 327,975 11. one 28.91
8. thousand 816,777 12. tenth 86.379
9. hundred 26,312 13. hundredth 5.5787
10. ten 6336
Round 23,793,611 to the place value shown.
14. millions
15. ten millions
16. thousands
17. hundreds
18. ten thousands
19. hundred thousands
Round to the nearest place value shown.
20. cent $87.2671 23. ten dollars $5,982
21. ten cents $213.432 24. hundred dollars $12,785
22. one dollar $671.98
APPLICATIONS
25. As an accountant for the advertising agency of Phillips & Phillips, Marcia Strasser writes many
checks. Write each check amount in words.
a. $27.83
b. $121. 77
c. $569.14
d. $8,721. 65
26. Juan Sanchez, an inventory clerk for a lumber yard, often rounds inventory figures for easier
handling. Round the number from the inventory list to the nearest ten.
a. grade 1 oak 519 ft.
b. grade 2 oak 795 ft.
c. grade 1 pine 323 ft.
d. grade 2 pine 477 ft.
Appendix 723
ADDING AND SUBTRACTING DECIMALS
When adding decimals, write the addition problem in vertical form. Be sure to line up the decimal points.
When adding amounts with different numbers of decimal places, write zeros in the empty decimal places.
EXAMPLE 15.27 + 16.39 + 36.19 EXAMPLE 58.2 3.97 8 123.796
SOLUTION SOLUTION 58.2 58.200
15.27
16.39 3.97 3.970
36.19 8. 8.000
67.85 123.796 123.796
193.966
When subtracting decimals, write the subtraction problem in vertical form. Be sure to line up the decimal points.
When subtracting amounts with different numbers of decimal places, write zeros in the empty decimal places.
EXAMPLE 78.63 42.41 EXAMPLE 149.9 28.37
SOLUTION 149.9 149.90
SOLUTION 78.63
42.41 28.37 28.37
36.22 121.53
Adding and subtracting amounts of money is just like adding and subtracting decimals. The decimal point separates
the dollars and cents. Remember to put a dollar sign in the total.
EXAMPLE $74.99 $8.76 EXAMPLE $750 $43.29
SOLUTION $74.99 SOLUTION $750.00
8.76 43.29
$ 83.75 $706.71
PROBLEMS
1. 19.87 2. 4.377 3. 8.3 4. 46.65 5. $ 2.77
32.24 6.829 12.78 3.5 35.96
27.55 2.707 322.437 125.397 10.37
6. 22.19 47.75 13.88 19.85
7. 0.78 9.82 36.242 37.4
8. 6.7 27.81 653.47 5.5
9. 54.32 0.37 2.5 0.797
10. $6.22 $53.19 $ .33 $7.85
11. $4.78 $12.50 $22 $17.10
12. 3.75 13. 376.55 14. 468.47 15. 367.05 16. $363.27
2.18 27.42 233.55 219.87 79.14
724 Appendix
ADDING AND SUBTRACTING DECIMALS
17. 547.7 127.6 18. 76.99 3.87
19. 695.13 428.1 20. 3076 2205.50
21. $300 $5.75 22. $445.19 $175.76
APPLICATIONS Complete the sales receipts by finding the subtotals and the totals.
23. 24.
Date Auth. No. Identification Clerk Reg./Dept. ❑✓ Take Date Auth. No. Identification Clerk Reg./Dept. ❑✓Take
6/1/-- 86430 DL ❑ Send 3/14/-- 42 JR ❑ Send
Qty Class Description Price Amount Qty Class Description Price Amount
1 dress 77 98 1 couch 599 95
1 jacket 85 99 1 pr draperies 279 88
2 hosiery 12.99 ea 25 98
a. Freight charges will be included with your invoice at the time of shipping.
You will be billed the published rates from UPS, US Postal Service. Subtotal ? a. Freight charges will be included with your invoice at the time of shipping. You
will be billed the published rates from UPS, US Postal Service. Subtotal ?
CUSTOMER
SIGNATURE X Shelley Turner Tax 13 30 CUSTOMER
SIGNATURE X Betty Clark Tax 57 19
b. Sales Slip Total ? b. Sales Slip Total ?
Complete the bank deposit slips by finding the subtotals and the total deposits.
25. 26. 27.
DOLLARS CENTS DOLLARS CENTS DOLLARS CENTS
CURRENCY 72 00 CURRENCY 23 00 CURRENCY
CASH
CASH
CASH
COINS COINS 7 44 COINS 4 75
LIST 95-76 413 12 LIST 85-76 175 66 LIST 57-12 25 95
CHECKS
CHECKS
CHECKS
SEPARATELY SEPARATELY SEPARATELY
98-11 25 00 88-11 23 33 57-10 38 11
95-13 211 10 12 87
a. SUBTOTAL ? a. SUBTOTAL ? SUBTOTAL ?
➲ LESS CASH RECEIVED 50 00 ➲ LESS CASH RECEIVED 75 00 ➲ LESS CASH RECEIVED 25 00
TOTAL DEPOSIT ? TOTAL DEPOSIT ? TOTAL DEPOSIT ?
b. b.
a. a. a.
b. b. b.
28. You are a cashier at a coffee shop. Compute the correct change for each of the following orders.
Customer’s Order Customer Gives You Change
a. $8.76 $10.00
b. $12.94 $15.00
c. $9.30 $10.50
d. $16.11 $20.00
e. $5.57 $5.75
f. $22.02 $25.00
g. $7.12 $7.15
h. $3.33 $5.00
i. $28.04 $30.04
j. $6.12 $10.25
Appendix 725
MULTIPLYING AND DIVIDING DECIMALS
When multiplying decimals, multiply as if the decimal numbers were whole numbers. Then count the total number
of decimal places in the factors. This number will be the number of decimal places in the product.
EXAMPLE 18.7 ➛ factor SOLUTION 18.7 ➛ 1 decimal place
0.34 ➛ factor 0.34 ➛ 2 decimal places
748 748
561 561
6358 ➛ product 6.358 ➛ 3 decimal places
If the product does not have enough digits to place the decimal in the correct position, you will need to write zeros.
Start at the right of the product in counting the decimal places and write zeros at the left.
EXAMPLE 0.63 SOLUTION 0.63 ➛ 2 decimal places
0.05 0.05 ➛ 2 decimal places
315 0.0315 ➛ 4 decimal places
When multiplying amounts of money, round the answer to the nearest cent. Remember to put
a dollar sign in the answer.
EXAMPLE $2.25 SOLUTION $ 2.25 ➛ 2 places $2.25 1.5 $3.375
1.5 1.5 ➛ 1 place $3.38
5
3.375 $3.375 ➛ 3 places rounded to the nearest cent
When multiplying by 10, 100, or 1000, count the number of zeros. Then move the decimal point to the
right the same number of spaces.
EXAMPLE 8.32 100 SOLUTION 8.32 100 8.32 832 100 has 2 zeros; move
哬
decimal 2 places.
PROBLEMS
1. 18.3 2. 27.5 3. 56.8 4. 88.1
2.5 8.2 0.33 0.23
5. 0.57 6. 0.88 7. 0.93 8. 0.323
0.14 0.07 0.04 0.005
9. $17.85 15.5 $276.675
10. $25.24 6.3 $159.012
11. $18.15 6.5 $117.975
12. $14.98 8.7 $130.326
13. 33.8 10
14. 55.399 100
15. 0.518 1000
16. 532.788 10,000
726 Appendix
MULTIPLYING AND DIVIDING DECIMALS
APPLICATION
17. Below are partial payroll records for Fanciful Flowers. Complete the records by calculating gross earnings (hourly
rate x hours worked), Social Security tax (gross earnings 0.062), Medicare tax (gross earnings 0.0145), federal
income tax (gross earnings 0.15), and state income tax (gross earnings 0.045). Round each deduction to the
nearest cent. Find the total deductions and subtract from gross earnings to find the net pay.
Employee Hourly Number Gross Social Medicare Federal State Total Net
Rate of Hours Earnings Security Tax Tax Inc. Tax Inc. Tax Deductions Pay
a. M. Smith $8.25 24
b. R. Nash $9.15 33
c. C. Young $7.75 15
d. D. Cha $9.15 30
When dividing decimals, if there is a decimal point in the divisor, you must move it to the right to make
the divisor a whole number. Move the decimal point in the dividend to the right the same number of places
you moved the decimal point in the divisor. Then divide as with whole numbers.
140 quotient
divisor 6 ) 840 dividend
EXAMPLE SOLUTION 4.52
3.44 )15.5488 3.44 )15.5488
哬 哬 344 )1554.88
1376
1788
1720
688
688
Add zeros to the right of the decimal point in the dividend if needed.
EXAMPLE SOLUTION 0.35
0.42 ) 0.147 0.42 ) 0.147
哬 哬 42 )14.70 zero added
126
210
210
When the dividend is an amount of money, remember to place the dollar sign in the quotient and round
the answer to the nearest cent.
EXAMPLE SOLUTION $1.981
48 ) $95.12 48 ) $95.120 $95.12 48 $1.98 rounded to
the nearest cent.
Appendix 727
MULTIPLYING AND DIVIDING DECIMALS
When dividing by 10, 100, or 1000, count the number of zeros in 10, 100, or 1000 and move the decimal
point to the left the same number of places.
EXAMPLE SOLUTION
15,213.7 1000 哬 1000 has 3 zeros;
15,213.7 1000 15213.7
15.2137 move decimal 3 places
PROBLEMS
Round to the nearest hundredth or the nearest cent.
18. 2.7 )11.61 19. 1.3 )7.67 20. 6.2 )44.02
21. 0.3 )1.62 22. .05 )1.47 23. .04 )28.4
24. 8.3 )46.99 25. 3.4 )178.3 26. 88 )$356.68
27. 45 )$42.79 28. 15 )$87.32 29. 14.1 )7.823
APPLICATIONS
30. Your family is looking into buying a late model, used vehicle. Calculate (to the nearest tenth) the
gas mileage for the following types of vehicles.
Type of Vehicle Miles Gallons of Fuel Miles per Gallon
a. Subcompact 631 17.8
b. 4-door sedan 471.4 16.6
c. Minivan 405.1 18.2
d. Compact 512.2 15.7
e. SUV 298.1 23.2
728 Appendix
FRACTION TO DECIMAL, DECIMAL TO FRACTION
Any fraction can be renamed as a decimal and any decimal can be renamed as a fraction. To rename a
fraction as a decimal, use division. Think of the fraction bar in the fraction as meaning “divide by.” For
example, 5/8 means “5 divided by 8.” After the 5, write a decimal point and as many zeros as are needed.
Then divide by 8.
EXAMPLE Change 3/8 to a decimal. EXAMPLE Change 1/5 to a decimal.
SOLUTION 0.375 SOLUTION 0.2
➛ ➛
3
/8 )
8 3.000 1
/5 5 )1.0
24 10
60
56
40
40
If a fraction does not divide evenly, divide to one more decimal place than you are rounding to.
EXAMPLE Change 5/7 to a decimal EXAMPLE Change 2/7 to a decimal
rounded to the nearest rounded to the nearest
hundredth. (Divide to the thousandth. (Divide to the
thousandths place.) ten thousandths place.)
SOLUTION 0.714 0.71 SOLUTION 0.2857 0.286
➛ ➛
5
/7 7 )5.000 2
/7 7 )2.0000
49 14
10 60
7 56
30 40
28 35
2 50
49
1
To rename a decimal as a fraction, name the place value of the digit at the far right. This is the denominator
of the fraction.
0.83 83/100 0.007 7/1000
3 is in the hundredths place, 7 is in the thousandths place,
so the denominator is 100. so the denominator is 1000.
Note that the number of zeros in the denominator is the same as the number of places to the right of the
decimal point. The fraction should always be written in lowest terms.
0.25 25/100 1/4 3.375 3 375/1000 3 3/8
Appendix 729
FRACTION TO DECIMAL, DECIMAL TO FRACTION
PROBLEMS
Change the fractions to decimals. Round to the nearest thousandth.
1. 2/5 2. 5/6 3. 4/9 4. 7
/10
5. 9/25 6. 115/200 7. 1/7 8. 13
/40
9. 4/15 10. 5/12 11. 11/16 12. 1
/4
Change the fractions to decimals. Round to the nearest hundredth.
13. 1/8 14. 5/9 15. 33/35 16. 12
/25
17. 7/20 18. 2/25 19. 15/16 20. 2
/9
3 3
21. /7 22. /4 23. 1/6 24. 31
/32
Change the decimals to fractions reduced to lowest terms.
25. 0.275 26. 0.3 27. 0.15 28. 0.8
29. 1.125 30. 0.117 31. 0.32 32. 2.5
33. 44.755 34. 0.005 35. 5.545 36. 0.2
APPLICATIONS
37. In the past, stock prices were quoted as dollars and fractions of a dollar. Change the stock prices to dollars
and cents. Round to the nearest cent.
Stock Price
a. AdobeSy 61 5/16
b. AirTran 4 15/32
c. CNET 50 3/4
d. ETrade 20 1/4
e. Omnipoint 112 5/8
f. Qualcomm 142 1/16
g. WebLink 17 13/16
h. Winstar 70 23/32
38. Individual bowling averages in the Southern Community League are carried to the nearest hundredth.
Convert the decimals to fractions reduced to the lowest terms.
Name Average
a. B. Taylor 220.13
b. J. Scott 217.02
c. T. Anfinson 216.97
d. G. Ingram 212.08
e. D. Ingram 210.50
f. B. Jordan 209.25
g. G. Maddux 207.88
h. A. Jones 205.15
730 Appendix
PERCENT TO DECIMAL, DECIMAL TO PERCENT
Percent is an abbreviation of the Latin words per centum, meaning “by the hundred.” So percent means “divide
by 100.” A percent can be written as a decimal. To change a percent to a decimal, first write the percent as a
fraction with a denominator of 100, then divide by 100.
EXAMPLE Change 31% to a decimal. EXAMPLE Change 17.3% to a decimal.
SOLUTION 31% 31/100 0.31 SOLUTION 17.3% 17.3/100 0.173
When dividing by 100, you can just move the decimal point two places to the left. When you write a
percent as a decimal, you are moving the decimal point two places to the left and dropping the percent
sign (%). If necessary, use zero as a placeholder.
EXAMPLE SOLUTION
A. 31% 31% 哬
31. 0.31 ➛ Drop % sign.
➛ Move decimal 2 places.
B. 7% 7% 哬
07. 0.07 Insert a zero as a placeholder.
➛
To write a decimal as a percent, move the decimal point two places to the right and add a percent sign (%).
EXAMPLE SOLUTION
A. 0.31 0.31 0.31 31 % ➛ Add % sign.
哬
➛ Move decimal 2 places.
B. 0.07 0.07 0.07 7%
哬
C. 2.5 2.5 2.50 250%
哬
D. 0.008 0.008 0.008 0.8%
哬
PROBLEMS
Write as decimals.
1. 35% 2. 22% 3. 68% 4. 30%
5. 49.2% 6. 88.7% 7. 11.5% 8. 92.9%
9. 322% 10. 526% 11. 663% 12. 275%
13. 9% 14. 5% 15. 4% 16. 12%
17. 7.03% 18. 9.02% 19. 2.0725% 20. 3.0843%
Write as percents.
21. 0.75 22. 0.17 23. 0.44 24. 0.26
Appendix 731
PERCENT TO DECIMAL, DECIMAL TO PERCENT
25. 0.06 26. 0.07 27. 0.01 28. 0.02
29. 0.003 30. 0.009 31. 0.0045 32. 0.0029
33. 3.12 34. 4.14 35. 6.007 36. 5.000
37. 0.1 38. 0.5 39. 325.5 40. 0.2015
APPLICATIONS
41. The percent changes in retail sales were reported as a decimal in the October issue of Retail Monthly
magazine. Change the decimals to percents.
Retail Sales
Month Change
a. February 0.012
b. March 0.006
c. April 0.013
d. May 0.038
e. June 0.043
f. July 0.011
g. August 0.022
42. The commission rate schedule for a stockbroker is shown. Change the percents to decimals.
Commission Rate Schedule
Dollar Amount % of Dollar Amount
a. $0 – $2,499 2.3%, minimum $30
b. $2,500 – $4,999 2.0%, minimum $42
c. $5,000 – $9,999 1.5%, minimum $65
d. $10,000 – $14,999 1.1%, minimum $110
e. $15,000 – $24,999 0.9%, minimum $135
f. $25,000 – $49,999 0.6%, minimum $175
$50,000 and above negotiated
732 Appendix
PERCENT TO DECIMAL, DECIMAL TO PERCENT
43. During the National Basketball Association season, the teams had these won–lost records. The Pct.
column shows the percent of games won, expressed as a decimal. Change the decimals to percents.
EASTERN CONFERENCE WESTERN CONFERENCE
Atlantic Division Midwest Division
W L Pct. GB W L Pct. GB
a. Miami 28 16 .636 - p. San Antonio 30 16 .652 -
b. New York 27 17 .614 1 q. Utah 27 17 .614 2
c. Philadelphia 25 21 .543 4 r. Minnesota 25 18 .581 31/2
d. Boston 21 25 .457 8 s. Denver 21 22 .488 71/2
e. Orlando 21 26 .447 81/2 t. Houston 19 27 .413 11
f. New Jersey 17 29 .370 12 u. Dallas 18 27 .400 111/2
g. Washington 15 31 .326 14 v. Vancouver 12 32 .273 17
Central Division Pacific Division
W L Pct. GB W L Pct. GB
h. Indiana 29 15 .659 - w. L.A. Lakers 34 11 .756 -
1
i. Milwaukee 26 21 .553 4 /2 x. Portland 34 11 .756 -
j. Charlotte 24 20 .545 5 y. Sacramento 28 16 .636 51/2
k. Toronto 24 20 .545 5 z. Seattle 29 18 .617 6
l. Detroit 22 23 .489 71/2 aa. Phoenix 26 18 .591 71/2
m. Cleveland 19 26 .422 101/2 ab. Golden State 11 32 .256 22
n. Atlanta 17 26 .395 111/2 ac. L.A. Clippers 11 34 .244 23
o. Chicago 9 34 .209 191/2
44. How many teams have won more than 75% of their games?
Who are they?
45. How many teams have won more than 50% of their games?
46. How many have won less than 30% of their games?
Appendix 733
FINDING A PERCENTAGE
Finding a percentage means finding a percent of a number. To find a percent of a number, you
change the percent to a decimal, then multiply it by the number.
EXAMPLE 30% of 90 is what number?
➛
SOLUTION ➛ n
30% 90 In mathematics, of means “times” and is means “equals.”
➛
Let n stand for the unknown number.
0.30 90 n Change the percent to a decimal.
27 n Multiply.
30% of 90 27 Write the answer.
EXAMPLE The delivery charge is EXAMPLE The student had 95%
8% of the selling price correct out of 80 questions.
of $145.00. Find the How many answers were
delivery charge. correct?
SOLUTION 8% $145.00 n SOLUTION 95% 80 n
0.08 $145.00 n 0.95 80 n
$11.60 n 76 n
8% $145.00 $11.60 delivery charge 95% 80 76 correct
PROBLEMS
Find the percentage.
1. 25% of 60 2. 45% of 80 3. 40% of 30 4. 33% of 112
5. 58% of 420 6. 50% of 422 7. 3% of 100 8. 2% of 247
9. 110% of 65 10. 7% of 785 11. 1% of 819 12. 4% of 19.5
13. 185% of 95 14. 200% of 720 15. 135% of 860 16. 120% of 3.35
17. 4.5% of 50 18. 1.25% of 300 19. 33.3% of 80 20. 67.2% of 365
Round the answer to the nearest cent.
21. 7% of $35.78 22. 6.5% of $80 23. 10% of $93.20 24. 5.5% of $135
25. 4.25% of $65.00 26. 2.75% of $115 27. 125% of $98 28. 7.5% of $150
29. 0.3% of $450 30. 0.15% of $125 31. 8.2% of $19.89 32. 5.25% of $110.15
734 Appendix
FINDING A PERCENTAGE
APPLICATIONS
33. The following items appeared in a sales flyer for a major department store. Calculate the
amount saved from the regular price as well as the sale price for each item. Round to the
nearest cent.
Amount Saved Sale Price
a. Save 25% on juniors knit shirts. Reg. $18.
b. Save 30% on women’s dresses. Reg. $69.99
c. Save 20% on men’s shoes. Reg. $135.
d. Save 25% on all nursery cribs. Reg. $119.99
e. Save 25% on all boxed jewelry sets. Reg. $19.99
f. Save 30% on family athletic shoes. Reg. $59.99
34. Student Sean Hu received these test scores. How many answers were correct on each test?
Subject Test Number Correct
Score of Items Answers
a. Math 90% 80
b. English 70% 90
c. Science 80% 110
d. Spanish 90% 50
e. Government 85% 100
35. Sales taxes are found by multiplying the tax rate times the selling price of the item. The total
purchase price is the selling price plus the sales tax. Find the sales tax and total purchase price
for each selling price. Round to the nearest cent.
Selling Price Tax Rate Sales Tax Total Purchase Price
a. $14.78 4%
b. $22.50 5%
c. $3.88 6%
d. $95.85 6.5%
e. $212.00 7.25%
f. $85.06 8.25%
g. $199.99 7.455%
Appendix 735
AVERAGE (MEAN)
The average, or mean, is a single number used to represent a group of numbers. The average, or
mean, of two or more numbers is the sum of the numbers divided by the number of items added.
EXAMPLE Find the average of 8, 5, 3, 7, and 2. Add to find the total.
SOLUTION 8 5 3 7 2 25
5 Divide by the number of items.
5 5
EXAMPLE Find the average of 278, 340, 205, and 235.
SOLUTION 278 340 205 235 1058
264.5
4 4
EXAMPLE Find the average of 4.3, 7.1, 1.5, 3.2, and 6.4. Round to the nearest tenth.
SOLUTION 4.3 7.1 1.5 3.2 6.4 22.5
4.5
5 5
EXAMPLE Find the average of $12, $35, $19, $23, $11, and $21. Round to the nearest dollar.
SOLUTION $12 $35 $19 $23 $11 $21 $121
$20.17 $20
6 6
PROBLEMS
Find the average for each group.
1. 3, 5, 7, 9, 11
2. 25, 40, 35, 50
3. 211, 197, 132
4. 416, 310, 344, 430
5. 4.4, 2.9, 3.7, 1.8, 6.5
6. 3.6, 7.1, 4.8, 4.7, 6.3, 5.3
7. $23, $21, $25, $24, $26
8. $98, $87, $79, $85, $88, $91
Find the average for each group. Round to the nearest hundredth or cent.
9. 8.1, 8.6, 7.7, 9.2, 5.5, 6.9, 7.3
10. 3.3, 5.8, 4.6, 2.8, 3.4, 5.2
11. $31.70, $33.91, $36.17, $33.85
12. $4.37, $3.74, $4.90, $5.74, $6.11
13. $55.78, $44.20, $43.95, $34.36
736 Appendix
AVERAGE (MEAN)
14. $121.19, $115.08, $135, $129.05, $111.88
15. Ben Agars had bowling scores of 187, 154, and 130. What was his average?
16. Kelley O’Reilly’s tips from being a waitress were $5.00, $5.50, $4.75, $3.00, $4.50, $2.00, $5.75,
and $4.50. What was her average tip?
17. Last year, Michael Legato’s telephone bills averaged $66.12 a month. What was his total bill for
the year?
18. Mark Purdue recorded his math test scores this quarter. What is his average?
Test Number 1 2 3 4 5 6 7 8
Score 65 77 81 79 90 86 92 98
19. What does he need on the next test to have an average of 85?
20. If Mark got a 97 on test 9 and 100 on test 10, what would be his average?
APPLICATIONS
21. As captain of the school golf team, Erica Samuelson has to complete this form after each game.
Help her by computing the total and the average for each golfer. She also computes the total
and the team average for each game. Round to the nearest whole number.
Golfer Game 1 Game 2 Game 3 Total Average
a. Samuelson 86 78 75
b. Haas 80 81 70
c. Sutherland 82 77 71
d. Beck 80 66 73
e. McCarron 78 81 82
f. Total
g. Team average
Appendix 737
ELAPSED TIME
To find elapsed time, subtract the earlier time from the later time.
EXAMPLE Find the elapsed time for Kaitlin Harper who worked from:
A. 4:30 P.M. to 11:45 P.M. B. 5:15 A.M. to 10:33 A.M.
SOLUTION 11:45 10:33
4:30 5:15
7:15 7 hours 15 minutes 5:18 5 hours 18 minutes
written as 7 h: 15 min written as 5 h: 18 min
You cannot subtract 45 minutes from 30 minutes unless you borrow an hour and add it to the 30 minutes.
Remember that 1 hour 60 minutes.
EXAMPLE Find the elapsed time from 2:50 P.M. to 9:15 P.M.
SOLUTION 9:15 8:15 :60 8:75 borrowed 1 hour
2:50 2:50 2:50
6:25 6 h: 25 min
To find elapsed time when the time period goes past noon, add 12 hours to the later time before subtracting.
EXAMPLE Find the elapsed time from 6:00 A.M. to 3:15 P.M.
SOLUTION 3:15 3:15 12:00 15:15
6:00 6:00 6:00
9:15 9 h: 15 min
EXAMPLE Find the elapsed time from 10:35 P.M. to 3:12 A.M.
SOLUTION 3:12 15:12 14:12 :60 14:72
10:35 10:35 10:35 10:35
4:37 4 h: 37 min
PROBLEMS
Find the elapsed time.
1. From 2:30 P.M. to 6:35 P.M. 2. From 1:18 P.M. to 7:25 P.M.
3. From 4:40 A.M. to 8:57 A.M. 4. From 3:33 a.m. to 10:47 A.M.
5. From 3:15 A.M. to 5:20 A.M. 6. From 1:25 P.M. to 9:05 P.M.
7. From 7:35 P.M. to 11:12 P.M. 8. From 8:43 A.M. to 11:30 A.M.
9. From 6:00 A.M. to 3:30 P.M. 10. From 10:30 A.M. to 6:45 P.M.
11. From 5:45 A.M. to 9:16 A.M. 12. From 1:45 A.M. to 7:05 A.M.
13. From 6:10 P.M. to 8:08 P.M. 14. From 3:28 A.M. to 11:16 A.M.
15. From 2:27 P.M. to 9:11 P.M. 16. From 3:56 P.M. to 10:22 P.M.
738 Appendix
ELAPSED TIME
17. From 12:07 A.M. to 7:25 A.M. 18. From 12:35 P.M. to 6:45 P.M.
19. From 8:10 A.M. to 4:45 P.M. 20. From 7:45 A.M. to 5:30 P.M.
21. From 7:00 A.M. to 3:00 P.M. 22. From 8:30 A.M. to 5:00 P.M.
23. From 7:30 A.M. to 4:10 P.M. 24. From 8:23 A.M. to 5:04 P.M.
25. From 5:45 A.M. to 2:15 P.M. 26. From 7:43 A.M. to 4:21 P.M.
27. From 8:45 P.M. to 1:18 A.M. 28. From 9:47 A.M. to 7:08 P.M.
29. From 11:27 P.M. to 4:11 A.M. 30. From 5:55 P.M. to 1:55 A.M.
APPLICATIONS
31. Jack Keegan worked from 7:15 A.M. to 5:00 P.M. How long did he work?
32. Elena Diaz took a bus that left Cincinnati at 5:45 P.M. and arrived in Cleveland at 1:10 A.M. How
long was the trip?
33. National Delivery Service (N.D.S.) ships hundreds of packages across the United States every day by
air freight. Below is an N.D.S. air freight schedule. Calculate the total transit time for each shipment.
(Note that all times given are Eastern Standard Time; therefore, time zones do not need to be taken
into account.)
Shipped Shipped Departure Arrival Total Transit
From To Time Time Time
a. Chattanooga, TN Atlanta, GA 7:35 A.M. 8:20 A.M.
b. Chicago, IL Houston, TX 8:10 A.M. 12:57 P.M.
c. Los Angeles, CA New Orleans, LA 8:35 A.M. 2:17 P.M.
d. New York, NY Cleveland, OH 5:25 P.M. 7:25 P.M.
e. Boston, MA Phoenix, AZ 11:45 A.M. 7:28 P.M.
f. Atlanta, GA Miami, FL 7:07 A.M. 9:00 A.M.
Appendix 739
READING TABLES AND CHARTS
To read a table or chart, find the column containing one of the pieces of information you have. Look across
the row containing the other piece of information. Read down the column and across the row. Read the
information you need where the column and row intersect.
Shipping Costs
Not Over Zone Zone Zone Zone Zone
(lbs) 2&3 4 5 6 7
1 $4.00 $4.00 $4.00 $4.00 $4.00
2 $4.00 $4.00 $4.00 $4.00 $4.00
3 $5.10 $5.10 $5.10 $5.10 $5.10
4 $6.20 $6.20 $6.20 $6.20 $6.20
5 $7.30 $7.30 $7.30 $7.30 $7.30
6 $8.60 $8.90 $9.10 $9.45 $9.70
7 $8.70 $9.30 $9.70 $10.40 $10.90
8 $8.80 $9.70 $10.30 $11.35 $12.10
9 $8.90 $10.10 $10.90 $12.30 $13.30
10 $9.00 $10.50 $11.50 $13.25 $14.50
EXAMPLE What is the cost to ship a 6-lb package to Zone 5?
SOLUTION a. Find the Zone 5 column. b. Find the 6-lb row.
c. Read across the 6-lb row to the Zone 5 column. The cost is $9.10.
To classify an item, find the row that contains the known data. Then read the classification from the head
of the column.
Men’s Body Measurement
Size S M L XL XXL
1 1 1 1
Neck 14–14 /2 15–15 /2 16–16 /2 17–17 /2 18–181/2
Chest 34–36 38–40 42–44 46–48 50–52
Waist 28–30 32–34 36 –38 40–42 44–46
Reg. Sleeve 32–33 33–34 34–35 35–36 36–37
Tall Sleeve 33–34 34–35 35–36 36–37 37–38
Height Reg. 5’8”– 6’ Tall 6’1”–6’4”
Talls: Measure 2” longer overall, 1” at sleeves
EXAMPLE What size shirt should a man with a 42-inch chest order?
SOLUTION a. Find the row for the Chest measurements. b. Read across the row to 42–44.
c. Read the size at the head of the column (L). A man with a 42-inch chest should order a
size L, which stands for large.
PROBLEMS
Use the shipping chart above to find the cost to ship each package to the indicated zone.
1. 3 lb, Zone 3 2. 4 lb, Zone 7 3. 9 lb, Zone 4
4. 2 lb, Zone 6 5. 6 lb, Zone 2 6. 5 lb, Zone 5
7. 1.5 lb, Zone 5 8. 6.4 lb, Zone 7 9. 8.2 lb, Zone 3
10. 7.1 lb, Zone 6 11. 5.8 lb, Zone 4 12. 9.3 lb, Zone 3
740 Appendix
READING TABLES AND CHARTS
Use the size chart on the previous page to determine what size to order. In-between sizes
should order the next size up.
13. Shorts—waist 33 14. Shirt—chest 37
15. Jacket— chest 47 16. Pants—waist 43
17. Sweater— chest 43 18. Shirt—height 6’2”, sleeves 36
APPLICATIONS
19. Use the shipping chart on the previous page to determine the maximum amount a package
can weigh.
a. b. c. d. e. f.
Shipping Zone 2 5 7 3 6 4
Shipping Cost $7.30 $4.00 $13.30 $8.90 $7.30 $5.10
Maximum Weight
Use the Federal Income Tax Table to find the amount of tax withheld in questions 20–25 and
the amount of wages earned in questions 26–31:
Federal Income Tax Table
MARRIED Persons—WEEKLY Payroll Period
If the And the number of withholding allowances claimed is—
wages are—
At But less 0 1 2 3 4 5 6 7
least than The amount of income tax to be withheld is—
$480 $490 $63 $56 $50 $44 $38 $32 $25 $19
490 500 64 58 52 45 39 33 27 21
500 510 66 59 53 47 41 35 28 22
510 520 67 61 55 48 42 36 30 24
520 530 69 62 56 50 44 38 31 25
530 540 70 64 58 51 45 39 33 27
540 550 72 65 59 53 47 41 34 28
550 560 73 67 61 54 48 42 36 30
560 570 75 68 62 56 50 44 37 31
570 580 76 70 64 57 51 45 39 33
580 590 78 71 65 59 53 47 40 34
590 600 79 73 67 60 54 48 42 36
600 610 81 74 68 62 56 50 43 37
610 620 82 76 70 63 57 51 45 39
620 630 84 77 71 65 59 53 46 40
20. 21. 22. 23. 24. 25.
Income $491.77 $501.07 $617.30 $525.00 $600.00 $531.13
Allowances 2 1 3 0 4 6
Amount Withheld
Number of Tax Wages
Allowances Withheld At least But less than
26. 5 $47
27. 2 $71
28. 3 $53
29. 1 $62
30. 4 $38
31. 0 $76
Appendix 741
CONSTRUCTING GRAPHS
A bar graph is a picture that displays and compares numerical facts in the form of vertical or horizontal
bars. To construct a vertical bar graph, follow these steps:
Metropolitan Statistical Areas
a. Draw the vertical and horizontal axes. Population (in millions)
b. Scale the vertical axis to correspond to the given data. Chicago, IL 8.6
c. Draw one bar to represent each quantity. San Francisco, CA 6.6
Philadelphia, PA 6.0
d. Label each bar and the vertical and horizontal axes. Detroit, MI 5.3
e. Title the graph.
EXAMPLE Construct a vertical bar graph of the given data.
b.
Metropolitan Statistical Areas e.
10 — .....................................
SOLUTION a. Draw vertical and horizontal axes. c.
Population (in millions)
8 — ....................................
b. Scale the vertical axis.
6 — ....................................
c. Draw one bar to represent
each quantity. 4 — ....................................
d. Label each bar and the vertical 2 — ....................................
and horizontal axes. 0 — ....................................
e. Title the graph. ➛➛
a.
ica
go cisc
o
ph
ia
tro
it
Ch Fran iladel De
San Ph d.
A line graph is a picture used to compare data over a period of time. It is an excellent way to show
trends (increases or decreases). To construct a line graph, follow these steps:
a. Draw the vertical and horizontal axes. Percentage of Women
b. Scale the vertical axis to correspond to in the Total Workforce
the given data. 1950 29.6%
1960 33.4%
c. Label the axes.
1970 38.1%
d. Place a point on the graph to correspond 1980 42.5%
to each item of data. 1990 45.8%
e. Connect the points from left to right. 2000 47.5%
f. Title the graph.
EXAMPLE Construct a line graph of the given data.
Percentage of Women
➛
SOLUTION a. Draw the vertical and in the Total Workforce
100% —
horizontal axes. ■
➛
90% — d. Place a point to correspond
b. Scale the vertical axis. ■ ➛ to each item of data. ■
Total Workforce (in millions)
80% —
c. Label the axes. ■
70% — e. Connect the points from
60% — left to right. ■
50% —
➛ •
➛
•
•
➛
40% — •
30% — •
• f. Title the graph. ■
20% —
10% —
0% — ❘ ❘ ❘ ❘ ❘ ❘
➛ 1950 1960 1970 1980 1990 2000
➛ Year
742 Appendix
CONSTRUCTING GRAPHS
PROBLEMS
1. Construct a vertical bar graph of the given data.
Wrenn’s Department Store
Total Sales by Department (in thousands)
Housewares 122
Men’s Clothing 145
Women’s Clothing 160
Appliances 183
Electronics 214
2. Read the vertical bar graph.
Projected Metropolitan
a. Of the metropolitan areas listed, which is Area Populations for 2033
projected to have the largest population
in 2033?
Population (in millions)
10 — ....................................
b. Which of the metropolitan areas listed is — ....................................
projected to have the smallest population 8— ....................................
in 2033? — ....................................
6— ....................................
c. What is Chicago’s projected population
— ....................................
for 2033? ....................................
4—
— ....................................
2— ....................................
— ....................................
es Yor
k C ago
gel on
,D
hic
s An New gt C
Lo shi
n
Wa
3. Construct a line graph of the given data.
Tollhouse Industries Stock
Month Average
Jan. 16.50
Feb. 17
Mar. 16.25
Apr. 15
May 17.50
June 18
Appendix 743
UNITS OF MEASURE
Here are abbreviations and conversions for units of measure in the customary measurement system.
Length Volume Weight
12 inches (in) 1 foot (ft) 2 cups (c) 1 pint (pt) 16 ounces (oz) 1 pound (lb)
3 ft 1 yard (yd) 2 pt 1 quart (qt) 2000 lb 1 ton (t)
5280 ft 1 mile (mi) 4 qt 1 gallon (gal)
Here are symbols and conversions for units of measure in the metric system.
Length Volume
1000 millimeters (mm) 1 meter (m) 1000 milliliters (mL) 1 liter (L)
100 centimeters (cm) 1 m Mass
1000 m 1 kilometer (km) 1000 grams (g) 1 kilogram (kg)
To convert from one unit of measure to another, use the conversions lists above.
When converting to a smaller unit, multiply.
EXAMPLE Convert 5 feet to inches. Convert 4 meters to centimeters.
SOLUTION Use 12 in 1 ft Use 100 cm 1 m
5 ft: 5 12 60 4 m: 4 100 400
5 ft 60 in 4 m 400 cm
When converting to a larger unit, divide.
EXAMPLE Convert 6 pints to quarts. Convert 6500 grams to kilograms.
SOLUTION Use 2 pt 1 qt Use 1000 g 1 kg
6 pt: 6 2 3 6500 g: 6500 1000 6.5
6 pt 3 qt 6500 g 6.5 kg
PROBLEMS
Make the following conversions.
1. 12 yd to feet 2. 8 gal to quarts
3. 9 lb to ounces 4. 2 ft to inches
5. 3 lb to ounces 6. 5 L to milliliters
7. 2.4 km to meters 8. 24 pt to cups
9. 3.6 kg to grams 10. 99 in to yards
11. 15 qt to gallons 12. 66 oz to pounds
13. 18 qt to gallons 14. 24 oz to pounds
15. 7000 g to kilograms 16. 60 cm to meters
17. 2200 mL to liters 18. 350 cm to meters
19. 29 kg to grams 20. 17.3 L to milliliters
21. 522 g to kilograms 22. 10.122 mL to liters
23. 72 cm to millimeters 24. 432.2 cm to meters
25. 1 yd 7 in to inches 26. 5 ft 7 in to inches
27. 3 qt 1 pt to pints 28. 6 lb 9 oz to ounces
29. 4 gal 1 qt to quarts 30. 3 yd 1 ft 5 in to inches
31. 5 gal 3 qt 1 pt to pints 32. 3 m 57 cm 29 mm to millimeters
744 Appendix
UNITS OF MEASURE
APPLICATIONS
33. How many quarts will a 6-gallon bucket hold?
34. How many milliliters will a 2-liter bottle hold?
35. How many cups of coffee does a 4-quart coffeepot hold?
36. How many cups of hot chocolate will a 1.5-gallon thermos jug hold?
37. How many inches long is an 8-yard roll of aluminum foil?
38. Strawberries are sold in 1-pint containers. How many pints must be
purchased to have enough for a recipe that calls for 3 cups?
39. James Jones knows that his jogging stride is about 1 meter long. The jogging
trail he uses is 4.2 kilometers long. How many strides does it take him to go
around the trail once?
40. The cafeteria receives 49 cases of milk each day. Each case contains 24 half-pint
cartons. How many gallons of milk are received each day?
41. A soft drink is sold in 355 mL cans. How many liters are in a six-pack?
42. Katie Karanikos baked a chocolate layer cake weighing 1.5 kilograms. How many
75-gram servings can be cut from the cake?
43. Joan Baird ordered baseboard molding for the rooms of a new house. Joan needs to
complete this chart to determine the total number of feet of molding needed.
How much molding is needed?
Length Width 2 lengths 2 widths Perimeter
12 ft 10 ft 24 ft 20 ft 44 ft
11 ft 8 ft 22 ft 16 ft
a. 11 ft 19 ft
b. 12 ft 12 ft 2 in
c. 15 ft 16 ft 8 in
d. 11 ft 8 in 12 ft 2 in
e. 12 ft 10 in 16 ft 10 in
f. 16 ft 9 in 24 ft 3 in
g. 9 ft 4 in 10 ft
h. Total
Appendix 745
Glossary
marital status and whether assigned risk pool a group of
A you have dependents (p. 386) people who cannot get motor
account a record that shows the amortization the reduction vehicle insurance (p. 436)
balance for a specific item, such of a loan balance through assisted-living facility (ALF)
as cash or equipment (p. 638) payments made over a period a residence complex that
accounting the systematic pro- of time (p. 221) provides personal and medical
cess of recording and reporting annual percentage rate services for the elderly (p. 485)
the financial position of a (APR) the cost of credit on automated teller machine
business (p. 561) a yearly basis, expressed as a (ATM) a computer terminal
accounting cycle the activities, percentage (p. 163) that allows a withdrawal of
or steps, that help a business annual percentage yield cash from an account (p. 126)
keep its accounting records in (APY) amount of interest that
an orderly manner (p. 637) a $100 deposit would earn,
accounting equation Assets ⫺ after compounding, for one B
Liabilities ⫽ Owner’s Equity, year (p. 137)
balance sheet a report of the
the basis for keeping all annuity term sometimes used balances of all asset, liability,
accounting records in balance for a series of equal regular and owner’s equity accounts
(p. 638) deposits to a savings account at the end of an accounting
accounting period a block of (p. 22) period (p. 654)
time covered by an accounting annuity (insurance) a contract bank reconciliation a
report (p. 637) purchased from an insurance report that accounts for
accounts payable the amount company that guarantees the differences between the
of money owed, or payable, a future fixed or variable bank statement and your
to the creditors of a business payment to the purchaser for a checkbook balance (p. 145)
(p. 640) certain number of years or for
life (p. 495) bankruptcy a legal process in
accounts receivable the total which some or all of the assets
amount of money owed to a appraisal an estimate of the of a debtor are distributed
business by customers (p. 639) current value of the property among the creditors because
(p. 226) the debtor is unable to pay his
actual cash value the replace-
ment cost of an item minus aptitudes the natural abilities or her debts (p. 188)
depreciation (p. 426) people possess (p. 34) bear market market condition
adjustable-rate mortgage arbitration a process whereby that occurs when investors are
(ARM) a mortgage with an a conflict between a customer pessimistic about the economy
interest rate that increases and a business is resolved by and sell stocks (p. 285)
or decreases during the life an impartial third party whose bearer bond a bond that is not
of the loan, also known as a decision is legally binding registered in the investor’s
“variable-payment mortgage” (p. 108) name (p. 310)
(p. 222) articles of incorporation beneficiary (estate) a person
adjusted gross income gross the application to operate as a who is named to receive a
income after certain reduc- corporation (p. 534) portion of someone’s estate
tions are calculated (p. 384) assets items of value that an (p. 499)
allowance an adjustment to individual or company owns, beneficiary (insurance) a
the tax withheld from your including cash, property, person named to receive the
paycheck, based on your personal possessions, and benefits from an insurance
investments (p. 65) policy (p. 464)
746 Glossary
Blue Cross an insurance com- closed-end credit credit as a
pany that provides hospital
C one-time loan that you will
care benefits (p. 453) cafeteria-style employee pay back over a specified
Blue Shield an insurance benefits programs that allow period of time in payments of
company that provides workers to choose the benefits equal amounts (p. 157)
benefits for surgical and that best meet their personal closed-end fund a mutual
medical services performed by needs (p. 49) fund with a fixed number of
physicians (p. 453) capital the money you need to shares that are issued by an
blue-chip stock a safe invest- establish a business, operate it investment company when
ment that generally attracts for the first few months, and the fund is first organized
conservative investors, usually expand it once it stabilizes (p. 327)
stocks issued by the strongest (p. 574) closing a meeting of the seller,
and most respected companies capital gain profit from the sale the buyer, and the lender of
(p. 277) of assets such as stocks, bonds, funds, or representatives of
board of directors a group or real estate (p. 261) each party, to complete the
of individuals who are transaction (p. 223)
capital loss the sale of an
responsible for overseeing investment for less than its codicil a document that explains,
the general affairs of the purchase price (p. 262) adds, or deletes provisions in
corporation (p. 538) an existing will (p. 504)
capitalization the total amount
bodily injury liability insur- of stocks and bonds issued by coinsurance the percentage
ance that covers physical a corporation (p. 279) of the medical expenses the
injuries caused by a vehicle policyholder must pay in
accident for which the insured career a commitment to work in addition to the deductible
is responsible (p. 430) a field that you find interesting amount (p. 447)
and fulfilling (p. 32)
break-even point the point at collateral a form of security to
which total sales equal total cash flow the amount of cash help guarantee that the creditor
costs (variable and fixed costs) that is available at any given will be repaid (p. 166)
(p. 707) time (p. 565)
collectibles items that appeal
budget a formal, written state- cash flow the money that goes to collectors and investors,
ment of expected income and into and out of your wallet including rare coins, works
expenses for a future period of and bank accounts (p. 70) of art, antiques, stamps, rare
time (p. 563) cash value in a whole life policy, books, comic books, sports
budget a plan for using money to the accumulated savings to memorabilia, rugs, ceramics,
meet wants and needs (p. 74) which you are entitled when and paintings (p. 366)
and if you cancel the policy collision insurance that covers
budget variance the difference (p. 467)
between the budgeted amount damage to your vehicle when
and the actual amount that certificate of deposit (CD) it is involved in an accident
you spend (p. 77) a savings alternative in which (p. 432)
money is left on deposit for a commercial bank a for-profit
bull market market condition stated period of time to earn a
that occurs when investors are institution that offers a full
specific rate of return (p. 132) range of financial services,
optimistic about the economy
and buy stocks (p. 285) chart of accounts a list of all including checking, savings,
the general ledger accounts and lending (p. 129)
business credit card a credit that a business will use (p. 598)
card issued to a business rather commercial debt financing
than to an individual (p. 627) class-action suit a legal action borrowing money from a bank
on behalf of all the people or other financial institution
business plan a written pro- who have suffered the same to fund a business (p. 618)
posal that describes a new injustice (p. 110)
business and strategies to
launch that business (p. 550)
Glossary 747
commercial finance company cooperative education a credit (accounting) an amount
a firm that lends money only program that allows students entered on the right side of a
to businesses (p. 628) to enhance classroom learning T˛account (p. 640)
commercial loan a loan that with part-time work related credit rating a measure of a
finances a new or ongoing to their majors and interests person’s ability and willing-
business (p. 618) (p. 41) ness to make credit payments
commercial property land co-payment a flat fee that you on time (p. 170)
and buildings that produce pay every time you receive a credit union a nonprofit
rental income (p. 353) covered service (p. 449) financial institution that is
commission an amount of corporate bond a corporation’s owned by its members and
money paid to an employee written pledge to repay a organized for their benefit
based on a percentage of the specific amount of money, (p. 130)
employee’s sales (p. 669) along with interest (p. 251) creditor an entity, such as
common stock a unit of corporate bylaws the rules a financial institution,
ownership of a company by which a corporation will merchant, or individual, that
that entitles the owner, operate (p. 534) lends money (p. 154)
or stockholder, to voting corporate charter a license to current yield the annual
privileges (p. 250) operate a corporation (p. 534) dividend of an investment
compounding the process in corporation a business organi- divided by the current market
which interest is earned on zation that operates as a legal value (p. 286)
both the principal—the origi- entity that is separate from its cyclical stock stock with a
nal amount you deposited— owners and is treated by law as market value that tends
and on any previously earned if it were an individual person to reflect the state of the
interest (p. 136) (p. 534) economy (p. 278)
consumer a person who pur- cosigning agreeing to be re-
chases and uses goods or sponsible for another person’s
services (p. 17) loan payments if that person D
consumer credit use of credit fails to make them (p. 182)
debenture a bond that is backed
for personal needs (p. 154) cost behavior the way a cost only by the reputation of the
consumer price index (CPI) changes in relation to a change issuing corporation, rather
a measure of the changes in business activity (p. 703) than by its assets (p. 306)
in prices for commonly cost of merchandise sold debit an amount entered on the
purchased goods and services the amount of money the left side of a T account (p. 640)
in the United States (p. 77) business paid for the goods
that it sold to customers debit card a cash card that
contribution margin the allows you to withdraw money
amount of money that the (p. 651)
or pay for purchases from your
sale of a particular product coupon bond a bond that is checking or savings account
contributes toward the registered in the owner’s name (p. 126)
payment of fixed costs and the for the face value only and not
profit of a business (p. 705) for interest (p. 310) deductible the set amount that
a policyholder must pay per
convertible bond a bond cover letter a personal letter loss on an insurance policy
that an investor can trade for you present along with your (p. 414)
shares of the corporation’s résumé (p. 45)
common stock (p. 307) deductions the various amounts
credit an arrangement to receive that are subtracted from an
cooperative a nonprofit organi- cash, goods, or services now employee’s gross earnings
zation owned and operated by and pay for them in the future (p. 669)
its members for the purpose of (p. 154)
saving money on the purchase
of goods and services (p. 99)
748 Glossary
deed the official document discretionary income the endorsement the signature of
transferring ownership from money left after paying for the payee, the party to whom
seller to buyer (p. 224) the essentials, such as food, the check has been written
defensive stock stock that clothing, shelter, transpor- (p. 144)
remains stable during declines tation, and medication (p. 71) endowment life insurance that
in the economy (p. 278) diversification the process of provides coverage for a specific
deficit the financial situation spreading your assets among period of time and pays a sum
that occurs when more money several different types of invest- of money to the policyholder
is spent than is earned or ments to reduce risk (p. 254) if he or she is living at the
received (p. 72) dividends distributions of end of the endowment period
money, stock, or other prop- (p. 468)
defined-benefit plan a retire-
ment plan that specifies the erty that a corporation pays to entrepreneur an individual
benefits an employee will stockholders (p. 246) who takes the risk of starting a
receive at retirement age, double-entry accounting a new business (p. 610)
based on total earnings and system of recordkeeping equity the value of the home
years on the job (p. 489) in which each business less the amount still owed
defined-contribution plan transaction affects at least two on the money borrowed to
an individual retirement accounts (p. 640) purchase it (p. 209)
account for each employee, down payment a portion of the equity capital money that a
also called an “individual total cost of an item that must business gets from its owners
account plan” (p. 488) be paid at the time of purchase in order to operate (p. 250)
demand the amount of goods (p. 96) escrow account an account
and services people are willing where money is held in trust
to buy (p. 14) until it can be delivered to a
E designated party (p. 217)
demographic trends tenden-
cies of people grouped by age, earnings per share a corpora- estate all property and assets
gender, ethnicity, education, tion’s net, or after-tax, earnings owned by an individual or
or income that change over divided by the number of group (p. 499)
time (p. 37) outstanding shares of common estate planning the process
direct deposit an automatic stock (p. 287) of creating a detailed plan for
deposit of net pay to an economics the study of the managing personal assets to
employee’s designated bank decisions that go into making, make the most of them while
account (p. 125) distributing, and using goods you are alive and to ensure
direct investment real estate and services (p. 14) that they are distributed wisely
investment in which the economy the ways in which after your death (p. 499)
owner holds legal title to people make, distribute, and estate tax a federal tax collected
the property he or she has use their goods and services on the value of a person’s
purchased (p. 352) (p. 14) property at the time of his or
direct labor the work required emergency fund a savings her death (p. 381)
to convert raw materials into a account you can access quickly exclusion income that is not
finished product (p. 704) to pay for unexpected expenses subject to taxes, also called
direct materials the raw or emergencies (p. 238) “tax-exempt income” (p. 383)
materials used to make a Employer Identification executor a person who is willing
finished product (p. 704) Number (EIN) a number and able to perform the tasks
disability income insurance assigned by the Internal involved in carrying out a will
coverage that provides regular Revenue Service that is used (p. 504)
cash income when you are for income tax purposes
unable to work due to a (p. 525)
pregnancy, non-work-related
accident, or illness (p. 460)
Glossary 749
exemption a deduction from financial statements reports
adjusted gross income for that summarize changes that
G
the taxpayer, the spouse, and result from business trans- general ledger a book or set of
qualified dependents (p. 385) actions during an accounting electronic files that contains
extension an extended deadline period (p. 650) the accounts used for a
for filing an income tax return first-in, first-out method business (p. 645)
(p. 391) (FIFO) an inventory costing general partner a business
system that assumes that the partner who has decision-
first items purchased (first in) making authority, takes an
F are the first items sold (first active role in the operation of
out) (p. 687) the business, and has unlimited
face value the dollar amount fixed costs costs that remain liability for all losses or debts of
that the bondholder will constant even if activity or the partnership (p. 528)
receive at the bond’s maturity production level changes
(p. 306) generally accepted account-
(p. 704) ing principles (GAAP) a
Federal Insurance Contribu- fixed expenses expenses that standard set of guidelines used
tions Act (FICA) the 1935 remain the same regardless of in recording and reporting
law that established the present business activity (p. 580) financial changes (p. 563)
Social Security system (p. 671)
fixed-rate mortgage a mort- geographic trends tendencies
Federal Reserve System the gage with a fixed interest of people moving from one
central banking organization rate and a fixed schedule of area of the country to another
of the United States (p. 16) payments, also called a “con- as financial centers shift
finance charge the total dollar ventional mortgage” (p. 221) location (p. 37)
amount you pay to use credit 401(k) plan a type of retire- goals things you want to
(p. 160) ment savings plan funded by accomplish (p. 6)
financial forecasting the pro- a portion of your salary that good a physical item that is
cess of estimating a business’s is deducted from your gross produced and can be weighed
operating capital (p. 579) paycheck and placed in a or measured (p. 11)
financial leverage the use special account, also called a
“salary-reduction plan” (p. 488) government bond the written
of borrowed funds for direct pledge of a government or a
investment purposes (p. 358) franchise a contractual agree- municipality, such as a city, to
financial plan a written outline ment to sell a company’s repay a specific sum of money
of how the business will get products or services in a with interest (p. 251)
money to start up and operate, designated geographic area
(p. 542) grace period a time period
and how the business will during which no finance
maintain financial operations fraud dishonest business charges will be added to your
and business records (p. 551) practices that are meant to account (p. 160)
financial planner a specialist deceive, trick, or gain an unfair
advantage (p. 104) gross earnings the total amount
who is trained to offer specific of money an employee earns in
financial help and advice free enterprise system an eco- a pay period (p. 667)
(p. 257) nomic system in which people
can choose what they buy, gross profit on sales the profit
financial reports written made from selling merchandise
records that summarize the what they produce and sell,
and where they work (p. 550) before operating expenses are
results of financial transactions deducted (p. 652)
affecting a business and report future value the amount your
its current financial position original deposit will be worth
(p. 636) in the future based on earning
a specific interest rate over a
specific period of time (p. 21)
750 Glossary
growth stock stock issued by a inheritance tax a state tax
corporation whose potential
I collected on the property
earnings may be higher than impulse buying purchasing left by a person to his or her
the average earnings predicted items on the spur of the heir(s) in a will (p. 381)
for all the corporations in the moment (p. 99) insolvency a financial state that
country (p. 278) occurs if liabilities are greater
income cash inflow, or the
guardian the person who accepts money you receive (p. 70) than assets (p. 69)
the responsibility of caring for insurance protection against
the children of the deceased income dividends the earnings
a fund pays to shareholders possible financial loss (p. 412)
and managing an estate for
the children until they reach a (p. 341) interest the price that is paid
certain age (p. 504) income statement a report of for the use of another’s money
the net income or net loss for (p. 17)
an accounting period (p. 650) interest inventories tests that
H income stock stock that pays help you identify the activities
higher-than-average dividends you enjoy the most (p. 34)
hazard anything that increases compared to other stock issues internship a position in which
the likelihood of loss through (p. 277) a person receives training by
peril (p. 413) working with people who are
income tax tax on wages,
health insurance a form of salaries, and self-employed experienced in a particular
protection that eases the earnings (p. 382) field (p. 41)
financial burden people may intestate a status of not having a
experience as a result of illness income tax return a form,
such as 1040 or 1040EZ, on valid will (p. 501)
or injury (p. 444)
which a taxpayer reports inventory the merchandise
health maintenance organi- how much money he or she retailers have for sale (p. 564)
zation (HMO) a health received from working and
insurance plan that directly investment liquidity the abil-
other sources and the exact ity to buy or sell an investment
employs or contracts with taxes that are owed (p. 383)
selected, or preapproved, quickly without substantially
physicians and other medical indirect investment a real reducing its value (p. 249)
professionals to provide health estate investment in which a investment-grade bonds
care services in exchange trustee is appointed to hold bonds that are issued by
for a fixed, prepaid monthly legal title to the property on financially stable companies or
premium (p. 454) behalf of an investor or group municipalities (p. 323)
of investors (p. 354)
heirs the people who will have itemized deduction a specific
the legal right to your assets individual retirement expense, such as a medical
when you die (p. 498) account (IRA) a special expense, that you deduct from
account in which a person sets your adjusted gross income
home equity loan a loan based aside a portion of income for
on the difference between (p. 384)
retirement (p. 490)
the current market value
of a home and the amount inflation rise in the level of
the borrower owes on the prices for goods and services J
mortgage (p. 223) over time (p. 16)
informational interview a job work you do mainly to earn
homeowners insurance money (p. 32)
coverage that provides meeting with someone who
protection for your residence works in your area of interest journal a record of all of the
and its associated financial who can provide you with transactions of a business
risks (p. 419) practical information about a (p. 644)
career or company of interest
hourly wage a specific amount (p. 43)
of money paid per hour to an
employee (p. 667)
Glossary 751
the owner’s life span or the manufacturing business a
K owner’s decision to terminate business that buys raw
Keogh plan a retirement plan the business (p. 528) materials or processed goods
specially designed for self- limited partner a business and transforms them into
employed people and their partner who does not take an finished products (p. 701)
employees, also known as active role in decision making margin of safety the target
an “H.R.10 plan” or a “self- or in running the business sales minus the break-even
employed retirement plan” (p. 529) sales, which indicates the
(p. 493) line of credit an arrangement amount of risk that sales will
in which bank customers meet the break-even point
can borrow a certain amount (p. 713)
L of money from the bank market value the price at which
immediately (p. 621) property would sell (p. 67)
landlord the person who owns
the property that is rented line of credit the maximum marketing plan a written
(p. 202) amount of money a creditor outline of how the business
will allow a credit user to will be promoted to increase
large-cap stock stock of a borrow (p. 157) customers and sales (p. 551)
corporation that has issued a
large number of shares of stock liquid assets cash and items markup the difference between
and has a large amount of that can be quickly converted the cost of an item to a
capitalization (p. 279) to cash (p. 67) business and the selling price
liquidity the ability to easily of the item (p. 699)
last-in, first-out method
(LIFO) a costing method convert financial assets into maturity date the date when a
that assumes the last items cash without loss in value bond will be repaid (p. 306)
purchased (last in) are the first (p. 9) mediation the attempt by a
items sold (first out) (p. 688) living will a legal document neutral third party to resolve
lease a legal document that in which you state if you a conflict between a customer
defines the conditions of the want to be kept alive by artifi- and a business through discus-
rental agreement between cial means if you become sion and negotiation (p. 108)
the tenant and the landlord terminally ill and are unable to Medicaid a medical assistance
(p. 205) make such a decision (p. 505) program offered to certain
legal aid society a network of load fund a mutual fund for low-income individuals and
community law offices that which you pay a commission families (p. 458)
provide free or low-cost legal every time you buy or sell medical payments coverage
assistance (p. 111) shares (p. 328) insurance that pays the costs
liabilities the debts you owe LowDoc Program a govern- of minor accidental injuries
(p. 68) ment loan program that to visitors on your property
allows businesses applying for (p. 422)
liability legal responsibility for loans of less than $150,000 to
the financial cost of another Medicare a federally funded
submit a one-page application health insurance program
person’s losses or injuries with a small amount of
(p. 418) available mainly to people
documentation (p. 626) over 65 and to people with
limited liability company certain disabilities (p. 456)
(LLC) a business that operates
Medicare tax the tax that
and pays taxes as a partnership M finances part of the Medicare
but has limited liability for the
owners (p. 542) managed care prepaid program (p. 671)
limited life a situation in health plans that provide mentor an experienced
which a business’s life span or comprehensive health care to employee who serves as a
existence is determined by their members (p. 453) teacher and counselor for a
less-experienced person (p. 52)
752 Glossary
merchandise the goods retailers net asset value (NAV) the operating costs the ongoing
buy with the intent to resell to amount one share of a mutual expenses for operating a
customers (p. 564) fund is worth (p. 328) business (p. 614)
minimum monthly payment net income the amount of opportunity cost what is given
the smallest amount you can revenue that remains after up when making one choice
pay and remain a borrower in expenses for the accounting instead of another (p. 8)
good standing (p. 168) period are subtracted from the overdraft protection an auto-
mobility the ability to move gross profit on sales (p. 652) matic loan made to an account
easily from place to place net income the income you if the balance will not cover
(p. 198) receive (take-home pay, checks written (p. 141)
money management planning allowance, gifts, and interest) over-the-counter (OTC)
how to get the most from your (p. 162) market a network of dealers
money (p. 60) net worth the difference between who buy and sell the stocks
money market account a the amount that you own and of corporations that are not
savings account that requires the debts that you owe (p. 65) listed on a securities exchange
a minimum balance and earns networking making and using (p. 292)
interest that varies from month contacts to get job information overtime rate the amount paid
to month (p. 134) and advice (p. 43) above the normal rate for
mortgage a long-term loan no-fault system an arrange- overtime, usually 1.5 times
extended to someone who ment whereby drivers who the employee’s regular hourly
buys property (p. 218) are involved in accidents wage (p. 668)
mortgage bond a bond that collect money from their own
is backed by assets of the insurance companies (p. 433)
corporation, also called a no-load fund a mutual fund
P
“secured bond” (p. 307) that has no commission fee par value an assigned dollar
municipal bond a security (p. 329) value that is printed on a stock
issued by a state or local certificate (p. 275)
government (town, city, or participation certificate
county) to pay for its ongoing O (PC) an investment in a
activities (p. 317) group of mortgages that
open dating a labeling method
mutual fund an investment that indicates the freshness, have been purchased by a
in which investors pool their or shelf life, of a perishable government agency (p. 357)
money to buy stocks, bonds, product, such as milk or bread partnership a business owned
and other securities selected (p. 100) by two or more persons
by professional managers (p. 528)
who work for an investment open-end credit credit as a
company (p. 252) loan with a certain limit on partnership agreement a
the amount of money you can written document that states
borrow for a variety of goods how the partnership will be
and services (p. 157) organized (p. 528)
N
open-end fund a mutual fund payroll a list of employees and
negative cash flow a situation with an unlimited number the payments due to each
that occurs when a business of shares that are issued and employee for a specific period
spends more money than it redeemed by an investment of time (p. 666)
receives (p. 565) company at the investors’ penny stock stock that typically
negligence the failure to take request (p. 327) sells for less than $1 a share,
ordinary or reasonable care operating capital the amount although it can sell for as
to prevent accidents from of capital needed to operate much as $10 a share (p. 280)
happening (p. 413) a business for the first few
months or years (p. 579)
Glossary 753
pension plan a retirement plan points extra charges that must price-earnings (PE) ratio the
that is funded at least in part be paid by the buyer to the price of one share of stock
by an employer (p. 49) lender in order to get a lower divided by a corporation’s earn-
peril anything that may possibly interest rate (p. 219) ings per share of stock over the
cause a loss (p. 413) policy a contract between an in- last 12 months (p. 287)
periodic inventory system surance company and a person pricing the process of assigning
a system in which inventory by which that person joins a a selling price to a good or
records are updated only risk-sharing group (p. 412) service (p. 698)
after someone makes an portfolio a collection of all the principal the original amount of
actual physical count of the securities held by an investor money you deposit (p. 20)
merchandise on hand (p. 684) (p. 294) private corporation a com-
perpetual inventory system posting the process of recording pany that issues stock to
a system that keeps a con- transfers of amounts from the a small group of people,
stant, up-to-date record of general journal to individual also called a “closely held
merchandise on hand (p. 682) accounts in the general ledger corporation” (p. 272)
personal balance sheet also (p. 646) private financing borrowing
a net worth statement, a potential earning power money from family or friends
financial statement that lists the amount of money you (p. 618)
items of value owned, debts may earn over time (p. 33) private investor a person out-
owed, and a person’s net power of attorney a legal docu- side an entrepreneur’s circle
worth (p. 65) ment that authorizes someone of friends and relatives who
personal financial planning to act on your behalf (p. 506) provides funding because he
arranging to spend, save, and precious gems rough mineral or she is interested in helping
invest money to live com- deposits (usually crystals) that a new business to succeed
fortably, have financial security, are dug from the earth by (p. 627)
and achieve goals (p. 6) miners and then cut and private mortgage insurance
personal financial state- shaped into brilliant jewels (PMI) a special policy that
ment a document that (p. 363) protects the lender in case the
provides information about precious metals valuable ores buyer cannot make payments
an individual’s current such as gold, platinum, and or cannot make them on time
financial position and presents silver (p. 361) (p. 218)
a summary of income and probate the legal procedure of
spending (p. 65) preferred provider organi-
zation (PPO) a group of proving that a will is valid or
personal property floater doctors and hospitals that invalid (p. 503)
additional property insurance agree to provide specified product costing the process of
that covers the damage or loss medical services to members at analyzing all costs involved in
of a specific item of high value prearranged fees (p. 455) creating products (p. 702)
(p. 420)
preferred stock a type of stock product cost-plus pricing
point-of-sale terminals elec- that gives the owner the the process of determining an
tronic cash registers (p. 683) advantage of receiving cash item’s selling price by adding
point-of-sale transaction a dividends before common the invoice cost of the item
purchase by a debit card of a stockholders receive cash (how much the business paid
good or service at a retail store, dividends (p. 250) for the item) to a certain per-
a restaurant, or elsewhere premium the fee a policyholder centage of that cost (p. 699)
(p. 127) pays for insurance (p. 412) profit the amount of money
point-of-service (POS) plan present value the amount of earned over and above the
a health insurance plan that money you would need to amount spent to keep the
combines features of both deposit now in order to have business operating (p. 550)
HMOs and PPOs (p. 455) a desired amount in the future
(p. 22)
754 Glossary
projected financial state- replacement value the full cost security deposit an amount
ments statements that of repairing or replacing an of money paid to the owner
predict the financial position item (p. 426) of the property by a tenant to
of a business in the months reserve capital money that is guard against any financial
and years to come (p. 579) set aside for unexpected costs loss or damage that the tenant
property damage liability or opportunities (p. 585) might cause (p. 208)
motor vehicle insurance that reserve fund money that can serial bonds bonds that are
applies when you damage the be made available for the issued at the same time but
property of others (p. 432) future expansion of a business mature on different dates
prospectus a document that (p. 614) (p. 309)
discloses information about a résumé one- or two-page sum- service a task that a person or
company’s earnings, assets mary of your education, a machine performs for you
and liabilities, its products or training, experience, and (p. 11)
services, a particular stock, qualifications (p. 45) service contract a separately
and the qualifications of its purchased agreement by the
management (p. 263) retained earnings profits that
a company reinvests (p. 249) manufacturer or distributor to
public corporation a company cover the costs of repairing an
that sells its shares openly in risk the chance of loss or injury item (p. 103)
stock markets, where anyone (p. 412)
service industries businesses
can buy them, also called a that provide services for a fee
“publicly held corporation” (p. 39)
(p. 272) S
simple interest the interest
safe-deposit box a small, secure computed only on the
storage compartment that you principal, the amount that you
R can rent in a bank (p. 63) borrow (p. 167)
rate of return the percentage salary a fixed amount of money sinking fund a fund to which a
of increase in the value of your paid to an employee for each corporation makes deposits for
savings from earned interest pay period, regardless of the the purpose of paying back a
(p. 135) number of hours worked bond issue (p. 308)
real estate land and any (p. 667) Small Business Administra-
structures that are on it, such savings and loan association tion (SBA) an indepen-
as a house or other building, (S&L) a financial institution dent agency of the federal
that a person or family owns that traditionally specialized government that offers
(p. 67) in savings accounts and mort- assistance to people who are
rebate a partial refund of the gage loans but now offers starting small businesses and
price of a product (p. 100) many of the same services as to those who want to expand
commercial banks (p. 130) existing businesses (p. 625)
refinance obtaining a new mort-
gage to replace an existing one secured loan a loan that is Small Business Investment
(p. 223) backed by collateral (p. 622) Companies (SBICs) private
securities all the investments investment firms that work
registered bond a bond regis- with the SBA to provide
tered in the owner’s name by that are bought and sold on
the stock market, including longer-term funding for small
the company that issues the businesses (p. 628)
bond (p. 310) stocks, bonds, mutual funds,
options, and commodities small claims court a court
renters insurance a type of (p. 272) that deals with legal disputes
insurance that covers the loss that involve amounts below a
of a tenant’s personal property securities exchange a market-
place where brokers who repre- certain limit (p. 109)
as a result of damage or theft
(p. 208) sent investors meet to buy and
sell securities (p. 291)
Glossary 755
small-cap stock stock issued stop-payment order a request tax liability the total amount
by a company with a capitali- that a bank or other financial of taxes owed (p. 380)
zation of $500 million or less institution not cash a particular taxable income adjusted gross
(p. 280) check (p. 143) income less any allowable tax
Social Security tax the tax that strategic plan a written outline deductions and exemptions
finances the federal programs of the business goals and the (p. 384)
that provide retirement, steps to take to achieve them tax-deferred income income
disability, and life insurance (p. 551) that is taxed at a later date
benefits (p. 671) supply the amount of goods and (p. 261)
sole proprietorship a business services available for sale (p. 14) tax-exempt income income
owned by one person (p. 524) surplus extra money that can be that is not taxed (p. 261)
specific identification method spent or saved, depending on tenant a person who pays for
an inventory costing method a person’s financial goals and the right to live in a residence
in which the exact cost of values (p. 72) owned by someone else
each item is determined and syndicate a temporary associa- (p. 202)
assigned to an item (p. 686) tion of individuals or business term insurance insurance that
speculative investment a firms organized to perform provides protection against
high-risk investment that a task that requires a large loss of life for only a specified
might earn a large profit in a amount of funds (p. 355) term, or period of time, also
short time (p. 243) called temporary life insurance
standard deduction an (p. 466)
amount of money set by the T
time value of money the
IRS that is not taxed (p. 384) increase of an amount of
T account a tool to increase or
standard of living a measure decrease each account that money due to earned interest
of quality of life based on the is affected by a transaction or dividends (p. 19)
amounts and kinds of goods (p. 640) title insurance a type of insur-
and services a person can buy ance that protects the buyer
(p. 32) take-home pay the amount
of income left after taxes and in case problems with the title
start-up capital the money other deductions are taken out are found later (p. 224)
required to start your business of your gross pay (p. 71) total gross earnings the
(p. 575) amount a business pays to
target profit the amount of net
start-up costs the costs or fees income that a business sets as all employees before any
involved in establishing your a goal (p. 711) deductions are taken out
business (p. 575) (p. 675)
target sales the number of units
statement of cash flows a a business needs to sell to total return a calculation
financial statement that reach a target profit (p. 711) that includes the annual
reports how much cash a dividend as well as any
business took in and where the tax audit a detailed examina- increase or decrease in the
cash went (p. 656) tion of your tax return by the original purchase price of an
IRS (p. 401) investment (p. 286)
stop-loss an insurance policy
provision that requires the tax credit an amount of money transaction any activity that
policyholder to pay all costs that can be subtracted directly has an effect on the financial
up to a certain amount, after from taxes you owe (p. 386) situation of a business (p. 561)
which the insurance company tax deduction an expense that trends developments that mark
pays 100 percent of the you can subtract from your changes in a particular area
remaining expenses covered in adjusted gross income to figure (p. 32)
the policy (p. 447) your taxable income (p. 384)
756 Glossary
trial balance a list of all the whole life insurance a
account names for a business V permanent policy for which
and their current balances you pay a specified premium
values beliefs and principles you
(p. 649) each year for the rest of your
consider important, correct,
trust an arrangement in which life (p. 467)
and desirable (p. 7)
a designated person known will a legal declaration of a
variable costs costs that change
as a trustee manages assets for person’s wishes regarding
in direct proportion to the
the benefit of someone else disposal of his or her estate
activity level of production
(p. 501) after death (p. 500)
(p. 703)
variable expenses expenses
U that may change (p. 580) Y
venture capital firm a
uninsured motorist’s protec- yield the rate of return, usually
company that provides private
tion insurance that covers stated as a percentage, earned
funding for small businesses
you and your family members by an investor who holds a
that need a substantial
if you are involved in an bond for a certain period of
amount of immediate cash
accident with an uninsured or time (p. 323)
(p. 628)
hit-and-run driver (p. 432)
vesting the right of an employee
unit pricing the use of a to keep the company’s con-
standard unit of measure- Z
tributions from company-
ment to compare the prices sponsored plans, such as zero-coupon bond a bond
of packages that are different pensions, even if the employee that does not produce interest
sizes (p. 100) no longer works for that (p. 311)
unlimited liability a situa- employer (p. 489)
tion in which the owner of
the business is responsible to
pay the business debts out of W
personal assets (p. 527)
warranty a written guarantee
unsecured loan a loan that
from the manufacturer or
does not require collateral
distributor that states the
from the borrower (p. 622)
conditions under which the
product can be returned,
replaced, or repaired (p. 101)
wealth an abundance of valua-
ble material possessions or
resources (p. 65)
Glossary 757
Index
Aggregate limits policy, 451 liabilities and net worth, 479
A Aggressive growth fund, 331 liabilities and owner’s equity,
ALF. See Assisted-living facility (ALF) 638–639, 649, 654
ABA. See American Bar Association
Allen, Paul, 532 reviewing, for retirement,
(ABA)
Allowance 480–481
Accidental death benefit, 470
claiming, 388 Assigned benefits, 449
Account
defined, 386, 670 Assigned risk pool, 436
defined, 638
American Bar Association (ABA), Assisted-living facility (ALF), 485
establishing, 638–640
110 ATMs. See Automated teller
rules of debit and credit, 640
American Bond Exchange, 313 machines (ATMs)
T account, 640
American Municipal Bond AT&T, 277
Account executive, 294–295
Assurance Corporation, 318 Audit, tax, 401
Accounting, 561, 563–567
American Stock Exchange (AMEX), Australia, 433
budgeting, 563
281, 291–292 Auto insurance declaration, 435
cash flow, 565–566
American Stock Exchange Index, Automated payroll preparation, 674
computerized posting, 659
264 Automated teller machines (ATMs),
defined, 561
Amortization, 221 126–127, 161
generally accepted accounting
Angel Capital Electronic Network Automobile insurance scams, 434.
principles (GAAP), 536,
(ACE-Net), 627 See also Motor vehicle insurance
565, 666
Annual interest, 21 Average inventory, 689
how used in business, 636
Annual percentage rate (APR),
inventory, 564
163–164
investments, 566–567
Annual percentage rate table for B
payroll, 565
monthly payments, 165
procedures (in case study), Back-end load fee, 329
Annual percentage yield (APY), 137
598–599 Balanced Budget Act of 1997, 456
Annual report, 283, 320–321,
transaction, 561 Balanced funds, 334
337–338. See also Prospectus
Accounting cycle, 636–649 Balance sheet, 654–655
Annuity, 248, 495–496
defined, 637 analyzing, 655
Apartment
steps of, 641–642, 644–648 defined, 81, 654
furnishing, 212
Accounting equation, 637–638, 654 projected, 583
renting, 200
Accounting period, 637 See also Personal balance sheet
selecting, 203
Accounting software, 656, 658–659 Balancing your checkbook, 145
sharing, 207
Accounting stationery, 644 Bank credit card, 157, 160
Apple Computer, 539
Accounting system Bank funding, 618–622
Application for business loan, 615
accounting assumptions, 637 commercial debt financing,
Appraisal, 226
accounting equation, 637–638 618–619
Appreciation of stock value, 273–274
purpose of, 636–638 commercial loan, 618, 620–621
APR. See Annual percentage rate (APR)
Accounting teacher, 639 lines of credit, 621
Aptitude, 34
Accounts payable, 640 secured and unsecured loans,
Aptitude test, 34
Accounts receivable, 639 622
APY. See Annual percentage yield
ACE-Net. See Angel Capital Bank reconciliation, 145
(APY)
Electronic Network (ACE-Net) Bankruptcy, 188–191
Arbitration, 108
Actual cash value method, 425–426 choosing lawyer for, 190
ARM. See Adjustable-rate mortgage
Add-on interest, 168 declaring personal, 188–191
(ARM)
Adjustable life policy, 468 defined, 188
Articles of incorporation, 534
Adjustable-rate mortgage (ARM), effects of, 191
Asset account, 640
222–223 in U.S., 189–190
Asset growth withdrawal, 344–345
Adjusted gross income, 384 Bank teller, 124
Assets, 66
Adjustments to income, 384 Barron’s, 262, 285, 319
collectible, 262
Advertising, 542, 556 Basic form (HO-1), 424
defined, 65
After-school activities, 40–41 Basic health insurance coverage,
identifying required, 575
Agency power, 529 446, 450
758 Index
Basic stock list, 690 Budget
Bearer bond, 310 defined, 74, 563
C
Bear market, 285 example of monthly, 76
Cafeteria-style employee benefits,
Beneficiary designation, for life how to, 79
49
insurance, 470 monthly worksheet, 12
Canada, 448
Beneficiary (estate), 499 to start savings program, 240
Cancellations and termination
Beneficiary (insurance), 464 Budget preparation, 74–79
provision, 450
Benefit limits provision, 450 estimate income, 84–85
Capital, 170, 250, 623, 640
Benefits. See Employee benefits for fixed expenses, 75
ability to raise, 536
BEP. See Bureau of Engraving and record what you spend, 77
available, 530
Printing (BEP) review spending and saving
case study, 592–593
Blank endorsement, 144 patterns, 77, 79
defined, 574
Blue-chip stock, 277 set financial goals, 74
determining, to start business,
Blue Cross, 453 for unexpected expenses, 75
612–616
Blue Shield, 453 for variable expenses, 75–77
determining required, 574
Board of directors, 273, 538–539 Budget summary, 77–78
equity, 250
Board of Governors of the Federal Budget variance, 77
operating, 579–584, 614
Reserve System, 184 Bull market, 285
reserve, 585–588
Bodily injury liability, 430–431 Bureau of Engraving and Printing
start-up, 575–578, 613
Bodily injury liability coverage, (BEP), 316
See also Limited capital
433–437 Bureau of the Public Debt, 321
Capital appreciation fund, 331
amount of, 434 Business
Capital gain, 34, 261, 340–341, 344
premium factors, 434, 436 creating, 576, 604–605
Capitalization, 279
reducing premiums, 436–437 determining capital to start,
Capital loss, 261–262
Bond indenture, 308 612–616
Career
Bond market requirements to start, 589
defined, 32
prices when interest rates go See also Funding, for business;
in science, 34
down, 247 Manufacturing business
See also Employment and
prices when interest rates go Business credit card, 627
entries for specific careers
up, 245–246 Business environment, 550
Career center, at school, 37
Bond mutual funds, 332–333 Business failure risk, 246
Career development, 50–53
Bond price quotation, 319–320 Business growth, 707-715
career paths and advancement,
Bond rating, 321–323 Business ownership, 524
52
Bond(s) forms of, 540–541
changing careers, 53
calculating yield of, separation of, and
stages of, 52
investment, 323, 325 management, 538–539
training opportunities, 51
determining investment values See also entries for specific
Career information sources, 41,
in, 319–325 types of business
43–44
issued by state and local ownership
Career planning, 32–39
governments, 317–318 Business plan
career decision trade-offs,
market value of, 311–312 case study, 589–591
32–33
methods corporations use to complete plan, 551
decision making and, 116–117
repay, 308–309 components of, 550–551
economic influences, 37
sources of information on, defined, 550
personal factors, 34
319–321 financial plan, 551, 556–560
plan of action, 36
See also Corporate bonds marketing plan, 556
social influences, 37
Bookkeeper, 566 setting goals, 552–553
stages of, 34–35
Bornstein, David, 521 steps to achieve goals, 553–554
training and skill development,
Borrowed money. See Loan strategic plan, 551–555
33
Borrowing, 124 strategic plan case study,
trends in industry and
Brand competition, 99 554–555
technology, 38–39
Branding, 99–100 Business Plan Pro, 558
Cash
Brazil, 333 BusinessWeek, 262, 285, 338
daily needs, 122–123
Bristol-Myers Squibb, 277 Buy-and-hold technique, 298
how to manage, 122
Broad form (HO-2), 424 Buying decisions, 90, 93–94
paying, for purchases, 96
Brokerage firm, 293, 312 Buying power, 90
sources of quick, 122
Buying stock on margin, 298
Index 759
Cash flow, 565–566 ChFC. See Chartered Financial Competition
defined, 70 Consultant (ChFC) brand, 99
negative, 565 Chief financial officer (CFO), 701 foreign, 37–38
payroll, inventory, and, 691 China, 259 price, 100–101
projected statement of, 584 Chronological résumé, 45–46 pricing among, 707
See also Statement of cash flows “Churning,” 294 Complaint letter, 107
Cash flow statement, 70–72 Class-action suit, 110, 183 Compounded rate of return, 137
Cashier’s check, 146 Class projects, 40–41 Compounding, 21–22, 136–137
Cash in Bank, 639, 647, 656, 677 Closed-end credit, 157 Comprehensive form (HO-5), 424
Cash inflows and outflows, 656–657 Closed-end fund, 327, 343 Comprehensive major medical,
Cash value, 467 Closely held corporation, 535, 541 447, 450
CCCS. See Consumer Credit Closing, 223–225 Comprehensive physical damage,
Counseling Service (CCCS) Closing cost, 223–225 433
CD. See Certificates of deposit (CD) CNN Fn (Financial), 262 Comptroller of the Currency, 184
Centex, 278 COB. See Coordination of benefits Condominium, 200, 211
Certificate of Doing Business Under (COB) provision Condominium association, 211
an Assumed Name (DBA), 525 COBRA. See Consolidated Omnibus Condominium owners insurance
Certificates of deposit (CD), 132– Budget Reconciliation Act of (HO-6), 424–425
133, 247 1986 (COBRA) Consolidated Omnibus Budget
Certified check, 146 Codicil, 504 Reconciliation Act of 1986
Certified Financial Planner (CFP), 3, Coinsurance, 447, 451–452 (COBRA), 445
258, 329 Colgate, William, 525 Consumable good, 11
CFO. See Chief financial officer Colgate-Palmolive, 525 Consumer, defined, 16
(CFO) Collateral, 166, 170, 623 Consumer agency assistance, 108
CFP. See Certified Financial Planner Collectible assets, 262 Consumer complaints, 104–111
(CFP) Collectibles, 363 complaint letter, 107
Chapter 7 Bankruptcy, 190–191 defined, 366 legal options for consumers,
Chapter 13 Bankruptcy, 190–191 fraud and, 368–369 109–111
Charity, 252 through Internet, 367 resolving differences between
Charles Schwab, 343 Collection agency, 187 buyers and sellers, 105–108
Chartered Financial Consultant Collision, 432–433 sources of, 104–105
(ChFC), 258 Commercial bank, 129, 158 U.S. Better Business Bureau,
Chart of accounts, 598 Commercial debt financing, 108
Check 21, 127, 141 618–619 Consumer credit, 154–161
Check, sample personal, 143 Commercial finance company, 628 advantages of, 156
Check clearing, 127, 141, 144 Commercial loan complaining about, 183–185
Checking account, 123–124, applications for, 622–624 credit uses and misuses, 154
139–141 defined, 618 defined, 154
activity accounts, 140 long-term, 621 disadvantages of, 156
check clearing, 144 short-term, 620–621 factors to consider before
fees and charges, 141 Commercial loan officer, 613 using, 155–156
interest, 141 Commercial property, 353 sources of, 157–161
interest-earning, 141 Commercial property manager, 359 types of, 157
keeping track of, 144–146 Commission, 294, 313–314, 669 See also Credit
making deposits, 144 Commission-only planners, 257 Consumer Credit Counseling
opening, 142 Common stock, 246, 248, 250 Service (CCCS), 187–188
questions about, 527 information regarding, 281 Consumer Credit Protection Act,
reconciliation, 145–146 why companies issue, 272–273 180
regular, 139 why investors purchase, Consumer credit protection laws,
restrictions, 141 273–275 180, 183–185. See also entries
sample personal check, 143 See also Stock(s) for specific laws
special services, 141 Common stock certificate, 296 Consumer Credit Reporting Reform
stop-payment order, 143 Community organizations, as career Act, 184
writing checks, 142–143 information source, 43 Consumer debt, 119
Checking account bank statement, Community-property states, Consumer demand, 35, 37
138 508–509 Consumer Federation of American
Check register, 142 Comparison shopping, 95 Insurance Group, 467
760 Index
Consumer finance company, 158 choosing form of ownership, Credit analyst, 49, 167
Consumer health information Web 543 Credit application, 172–173
sites, 459 defined, 534 Credit application information,
Consumer information, sources of, disadvantages of, 539 170
92–93 franchise, 542 Credit bureau, 174, 176–177
Consumer installment credit, limited liability, 542 Credit card, 96, 123, 159–161
154–155 starting, 534–535 bank, 157, 160
Consumer Leasing Act, 183 Cosigning, 182–183 business, 627
Consumer loan, 617 Cost behavior, 703 choosing and using, 160
Consumer myths, 93–94 Cost of living protection, 471 deciding on, 169
Consumer price index (CPI), 77 Cost of merchandise sold, 651 department store, 157
Consumer prices, 16–17 Cost-plus pricing, 707 history of, 174
Consumer Product Safety Costs interest charged on, 82
Commission, 108 classifying, 703-704 tips for business, 616
Consumer purchasing, 90–103 direct variable, 704 use of, 593, 611
after, 97 fixed, 704, 706, 711-712 Credit card statement, 171–172
factors influencing buying variable, 703, 711-712 Credit file, 174
decisions, 90–91 Counterfeit currency, 75 Credit history, 170, 623
making purchase, 96–97 County auditor, 356 Crediting, 154
researching, 91–97 County real estate valuation, 356 Credit life insurance, 468
smart buying strategies, 97–103 Coupon bonds, 310 Creditor, 154, 177
strategies to reduce taxes, 403 Coverage, 412 Credit rating, 157, 170, 178
timing purchases, 98 Coverdell Education Savings Credit report, 174–177
weighing alternatives, 95 Account, 492 credit bureau, 174
before you shop, 91–94 Cover letter, 45, 47. See also Résumé credit file, 174
Consumer records, 62 CPI. See Consumer price index (CPI) fair credit reporting, 175
Consumer Reports, 262, 429, 436 Credit, 640 incorrect information, 176
Consumer Resource Handbook, 107 applying for, 169–173 legal action, 177
Consumer spending, 16–17 bank cards, 157 time limits on unfavorable
Contractual savings plan, 343 being denied, 173 data, 176
Contribution margin, 705 billing errors and disputes, 178 who can obtain, 175
Contributions, 385 calculating cost of, 167–168 Credit services, 123
Controller, 593 closed-end, 157 Credit-shelter trust, 507
Convenience store, 98 complaining about, 183 Credit union, 130, 158
Conversion term policy, 467 cosigning for loan, 182–183 Cumulative preferred stock, 276
Convertible ARM, 222 cost of, 163–168 Currency exchange rate, 247
Convertible bond, 37 cost of open-end, 168 Current yield, 286
Convertible preferred stock, 276 costs and methods of Customers, as source of business
Cooperative, 99 obtaining, 162–177 growth, 709
Cooperative education, 40–41 credit cards, 159–161 Cyber auctions, 367
Cooperative housing, 211 defined, 154, 640 Cyclical stock, 278
Coordination of benefits (COB) department store, 157
provision, 445 equal opportunity and, 172
Co-payment, 449 five C’s of, 169–170, 622–623 D
Corporate bonds, 246, 248, 251 interest for using, 155
annual interest of, 307 keeping track of, 180–182 Daily cash needs, 122–123
methods used to repay, line of, 157, 621 DataDot technology, 433
308–309 loans, 159 Davis, Jacob, 530
sample transactions, 313–314 open-end, 157 DBA. See Certificate of Doing
types of, 306–307 protecting from theft of loss, Business Under an Assumed
where you can purchase, 180 Name (DBA)
312–314 protecting information on Deadlines and penalties, for income
why corporations sell, 309 Internet, 182 tax filing, 390–391
why investors buy, 310–312 rules of, 640 Death, 415
Corporate bylaws, 534 stolen identity and, 179–181 Debenture, 306
Corporate charter, 534 ways to build and protect, 175 Debit, 640
Corporation, 534–543 when to use, 154 Debit card, 126–127, 159, 161
advantages of, 536–539 See also Consumer credit; Debt
Index 761
Debt student, 424 Elective savings plan, 241
collection practices, 187 vehicle insurance, 436 Electronic banking services,
consumer, 119 Discount brokerage firm, 312 125–127
declaring personal bankruptcy, Discount coupon, 100 automated teller machines
188–191 Discount store, 98 (ATMs), 126–127
financial counseling services, Discretionary expenses, 12 automatic payments, 126
187–188 Discretionary income, 71 plastic payments, 127
signs of problems with, 186 Discrimination, 172 Electronic cash, 127
See also Credit Dispute resolution, 108 Eligibility provision, 449
Debt-payments ratio, 72 Diversification, 254, 326, 359 Emergency Banking Act of 1933,
Debt payments-to-income ratio Dividend and distribution 141
(DPR), 162–163 withdrawal, 345 Emergency fund, 238, 240
Debt ratio, 72 Dividend income, 383 Emergency road service coverage,
Decreasing term policy, 467 Dividend reinvestment plans, 298 433
Deductible, 414, 451–452 Dividends, 246, 261, 273 Employee benefits
Deduction Division of Consumer and measuring, 48–50
defined, 669 Community Affairs, 184 as part of estate, 510
itemized, 384–385 Dollar cost averaging, 298 Employee Retirement Income
to liabilities, 675–676 Dollarization, 106 Security Act of 1974 (ERISA),
See also Payroll deduction; Tax Double-entry accounting, 640 489
deduction Double indemnity, 470 Employee rights, 50
Deed, 224 Dow Chemical, 277 Employees, as source of business
Defensive stock, 278 Dow Jones Bond Average, 264 growth, 710
Deferred annuity, 496 Dow Jones Industrial Average, 264, Employee’s Withholding Allowance
Deficit, 72, 77 279 Certificate, 386
Defined benefits plan, 489 Dow Jones Spot Market Index, 264 Employer Identification Number
Defined-contribution plan, 488 Down payment, 96, 212, 218 (EIN), 525, 531
Demand, 14. See also Consumer DPR. See Debt payments-to-income Employer pension plan, 488–489,
demand ratio (DPR) 495
Demand deposit, 124 Dread disease policies, 449 Employer self-funded health plan,
Demographic trends, affecting Driver classification, 436 456
career, 35, 37 Duplex, 211 Employer’s payroll tax, 677–678
Dental expense, 384 Durable goods, 11 Employer-sponsored retirement
Dental expense insurance, 448 plan, 241
Department of the Treasury, 316, Employment
382 E applying for job, 45–47
Department store, 98 career information sources,
Department store credit card, 157 Earned income, 383 41, 43
Dependent, 385 Earned income credit (EIC), 386 considering job offer, 47–50
Depositing checks, 144 Earnest money, 217 identifying job opportunities,
Deposit institutions, 129–130 Earnings per share, 287–288 43–44
Diner’s Club, 174 Ebony, 525 obtaining experience, 40–41
Direct deposit, 125, 673–674 ECOA. See Equal Credit rights as employee, 50
Direct investment, 298, 352–354 Opportunity Act (ECOA) search strategies, 40–43
Direct labor, 704 Economic conditions, affecting See also Career; Job
Direct materials, 704 career, 35 Employment agencies, 44
Direct variable cost, 704 Economic factors Encyclopedia of Associations, 43
Disability, 415 affecting career, 37 Endorsement, 144
Disability income insurance, of financial planning, 14–18 Endowment life insurance, 468
460–463 Economics, 14 Entrepreneur, 524
needs, 463 Economy, 14 characteristics of, 610–611
sources of, 460–461 Ecuador, 106 defined, 610
through employer, 461 Education, 33. See also Training Equal Credit Opportunity Act
trade-offs, 462–463 Education IRA, 492 (ECOA), 172, 183
Disability insurance, 460–463, 677 Efficient theory, 290 Equifax, 174
Disclaimer trust, 508 EIC. See Earned income credit (EIC) Equity, 209
Discount, 311 EIN. See Employer Identification Equity capital, 250
home insurance, 428 Number (EIN) Equity income fund, 331
762 Index
ERISA. See Employee Retirement F FHA. See Federal Housing
Income Security Act of 1974 Administration (FHA)
(ERISA) Fields, Debbi, 525
Face value, 306, 311
Escrow account, 217, 224–225 Finance charge, 160, 163–164
Factory outlet, 98
Estate Finance company, 130–131
Fair Credit Billing Act, 178
defined, 499 Financial advisor, 69
Fair Credit Opportunity Act, 183
joint ownership, 509 Financial counseling services,
Fair Credit Reporting Act, 175, 184
life insurance and employee 187–188
Fair Debt Collection Practices Act
benefits, 510 Financial forecasting, 579
(FDCPA), 187
lifetime gifts and trusts, 510 Financial fraud, 392
Family of funds, 334
ownership, 508–509 Financial goals. See Goals
Fannie Mae. See Federal National
Estate administrator, 483 Financial habits, 14
Mortgage Association (Fannie
Estate and trust federal income tax, Financial information, sources of,
Mae)
511 8–9, 338
FDA. See Food and Drug
Estate planning, 499–510 Financial institutions, 15–16,
Administration (FDA)
defined, 499 122–131
FDCPA. See Fair Debt Collection
legal document, 500 comparing, 131
Practices Act (FDCPA)
life insurance and employee deposit institutions, 129–130
FDIC. See Federal Deposit Insurance
benefits, 510 Federal Deposit Insurance
Corporation (FDIC)
lifetime gifts and trusts, 510 Corporation (FDIC), 129
Federal Deposit Insurance
living will, 505–506 non-deposit institutions,
Corporation (FDIC), 129, 184,
ownership, 508–510 130–131
671, 677
taxes and, 510–513 your money and, 147
Federal Emergency Management
trusts, 506–508 Financial leverage, 358–359
Agency (FEMA), 423
wills, 499–505 Financial management, 561–567
Federal Home Loan Mortgage
Estate planning and retirement Financial market risk, 246
Corporation (Freddie Mac), 357
records, 62 Financial opportunity cost, 19–23
Federal Housing Administration
Estate tax, 381, 510 Financial plan, for business, 551
(FHA), 222–223
Estimated tax payments, 387–388 aspects of, 556, 558
Federal income tax, 669–670
Estonia, 619 background information, 591
Federal income tax return. See
E*Trade, 343 case study, 589–599
Income tax return
Exclusion, 383 elements of, 591
Federal Insurance Administration,
Exclusions and limitations identifying needed assets, 558
423
provision, 450 importance of, 574
Federal National Mortgage
Executor, 504 purchasing assets, 558–560
Association (Fannie Mae), 316,
Exemption, 385 recording and reporting
357
Exemption trust will, 501 business finances, 560
Federal Reserve Bulletin, The, 263
Expansion plan, for business, Financial planner, 2–3, 257–259
Federal Reserve Regulation DD, 137
713-714 certification of, 258
Federal Reserve System, 16–17, 135,
See also Business growth defined, 257
147, 183
Expected inflation, 168 selecting, 258
Federal savings bank, 158. See also
Expenses, 12, 70–71, 384 types of, 257
Savings and loan associations
budget for, 75–77 Financial planning. See
(S&L)
business, 703 Investment(s); Planning
Federal Trade Commission (FTC),
cutting office, 565 Financial records
182, 184, 187
income versus, 70–72 organizing, 60–64
Fee-and-commission planners, 257
for older households, 481 where to keep, 61–64
Fee-offset planners, 257
recording, 71 Financial report, 283–284, 636
Fee-only planners, 257
Schedule A, 392 Financial Security Assurance
Fees
See also Tax deduction and Corporation, 318
avoiding, 710
entries for specific expenses Financial services, 122–128
checking account, 141
Expensive loan, 159 opportunity costs of, 127–128
for mutual funds management,
Experian, 174 types of, 123–124
329
Express warranty, 101, 103 Financial services records, 62
savings plans, 139
Extended liability policy, 422 Financial statement, for business
FEMA. See Federal Emergency
Extended warranty, 103 balance sheet, 654–655
Management Agency (FEMA)
Extension, for filing tax return, 391
Index 763
computerized accounting, SBA Guaranteed Loan Program, Government bonds, 248, 251,
658–659 625–626 314–316
defined, 650–659 state and local, 628 Government consumer health
income statement, 650–653 venture capital firm, 628 information Web sites, 459
statement of cash flows, Future value, 21–23 Government financing program,
656–657 222–223
See also Personal financial Government health care programs,
statement G 456–459
Financing, for home purchase, Medicaid, 458
218–221. See also Funding, for GAAP. See Generally accepted Medicare, 456–457
business accounting principles (GAAP) Government National Mortgage
First-in, first-out costing method, Gates, Bill, 532 Association (Ginnie Mae), 357
687–688 GDP. See Gross domestic product Grace period, 160
Fixed annuity, 496 (GDP) Grantor, 506
Fixed costs, 704, 706, 711-712 Gemological Institute of America, Greece, 555
Fixed expenses, 71, 75, 580 364 Gross domestic product (GDP), 17
Fixed-rate loan, 166 General contractor, 526 Gross earnings, 667. See also Total
Fixed-rate mortgage, 221 General Electric, 277 gross earnings
Flexible expenses, 12 General ledger, 644–647 Gross earnings and overtime, 668
Floor broker, 295 defined, 645 Gross income, 383–384
Food and Drug Administration posting in, 646 Gross profit on sales, 652–653
(FDA), 459 Generally accepted accounting Group health insurance, 444–445
Forbes, 262, 338 principles (GAAP), 565, 636, Group life insurance, 468
Ford, 278 666 Growth
“For deposit only,” 144 General obligation bond, 317 challenges of, 714
Foreign competition, 35, 37–38 General partner, 528 importance of planning for,
Foreign investment, 258 Geographic trends, affecting career, 715
Formal will, 503 37 See also Business growth
Fortune, 262, 285 Germany, 423 Growth company, 278
401(k) plan, 261, 343 Gift giving, 367 Growth fund, 331
advantages of, 391 Gifts, 241 Growth stock, 248–249, 278
defined, 488–489 Gift tax, 381, 511–512 Guaranteed insurability option, 471
as employee benefit, 49, 241 Ginnie Mae. See Government Guaranteed renewable provision,
as popular payroll deduction, National Mortgage Association 450
672 (Ginnie Mae) Guardian, 504
for rollover IRA, 235 Global Entrepreneurship Monitor, Guernsey’s Auction House, 367
403(b) plan, 241, 261, 343, 489 521
France, 658 Global investment risk, 246–247
France Telecom, 658 Global mutual funds, 246–247 H
Franchise, 542 Global stock fund, 331
Fraud, 104–105 Goals Habits, financial, 14
financial, 392 defined, 6 Handbook of Common Stocks, 265
life insurance, 467 determining current, 6 Harvard Business Review, 262
Freddie Mac. See Federal Home developing, 6–7, 10–11, 13 Hazard, 412–413
Loan Mortgage Corporation evaluating alternatives, 7–9 Health care programs
(Freddie Mac) guidelines for setting, 13 government, 456–459
Free enterprise system, 550 identifying options, 7 private, 453–456
FTC. See Federal Trade Commission intermediate, 10 Healthfinder, 459
(FTC) outlining, 239 Health insurance
Full-service brokerage firm, 312 setting, 74 basic coverage, 446
Full warranty, 103 strategies for achieving, 24–25 choosing coverage, 450–452
Fundamental theory, 289 types of, 10–11 Consolidated Omnibus Budget
Funding, for business, 611–612 values and, 238 Reconciliation Act of 1986
business credit card, 627 Going public, 535 (COBRA), 445
commercial finance Gold, 361–362 defined, 444
companies, 628 Good dental expense, 448
private investors, 627 defective, 178 dread disease policies, 449
defined, 11 group, 444–445
764 Index
hospital indemnity policies, Homeowners insurance cost factors, rental, 261
447 426–429 tax-deferred, 261
individual, 445 company differences, 428–429 tax-exempt, 261
long-term care, 449 discounts, 428 Income dividends, 341, 344
major medical, 446–447 location of home, 427 Income fund, 331
major provisions in, 449–450 price, coverage amount, policy Income risks, 9
trade-offs, 451–452 type, 427–428 Income statement, 643, 650–653
vision care, 449 type of structure, 427 analyzing, 652–653
Health Insurance Portability and Home selling, 225–227 cost of merchandise sold, 651
Accountability Act of 1996, 444 choosing real estate agent, 226 defined, 650
Health Maintenance Organizations determining selling price, 226 gross profit, 652
(HMO), 453–455 preparing home for, 225 net income, 652
Heirs, 498 sale by owner, 227 revenue, 651
High-risk mortgage, 357 Hospital and medical services plan, Income stock, 277
High-yield (junk) bond fund, 332 453 Income tax, 380–388
HMO. See Health Maintenance Hospital expense coverage, 446 adjusted gross income, 384
Organizations (HMO) Hospital indemnity policies, 447 calculating, 385–386
Holographic will, 503 Houghton, Amory, 525 determining how much you
Home Hourly wage, 667–668 owe, 383–386
investment, 352 Household inventory, 420 gross income, 383–384
owning, 200, 232–233 Housing state and local, 672
renting, 200 retirement relocation pitfalls, taxable income, 384–385
vacation, 353 482–484 See also Federal income tax
Home buying, 209–225 review, for retirement, 480 Income tax return, 383, 389–400
affordability and needs, 212 Housing information services, choosing tax form, 391–392
benefits of owning, 209 200–201 completing Form 1040A, 396
closing transaction, 223–225 Housing loan, 172 completing Form 1040EZ,
disadvantages of owning, 210 Housing options, 198–201 393–396
elements of, 224–225 evaluating alternatives, 199– completing state, 400
finding and evaluating 200 deadlines and penalties,
property, 213, 215 information sources, 200–201 390–391
obtaining financing, 218–221 opportunity costs of, 198–199 filing, 397
pricing property, 215, 217 renting, 202–208 gathering information and
types of housing, 210–212 renting versus buying, 199–200 documents, 392
types of mortgages, 221–225 Housing records, 62 W-2 Form, 389–392
Home computer, 62, 64 How to Change the World: Social who must file, 389–390
Home Depot, 278 Entrepreneurs and the Power of Incontestability clause, in life
Home equity loan, 159, 223 New Ideas, 521 insurance, 470
deduct interest on, 403 HUD. See U.S. Housing and Urban Indemnity policy, reimbursement
personal financing and, Development (HUD) versus, 451
617–618 Human resources, 527 Index fund, 331
Home health care agency, 455 Hurricane Charley, 417 India, 15
Home inspection, 215–216 Hypermarket, 98 Indirect investment, 354–359
Home insurance policy forms, Individual health insurance, 445
424–425 Individual retirement account
Home investment, 352 I (IRA), 383–384, 405
Homeowners insurance, 419–424 Education IRA, 492
additional living expenses, 419 Identity theft, 179–180 federal income tax and, 261
buildings and other structures, Illiquidity, 359 as part of payroll deduction
419 Immediate annuity, 496 plan, 343
defined, 419 Implied warranty, 101 regular, 490, 492
how much you need, 425–426 Impulse buying, 99–100 rollover, 491–492
personal liability and related Income, 71 Roth IRA, 490, 492
coverages, 421–422 defined, 70 Simplified Employee Pension
personal property, 420 from dividends, 273 (SEP) plan, 490, 492
specialized coverages, 423–424 estimate, 74–75 Spousal IRA, 491–492
interest, 261, 310–311 withdrawals, 493
Index 765
Industry trends, affecting career, 35, tax audits and, 401 Investment period liquidation,
38–39 tax tables supplied by, 670 344–345
Inexpensive loan, 159 Web site, 402, 487 Investment period withdrawal,
Inflation, 37, 139, 358–359 International fund, 331 344
bond market prices and, International investments, 247 Investment records, 62
245–246 International Monetary Exchange, Investment(s), 250–253
defined, 16–17 164 accounting and, 566–567
expected, 168 Internet commercial property, 353
investments and, 245 bond information, 321 developing plan for, 255–256
over time, 482 career information, 43 direct, 352–354
precious gems and, 363–364 buying and selling bonds on, diversification, 254
Inflation risk, 9, 244–245 312 evaluating your own, 260
Informational interview, 43 collectibles on, 367 foreign, 247, 258
Inheritance, 241 courses in finance education home, 352
Inheritance tax, 381, 511 on, 621 income from, 247–248
Initial public offering (IPO), 291 government consumer health keeping accurate records of,
Insolvency, 69 information Web sites, 459 261
Inspection report, 216 investment information, 262 land, 354
Insurance, 240, 412, 414. See also mutual funds information, 340 managing your own, 259–262
entries for individual insurance protecting credit information monitoring your own, 260
policies on, 182 to reduce taxes, 403
Insurance agent, 458 shopping on, 543 review, for retirement, 481
Insurance claims adjuster, 428 stock information, 280–281 safety and risk, 243–247
Insurance company, 412 virtual home tours, 205 sources of money for, 239–241
Insurance goals, setting, 415 Internet Fraud Watch, 368 tax considerations, 261–262
Insurance program, planning, Internet service provider (ISP), 262 tax-deferred, 403
415–416 Internship, 40–41 tracking stock, 273–274
Insurance records, 62 Interview, 45 value of long-term program,
Insured, 412 Inter vivos trust, 508 242
Insured municipal bond, 318 Intestate, 501 See also Savings and entries for
Insured municipal bond fund, 332 Inventory, 680–691 specific investments
Intangible goods, 11 amount of, 564 Investment services, 123
Intel, 292 analyzing, turnover, 688–690 Investment strategies, 297–299, 403
Interest, 21, 155, 167–168, 384 causes of shortage in, 684 Investment theories, 289–290
bond’s annual, 307 choosing costing method, 688 Investor services, 265
calculating, 20 defined, 564 IPO. See Initial public offering
defined, 17–18 determining cost of, 686–688 (IPO)
See also Simple interest determining how much, IRA. See Individual retirement
Interest and Dividend forms, 682–684, 686 account (IRA)
392–393 establishing system for, IRA rollover, 235
Interest compounded monthly, 136 680–681 IRC. See Internal Revenue Code
Interest income, 261, 310–311, 383 household, 420 (IRC)
Interest inventory, 34 importance of controlling, 682 Irrevocable trust, 507
Interest rate risks, 245–246 number of days in stock, 690 IRS. See Internal Revenue Service
defined, 9 payroll, and cash flow, 691 (IRS)
lender versus, 165–166 Inventory losses, 684 IRS e-file provider, 397
Interest rate(s), 17–18 Inventory turnover, 688–690 IRS Form 1040, 383, 392
affecting career, 37 Investment advisor. See Financial IRS Form 4868, 391
charged on credit card, 82 planner IRS Form 1040A
as economic condition Investment analyst, 252 completing, 396
affecting career, 35 Investment assets, 66, 68 defined, 391–392
Intermediate corporate bond fund, Investment bank, 291 IRS Form 1099DIV, 341
332 Investment company, 130 IRS Form 1040EZ, 383–384
Intermediate financial goals, 10 Investment-grade bonds, 323 completing, 393–396
Intermediate U.S. bond fund, 332 Investment growth, 248–249 defined, 391
Internal limits, 449, 451 Investment information, sources sample, 394–395
Internal Revenue Code (IRC), 678 of, 262–265. See also Financial IRS Form SS-4 Application for
Internal Revenue Service (IRS), information, sources of Employer Identification
382–383, 487 Investment liquidity, 249 Number (EIN), 531
766 Index
IRS Form W-2, 389–392, 404 Liabilities account, 640, 646 Local zoning laws, 215
IRS Form W-4, 42, 386–688 Liability insurance, 417–418 London Stock Exchange (LSE),
ISP. See Internet service provider Liability risk, 413, 415 279
(ISP) Life expectancy, 465 Long-term care insurance, 449
Israel, 164 Life insurance, 50, 464–471 Long-term commercial loan,
Itemized deduction, 384–385 credit life, 468 620–621
defined, 464 Long-term corporate bond fund,
endowment, 468 332
J fraud and, 467 Long-term financial goals, 10
group life, 468 Long-term U.S. bond fund, 332
Japan, 38 key provisions in, 468–471 LowDoc Program, 626
Job, defined, 32. See also Career; need for, 465 Low-liquidity investment, 249
Employment as part of estate, 510 LSE. See London Stock Exchange
Job advertisements, 43 principle of, 464 (LSE)
Job application process, 45–47 purpose of, 464
Job description, 562 review, for retirement, 480
Job fair, 44 riders to, 470–471 M
Job offer term insurance, 466–467
factors affecting salary, 48 whole life, 467–468 Major medical expense insurance,
measuring employee benefits, Life insurance company, 130, 158 446–447
48–50 Life insurance policy statement, Managed care, 453
work environment, 47–48 469 Manufacturing business
Johnson, John, 525 Life planner, 2 costing and pricing in,
Joint ownership, 509 Life situations, 13–14 701–702
Joint tax return, 384 Lifetime gifts and taxes, 510 defined, 701
Journal, 644 Limited capital, 527 Margin of safety, 713
Journalizing, 644 Limited human resources, 527 Market crash, stock, 292
Limited liability, 536–537 Marketing plan, 591
Limited liability company (LLC), Market orders, 294
K 542 Market research, 557
Limited life, 528 Market share, business growth and,
Kellogg, 277 Limited partner, 529 710
Keogh plan, 493 Limited partnership, 355, 358 Market value, 67
Kiplinger’s Personal Finance, 262, Limited payment policy, 467 Market value of bond, 311
285, 338 Limited warranty, 103 Markup, 699-700
Limit orders, 296–297 Mass media, as career information
Lines of credit, 157, 621 source, 43
L Linn’s Trends of Stamp Values, 264 Maternity ward, 446
Lipper Analytical Services, 340 Maturity date, 132, 135, 306
Label information research, 100 MBA Wizard, 535, 579
Lipper Mutual Funds Index Mutual
Labels, 100 MBIA, Inc., 318
Funds, 264
Land, 354 MCI, 292
Liquid assets, 66–67
Landlord, 202 Mediation, 108
Liquidity, 139
Large-cap fund, 331 Medicaid, 456, 458
Liquidity ratio, 72
Large-cap stock, 279 Medical expense, 384
Liquidity risks, 9
Last-in, first-out costing method, Medical payments coverage, 422,
Living expenses, for retirement,
688 431–432
481–482
Layaway plans, 403 Medicare, 456–457
Living trust, 508
Lease, 205–206 Medigap, 457
Living will, 505–506
Legal aid society, 111 what is not covered by, 457
LLC. See Limited liability company
Lender risk versus interest risk, Medicare finance, 456
(LLC)
165–166 Medicare tax, 669, 671, 675
Load fund, 328
Letter of last instruction, 506 Medium-priced loan, 159
Loan, 159
Levi’s, 530 MedlinePlus, 459
cosigning for, 182–183
Liabilities, 66, 68 Mentor, 52
defined, 162
assets, and net worth, 479 Merchandise, 564, 681. See also
fixed-rate, 166
assets, and owner’s equity, Inventory
home equity, 223
638–639, 649, 654 Merchandise pricing, 699–700. See
secured, 166
See also Personal liability also Pricing
See also entries for specific loans
Index 767
h
Mergent’s Handbook of Common Motor vehicle property damage Net cash flow, 71–73
Stocks, 283 coverages, 432–533 Netherlands, 537
Mexico, 491 Mrs. Fields Cookies, 525 Net income, 162–163, 652
Micro-cap fund, 332 Multiunit dwelling, 211 Networking, 43–44
Microsoft, 292, 532 Multiyear level term policy, 466 Net worth, 65, 68–69
Microsoft tax collection software, Muni. See Municipal bond (muni) assets, liabilities, and, 479
383 Municipal bond fund, 332 calculator for, 63
Mid-cap fund, 331 Municipal bond (muni), 43, Never-out list, 690
Minimum monthly payment trap, 317–317 New cash flow, 70–73
168 Music CDs, listening before buying, New England Education Loan
Mixed bond funds, 333–334 298 Marketing Corporation (Nellie
Mobil Corporation, 308 Mutual agency, 529 Mae), 358
Mobile home, 212 Mutual fund account statement, New Residential Sales Index, 264
insurance for, 425 324 Newspaper
owning, 200 Mutual fund prospectus, 337 as career information source,
Mobility, 198 Mutual funds, 130, 246–248, 341 43
Model stock list, 690 buying and selling, 342–345 as information source for
Money, 262, 285, 338 categories of, 330–334 mutual funds, 336
Money management, 60 defined, 251–252, 326 as source for stock information,
Money management records, 62 information on, 335–340 281
Money market account, 133–134 investing in, 335–345 New York Bond Exchange, 313
Money market fund, 334 management and other fees, New York Stock Exchange Index,
Money order, 146 329 264
Money-purchase plan, 488 purchasing options, 343–344 New York Stock Exchange (NYSE),
Money supply, 16–17 return on investment, 340 281, 291–292, 295–296
Monthly budget worksheet, 12 taxes and, 341–342 NFCC. See National Foundation for
Moody’s Bond Survey, 322 types of, 327–329 Consumer Credit (NFCC)
Moody’s Investors Service, 283, why investors buy, 326 NIH. See National Institute of
322–323 withdrawal options, 344–345 Health (NIH)
Morningstar, Inc., 339–340 Mutual funds annual report, No-fault system, 433
Morningstar Mutual Funds, 265 337–338 No-load fund, 329
Mortgage Bankers Association of Mutual savings bank, 130 Non-deposit institutions, 130–131
America, 352 Nonprofit credit counseling
Mortgage bond, 307, 309 services, 188
Mortgage company, 131 N NYSE. See New York Stock Exchange
Mortgage payment, 214 (NYSE)
Mortgage(s), 157, 217 NASDAQ, 292–293
application process, 221 NASDAQ Composite Stock Index,
comparing points, 220 264 O
defined, 218 National Credit Union
interest rates, 219 Administration, 184 Occupational Outlook Handbook, 41
paying points, 219–220 National Flood Insurance Program, Occupational Outlook Quarterly
qualifying for, 218–219 423 Online, 41
types of, 221–225 National Foundation for Consumer Office expenses, 565
Motor vehicle bodily injury Credit (NFCC), 188 Office of Thrift Supervision, 184
coverage National Institute of Health (NIH), O*NET Dictionary of Occupational
bodily injury liability, 430–431 459 Titles, 41
medical payment coverage, National Security Survey Final Report, Online. See Internet
431–432 684 Online virtual home tours, 205
Motor vehicle insurance NAV. See Net asset value (NAV) Open dating, 100
bodily injury coverage, 430–432 Need, defined, 7 Open-end credit, 157
costs, 433–437 Negative cash flow, 565, 691 Open-end mutual fund, 327–328,
emergency road service Negligence, 413 343
coverage, 433 Nellie Mae. See New England Operating capital, 579–584
no-fault system, 433 Education Loan Marketing defined, 579
property damage coverage, Corporation (Nellie Mae) projected balance sheet, 583
432–433 Nest egg, using, 497–498 projected income statement,
rental reimbursement, 433 Net asset value (NAV), 328–329 579–582
768 Index
projected statement of cash Payroll deduction, 669–672 Plastic payment, 127
flows, 584 required by law, 669–672 Platinum, 361
Operating costs, 614 voluntary, 672 PMI. See Private mortgage insurance
Opportunity costs, 19–25 Payroll deduction plan, 343 (PMI)
achieving financial goals, Payroll register, 673 Point-of-sale terminal, 683–684
24–25 Payroll savings deduction, 82–83 Point-of-sale transaction, 127
defined, 8 Payroll withholding, 386 Point-of-service (POS) plan, 455
financial, 19–23 Pay to the order of, 144 Points, 219–220
of financial services, Pay yourself first, 10, 82, 239 Policy, 412
127–128 PC. See Participation certificate (PC) Policyholder, 412
money management and, PDA. See Personal Digital Assistant Portfolio, 275, 294
60–61 (PDA) POS. See Point-of-service (POS)
personal, 19 PE. See Price-earnings (PE) ratio plan
Orders for stocks, types of, 294–297 Penny stock, 280 Posting, 646, 659
Out-of-pockets limits, 452 Pension plan, 49 Potential earning power, 33
Overdraft protection, 141 Peril, 412–413 Power of attorney, 506
Over-the-counter market, 292, 327 Periodic inventory system, 684, 686 PPO. See Preferred Provider
Overtime rate, 668–669 Perpetual inventory system, Organization (PPO)
Owner’s equity, 638–640, 646, 649, 682–684 Precious gems, 363–35
654 Personal and employment records, Precious metals, 361. See also Gold
Ownership. See Business ownership 62–63 Prefabricated home, 211
Personal balance sheet, 65–66, 81 Preferred Provider Organization
Personal banker, 11 (PPO), 453, 455
P Personal bankruptcy. See Preferred stock, 246, 248, 250–251
Bankruptcy why corporations issue, 275
Palladium, 361 Personal catastrophe policy, 422 why investors purchase,
Parent corporation, 542 Personal check, sample of, 143 275–276
Participation certificate (PC), Personal Digital Assistant (PDA), 244 Premium, 412, 427
357–360 Personal financial planning, 6 bond selling at, 311
Participation feature, 276 Personal financial statement, 587 defined, 308
Partnership, 250, 540, 542 calculate net worth using, reducing vehicle insurance,
advantages of, 529–530, 532 72–73 436–437
defined, 528 cash flow statement, 70–72 Prepaid card, 127
disadvantages of, 532–533 defined, 65 Prepaid travelers card, 146
Partnership agreement, 528 personal balance sheet, 65–69 Present value, 22–23
Part-time work, 40 Personal financing, 616–618 Price competition, 100–101
Par value, 275 consumer loan, 617 Price-earnings (PE) ratio, 287–288
Passbook account, 132 home equity loan, 617–618 Price negotiation, 96–97
Passbook savings account, 249 Personal identification number Pricing, 100–101
Patriot Bond, 134 (PIN), 126–127, 180 adjusting, 700
Paycheck, 673–674 Personal income tax, 381 among competition, 707
Paycheck stub, 685 Personal liability, 421–422 defined, 698
Payment services, 124 Personal opportunity cost, 19 goals of, 698
Payroll, 565, 666–679 Personal possessions, 66–67 for selling, 705
calculating deductions, Personal property floater, 420 See also Merchandise pricing
669–672 Personal retirement plan, 490–493 Primary market, 291, 313
calculating gross earnings, Personal risk, 9, 413 Principal, 20–21
h667 Personal values. See Values Privacy Rights Clearinghouse, 182
defined, 666 Physician expense coverage, 446 Private corporation, 272
employer’s payroll taxes, PIN. See Personal identification Private financing, 618
677–678 number (PIN) Private health care plan, 453–456
inventory, cash flow, and, 691 Planning, 25 Private income insurance program,
preparing paychecks, 673–674 economic factors, 14–18 461
preparing records, 672–673 influence on personal Private insurance company, 453
recording information, financial, 14–18 Private investor, 627
675–677 life situations and personal Private mortgage insurance (PMI),
reporting information to values, 14 218
government, 678 See also Career planning Probate, 503, 506
Index 769
Procter & Gamble, 278 choosing, 226 public pension plans,
Product costing, 702 hiring, 215 486–488
Product cost-plus pricing, 699 Real estate investment, 352–360 using your nest egg, 497–498
Product development, as source of advantages of, 358–359 Veterans Administration, 488
business growth, 710 direct, 352–354 working during retirement,
Product label. See Labels disadvantages of, 359–360 497
Professional organizations, as career Real Estate Investment Trust Retirement planning, 478–485,
information source, 43 (REITS), 248, 355, 357, 359–360 518–519
Profit, 526, 550, 563, 652, 710 Real estate property tax, 381 conducting financial analysis,
Profit planning, 711-714 Real estate syndicate, 355 479
Profit-Sharing Plan, 488 Rebate, 100 housing, 482–485
Projected balance sheet, 583 Reconciliation, 145–146 living expenses, 481–482
Projected financial statement, 579 Redlining, 172 reviewing assets, 480–481
Projected income statement, Refinance, 223 setting long-range goals, 479
579–582 Refund, tax, 388, 391 Retirement plans, 405. See also
Projected Retirement Budget Regional fund, 332 entries for specific plans
Worksheet, 494 Registered bonds, 310 Retirement relocation pitfalls,
Projected statement of cash flows, Regular account transaction, 343 482–484
584 Regular IRA, 490, 492 Return on investment, 341
Property damage liability, 432 Regular savings account, 132–133 Revenue, 651
Property insurance, 417 Reimbursement versus indemnity Revenue bond, 317
Property loss, 415 policy, 451 Revocable trust, 507
Property risk, 413 Reinvestment plan, 344 Rhodium, 361
Property value, declining, 359 REITS. See Real Estate Investment Riders, to life insurance policies,
Prospectus, 263, 283 Trust (REITS) 470–471
Public assistance, 172 Renewable term policy, 466 Right of survivorship, 509
Publication 554, Older Americans’ Rental income, 261 Rights
Tax Guide, 487 Rental reimbursement coverage, 433 employee, 50
Publication 915, Social Security and Renters insurance, 208, 424 privacy, 182
Equivalent Railroad Retirement Renting voting, 275
Benefit, 487 advantages of, 204 Risk assumption, 414
Public corporation, 272 versus buying, 199–200 Risk avoidance, 413–414
Publicly held corporation, 535, 541 cost of, 207–208 Risk-management methods,
Public pension plans, 486–488 disadvantages of, 205 413–416
Social Security, 486–487 finding and living in rental Risk reduction, 414
Veterans Administration, 488 housing, 207 Risk(s), 412–413
Purchasing. See Consumer selecting residence, 202–203 from business failure, 246
purchasing Repayment at maturity, 312 defined, 412
Purchasing agent, 667 Replacement value, 426 financial market, 246
Reserve capital, 585–586, 588 global investment, 246–246
Reserve funds, 567, 614 income, 9
Q Residence. See Housing options inflation, 9, 244–245
Restrictive endorsement, 144 interest rate, 9, 245–246
Quick cash, 159 Résumé, 45–46 lender versus interest,
Quick cash, sources of, 122 Retailers, types of, 98–99 165–166
Quicken, 7 Retail pricing methods, 699 liquidity, 9
Quotations, 336 Retail sales associate, 109 personal, 9
QuoTrek, 244 Retained earnings, 249 reducing, 257–262
Retirement income, 486–498 safety in investment decisions
annuities, 495–496 and, 243–244
R
employer pension plans, understanding, 9
Rate cap, 222 488–489 See also entries for specific risks
Rate of return, 135–137 limits on, 493 Risk shifting, 414
Rating territory, 434 living on, 496–498 Rollover IRA, 491–492
Real estate, 66–67, 252 personal retirement plans, Roth IRA, 490, 492–493
Real estate agent 490–493 Russia, 586
career as, 213
770 Index
Secured bond, 307. See also Small-cap fund, 331
S Mortgage bond Small-cap stock, 280
Secured loan, 166, 622 Small claims court, 109
Safe-deposit box, 62–63 Securities, 272, 314–316 Smart card, 161
Safety and risk, of investment Securities and Exchange Smart Money, 262, 285
decisions, 243–244 Commission (SEC), 258, 321 Smart Phone, 244
SAIF. See Savings Association Securities exchange, 291 Smart shopping, 97
Insurance Fund (SAIF) Security deposit, 208 brand competition, 99
Salaries expense account, 675 Self-insurance, 414 label information research, 100
Salary, 667 Selling price, 705 price competition, 100–101
factors affecting, 48 Selling short, 298–299 store selection, 99
plus commission, 669 SEP. See Simplified Employee timing purchases, 98
Sale by owner, 227 Pension (SEP) plan warranty evaluation, 101, 103
Sale proprietor, 250 SEP-IRA. See Simplified Employee Social entrepreneur, 521
Sales, as source of business growth, Pension (SEP) plan Social influences, affecting career,
710 Serial bond, 309 35, 37
Sallie Mae. See Student Loan Series EE Savings Bond, 134–135, Social Security, 241
Marketing Association (Sallie 315 dependent eligibility, 487
Mae) Series HH Bond, 135 long-term disability and,
Saudi Arabia, 382 Series I Savings Bond, 316 460–461
Saving patterns, 77, 79 Service retirement benefits, 487
Savings, 123, 416, 447 defective, 178 taxes for, 381–383, 486, 669,
credit card use, 593 defined, 11 671, 675, 677
dollar-a-day, 261 Service benefits provision, 450 who is eligible, 486
goals and values, 238–239 Service contract, 103 Social Security Administration, 182,
loose change, 144 Service industry, 39 486
mind-set for, 310 Services, 328 calculator, 488
money to get started, 239–241 Share account, 132 Web site, 487
non-smokers and health Shopping Software
insurance, 456 for clothes, 95 for accounting, 656, 658–659
performing financial check up, online, 99 online virtual home tours, 205
239–240 for used car or van, 575 for personal expenses, 7
ways to increase, 79–80, 82–83 Shorter term, 166 smart, 535
Savings account, 132–133, 142, 247 Short-term commercial loan, for tax collection, 383
Savings and loan associations 620–621 for tax preparation, 401
(S&L), 130 Short-term corporate bond fund, for writing business plan, 558
Savings Association Insurance Fund 332 Sole proprietorship, 540, 542
(SAIF), 129 Short-term financial goals, 10 advantages of, 525–527
Savings bond. See U.S. Savings bond Short-term techniques, 298–299 defined, 524
Savings plans Short-term U.S. bond fund, 333 disadvantages of, 527–528
evaluating, 135–139 Silver, 361 Sonny Mae. See State of New York
restrictions and fees for, 139 Simple interest, 166–167 Mortgage Agency (Sonny Mae)
types of, 132–135 Simple will, 501 Sotheby’s Art Sales Index, 264
worksheet for, 253 Simplified Employee Pension (SEP) Source document, 641
Savings ratio, 72 plan, 490, 492 South Africa, 365
SBA. See Small Business Singapore, 676 South Korea, 80
Administration (SBA) Single-family dwelling, 210 Southwest Airlines, 278
SBCs. See Small Business Investment Single-premium deferred annuity, Spain, 220
Companies (SBCs) 496 Special endorsement, 144
Schedule A, 392. See also Expenses Sinking fund, 308 Special form (HO-3), 424
School guidance office, as career Skill development, career, 33 Specialty store, 98
information source, 43 Skills résumé, 45–46 Specific identification costing
Science, careers in, 34 S&L. See Savings and loan method, 686
Seaside Production, 309 associations (S&L) Speculative investment, 243, 248
SEC. See Securities and Exchange Small Business Administration Speculative risk, 413
Commission (SEC) (SBA), 559, 587, 625 Spending patterns, 77, 79
Secondary market, 291–292, 313 Small Business Investment Spousal IRA, 491–492
Sector fund, 332 Companies (SBCs), 628 Standard deduction, 384
Index 771
Standard of living, 32 case study, 554–555, 590–591 Tax payment, 386–388
Standard & Poor’s, 340 defined, 551 estimated payments, 387–388
Standard & Poor’s Stock and Bond setting goals, 552–553 payroll withholding, 386
Guide, 283, 322 steps to achieve goals, 553–554 Tax preparation software, 401
Standard & Poor’s 500 Stock Index, Student discounts, 424 Tax preparer, 390
264–265, 331 Student Loan Marketing Tax rate, 42
Stanford Innovation Review, 521 Association (Sallie Mae), 357 Tax records, 62
Start-up capital, 575 Subordinated debenture, 309 Tax Reform Act of 1986, 355, 360
assigning, to identified items, Suicide clause, in life insurance, 470 Tax refund, 388, 391
577–578 Superstore, 98 Tax return, 392. See also Income tax
determining, 612–613 Supply, 14 return
identifying start-up costs, 577 Surgical expense coverage, 446 Tax shelter, 360
statement of start-up capital, Surplus, 72, 77 Tax-sheltered annuity (TSA), 489
578 Survey of Current Business, 263 Tax strategies, 403–405
Start-up cost, 613 Switzerland, 140 changing, 405
assigning, to identified items, Syndicate, 355, 358–360 consumer purchasing, 403
577–578 investment decisions, 403
defined, 575 retirement plans, 405
identifying, 577 T Tax withholding, 42
Stated dollar amount will, 502 T-bills. See U.S. Treasury bills
Statement of cash flows, 656–657 T account, 640 (T-bills)
State of New York Mortgage Agency Take-home pay, 12, 70–71 T&E card. See Travel and
(Sonny Mae), 358 Target profit, 711-713 entertainment (T&E) card
Statutory will, 503 Target sales, 711-713 Technical theory, 290
Stock advisory service, 283 Tax, 50, 384, 526 Technology
Stock/bond blend fund, 334 calculating, 385–386 DataDot, 433
Stock bonus plan, 488 estate and trust federal income, to prepare financial
Stockbroker, 289 511 information, 588
Stock certificate, 535 estate planning and, 510–513 trends affecting career, 35,
Stock Confirmation Report, 282 gift, 511–513 38–39
Stockholders, 273–275, 535 inheritance, 511 See also Software
Stock list, 690 lifetime gifts and, 510 Temporary life insurance. See Term
Stock market crash, 292 paid by corporations, 539 insurance
Stock mutual fund, 330–332 paying estate, 512 Temporary worker, 40
Stock(s), 250–251 on property, 381 “Tenancy in entirety,” 509
computerized transactions, 297 on purchases, 380 Tenant, 202
current yield of, 286 on U.S. Savings Bond, 135 Tenants’ form (HO-4), 424
factors influencing price of, on wealth, 381 “Tenants in common,” 509
285–288 See also Deduction and entries Term, 132
issuing, 535 for specific taxes Term insurance, 466–467
market for, 291–292 Taxable income, 384–385. See also Term versus interest cost, 165
numerical measures for Income tax Testamentary trust, 508
corporation, 286–288 Tax assistance, 401–402 Ticker system, 296
research before buying, 296 Tax audit, 401 Ticker-tape machine, 244
sources for evaluating, 280–285 Tax collection software, 383 Time deposit, 123
trading, 293–297 Tax considerations, 139 Time value of money, 19–20, 242
types of, 277–280 Tax credit, 386 Timing purchases, 98
See also Common stock Tax deduction, 384, 386. See also Title insurance, 224
Stock splits, increase value from, Deduction; Expenses Total gross earnings, 675
273–274 Tax-deferred benefit, 50 Total return, 286–287
Stock value, appreciation of, Tax-deferred income, 261, 383 Townhouse, 211
273–274 Tax-deferred investments, 403 Trade-offs, 90, 127
Stolen identity, credit and, 179–181 Tax-exempt benefit, 50 buying decisions and, 90
Stop-loss provisions, 447 Tax-exempt income, 261, 383 in selecting financing, 165–166
Stop orders, 297 Tax-exempt status, 318 Trading stock, 293–297
Stop-payment order, 143 Tax form, choosing, 391–392 Trading up, 212
Stored-value card, 127 Tax-free “holidays,” 164 Traditional marital share will, 501
Strategic plan, 551–555 Tax liability, 380
772 Index
Training U.S. Secret Service, 182 Want, defined, 7
career, 33 U.S. Treasury bills (T-bills), 245, Warehouse, 98
opportunities, 51 247, 321 Warranty, 101–103
Transaction, 561 defined, 314 defined, 101
Transferable Skills Analysis (TSA), dollar amount of return on, types of, 101, 103
462 315 Wealth
Trans Union, 174 rate of return on, 316 defined, 65
Travel and entertainment (T&E) U.S. Treasury bonds, 314–316, 321, taxes on, 381
card, 160–161 358 Whole life insurance, 467–468
Travelers check, 146 U.S. Treasury notes, 315–316, 321, Wiesenberger Investment
Treasury Direct, 314 358 Companies, 340
Treasury notes, 314–315 Utilities, 208 Wiesenberger Investment Companies
Trends, 32 Utility fund, 332 Yearbook, 265
Trial balance, 648–649 Utility stock, 248 Will(s)
Triplex, 211 altering and rewriting, 504
Trust, 506–508 defined, 500
defined, 501 V format of, 503
importance of avoiding importance of, 501
probate, 506 VA. See Veterans Administration living, 505–506
types of, 507–508 (VA) probate and, 503
Trustor, 506 Vacation home, 353 types of, 501–502
Truth in Lending Act, 164, 168, 183 Value Line, 340 writing your, 503–504
Truth in Savings law, 137 Value Line Investment Survey, 283 Windfall, 241
TSA. See Tax-sheltered annuity Value Line Stock Index, 264–265 Withdrawal options, 344
(TSA) Value of a bond, 251 Work culture, 48
TSA. See Transferable Skills Analysis Values Work environment, 47–48
(TSA) defined, 7 Worker’s compensation, 460
Turnover ratio, 337 life situations and, 14
21st Century Act, 127, 141 Variable costs, 703, 711-712
Variable expenses, 71, 75-77, Y
580-582
U Variable interest rate, 166 Yield, 323, 325
Variable life policy, 467–468
Unemployment, 17 Venture capital firm, 628
Unemployment insurance, 677 Vesting, 489 Z
Unemployment tax, 677–678 Veterans Administration (VA),
Unified transfer tax rate, 512 222–223, 488 Zero-coupon bond, 311
Uninsured motorist’s protection, Vietnam, 702 Zoning laws, local, 215
432 Vision care insurance, 449
United Kingdom, 279 Voluntary savings plan, 343
United States Secret Service, 75 Volunteering, 40–41, 506
Unit pricing, 100–101 Voting rights, 275
Universal life insurance, 468
Unlimited liability, 527, 532
Unsecured loan, 622 W
Up-front cash, 166
U.S. Bankruptcy Act of 1978, 190 Wage and Tax Statement. See IRS
U.S. Better Business Bureau, 108 Form W-2
U.S. Department of Commerce, 263 Wage loss insurance, 433
U.S. Department of Housing and Waiver of premium disability
Urban Development (HUD), benefit, 470
184, 201 Wall Street Journal, The, 43, 262,
U.S. Savings Bond, 133–135, 247, 264, 281, 319
321 Walt Disney Company, The, 541
Index 773
Features Index
A Common Cents
B Advertising Dollar, 556
Academic Connection, 671 BusinessWeek Finance File Be a Volunteer, 506
Art, 449 Best Homes for Rollover Business Expenses, 703
currency, 75 IRAs, 235 Career Center, 37
Diner’s Club, 174 Consumer Debt, 119 Costly Corrections, 640
Economics, 292 Cycling Back to the Future, Dollar a Day, 261
Emergency Banking Act, 607 Fitness Fun, 447
141 Good Works—with a Gift Giving, 367
Geography, 364 Business Plan, 521 Impulse Buying, 100
Government, 321 So What’s the Plan?, 377 Inventory Losses, 684
International Finance/ Which Adviser Knows the Listen Up, 298
Math, 652 Way?, 3 Money Toss, 144
Language Arts, 13, 258, 495, On Your Own, 207
591, 622 One Is Enough, 169
Marketing, 542 Paid in Full, 611
C Pay or Save?, 82
Math, 217, 384, 704
Science, 34 Pay Yourself First, 10
Careers in Finance
U.S. Better Business Bureau, Saving is Better, 593
Accounting Teacher, 639
108 Savings Mind-Set, 310
Bank Teller, 124
Ask Standard & Poor’s Shop by Phone, 543
Bookkeeper, 566
Accounting Cycle, 635 Student Discounts, 424
Certified Financial Planner
Business ownership, 523 Try Layaway, 403
(CFP), 329
Business Plan, 549 Chief Financial Officer
Collectibles, 351 (CFO), 701
Comparison Shopping, 89 Commercial Loan Officer, D
Credit Payments, 153 613
Electronic taxes, 379 Commercial Property Document Detective
Fast Cash, 609 Manager, 359 Application for Business
Financial Plan, 573 Controller, 593 Loan, 615
Health Care Costs, 443 Credit Analyst, 49, 167 Application for Employer
Housing Options, 197 Estate Administrator, 483 Identification Number
Insurance Rates, 411 Financial Advisor, 69 (EIN), 531
Investments, 237 General Contractor, 526 Auto Insurance Declaration,
Money Plan, The, 5 Insurance Agent, 458 435
Money When You Need It, Insurance Claims Adjuster, Break-Even Analysis, 706
59 428 Calculating an Affordable
Mutual Funds, 305 Investment Analyst, 252 Mortgage Payment, 214
Planning for Life, 31 Personal Banker, 11 Checking Account Bank
Savings Account, 121 Purchasing Agent, 667 Balance, 138
Selling price, 697 Real Estate Agent, 213 County Real Estate
Social Security and Retail Sales Associate, 109 Valuation, 356
Medicare, 665 Stockbroker, 289 Credit Card Statement, 171
Stock Certificates, 271 Tax Preparer, 390 Income Statement, 643
Will Power, 477 IRS Form W-2, 404
774 Features Index
IRS Form W-4, 42 Current Yield of a Stock elements of financial plan,
Job Description, 562 Investment, 286 573
Life Insurance Policy Debt Payments-to-Income health insurance, 443
Statement, 469 Ratio (DPR), 163 housing decisions, 197
Monthly Budget Worksheet, Dollar Amount of Return insurance, 411
12 on a T-Bill, 315 inventory system, 665
Mutual Fund Account Earnings Per Share, 288 managing credit, 153
Statement, 324 FICA Deduction, 671 money management, 59
Paycheck Stub, 685 Future Value of a Single personality and goals, 237
Personal Balance Sheet, 81 Deposit, 21 personal values and
Personal Financial Gross Earnings and financial goals, 5
Statement, 587 Overtime, 668 pricing to encourage sales,
Projected Retirement Home Equity Loan, 617 697
Budget Worksheet, 494 Inflation Rate and researching stocks, 271
Savings Goals Worksheet, 253 Investments, 245 retirement planning, 477
Stock Confirmation Report, Interest Compounded sources of funding, 609
282 Monthly, 136 taxes, 379
Warranty, 102 Inventory Turnover, 689
Net Asset Value, 328–329
Net Cash Flow, 71 S
G Net Worth, 68
Number of Day in Stock, Savvy Saver
Get a Financial Life! 690 Accounting for Your Money,
Business is Born, A, 604–605 Percentage of Assets Growth 637
Growing a Business, Withdrawal, 344 Advantages of 401(k) Plans,
720–721 Price-Earnings Ratio, 288 391
Home Ownership, 232-233 Rate of Return, 137 Avoiding Fees, 710
Investment Strategies, Rate of Return on a T-Bill, Business Credit Cards Tips,
374–375 316 616
Making Retirement Plans, Simple Interest on a Loan, Checking Account
518–519 166 Questions, 527
Setting Up a Career Plan, Target Sales, 712 Cutting Office Expenses,
116–117 1040EZ Tax Due, 396 565
Go Figure/Financial Math Total Return, 287 Finding the Best Savings
Annual Interest, 21 Unemployment Taxes, 678 Account, 142
Approximated Market Value Unit Pricing, 101 Furnishing Your First
of a Bond, 312 Apartment, 212
Average Inventory, 689 Get a Good Credit Rating,
Bond’s Annual Interest, 307 I 157
Bond’s Market Price When Giving Is Fun, 252
Interest Rates Go Down, In the Real World ... Good Financial Habits, 14
A, 247 accounting records, 635 Have Fun for Less, 77
Bond’s Market Price When bonds and mutual funds, Inventory at Home, 688
Interest Rates Go Up, A, 305 Making the Most of a
246 business ownership, 523 401(k) Plan, 489
Break-Even Point, 707 business plan, 549 Money for College, 41
Capital Gain, 340 collectibles, 351 Non-Smokers Save, 456
Current Yield of a Bond education and training, Research Before You Buy
Investment, 323 31 Stock, 296
Features Index 775
Saving Gasoline and checking vs. savings Managing Cash Flow, 672
Money, 416 accounts, 139 Net Worth Calculator, 63
Savvy Savings Bonds, 314 choosing annuity, 22 Paperless Banking, 127
Shopping for a Used Car or choosing health insurance Playing Games, 275
Van, 575 plans, 455 Pricing Science, 707
Shopping for Clothes, 95 consulting Certified Public Reducing Car Insurance
Utility Savers, 354 Accountant (CPA), 396 Costs, 433
Standard & Poor’s Global credit card debt, 163 Security in an Uncertain
Financial Landscape diversification, 366 Time, 316
Brazil, 333 expense categories, 79 Smart Cards, 161
Canada, 448 insurance program, 417 From Ticker Tape to PDAs,
China, 259 inventory systems, 688 244
Ecuador, 106 investment advising, 254 Transferable Skills, 462
Estonia, 619 mutual funds, 332 Using Software, 7
France, 658 preparing projected income Virtual Consultants, 535
Germany, 423 statement for bank, 585 Virtual Tour Software, 205
Greece, 555 rate of return, 290
India, 15 shopping online, 99
Israel, 164 starting salary, 48 W
Japan, 38 “tenants in common,” 509
Mexico, 491 what to do with profit, 563 WebQuest
Netherlands, 537 Avoiding Financial Fraud,
Russia, 586 392, 434, 467, 510
Saudi Arabia, 382 T Be Your Own Boss, 520,
Singapore, 676 539, 559, 588
South Africa, 365 TechByte Franchise Ownership, 614,
South Korea, 80 Business Planning Software, 638, 682, 705
Spain, 220 558 Nest Egg, 234, 241, 297,
Switzerland, 140 Calculate Your Benefits, 488 337, 358
United Kingdom, 279 Collectibles, 363 One Life to Plan, 2, 25, 52,
Vietnam, 702 Collecting Taxes, 383 71, 108
Standard & Poor’s Put on Your Computerized Account Your Own Home, 118, 135,
Financial Planner’s Cap, 628 Software, 656 170, 223
business expansion, 713 Easy Planning, 579
business ownership, 532 Internet Finance Education,
business partnerships, 641 621
calculating price for house, Job Hunting Online, 43
221 Lawyering Up, 110
776 Features Index
Photo Credits
Cover Photography: Brand X Pictures(RF)/Picture Quest.
AFP/Corbis 309; AFP/Getty Images 705; AbleStock/Royalty Free 181ml; age fotostock/SuperStock 293, 295br, 427,
681bl; Alan Abramowitz/Getty Images 426; Erik Aeder/SuperStock 461; Bruce Ayers/Getty Images 110, 450; Bill
Bachman/PhotoEdit 38, 541t, 240mc; David Ball/Getty Images 366; Paul Barton/Corbis 176, 181mr, 381; Paul
Barton/Getty Images 576tr; Peter Beck/Corbis 540b; Randa Bishop/Image State 80; Ed Bock/Corbis 216b, 240b, 577,
626; Cleve Bryant/PhotoEdit 317; Jeffrey Burke/Image State/Royalty Free xiii(t), 78b, 548; Jeffrey Burke/Imagestate
x(t), 350; Paul Chesley/Getty Images 497; Steve Chenn/Corbis 446; Stephen Chernin/Getty Images 295t; Gianni
Cigolini/Image Bank 362t; Kindra Clineff/Index Stock 128r; Jason Cohn/Reuters/Corbis 536; Stewart Cohen/
Getty Images 96; Comstock Images/Alamy/Royalty Free 128l; Comstock Images/Getty Images/Royalty Free 51;
Corbis/Royalty-Free viii(t), xii(t), xiv(m), 153, 196, 476, 507, 537, 559, 634, 653; Philip James Corwin/Corbis x(b),
378; Steve Craft/Masterfile 620; Will Crocker/ Image Bank 362m; Jim Cummins/Getty Images 457, 487; Robert E.
Daemmrich/Getty Images 384; Tim De Waele/Corbis 606–607; Patrick De Wilde/Imagestate 365; Kayte M. Deioma/
PhotoEdit 529; Tony Demin/Imagestate xi(b), 442; Palais Didler/SuperStock 700; Digital Vision/Getty Images/
Royalty Free 164, 502; Melanie Einzig/Getty Images 285; Amy Etra/PhotoEdit 642, 699; Jon Feingersh/Getty Images
622; Jon Feingersh/Masterfile 576tl; Myrleen Ferguson/PhotoEdit 36bl; Fisher/Hatcher/Getty Images 210; Peter M.
Fisher/Corbis 156; Tony Freeman/PhotoEdit 93, 656; Getty Images 9l; Getty Images/Royalty Free viii(b), 681ml,
240br, 236, 702; Martyn Goddard/Corbis 187; Lynn Goldsmith/Corbis 580; Larry Dale Gordon/Getty Images 484br;
Spencer Grant/PhotoEdit 677; Jeff Greenberg/PhotoEdit 41, 125, 278, 553; Nick Gunderson/Getty Images 462;
Charles Gupton/Corbis 422; Will Hart/PhotoEdit 33; Gavin Hellier/Imagestate 619; Chip Henderson/Getty Images
48; Hemera.com 153b, 154t, 155, 156b; Maria Hesse/Imagestate 402tl; Hirb/Index Stock 557bl; Jeremy Hoare/Life
File/Getty Images 448; Jack Hollingsworth/Corbis 714; Tony Hopewell/Getty Images 179; Dave G. Houser/Corbis
v(b), 30; Richard Hutchins/PhotoEdit 226; Image State 20, 140; Imagestate/Royalty Free 204, 295mr, 676, 681bl, 669;
Index Stock 234–235; iStock 161, 163; Mark Junak/Getty Images 24; Wolfgang Kaehler/Corbis 382; Reed Kaestner/
Imagestate 511; Zigy Kalunzny/Getty Images 480; Bonnie Kamin/PhotoEdit 129r, 273; Mitch Kezar/Getty Images
564; Helen King/Corbis 181bl; Jutta Klee/Corbis 181tr; Michael Krasowitz/Getty Images 78tr, 675; LWA-JDC/Corbis
720–721; Rich LaSalle/Getty Images 638; Mark Lewis/Getty Images xiv(t), 608; Frederic Lucano/Getty Images 8m;
Willie Maldonado/Getty Images xv, 696; Manchan/Getty Images/Royalty Free 576br; Court Mast/Getty Images 169;
Masterfile/Royalty Free 374–375; Francis G. Mayer/Corbis 364; Joe McBride/Corbis 118–119; Patti McConville/Getty
Images xi(t), 410; Medioimages/Imagestate 333, 423; Cathy Melloan Resources/PhotoEdit 211; Bill Miles/Corbis
520–521; Benn Mitchell/Image Bank 362b; Antonio Mo/Getty Images 357; Christopher J. Morris/Corbis 277; Roy
Morsch/Corbis 2–3; John Neubauer/PhotoEdit 251, 541b; Michael Newman/PhotoEdit 44, 92r, 99, 134, 402b,
403; Chris Noble/Getty Images 248; David Oliver/Getty Images xiii(b), 572; John Olsen/Corbis 576bl; Roy Ooms/
Masterfile 234–235; Lisa Peardon/Getty Images 414; Jose Luis Pelaez, Inc./Corbis 9r, 116–117, 129l, 294; Photos.
com/Royalty Free 167, 169; Pictor/Imagestate 279; Pluriel Phototheque/SuperStock 216t; Frank Polich/Reuters/
Corbis 417; Todd Powell/Index Stock vii(t),120; Michael Prince/Corbis 08l; Patrick Ramsey/Imagestate 454; Reuters
Newmedia, Inc/Corbis 295bl, 295tl; Reuters/Corbis ix(t), 270; Mark Richards/PhotoEdit 402m; Jon Riley/Getty
Images 9m, 36t, 311; Elena Rooraid/ PhotoEdit 217m; David Rosenberg/Getty Images 263; Galen Rowell/Corbis 15;
Norbert Schaefer/Corbis 61; Alan Schein Photography/Corbis 535; Jed & Kaory Share/Getty Images 126; Shannon
Stapleton/Reuters/Corbis 616; George Shelley/Masterfile 611; H. Sitton/Corbis 146; George Shelley/Corbis 376–377;
Ariel Skelley/Corbis 105, 129r, 219, 590, 466, 604–605; Don Smetzer/Getty Images v(t), 04; Bruce Smith/Corbis
554; Steve Smith/SuperStock xiv(b), 664; Lee Snider/Corbis 334; Bill Stanton/Imagestate ix(b), 304; Gerhard
Steiner/Corbis 579; Tom Stewart/Corbis vi(t), 58, 159, 36tl, 518–519, 621; Mark Stone/Getty Images 251; Stockbyte
Platinum/Alamy 82; Superstock Inc./SuperStock 220; SuperStock/Royalty Free 585, 713; The Cover Story/Corbis
247; ThinkStock/Royalty Free vi(b), 88; ThinkStock/SuperStock/Royalty Free 354; Wes Thompson/Corbis 617;
Bob Torrez/Getty Images 216m; Susan Van Etten/PhotoEdit 552; Pablo Corral Vega/Corbis 106; Anton Venon/
SuperStock 703; Victoria Blackie/Getty Images 484l; Steve Vider/Imagestate 259, 491, 555, 586, 658; Alana Wesley
White/PhotoEdit vii(b), 152; Dana White/PhotoEdit 67; Marshall Williams/Imagestate xii(b), 522; Matthew Wiley/
Masterfile 512; David Young Wolff/PhotoEdit 7, 36br, 240tr, 342, 484tr, 500, 557mr, 684; Alex Wong/Getty Images
557tr; Mei Yan/Masterfile 92l; Yoshikazu/Tsuno/AFP/Getty Images 557ml.
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