Financial Literacy
Decoded

What is financial literacy?

Financial literacy is a set of skills and knowledge that can help people make good decisions with their money.

In short, financial literacy is the ability to handle your finances well by managing them yourself, or by leaning on a trusted advisor for advice and guidance. It varies from high-level concepts about how economies work, to more practical tools like budgeting and saving strategies.

What is the purpose of financial literacy?

The purpose of financial literacy is to provide you with knowledge for your personal finances. Financial security comes from understanding and managing your money, which can then lead to overall peace of mind. As an individual, being financially literate means that you have the skills and knowledge to find ways out of a sticky situation even when faced with difficult decisions-- it means knowing how to make use of information resources in times when we need them the most (in emergency).

Hence financial literacy also educates individuals about safe habits that will avoid serious financial hardship.

Can financial literacy save you money?

It depends. Financial literacy is a skill, like many other skills, and some people are better at it than others.

Financial literacy can save you money in two ways. One is that having good financial knowledge allows you to make sound financial decisions based on your goals and risk tolerance, which can result in lower interest rates and less debt over the long term. The second way is by teaching someone how to control their own spending habits or teach them how to be smarter about where they spend their money so that they might make wiser purchases.

 

Financial Literacy Definitions

Annual percentage rate

Annual percentage rate is just another term for the effective annualized interest rate that is being calculated. It's a calculation of the fees and financing charges as well as the true cost of borrowing money over time for a loan or mortgage, expressed on an annual basis (rather than based on daily fluctuations) due to compounding calculations.

Asset

An asset is a resource that provides long term utility or value. Assets can further be categorized into tangible and intangible assets. Tangible assets include items such as land, minerals, buildings, machinery to name a few. Intangible assets are those which provide non-physical value but not physical utility to the company they belong to (such as intellectual property). A business' tangible assets will typically include inventory, customer records and accounts receivable- anything that the company owns outright. Business intangible assets may include brand equity or patents and copyrights about what it's invented in particular area of technology for example. 

Bankruptcy

Bankruptcy is legally declared inability sanely or honourably to pay debts, and can happen in person or corporations. There are two types of bankruptcies, personal and business.

 

Personal bankruptcy happens when an individual cannot cover their debt with the assets they own. This usually means mortgages, unpaid medical bills, vehicle loans, credit cards and utility bills past due at the time of filing for bankruptcy.

 

Business bankruptcy happens when a corporation or small business cannot meet its financial obligations because it's been hindered by creditors withholding payments owed on accounts receivable or other liabilities such as payroll taxes that have come due but not yet paid. When these types of repayments dry up (or almost dry up) then it becomes clear that this company is bankrupt.

Budget

Budget: A plan to use the money that is available to you. There are many types of budgets in terms of their complexity and scope, such as these: 

 

Personal Budget - a household budget that estimates income and expenses. It also forecasts anticipated balances at the end of a specified time period

 

Business Budget Statement - an economical plan for a company by predicting future revenues and expenditures over an initial amount of time. The business budget thesis statement is usually published on reports as statements or proposals so that companies can accept them in order to run it efficiently. 

 

Personal Budget Calculator - calculating sums necessary for living based on calculations that include income, bills, debts, loans or other expenses . These are used by individuals who are planning to get loans and want to make sure they know how much money they can put aside per month for their monthly bills.

 

The budget is also essential as a management tool in keeping businesses afloat especially those that undergo economic instability or simply have low incomes. Bills and expenses pile up due to the poor financial status of these businesses and this could lead to a loss in sales if the situation is not immediately rectified. It is important that businesses have their own budget planning for it ensures that they can make sure that all financial aspects are managed accordingly. This will help them avoid cash shortages, which is very crucial in any business as it may lead to shut down especially in a small scale business.

Cash Flow

Cash Flow is a measure of how fast money comes in your company. There are two variations of Cash Flow, positive and negative. Positive cash flow means that you're earning more than you spend - which usually translates into profit! Negative cash flow means the opposite, where you earn less than what you spend - this leads to debt. To find out which category your company falls under, search for free online accounting software and use it to generate a report on what's happening with all the transactions in your business.

Capital Gain

An "asset" means anything you own that has potential value. A capital asset is an asset other than cash. Capital assets typically produce income, e.g. stocks and real estate.

 

Capital gains are the profit made from selling an asset, this includes any increase in value from purchasing price + selling price (excluding inflation or depreciation).

 

It is important to note that it does not matter how long a person holds the asset for – if you hold it for one day and then sell it at a greater cost, you are entitled to all of the income gained as capital gain.

 

A simpler way to put this might be 'upward movement in prices without new ones coming into being". Basic information like stocks or property can also go up in value.

Comparison shopping

Comparison shopping, also known as price comparison, is the act of comparing prices across multiple retailers for the purpose of finding the best offer. It is a common practice in our digital age and can be accomplished by using dedicated comparison websites or through online searches via aggregators like Google Shopping.

 

Comparison shopping requires a lot of work on behalf of the shopper, but this diligence does not go unrewarded since it ultimately saves time and money. The secondary benefit to comparison shoppers is that they find products they may have otherwise missed out on completely had they chosen one place to shop for goods or services--those hidden gems that are unique deals because nobody else had them!

Compound Interest

Compound interest is the act of earning a constant sum on your original investment plus earnings on its accumulated interest. Essentially, compound interest means earning money on money you've made and, in the process, earning even more money. It's compounded by adding up all of the little bits of time over which that growth has occurred and then calculating what they would be worth if you put them together now.

Consumer Price Index

The Consumer Price Index (CPI) is a measure of the monthly change in the average price of goods and services so that analysts can track price levels over time. It is crucial for calculating changes in purchasing power-that is, it measures what the money you have will buy at different times. The index calculates how much more expensive most goods are compared to their prices one year ago.

 

This tool reflects hourly wages and costs on taxes, rent, food, energy and clothing. The CPI contains information about the price of 500 items in various categories such as transportation and education. It tracks these prices from month to month because prices increase or decrease over time-the cost of living changes with inflation like food or fuel products through the markets.

Credit

Credit is a financial instrument given by a credit institution to an applicant. In return for the funds, the borrower owes interest, which will be due periodically (usually monthly). The borrower can also owe fees as prescribed in the loan agreement. If the borrower fails to repay on time or abide by what's been agreed upon, he may forfeit some collateral and his credit rating suffers.

Credit report

A credit report is a lender's evaluation of your credit worthiness. Credit reports are also sometimes called credit histories or run-of-the-mill credit records.

Credit reports can be used to evaluate a person's eligibility for loans, mortgages, and other financial assistance when there is no prior information about their income levels or employment history.

 

Credit score

A credit score is a type of mathematical score used in credit rating to represent the risk level of the individual or company requesting new funds. It is an indication of how likely you are to pay your debts according to set terms and conditions. Technically, it's just one number, but they don't use just one magic figure that you have no control over. A good credit score ranges from 740-850+ for excellent, 579-739 median or fair (580-669), 300-578 poor (260 - 299) and below 260 very bad. The high end scores allow for a larger lending amount because they're less risky deals whereas lower scores require all borrowers to provide more collateral upfront in order to convince banks to lend them the money.

Creditworthiness

Creditworthiness is the idea that you will pay back money owed to a creditor. In other words, when assessing your ability and willingness to repay debts, creditors or lenders take into account not only you current income but also obligations such as rent and car payments which may significantly reduce available funds for repaying debts. Creditworthiness can be assessed through inquiries into your credit score (e.g., credit reports). Many companies offer free reports annually which can help individuals understand their creditworthiness; it's good practice to check one's own report periodically after any significant changes in assets or liabilities- e.g., marriage, divorce, home purchase, etc.-as these could drastically change an individual's debt rating (free annual reports are a great way to ensure you are not being overcharged for a loan or credit card).

Debit card

A debit card is a plastic card that allows the holder to perform banking transactions such as cash withdrawals, balance inquiries, and check purchases. Debit cards are often linked to bank accounts which have a checking or savings account for automatic funds transfers. There are two types of debit card products offered on the market today: Traditional "passbook" style where records of transactions are maintained in paper form and all funds (including receipts) must be withdrawn from an ATM accessible by the holder; and Newer "electronic" style linked directly to your account like a credit card allowing you to access those funds using an automated teller machine or point-of-sale device anywhere in the world.

Debt

In simplest terms, debt is the formal, legal agreement to repay a loan. When you borrow money (a "debt") from another person or entity, you create long-term obligations for yourself in the form of monthly payments and repayment at some agreed-upon future date. Debt can be created by any short or long term financial obligation which usually occurs owing to monetary expenses that exceed people's income. Unpaid debt can cause severe consequences such as social stigma, bankruptcy and legal punishments. In common language, "creditors" come together to try settling debts with each other; if all parties fail to meet their financial obligations then lenders may take the debtor assets by force in order settle their collective claims against them on mutually agreeable terms.

Default

Default is a borrower not making the payments according to the loan agreement, and it's usually deliberately opted for by some rather than chosen. A company or individual may choose default as a way of taking an aggressive stance against their creditors, for instance they could be announcing to them that he intends not paying back any of his considerable debts.

 

The term is also used in economics when talking about currencies or derivatives contracts with negative repayments. The market value will then change on these assets from stable into unstable as investors sell them off and scramble to avoid so-called risky investments all together because now everyone thinks defaults are going up because investors were shut off from making any money and default was now the only way out with the price for it dropping to zero.

 

The international financial crisis of 2008 is seen as a period when investors took on too much risk in their investments without really thinking about how they were going to pay back their debts if they fell into bankruptcy leading to defaults and more panic selling that led to the whole situation spiralling out of control.

Diversification

Diversification is a form of asset allocation that aims to reduce risk by investing in various asset classes with low or negative correlations. For example, if one investment falls in value, another may rise and offset some of the losses. Asset classes consist of groups of investment vehicles that exhibit similar characteristics such as stocks, bonds, cash equivalents (short-term securities such as Treasury bills) and commodities (gold).

 

Risk rewards come into play when determining appropriate allocations for clients. Generally speaking, an investor with higher risk tolerance will have a higher allocation to equities and real estate than an investor with lower risk tolerance would have. The reason being that the potential reward is much greater for those investments than they are for safer ones like bonds and cash.

Emergency Fund

Emergency funds are meant to provide a safety net for you and your family in the case of an emergency situation, like a job loss, medical emergencies or natural disasters. Ideally these funds should not detract from other savings such as retirement funds as emergency funds are often the last savings made after all others have been satisfied.

 

An emergency fund should also be accessible quickly and easily if necessary so that it can serve its purpose.

Financial Plan

Financial planning is the process of analysing your current and future financial needs, taking into account risks to your investments and estate. It usually includes determining how much of our current income we should save, understanding where the money will come from when emergencies arise, estimating future expenses for retirement and major life events and developing a strategy to achieve our goals. In this context, "planning" includes identifying ways to deal with opportunities as well as challenges that might pop up during our lifetime.

 

Good financial planners use risk management techniques which evaluate what kind of risk lead you to undesirable circumstances in order to take precautionary measures against the risk before it actually happens. To avoid uncertainty in the future, good financial planners will outline steps one will take after an emergency or problem has occurred.

Fixed Expenses

Fixed expenses are one of the 4 major categories of business costs because they're not eligible for variable expense treatment.

Fixed expenses are a part of all businesses, and within this category is where you count things like office space, utilities, administrative costs, and more.

Expenses you would most likely start to think about being classified as a fixed expense come from the following categories: rent or mortgage payments; payroll deductions; invoices for subscriptions to such services as gas and electricity meter readings; overhead costs such as those incurred in running an operational facility that produces or stores goods just in case the end user comes to make a purchase.

Income

Income refers to the salary, wages, and investment income someone receives. In simple terms, it is typically how much money you have coming in each month so that you can support your financial obligations and your lifestyle without compromising your savings or ever experiencing an interruption of income.

 

Income can either be earned or unearned and there are various ways that one can acquire income: through employment, self-employment (e.g., business ownership), rental property investments, lending money for interest rates on returns, etc.).

Interest

Interest is a transaction fee that's collected for loans and deposits of an institution. The borrower or depositor pays the interest to the lender or bank, which the bank makes from selling products of financial services to other customers. Institutions can offer a lower than average interest rate, attracting more clients and collecting more in transaction fees--or they can offer a higher than average interest rate because they're confident enough in their own security and ability.

Need vs. Want

A need, in economics and personal finance, is a basic requirement to live and survive. The most basic needs are food, shelter, water and sanitation. Lacking the first four could lead to death also known as dying from outright starvation. Other needs include clothing for warmth or modesty; medicine for injury or illness; safe transportation; electricity or phone chargers so one can contact emergency services.

 

All of these might be thought of as entry-level requirements in life that everyone requires. A want would be anything beyond the basics that falls under the broader category of wants versus needs - but still doesn't reach necessity levels yet of an item like food because not every person has need for such items (e.g., one only has to eat so much food per day).

Opportunity Cost

Opportunity Cost is the financial decision to their cost of giving up an alternative opportunity in order to proceed with another opportunity.

 

It is based on the concept that each choice or opportunity comes with an inherent cost;  for going down one path, you are automatically missing out on all of the opportunities available for which you chose not to give your time. The opportunity cost will be greater if the other option was a perfect option and less when it falls into something of a ranking nearer the bottom.

Pay yourself first

Paying yourself first is a concept where you spend a predetermined amount from your paycheck on yourself before you meet any household expenses. It means that you can set aside, for example, $10 or $20 every time you get paid and make sure to pay that money back to yourself before paying off any of your other bills.

Principal

The principal of a loan refers to the amount that you borrowed or invested. Therefore, it's equivalent to the original loan balance and does not include interest charges accrued over a period of time, nor does it factor any previous payments made on the loan.

Rate of Return

What is the Rate of Return? The rate of return or profit margin on an investment is an expression for the percentage gain. It can be represented as Total Gain/Initial Capital.

The rate of return differs from ROI which measures a firm's performance over one or more business cycles and takes into account total earnings and total investment in order to accurately assess the present value gains that exist against initial invested capital, also taking into account oft ignored risks inherent in any venture. 

Time value of money

Time value of money represents the net worth or value of a sum of money given now in exchange for what might be received in the future. It's one way to look at how much something is worth today, based on what might be earned as interest elsewhere. The concepts are simple and straightforward and can be applied to many different situations, e.g., estimating cost benefit analysis, understanding accounting impacts with inflation/deflation, determining financial return on an investment over time (which gives consideration to compounding), business valuation models etc ...

 

The other components that are most commonly used when looking at time value pricing models are an opportunity cost and a rate of return - which also both appreciate time but offer different approaches in calculating profitability . The time value of the money model can be used in the analyses independently or in combination with the other two models.