What is Financial Literacy?
“Financial literacy is an understanding of personal finance concepts like budgeting, investing and managing finances. This includes planning what to do with your money, paying off debt, understanding the time/money trade-off, tracking spending, retirement planning and more.”
In this post, we go through what we think are the most important concepts in basic financial literacy. We can’t cover everything, but we hope you find it useful.
Cash Flow
This is the most important concept in personal finance. Cash flow monitors where money comes from and where it goes. Increasing inflation means monitoring cash flow will be very important to keeping control of your finances.
Positive Cash Flow
Positive cash flow can come from employment income streams, revenue streams, gifts, investments or loans. It’s money that becomes available for you that wasn’t previously available.
Negative Cash Flow
Negative cash flow is all the money out. Paying a credit card bill, buying groceries and paying rent are examples of negative cash flow.
Net Cash Flow
You want this to be positive. If your money out is greater than your money in, you could get into financial trouble. If you are spending more than you make, the shortfall (deficit) has to come from somewhere. This means you are using savings or investments (eroding capital), or incurring debt, to finance your spending.
Assets
Assets are things of value that you own that provide a benefit to you. This property can be sold, traded or leveraged. Some assets increase in value (appreciate) while some decrease in value (depreciate). Not every asset creates positive cash flow. Some examples of assets are stocks, your house, your car, collectibles and cash. Not all assets are created equal.
Positive Cash Flow Assets
A positive cash flow asset creates cash flow every month. An artist who gets a royalty every time their song is played on the radio has a positive cash flow asset. A landlord providing a condo where rent received is higher than expenses paid, has a positive cash flow asset.
Negative Cash Flow Assets
A negative cash flow asset costs you money to keep it. The perfect example of this is a car. Although a car has value and you can sell the car, you will rarely get more than what you paid for it. You need to pay for gas, insurance, oil changes, maintenance and repairs to keep the car functioning. In most cases, a car is a great example of a negative cash flow asset.
Cash
Cash used to be a positive cash flow asset in our parents’ day – they got interest. With inflation and changes in bank fee structures, cash has become a negative cash flow asset in most cases. You pay the bank a monthly fee to hold your money securely. In addition, as prices rise, the real value of your cash decreases. Holding excess funds in cash is a losing proposition these days.
Liabilities
Liabilities are amounts that need to be repaid over time. Common examples include car loans, mortgages and credit card debt. Paying these liabilities down is called debt servicing. One of the key factors in deciding how to service your debt is the interest rate.
Interest Rate
The interest rate is the amount of money you have to pay in excess of what you borrowed. For instance, if you carry debt on a credit card, your interest could be very high. However, most mortgages carry a very low interest rate. If you have excess cash that you’ll use toward servicing debt, pay the highest interest debt first.
The Bank of Canada’s prime rate decisions usually trickle down into the economy and determine lending rates for everything from cars to houses. That’s why when the Bank of Canada increases the interest rate, it becomes more expensive to borrow money.
Credit Score
Having a good credit score is instrumental in accessing low-interest debt. It can mean the difference between being able to buy something or not. The highest potential credit score is 900. A good credit score is between 660 and 724, with 724 to 759 being considered very good and 760 and above considered excellent. If you don’t know your credit score, it would be good to find out. There are many free resources to find out your credit score, the most popular being Equifax.
Credit scores can also be used by landlords and employers in making decisions about whether to accept you as a tenant or hire you as an employee. For employers, Dutton Law recommends getting a potential employee’s permission before asking for a credit check because it can violate privacy laws. (We recommend contacting an employment lawyer to help you with your employment policies.)
Essentially, a good credit score tells someone you can be trusted when it comes to money. There are many other factors to consider when evaluating a human being, but we’re accountants and that’s how we think.
Budgeting
This is one of the easiest and most reliable ways to understand what is happening with your money. Essentially, this is creating a list that shows your money in and your money out. How detailed this needs to be depends on your situation. Below are a couple of examples:
| Item | Person A | Person B |
| Income | 3,000 | 3,000 |
| Rent/Mortgage Payment | 2,150 | 2,150 |
| Groceries | 200 | 200 |
| Other things | 400 | 800 |
| Net Cash Flow | 250 | -150 |
In this example, Person A is in a positive cash flow situation. Every month, they have an extra $250 they can save, invest or otherwise use. Person B is in a negative cash flow situation. They are spending twice as much on Other Things. To put this into perspective, Person B might be a smoker while Person A is not. Person B may eat out more often or get more takeout. There are a lot of different factors that can affect an individual’s cash flow.
Here’s a list of things to consider when creating your budget in order of importance:
- Income is what you actually receive
- Necessities come first
- Rent/Mortgage payments
- Groceries
- Utilities, phone, internet (not TV)
- Maintenance and repairs
- Necessary clothing
- Debt payments
- Investments for the future
- RRSP, TFSA & RESP contributions
- Savings for big purchases
- Travel expenses
- Transit costs
- Car payments
- Car insurance
- Gas
- Repairs and maintenance
- Luxury items
- Clothing beyond the basics
- Take-out and restaurants
- Alcohol, tobacco and cannabis
- Entertainment expenses
Obviously, this list is not exhaustive. It’s just meant to be a basic guide to help with your situation. Everyone is different, so everyone may have different items to track. For instance, Jonathan, KATA’s founder, has a budget for fishing expenses in the Luxury items section. On the other hand, Tim, KATA’s tax preparer, has no car costs in the Travel section but spends more time on travel as walking is a lot slower, which is hard to put a dollar value on.