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AOF Principles of Finance

Lesson 4Wealth, Income, and Cash Flow

Student Resources

Resource Description

Student Resource 4.1 Reading: Wealth, Income, and Cash Flow

Student Resource 4.2 Reading: The Function of Money

Student Resource 4.3 Note-Taking Guide: Three-Column Graphic Organizer

Student Resource 4.4 Reading: Money Sources and Uses

Student Resource 4.5 Assignment Sheet: Reflecting on Money

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AOF Principles of FinanceLesson 4 Wealth, Income, and Cash Flow

Student Resource 4.1

Reading: Wealth, Income, and Cash FlowAlvaro and Sasha have been struggling with their finances lately. Every month they seem to fall short on cash and have resorted to using their credit cards for necessities such as food and transportation costs. In the last year they have racked up an enormous amount of debt. Although they both are earning more money than they ever have before, they can’t seem to figure out what is wrong. All of their friends think that they are wealthy, but they sure don’t feel like it. In desperation, Alvaro decides to call upon his Aunt Arcelia, a financial planner, for help.

Arcelia begins by clarifying the term wealth. She points out that people can make a large annual income and have little wealth, just as individuals can earn a low income and still have some wealth. She explains that the term wealth refers to the value of everything people own—their assets—minus what they owe—their liabilities. Net worth, or wealth, is often defined as the items of value that are left over after all of the bills are paid. Arcelia then points out that, while Alvaro and Sasha may be wealthy in other ways, they unfortunately have no financial wealth right now.

Arcelia continues by explaining that they have a cash flow problem. She describes cash flow as the available money flowing into and out of a business or a household. Cash flow is essential to the health of any business and/or household, and it is apparent that Alvaro and Sasha have a major cash flow problem! All of the cash that they have coming in does not equal the amount of cash that is going out. This fact is putting them in a position where they run out of money and go into a little more debt each month. She explains that the first step the couple must take to manage their finances is to understand the inflows and outflows of their money. Understanding where your cash is coming from and going to is critical to good money management.

She tells them that as soon as they understand their cash flow problem they can look at some ways to fix their financial issues. Arcelia explains that they need to either increase their income or cut some of their spending. Cash flows out of a home through general living expenses like mortgage, rent, food, utilities, insurance taxes, retirement, and, of course, purchases, and cash is generated through three types of income. Any money that they make will fall into these three income categories.

Earned income is the most common way to earn money and refers to any income that is made by working. It is your salary made from working a job, owning a business, or any other activity that pays based on your time and effort spent completing a task. Earned income allows you to save up cash to generate the other two types of income.

Portfolio income is any income that is made by actively managing different types of investments. Buying and selling real estate, stocks, bonds, mutual funds, saving accounts, money market funds, and even some collectibles like antiques or cars and then selling them for a higher price can result in portfolio income. The stock market is one of the most common ways to actively manage your portfolio income.

Passive income includes money that you get from items that you have purchased or created. If you buy a house and then rent it out for more money than the mortgage payments, the money or profit that you make is passive income. You can also earn passive income by selling or creating an idea or a product, like writing a book and then earning money or royalties off of each sale.

Arcelia explains that Alvaro and Sasha should begin by cutting their spending and looking at ways to focus on making a bit more earned income. Once they are earning more and spending less they can focus on creating some portfolio and passive income for themselves. With this plan in place, coupled with perseverance, patience, and motivation, they will be on the road to achieving wealth.




Reading: The Function of Money

Money flows in and out of our hands on a daily basis in a variety of different ways. But what defines money and what is its true function? Money can be categorized as having three general functions: as a medium of exchange, a unit of account, and a store of value.



Money can be characterized in the following ways:

• Durable: Money should be able to last a long time and should be able to withstand many exchanges and transactions from person to person and business to business.

• Portable: Money should be easy to carry around. Consumers must be able to transport their money around from shop to shop with ease.

• Scarce: Money needs to be scarce enough to be valuable. Money needs to retain its value.

• Divisible: Money needs to be able to be divided into small units, meaning that consumers must be able to get their change after making a purchase.



Bartering is a type of trade in which goods and/or services are exchanged for other goods and/or services. Bartering dates back to over 100,000 years ago. Stones, shells, livestock, and tea leaves have all been used as money during one time or another. Before money was created, people found ways to obtain the goods and services that they needed through bartering.

After a while bartering proved to be inefficient, inconvenient, and unsuccessful, and the evolution of money began. From shells to stones, from livestock to tea leaves, money gradually evolved into what it is today.



The most important job of money is to serve as a medium of exchange. Money makes trading easier by replacing the barter system with a system that involves currency, coins, or checks. Money makes it faster and easier to buy and sell things. As a medium of exchange, everyone must have faith that everyone else will accept it for their goods and services.

Money also encourages specialization and efficiency. People who are really good at making a product can just sell their product for cash in order to get what they need rather than try to make other products that they are not very efficient at making. In this way, individuals can specialize in one area and increase productivity with that item.



Money is a store of value. Something that is stored is put away to be used later. It’s valuable now, and it will be valuable later too. Money can store value that you use in the future. As a store of value, money can be held until an individual chooses to exchange it for a good or service. Money makes it easier for people to save and then make purchases in the future.



Money serves as a way to measure and compare the value of specific goods and services. When comparing prices, individuals can compare values of goods and services and determine if one good is a better buy than another. In other words, money provides a common unit for measuring the value of every good and service. Without money, the worth of an item would have to be valued in terms of other goods and services.



With the evolution of money came an ease of purchasing goods and services. In some respects, life became more convenient and efficient. Unlike livestock, shells, fur, and stones, money was easy to transport, lasted a long time, was widely accepted, and was easily converted into smaller units. However, money can also be complex and confusing by nature. It is very important to manage your money effectively, to make responsible spending choices, and to be deliberate about your financial goals for the future.




Note-Taking Guide: Three-Column Graphic OrganizerStudent Name:_______________________________________________________ Date:___________

Directions: Complete the following three-column organizer as you read Student Resource 4.4, Reading: Money Sources and Uses.

BeforeList three things you know about money and its sources and uses

before reading.

DuringWrite down new information you learned during the reading about the sources and uses of money.

AfterWrite two or three questions that you still have about the reading.




Reading: Money Sources and UsesDirections: Individually read the following document. While you are reading, use the three-column graphic organizer (Student Resource 4.3) to help you organize your thoughts. Once you have completed both tasks, share your thoughts from the note-taking guide with your partner.

Money and Its SourcesThink of all the money that you have received in the past month. Where did it come from? Did your parents give it to you? Did you earn it by working at a part-time job? Did you receive it as a gift? Did you work around the house and receive an allowance? Or, maybe you earn your money from a variety of sources. Whatever the source of your money, it is important to realize that there are many different ways for a young adult to earn money.

Just as you receive money in different ways, households rely on various sources of income. Some households rely solely on earned income, where the only source of money is from an individual’s job. Other households get their money from a combination of passive, portfolio, and earned income. For example, a household can receive income from a job, a rental property, and dividends from stocks. All three of these sources flow into a household as forms of income.

Income can be generated through a person’s wages, stocks, bonds, mutual funds, rental income, social security income, public assistance, gifts, retirement income, and child support, just to name a few. There are also ways to earn income seasonally. Landscaping, snow and ice removal, and picking up a retail job to help with holiday sales are examples of seasonal jobs. All of these represent some of the sources of possible personal and household income.

Money and Its UsesNow think about all the money that you have spent in the past month. You probably did a lot of different things with it. Did you save it? Did you spend it on clothes or entertainment? Did you give it away or donate it to a church or a charity? Did you spend it on your family by purchasing groceries or other necessities? Whatever you did with your money, it is important to realize that uses for money can generally be placed into three different categories: spending, saving, and giving.

Households use money in various ways as well. According to the US Department of Labor Bureau of Labor Statistics, households spend their money in eight major categories. These categories are food, housing, apparel and services, transportation, health care, entertainment, personal insurance, and pensions. Housing, transportation, and food top the list. What does your household spend most of its money on?

There’s really not a formula for how an individual or a household should use its money, but one thing remains true: saving a portion of your income is important. It is always a good idea for an individual to save a portion of the money he or she makes each month, or, in other words, pay yourself first! Realizing the importance of saving and following through with this concept will help individuals and households to better manage their money for the future. Remember, knowing where your money is going and how it is spent is just as important as realizing where your money is coming from.




Assignment Sheet: Reflecting on MoneyStudent Name:_______________________________________________________ Date:___________

Directions: For this assignment you will write a one-page reflective essay in which you apply some of the concepts learned in the lesson to your own lives. You will be given a selection of topics to choose from and you must choose one topic that best applies to you. Remember to choose a topic that you have something to say about! Make sure to thoroughly read the assignment directions and example before you begin writing, and ask questions if there’s something you don’t understand.

A reflective essay lets writers express how they feel about a particular issue. In other words, this essay will allow you to show how you feel about what you’ve learned. When writing a reflective essay you must:

Think about what you have learned.

Describe in detail what you know about the topic.

Make some sort of conclusion about how it relates to you personally.

Be careful not to just list your opinions about the issue but to make interpretations and evaluations about how the issue or topic affects your life.

Choose one of the following topics to write about. If you feel strongly about another issue that pertains to the lesson, you must get approval from your teacher.

Describe you own personal spending habits. In what ways do your own personal spending habits affect your household?

What is your main source of income? What steps could you personally take to improve your income?

In your opinion, what is the function of money? Have your views of money changed from the beginning of the lesson to now?

What does it mean to be wealthy? What steps should people take if they want to have wealth?

To BeginBefore you begin writing your essay, respond to the following questions. Doing a thorough job will help you to organize your thoughts for your essay.

What topic did you choose to write about?

Why did you choose your topic?



What do you know about this topic? Cite evidence, data, personal observations, and experience.

Why is knowing about or being aware of this topic important?

In what ways does this topic apply to your life?

How will this new learning affect your financial decisions in the future?

Assessment CriteriaAs you begin writing your essay, make sure that:

Your essay clearly explains the topic.

Your essay shows evidence of understanding regarding the topic.

Your essay includes accurate details and knowledge and uses relevant examples to support your claims.

Your essay maintains a clear and consistent viewpoint throughout.

Your essay shows adequate insight into the topic and reflects on the significance of learning upon your own life.

Your essay is neat, legible, and presentable and uses proper grammar and spelling.

ExampleThe following is an example of a reflective essay. Although the essay topic is not listed as one of the options, the essay still meets all of the assessment criteria for the assignment.



Topic: What steps could you take to manage your cash flow better?It happened again. Ten days away from the end of the month and my husband Alvaro and I are out of money. Once again we have resorted to using our credit cards to purchase groceries, pay our cell phone bill, and get gasoline. How does it happen? Where does our money go?

We have finally made a resolution to manage our money responsibly. The first step that we must take is to understand the inflows and outflows of our money. Understanding the cash flow, or the available money that is flowing into and out of our home, is important to grasp before we can even begin to make any financial changes.

To start we must identify our sources of income. Where does our money come from? From our monthly earned income to Alvaro’s yearly bonuses and even the monetary gifts that we receive, how much money do we actually make each month? We have made a promise to one another that next Friday we will have a household financial meeting and write down our yearly, monthly, and weekly inflows. Once we understand the sources of our cash inflow and the total cash inflow we actually have to spend, we will have taken the first step to understanding our cash flow problem.

Secondly, before we can begin to cut back on our spending, it is imperative that we understand exactly what we are spending our money on, or our total cash outflows. Where is our money going? What percentage of our income is spent on housing and utilities? How much are we spending on transportation costs? How much dining out do we actually do? How much money do we spend on birthday gifts for our friends and family? These are just a few of the questions that we must investigate and resolve in order to make any other financial decisions.

Once we understand where our money comes from (inflows) and how much we actually have to spend (outflows), we can create a budget that can allow us to manage our money more effectively. No longer will we resort to using credit cards every month for basic living expenditures. In fact, hopefully we can toss out our credit cards altogether! The credit cards give us temporary access to money, but it is not income, it is a loan. These credit card loans add up quickly and become our future cash outflows. We know that we will never be able to match our cash inflows to our outflows if we keep borrowing money against our credit cards.

It is unfortunate that we have put ourselves in such a terrible financial situation. We have made irresponsible purchases and have lived beyond our means and the result is debt, high interest rates, and material possessions that are worth one third of what we paid for them in the first place. But, there is a silver lining. This new financial awareness has put us in a place where hopefully within the next few years we will be in a much better financial situation—one where we understand the power of money and consumerism and choose not to spend more than we have; one where we choose to save and invest in our future; one where we hope to have more than just possessions but instead a newfound sense of financial freedom!


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