Measuring Your Financial Health and Making a Plan

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Chapter 2

• Measuring Your Financial Health and Making a Plan

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Using a Balance Sheet to Measure Your Wealth

• First Step in a Personal Financial Plan
• A personal balance sheet is a statement of your
  financial position on a given date.
• A snapshot of your financial status at a
  particular time.
• It lists the assets you own, the debt or
  liabilities youve incurred, and your general
  level of wealth, known as net worth or equity.

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Assets What You Own

• All of your possessions are considered assets
  even if you owe money on them.
• Assets are listed using fair market value.

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Assets What You Own

• Different types of assets
• Monetary assets liquid assets including cash,
  checking and savings accounts, money market funds
  
• Investments common stocks, mutual funds, bonds
• Retirement plans IRAs, 401(k) or 403 (b)
  plans, Keogh plans, SEP-IRA plans, company
  pension plans

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Assets What You Own

• Different types of assets
• House
• Vehicles
• Personal property furniture, jewelry, TVs
• Other collectibles, part ownership in a business

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Liabilities What You Owe

• Liability is debt that must be repaid in the
  future.
• Current liabilities must be paid off within the
  next year.
• Long-term liabilities come due beyond a year.
• List only the unpaid balances.

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Liabilities What You Owe

• Different types of liabilities
• Current bills unpaid bills including utility
  bills, insurance premiums, credit card balances.
• Long-term liabilities debt on larger assets
  such as home, car, or student loan.
• Other loans any other outstanding debt
  including installment loans, bank loans.

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Net Worth A Measureof Your Wealth

• Net worth total assets - total debt

• If liabilities gt assets, then a negative net
  worth and insolvency.
• If liabilities lt assets, then a positive net
  worth.
• Manage your net worth so that goals are met in a
  timely manner.

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Using an Income Statementto Trace Your Money

• Second Step in a Personal Financial Plan
• Trace your money.
• Income statement states where your money has come
  from and where it has gone over a period of time.
  
• While the balance sheet was a snapshot, the
  income statement is like a movie video.
• Personal income statements are on a cash basis,
  using actual cash flows.

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Income Where Your MoneyComes From

• Income or cash inflows
• Wages, salary, bonuses, tips, commissions
• Other sources such as family income, government
  payments (veterans benefits, welfare), investment
  income.
• Some income may be automatically invested for you
  towards a retirement plan or insurance plan.
• Subtract taxes (federal, state, social security)
  from earnings to calculate your take-home pay.

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Expenditures Where YourMoney Goes

• While income is easy to calculate, spending may
  not be.
• Cash transactions may not leave a paper trail.
• Classify living expenses as either variable or
  fixed expenditures.
• The average household in 2005 worked 107 days to
  pay taxes 70 days for federal taxes, 37 days
  for state and local taxes.

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Using Ratios Financial Thermometers

• Third Step in a Personal Financial Plan
• Use ratios.
• With financial ratios, you analyze raw data in
  the balance sheet or income statement then
  compare it to targets.
• Use ratios to better understand how you are
  managing financial resources.

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Using Ratios Financial Thermometers

• Use financial ratios to answer these questions
• Do I have enough liquidity to meet emergencies?
• Can I meet debt obligations?
• Am I saving as much as I think I am?

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Question 1 Do I Have Enough Liquidity to Meet
Emergencies?

• Current ratio monetary assets current
  liabilities

• To judge liquidity, compare cash and other liquid
  assets with debt.
• While financial advisors look for ratio to be
  above 2.0, the trend is most important.
• This ratio does not consider monthly payments
  towards long-term debt (mortgage, car loans).

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Question 1 Do I Have Enough Liquidity to Meet
Emergencies?

• Months Living Expenses Covered Ratio
  monetary assets annual living expenses

• Tells how many months of living expenses can be
  covered with present monetary assets.
• Liquid assets covering 3-6 months are optimum,
  less if credit and insurance protection.
• Liquid investments have low risk/low return
  trade-off.

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Question 2 Can I MeetMy Debt Obligations?

• Debt Ratio total debt total assets

• Debt ratio tells you what percentage of your
  assets has been financed by borrowing.
• This ratio should decrease as you age.

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Question 2 Can I MeetMy Debt Obligations?

• Long-term Debt Coverage Ratio total
  debt total assets

• Relates the amount of funds available for debt
  repayment to the size of the debt payments.
• This is the number of times you could make your
  debt payments with your current income.

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Question 3 Am I Saving as Much as I Think I Am?

• Savings Ratio
• total debt
• total assets

• This is the ratio of income available for savings
  and investment to income available for living
  expenses.
• It tells you the proportion of your after-tax
  income that you are saving.