1. Measuring Your Financial Health and Making a Plan
Chapter 2
Measuring Your Financial Health and Making a Plan

2. Learning Objectives
Calculate your level of net worth or wealth using a balance sheet.
Analyze where your money comes from and where it goes using an income statement.
Use ratios to identify your financial strengths and weaknesses.
Set up a record-keeping system to track your income and expenditures.
Implement a financial plan or budget that will provide for a level of savings needed to achieve your goals.
Decide if a professional financial planner will play a role in your financial affairs.

3. 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 you’ve incurred, and your general level of wealth, known as net worth or equity.

4. 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.

5. 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 – IRA’s, 401(k) or 403 (b) plans, Keogh plans, SEP-IRA plans, company pension plans

6. Assets: What You Own Different types of assets: House Vehicles
Personal property – furniture, jewelry, TV’s
Other – collectibles, part ownership in a business

7. 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.

8. 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.

9. Net Worth: A Measure of Your Wealth
Net worth = total assets - total debt
If liabilities > assets, then a negative net worth and insolvency.
If liabilities < assets, then a positive net worth.
Manage your net worth so that goals are met in a timely manner.

10. Using an Income Statement to 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.

11. Income: Where Your Money Comes 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.

12. Expenditures: Where Your Money 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.

13. 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.

14. 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?

15. 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).

16. Question 1: Do I Have Enough Liquidity to Meet Emergencies?
Month’s Living Expenses Covered Ratio = Monetary Assets Annual Living Exp / 12
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.

17. Question 2: Can I Meet My Debt Obligations?
Debt Ratio = Total Liabilities Total Assets
Debt ratio tells you what percentage of your assets has been financed by borrowing.
This ratio should decrease as you age.

18. Question 2: Can I Meet My Debt Obligations?
Long-term Debt Coverage Ratio = Total Income Available for Living Exp Total Long - Term Liability Payments
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.
Ratio should not be Less than 2.5

19. Question 3: Am I Saving as Much as I Think I Am?
Savings Ratio =
Income Available for Savings & Investments
Income Available for Living Expenses
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.

20. Fourth Step in Personal Financial Planning
Record Keeping
Fourth Step in Personal Financial Planning
Keep and maintain records.
Without records it is difficult to prepare taxes.
Strong record keeping allows you track expenses and know how much and where you are spending.
Organized record keeping makes it easier for someone to step in during an emergency and understand your financial situation.

21. Record Keeping Record keeping involves just 2 steps:
Track your financial dealings.
File and store your financial records so they are readily accessible.

22. Record Keeping
Credit card and check expenditures are easy to track, but cash expenditures must be tracked as they occur.
After tracking, record transactions in a ledger.

23. Putting It All Together: Budgeting
5-step planning process:
Evaluate your financial health using the balance sheet and income statement.
Set financial goals by using the balance sheet and income statement to set and achieve goals.
Develop a plan of action using the income statement.
Set up a cash budget by using the income statement for flexibility, liquidity, protection, and minimizing taxes.
Monitor your progress, using the balance sheet and income statement.

24. Developing a Cash Budget
A budget is a plan for controlling cash inflows and outflows.
The cash budget keeps income in line with expenditures and savings and allocates amounts to different spending categories.

25. Developing a Cash Budget
Preparing a cash budget:
Begin with the most recent personal income statement, examine last year’s total income, make adjustments for the coming year.
Estimate your taxes.
Calculate your anticipated after-tax income or “take home pay.”
Estimate your living expenses, identify fixed then variable expenditures.

26. Developing a Cash Budget
Income Available for Savings & Investment = Anticipated Take Home Pay - Anticipated Living Expenditures.
Compare anticipated monthly savings with target savings.
Remember: No budget is set in stone.

27. Hiring a Professional How to incorporate professionals:
Do it alone; make your own plan and have it checked by a professional.
Work with a professional to develop a plan.
Leave it all in the hands of a professional.
The more unique your situation, the greater the need for professional help.

28. Choosing a Professional Planner
The title “financial planner” is not legally defined.
Accreditations:
Personal financial specialist (PFS) is a certified public accountant
Certified financial planner (CFP)
Chartered financial consultants (ChFh)

29. Choosing a Professional Planner
Ascertain the planner’s credentials
Consider their level of experience
Ask for referrals

30. Choosing a Professional Planner
Fee-Only Planners earn income through fees
You control the products and commissions
Fee and Commission Planners charge a commission on products they recommend
Lower fees if you use their commissioned products

31. Choosing a Professional Planner
Fee Offset Planners charge a fee but reduce it by earned commission
Commission Based Planners work on a commission basis only
This is the most available type of planner