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

Measure Your Wealth The Balance Sheet Is a statement of your financial position on a given date. Lists your assets, the liabilities (debts) you’ve incurred, and your net worth. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

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. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Different Types of Assets Monetary assets – are liquid. Investments. Retirement plans. Real estate. Vehicles. Personal property. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Liabilities: What You Owe Liability is debt that must be repaid in the future. List only the unpaid balances. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Different Types of Liabilities Current liabilities - must be paid off within the next year. Long-term liabilities – come due beyond a year. Other liabilities. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Net Worth: A Measure of Your Wealth total assets - total debt Liabilities > assets = negative net worth (insolvency). Liabilities < assets = positive net worth. Manage your net worth. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Trace Your Money The Income Statement Tells where your money has come from and where it has gone over a period of time. Is prepared on a cash basis. Based on actual cash flows. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Income: Where Your Money Comes From Income is amount earned, not amount received. Sources of income. Automatic investment for retirement plans. Calculate take-home pay. Subtract taxes. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Expenditures: Where Your Money Goes Fixed expenses. Variable expenses. Major expenditures. Cash transactions may not leave a paper trail. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Using Ratios: Financial Thermometers Use financial ratios. Ratios allow you to analyze data in your balance sheet and income statement and compare the data to targets or to previous performance. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Financial Ratios 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? © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

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. Should be above 2.0; trend is most important. This ratio does not consider monthly payments towards long-term debt (mortgage, car loans). © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Question 1: Do I Have Enough Liquidity to Meet Emergencies? Month’s Living Expenses Covered Ratio = monetary assets ÷ annual living expenses/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. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Question 2: Can I Meet My 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. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Question 2: Can I Meet My Debt Obligations? Long-term Debt Coverage Ratio = total income available for living expenses ÷ total long-term debt 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. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Another Way to Look at Debt Coverage Total debt payments ÷ Total income available for living expenses Tells you what % total income available for living expenses goes to cover debt payments. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Question 3: Am I Saving as Much as I Think I Am? Savings Ratio = Income available for savings and investment ÷ Income available for living expenses It tells you the proportion of your after-tax income that you are saving. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Record Keeping Keep and maintain records. Needed to prepare taxes. Allows you track expenses and know how much and where you are spending. Makes it easier for someone to step in during an emergency and understand your financial situation. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Record Keeping Involves just 2 steps: Track your financial dealings. File and store your financial records so they are readily accessible. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Record Keeping Cash expenditures are more difficult to track. Record transactions in a ledger. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Budgeting A budget is a plan for controlling cash inflows and outflows. Purpose is to keep income in line with expenditures plus savings. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Preparing a Cash Budget Examine last year’s total income and make adjustments for the coming year. Estimate your taxes and calculate your anticipated after-tax income. Estimate your living expenses. Identify fixed and variable expenditures. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Implementing the Cash Budget At the end of the month, compare your actual income and expenditures with your budgeted amounts. No budget is set in stone. Try the envelope system. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Hiring a Professional Options: Go 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. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Choosing a Professional Planner Accreditations: Personal financial specialist (PFS) - is a CPA. Certified financial planner (CFP). Chartered financial consultants (ChFh). © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Choosing a Professional Planner Ascertain the planner’s credentials. Consider their level of experience. Ask for referrals. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Choosing a Professional Planner Fee-Only Planners - earn income through fees. Fee and Commission Planners - charge a fee and a commission on products they recommend. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown

Choosing a Professional Planner Fee Offset Planners - charge a fee but reduce it by any commissions earned. Commission Based Planners - work on a commission basis only. Make sure your planner has a wide range of choices available. © 2007 Prentice Hall Business Publishing Personal Finance: Turning Money Into Wealth Keown