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

2. Using A Balance Sheet to Measure Your Wealth
Personal balance sheet: the financial Polaroid
The financial equation: calculating net worth or equity
Assets - Liabilities = Net Worth

3. Your Assets: What You Own
Monetary
Investment
Retirement plans
Real estate
Automobiles and other vehicles
Personal property
Other tangible and intangible assets

4. Monetary Assets:
Cash or other assets that can be easily converted into cash
These assets provide necessary liquidity in case of an emergency.
Examples -- cash, checking accounts, savings accounts

5. Investment Assets: Assets that are invested for the future
These assets are used to accumulate wealth to satisfy a goal.
Examples -- stocks, bonds, mutual funds, cash value life insurance

6. Retirement Plans:
Investments by you or your employer to save for retirement
Long-term investments that often carry a penalty if used before a certain age
Examples -- pensions, IRAs, 401(k), 403(b), Keogh, or SEP-IRA plans

7. Real Estate:
Tangible asset such as land and a dwelling, reported as fair market value
Represents most of your savings, and normally appreciates in value
Examples -- primary residence, vacation home, and rental property

8. Automobiles and Other Vehicles:
Tangible assets that normally must be inspected and licensed
Reported as fair market value, but normally depreciate in value
Examples -- cars, trucks, motorcycles, and recreational vehicles

9. Personal Property: Tangible assets that represent your lifestyle
Reported as fair market value, but normally depreciate in value
Examples -- boats, furniture, electronics, clothing, jewelry

10. Other Assets:
Any other tangible or intangible asset that may or may not be of value
Examples -- business ownership, collections, money owed you

11. Your Liabilities: What You Owe
Current liabilities are liabilities that must be paid-off within the next year.
examples -- credit cards and utility bills
Long-term liabilities are liabilities that extend beyond one year.
examples -- home mortgage and auto loans

12. Your Net Worth: A Measure of Your Wealth
Insolvency: do you owe more than you own?
How age affects net worth guidelines
Uses of a balance sheet

13. Using an Income Statement to Trace Your Money
Personal income statement -- the financial motion picture
Cash basis: statement based entirely on actual cash flows

14. Income: Where Your Money Comes From
Sources of income: wages, tips, royalties, salary, and commissions
Income is amount earned, not necessarily amount received.

15. Expenditures: Where Your Money Goes
The two major expenditure categories: taxes and living expenses
Fixed expenses: Expenses you don’t directly control -- e.g., mortgage, rent, cable TV
Variable expense: Expenses you can control -- e.g., food, entertainment, clothing

16. Where Does It Go, On Average?
Taxes, Food, Housing, Medical Care
The more earned, the more spent on education and entertainment.

17. Using Ratios: A Financial Thermometer
Question 1: Do you have adequate liquidity to meet emergencies?
Question 2: Do you have the ability to meet your debt obligations?
Question 3: Are you saving as much as you think you are?

18. Question 1: Do You Have Adequate Liquidity
Ratios to determine whether or not you have enough monetary assets (1) to pay for an unexpected large expense or (2) to tide you over during periods of reduced or eliminated earnings.
Current ratio
Month’s living expenses covered ratio

19. Current Ratio monetary assets current liabilities
This ratio shows you whether you have enough liquid assets to cover expenses currently due.

20. Interpretation Ratio greater than 2 recommended
Track the trend and if going down --make changes

21. Month’s Living Expenses Covered Ratio
monetary assets
month’s living expenses
This ratio tells you how many months living expenses you can cover with your present level of monetary assets.

22. Interpretation The rule of thumb: 3 to 6 months of expenses
Factors that affect the rule of thumb:
Available credit cards or home equity loans
Potential for higher earnings on less liquid accounts
Stability of income
Track the trend and if going down--make changes

23. Question 2: Can You Meet Your Debt Obligations?
Ratios to determine whether or not you can meet current or long-term debt obligations:
Debt ratio
Long-term debt coverage ratio

24. Debt Ratio total liabilities total assets
This ratio tells you whether you could payoff all your liabilities if you liquidated all your assets.

25. Interpretation Represents percentage of assets financed with borrowing
Track the trend; ratio should go down with age

26. Long-term Debt Coverage Ratio
total income available for living expenses
total long-term debt payment
This ratio tells you how many times you could make your debt payments with your current income.

27. Interpretation Ratio of 2.5 or greater recommended
Track the trend and if going down -- make changes
Consider the inverse --the percentage of take-home pay needed to repay debt

28. Question 3: Are You Saving As Much As You Think?
Ratio to determine whether you are saving as much of your income as you think.
Savings ratio

29. Savings Ratio income available for savings
income available for living expenses
This ratio tells you what proportion of your after-tax income is being saved.

30. Interpretation U.S. rate typically 3% - 8%
Varies with stage of the financial life cycle and goals

31. Record Keeping The three reasons for accurate record keeping
Preparing taxes
Tracking expenses
Providing information for others to use in the event of an emergency

32. Record Keeping (cont’d)
The two steps of record keeping
Tracking your personal financial dealings
Storing your financial records in an accessible manner

33. Ways to Track Expenditures
Using checks and credit cards: Those expenditures leave a paper trail
Using cash: Record expenditures in a notebook or ledger
Generating a monthly income and expense statement
Using computer programs to track all financial transactions
Learning what and where to keep records

34. Taxes Keep all tax-related receipts and records for 6 years.
Always keep accurate tax records in the event of an audit.

35. Putting It All Together: A Review
Evaluate your financial health: balance sheet, income statement, and ratios
Define your financial goals: must know how much you can save
Develop a plan of action: use the income statement and a cash budget
Implement your plan: Just do it!
Review your progress, reevaluate, and revise your plan: back to the balance sheet, income statement, ratios, and budget

36. A Cash Budget A plan for controlling cash inflows and outflows
Purpose: To balance income with expenditures AND savings

37. Putting It All Together: Budgeting
Evaluate your financial health and your financial plan
Develop a cash budget
Implement a cash budget

38. Developing a Cash Budget
Examine last year’s total income and adjust for the current year.
Estimate your tax liability.
Identify all fixed expenditures.
Identify all variable expenditures.
Look for ways to reduce your variable expenses.
Consider the effect of credit payments on future income

39. Calculating the Bottom Line

40. Implementing a Cash Budget
Try the budget for a month.
Adjust the plan or your expenses as necessary to maintain the plan.
Try the envelope system.

41. Managing Your Own Affairs Versus Hiring a Professional
The 3 options
Go it alone,make a plan and have it checked by a professional.
Work with a professional and develop a plan.
Let the professional do it all.

42. Paying Your Financial Planner:
Fee-only planners derive income from charging the client for the service provided or for a financial plan.
Commission-based planners derive income from the sale of financial products.
Some planners charge a combination of fees and commissions.

43. Choosing a Professional Planner
Pick a competent planner with accreditation(s) from a professional organization(s).
Pick a planner with whom you are comfortable.
Pick a planner with experience.

44. Choosing a Professional Planner (cont’d)
Before hiring a planner, ask lots of questions about his/her history.
Call professional organizations to get recommendations.

45. Summary
Balance sheet -- determines net worth based on a comparison of assets and liabilities
Income statement -- summarizes cash inflows and cash outflows
Financial ratios -- diagnose your financial health

46. Summary (cont’d)
Record keeping -- implement strategies to accurately track expenses and maintain necessary financial records for the future
Cash budget -- provides a plan for achieving your goals by balancing cash inflows and outflows
Financial planners -- can provide many levels of assistance for your planning needs