Unit 2: Measuring Financial Health

Learning Objectives O Define asset, liability, and net worth. O Calculate the level of net worth using a balance sheet. O Analyze where money comes from and where it goes using an income statement. O Use ratios to identify financial strengths and weaknesses O Set up a record keeping system to track income and expenditures O Implement a financial plan to help meet my financial goals.

Using a Balance Sheet to Measure Wealth O Before you can decide how much you need to save to reach your goals, you have to measure your financial condition. O A personal balance sheet is a statement of your financial position on a given date. O Lists assets, liabilities, and net worth (equity)

Assets: What You Own O First section of balance sheet represents assets O All your possessions are considered assets, whether or not you still owe money on them O Fair market value is what an asset could be sold for rather than what it cost or what it will be worth sometime in the future.

Assets: What You Own O Types of Assets O Monetary assets are liquid asset, including cash you hold, your checking and savings account balances, and your money market funds O A liquid asset is either cash or can easily be turned into cash O Financial assets are investments, including common stocks, mutual funds, or bonds, used to accumulate wealth.

Assets: What You Own O Types of Assets (cont.) O Tangible Assets are physical assets, such as a house or a car, as opposed to an investment O Personal Property consists of tangible assets. Personal property is all your possessions— furniture, appliances, jewelry, TV’s, etc. O Fair market value will be only a fraction of the purchase amount O Value decreases over time

Liabilities: What You Owe O A liability is debt that you have taken on and that you must repay in the future. O A current liability must be paid off within the next year O Utility bills, past-due rent, cable bills, credit card bills O A long-term liability consists of a debt on a larger asset O Home, car, or student loan

Net Worth: A Measure of Your Wealth O To calculate your net worth or equity, subtract total debt (liabilities) from total assets. O Represents the level of wealth you have accumulated O If you owe more money than you are worth you are considered insolvent.

Using an Income Statement to Trace Your Money O Step 2: Trace your money O An income statement tells you where your money has come from and where it has gone over some period of time. O Helps you stay solvent

Using an Income Statement to Trace Your Money O Prepared on a cash basis O Record income when you actually receive money O Record expenditures only when you actually pay money out

Income: Where Your Money Comes From O Income includes wages, salary, bonuses, tips, royalties, and commissions O Take home pay= earnings- taxes

Expenditures: Where Your Money Goes O Expenditures are difficult to calculate because many expenditures are cash transactions and do not leave a paper trail. O A variable expenditure is one over which you have control. O A fixed expenditure is one over which you have no control.

O A budget is the process of setting spending goals. O A plan for controlling cash inflows and outflows. O Limits spending in different categories.

Using Ratios: Financial Thermometers

Question 1: Do I have enough liquidity to meet emergencies? O Current ratio is aimed at determining if you have adequate liquidity to meet emergencies. O = Monetary assets Current liabilities O Month’s living expenses covered ratio= monetary assets Annual living expenditures/12

Question 1: Do I have enough liquidity to meet emergencies? O Current Ratio= 3950/1500 O 2.39 O Month’s Living Expenses Covered ratio= 3590/(52,234/12)= 3590/4353=.825 months O Tells how many months of living expenditures you can cover with your present level of monetary assets

Question 2: Can I meet my debt obligations? O Debt ratio= total debts or liabilties total assets O Long term debt coverage ratio= total income available for living expenses total long term debt payments

Question 3: Am I saving as much as I think I am? O Savings ratio= income available for savings and investment income available for living expenses O Tells what after tax portion of your income you are saving

Record Keeping O Fourth step: maintain records O Without adequate records it is difficult to prepare taxes O Allows you to track expenses and know how much you spend and where O Makes it easier for someone else to step in during an emergency

Record Keeping O Involves two steps O Tracking your personal financial dealings O Filing and storing your financial records O The best record keeping system is one that you will use! O A ledger is a book or a notebook set aside to record expenditures