Unit 2: Measuring

Financial Health

Learning ObjectivesO 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

weaknessesO Set up a record keeping system to track

income and expendituresO 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 OwnO First section of balance sheet

represents assetsO 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 OwnO Types of Assets

O Monetary assets are liquid asset, including cash you hold, your checking and savings account balances, and your money market fundsO 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 OwnO 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 yearO Utility bills, past-due rent, cable bills,

credit card billsO A long-term liability consists of a debt

on a larger assetO 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 moneyO 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 basisO Record income when you actually

receive moneyO 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.

Clothing and Ac-cessories; 13

Transporta-tion; 31 Recre

ation ; 22

Food; 31

Med-ical

Care; 52All Other; 42

House and

Household

Oper-ation;

65

State/Local

Taxes; 37

Fed-eral

Taxes; 70

How Americans Spent Their Money in 2005

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 liabilitiesO 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= 3950/1500O 2.39

O Month’s Living Expenses Covered ratio= 3590/(52,234/12)= 3590/4353= .825 monthsO 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 assetsO 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 expensesO Tells what after tax portion of your

income you are saving

Record KeepingO 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 KeepingO 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