Measuring Your Financial Health and

Making a Plan

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Learning Objectives

1. Calculate your level of net worth or wealth using a balance sheet.

2. Analyze where your money comes from and where it goes using an income statement.

3. Use ratios to identify your financial strengths and weaknesses.

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Learning Objectives

4. Set up a record-keeping system to track your income and expenditures.

5. Implement a financial plan or budget that will provide for a level of savings needed to achieve your goals.

6. Decide if a professional financial planner will play a role in your financial affairs.

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Introduction

Where does all your money go?

Planning and budgeting requires control

Evaluate your financial health

Develop a plan of action

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Using a Balance Sheet to Measure Your Wealth

A snapshot of your financial status at a particular time.

Assets you own

Debt or liabilities you’ve incurred

Your net worth or equity.

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Assets: What You Own

Assets are your possessions even if you owe money on them.

List assets using their fair market value

All values must be current

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Assets: What You Own

Monetary assets – cash or liquid asset

Investments

Retirement plans

Tangible assets—physical assetshouse, vehicles, furniture, jewelry, collectibles,

etc.

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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.

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Liabilities: What You Owe

Current bills –utility bills, insurance premiums, credit card balances.

Long-term liabilities –home, car, or student loans.

Other loans –other installment loans, bank loans, insurance policy loans.

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Net Worth: A Measureof Your Wealth

Net worth = total assets - total debt

If liabilities > assets, negative net worth and insolvent.

If liabilities < assets, positive net worth.

Good level of net worth depends on yours goals and your place in the financial life cycle.

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Using an Income Statementto Trace Your Money

Financial motion picture—tells you where your money has come from and where it has gone over some period of time.

Income and expenditure, net income statement

Cash basis—based on actual cash flows

Income – expenses (over given time period)

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Income: Where Your MoneyComes From

Income or cash inflows:Wages, salary, bonuses, tips,

commissions before tax or automatic investments

Other sources: family income, government payments (veterans benefits, welfare), investment income.

Subtract federal, state, social security taxes from earnings to calculate your take-home pay.

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Expenditures: Where YourMoney Goes

Cash transactions may not leave a paper trail.

Variable or fixed expenditures.

Control over expenditures

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Using Ratios: Financial Thermometers

Financial ratios allow you analyze raw data in the balance sheet or income statement then compare it to targets.

Ratios help you understand how you are managing financial resources.

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Question 1: Do I Have Enough Liquidity to Meet Emergencies?

Current ratio: monetary assets divided by current liabilitiesShould be greater than 1.0Aim for above 2.0

Month’s Living Expenses Covered Ratio: monetary assets divided by annual living expenditures divided by 12Should aim for 3 to 6 months of liquid assetsLess if enough credit and insurance

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Question 2: Can I MeetMy Debt Obligations?

Debt Ratio: total debt or liabilities divided by total assetsShould decrease as you get older.

Long-term Debt Coverage Ratio: total income available for living expenses divided by total long-term debt payments Less than 2.5 is a red flag

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Question 3: Am I Saving as Much as I Think I Am?

Savings Ratio: income available for saving and investments divided by income available for living expenses

Effective saving is by paying yourself first

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Record Keeping

Without records difficult to prepare taxes.

You track expenses and know how much and where you are spending.

Easier for someone to step in during an emergency and understand your financial situation.

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Record Keeping Steps

1. Track your financial dealings.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.

2. File and store your financial records so they are readily accessible.

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Putting It All Together: Budgeting

Evaluate your financial health by using the balance sheet and income statement:to set financial goalsto achieve financial goals

Develop a plan of action and cash budget using the income statement

Monitor your progress using the balance sheet and income statement.

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Developing a Cash Budget

Plan for controlling cash inflows and outflows.

Allocate dollar amounts for different spending categories

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Preparing a Cash BudgetEstimate anticipated after-tax income or

take home pay from most recent annual personal income statement.

Estimate living fixed and variable expenses

Estimate income available for saving and investing: subtract anticipated living expenditures from anticipated take-home pay

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Implementing the Cash BudgetPut it in place for a month.

Compare actual expenditures in each category with budget amounts at the end of the month

Evaluate whether you change budget estimates or exert self-control?

Stick your desired budget for a month with an envelope system

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Hiring a Professional

Three options for working with professionals

1.Go it alone and have your plan checked by a professional.

2.Work with a professional to develop a plan.

3.Leave it all in the hands of a pro.

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What Planners Do

More unique financial situations need professional help.

They give advice.

You still need to know the basics and still bear ultimate responsibility

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Choosing a Professional PlannerCheck accreditations:

Personal financial specialist (PFS)

Certified financial planner (CFP)

Chartered financial consultants (ChFC)

Check experience

Referrals

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Choosing a Professional Planner

Fee-only planners

Fee-and-commission planners

Fee offset planners

Commission based planners

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Summary

Use a balance sheet to determine the level of wealth that you or your family has accumulated on a given date.

Use an income statement to understand where your money comes from and goes to be able to save enough to meet goals.

Use financial ratios as targets or standards in managing financial resources.

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Summary

A sound record-keeping systems makes tax preparation and tracking of spending easier.

Use a budget to plan and evaluate spending and saving.

Professional financial planners can help by validating your plan or developing a plan.

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