1 chapter 2 – measuring financial health important parts construct & interpret financial...
Post on 21-Dec-2015
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Chapter 2 – Measuring Financial Health
Important parts
• Construct & interpret financial statements
• Budgeting
• Record-keeping
• Financial planners
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Measuring Financial Health
• Balance sheet – as of a particular date– Assets – what you own– Liabilities – what you owe/borrowed– Net Worth – a measure of your wealth
• Assets less liabilities is net worth
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Types of Assets
• Monetary assets – cash• Investments – provide
income• Retirement plans
• Automobiles• Real estate• Personal Property• Other – owed to you
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Liabilities
• Money you owe– Unpaid bills, credit cards, car loans, mortgages
• Only include principal on balance sheet
• Liabilities may be current or long-term
• Net worth equals assets less liabilities
• Insolvent – owe more than assets worth
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Income Statement
• Shows where money comes from and goes– Covers a period of time; uses actual cash flows– Helps you stay solvent
• Variable or discretionary versus fixed or mandatory
• Paper trail is hard to follow
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Ratios – Financial Thermometers
#1. Do I have adequate liquidity to meet
financial emergencies?
– A. Current ratio is liquid assets divided by current liabilities
– B. Months of living expenses covered by liquid assets
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#2 – Ability to Meet Debt
A. Debt ratio asks – What percent of assets financed by
borrowing? – Do I have too much debt?
Debt ratio = Total Debt
Total assets
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Savings
#3 - Am I really saving as much as I think I am?
What percentage of after-tax in come is being saved? Measured by savings ratio
Not saving = living above your means
Pay yourself first!
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Record Keeping
• Organizing and maintaining records is essential for financial planning– For taxes, tracking expenses, preparing family
for an emergency
• Systems – from software to envelope system
• Good checklist on page 46
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What is a Budget?
“A method of going broke methodically”
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Cash Budgets
• Plan for controlling cash inflows and outflows to keep expenditures in line with income
• Done on both monthly and cumulative basis
• Show and explain variances by line item
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The Budget Process
• Purpose: know where money comes from and where it goes.– Take remedial action to control spending– Both forward and backward looking
• Starts with income• Expenses divided into mandatory and
discretionary spending• What’s left should be change in savings
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Budgeting Steps
• Start with latest income statement
• Estimate tax liabilities and other deductions
• Identify fixed (mandatory) expenses
• Identify variable (discretionary) expense– Any way to reduce?
• Calculate amount available for savings.– Is it sufficient to reach goals?
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Financial Planners
Wide range of services:
Help develop plans and budgets; sanity check
Various types – usually registered w/ SEC/state
But often insurance or securities sales people
Understand their compensation arrangements
Do commissions affect recommendations/ judgment?
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