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PART 1:
FINANCIAL PLANNING
Chapter 2
Measuring Your Financial
Health and Making a Plan
Measure Your Wealth
The Balance Sheet
Is a statement of your financial position on
a given date.
Lists your assets, the liabilities (debts)
you’ve incurred, and your net worth.
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-2
Assets: What You Own
All of your possessions are considered assets
even if you owe money on them.
Assets are listed using fair market value.
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-3
Different Types of Assets
Monetary assets – are liquid.
Investments.
Retirement plans.
Real estate.
Vehicles.
Personal property.
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-4
Liabilities: What You Owe
Liability is debt that must be repaid in the
future.
List only the unpaid balances.
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Personal Finance: Turning Money Into Wealth
Keown
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Different Types of Liabilities
Current liabilities - must be paid off within
the next year.
Long-term liabilities – come due beyond a
year.
Other liabilities.
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-6
Net Worth: A Measure
of Your Wealth
Net worth =
total assets - total
debt
Liabilities > assets = negative
net worth (insolvency).
Liabilities < assets = positive
net worth.
Manage your net worth.
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-7
Trace Your Money
The Income Statement
Tells where your money has come from and
where it has gone over a period of time.
Is prepared on a cash basis.
Based on actual cash flows.
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-8
Income: Where Your Money
Comes From
Income is amount earned, not amount
received.
Sources of income.
Automatic investment for retirement
plans.
Calculate take-home pay.
Subtract taxes.
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-9
Expenditures: Where Your
Money Goes
Fixed expenses.
Variable expenses.
Major expenditures.
Cash transactions may not leave a paper
trail.
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-10
Using Ratios: Financial
Thermometers
Use financial ratios.
Ratios allow you to analyze data in your balance
sheet and income statement and compare the
data to targets or to previous performance.
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-11
Financial Ratios Answer These
Questions
Do I have enough liquidity to meet
emergencies?
Can I meet debt obligations?
Am I saving as much as I think I am?
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-12
Question 1: Do I Have Enough
Liquidity to Meet Emergencies?
Current ratio =
monetary assets
÷
current liabilities
© 2007 Prentice Hall Business Publishing
To judge liquidity, compare
cash and other liquid
assets with debt.
Should be above 2.0; trend
is most important.
This ratio does not
consider monthly
payments towards longterm debt (mortgage, car
loans).
Personal Finance: Turning Money Into Wealth
Keown
2-13
Question 1: Do I Have Enough
Liquidity to Meet Emergencies?
Month’s Living Expenses
Covered Ratio =
monetary assets
÷
Tells how many months of
living expenses can be
covered with present
monetary assets.
Liquid assets covering 3-6
months are optimum, less
if credit and insurance
protection.
annual living expenses/12
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-14
Question 2: Can I Meet
My Debt Obligations?
Debt Ratio =
total debt
÷
total assets
© 2007 Prentice Hall Business Publishing
Debt ratio tells you
what percentage of
your assets has been
financed by borrowing.
This ratio should
decrease as you age.
Personal Finance: Turning Money Into Wealth
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Question 2: Can I Meet
My Debt Obligations?
Long-term Debt Coverage
Ratio =
total income available for
living expenses
÷
total long-term debt
payments
© 2007 Prentice Hall Business Publishing
Relates the amount of
funds available for debt
repayment to the size of
the debt payments.
This is the number of
times you could make your
debt payments with your
current income.
Personal Finance: Turning Money Into Wealth
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Another Way to Look at Debt
Coverage
Total debt payments
÷
Total income available for
living expenses
Tells you what % total income available for
living expenses goes to cover debt
payments.
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-17
Question 3: Am I Saving as
Much as I Think I Am?
Savings Ratio =
Income available for
savings and investment
It tells you the
proportion of your
after-tax income that
you are saving.
÷
Income available for
living expenses
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-18
Record Keeping
Keep and maintain records.
Needed to prepare taxes.
Allows you track expenses and know how
much and where you are spending.
Makes it easier for someone to step in
during an emergency and understand your
financial situation.
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
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Record Keeping
Involves just 2 steps:
Track your financial dealings.
File and store your financial records so they are
readily accessible.
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-20
Record Keeping
Cash expenditures are more difficult to
track.
Record transactions in a ledger.
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Personal Finance: Turning Money Into Wealth
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2-21
Budgeting
A budget is a plan for controlling cash
inflows and outflows.
Purpose is to keep income in line with
expenditures plus savings.
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-22
Preparing a Cash Budget
Examine last year’s total income and make
adjustments for the coming year.
Estimate your taxes and calculate your
anticipated after-tax income.
Estimate your living expenses.
Identify fixed and variable expenditures.
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-23
Implementing the Cash Budget
At the end of the month, compare your actual
income and expenditures with your budgeted
amounts.
No budget is set in stone.
Try the envelope system.
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-24
Hiring a Professional
Options:
Go it alone; make your own plan and have
it checked by a professional.
Work with a professional to develop a
plan.
Leave it all in the hands of a professional.
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-25
Choosing a Professional Planner
Accreditations:
Personal financial specialist (PFS) - is a
CPA.
Certified financial planner (CFP).
Chartered financial consultants (ChFh).
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-26
Choosing a Professional Planner
Ascertain the planner’s credentials.
Consider their level of experience.
Ask for referrals.
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
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2-27
Choosing a Professional Planner
Fee-Only Planners - earn income through
fees.
Fee and Commission Planners - charge a fee
and a commission on products they
recommend.
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-28
Choosing a Professional Planner
Fee Offset Planners - charge a fee but
reduce it by any commissions earned.
Commission Based Planners - work on a
commission basis only.
Make sure your planner has a wide range of
choices available.
© 2007 Prentice Hall Business Publishing
Personal Finance: Turning Money Into Wealth
Keown
2-29