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Unit 2: Measuring Financial Health

Unit 2: Measuring Financial Health. Learning Objectives. Define asset, liability, and net worth. Calculate the level of net worth using a balance sheet. Analyze where money comes from and where it goes using an income statement. Use ratios to identify financial strengths and weaknesses

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Unit 2: Measuring Financial Health

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  1. Unit 2: Measuring Financial Health

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

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

  4. Assets: What You Own • First section of balance sheet represents assets • All your possessions are considered assets, whether or not you still owe money on them • 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.

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

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

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

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

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

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

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

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

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

  14. Using Ratios: Financial Thermometers

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

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

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

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

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

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

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