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Chapter 2: Measuring your Financial Health
Chapter 2:
Measuring your Financial HealthBalance sheetIncome statement BudgetIncome & expense statement (P&L)Financial ratiosRecordkeepingBudgetingProjections of your income and expensesWhere are you today?What you own and how you paid for it
What you own vs what you oweOn a given date
Terms:Assets what you ownListed at fair market valueLiabilities your debts, what you owe to someoneNet Worth your financial value
Net worth = Assets - LiabilitiesBalance SheetMonetary assets Cash, checking, savings, CDs, MMAs, emergency funds
Investments (non-retirement)Stocks, bonds, mutual funds, real estateCash value of life insurance, annuities
Retirement assetsValue of IRAs, 401(k), pensions
HousingValue of owned residences
Balance Sheet - AssetsAutomobilesValue of all autos
Personal propertyCollections, clothing, furnishings, etc.
OtherAnything else you own thats not listed aboveValue (equity) of any businesses you ownMoney owed to you
Balance Sheet - AssetsClassifications:Monetary (liquid)
InvestmentNon-retirement
Retirement
TangibleBalance Sheet - AssetsWhat you legally owe as of TODAY
Current liabilities due within 1 yearPayables bills you owe but havent paid yetUtilities, taxes, insurance premiums, etc.Credit card balances (principal only)
Long-term or non-current liabilitiesPrincipal remaining on each loanAuto loans, mortgage, consumer loans, student loansBalance Sheet - LiabilitiesWhat you are worth (in $); your wealthNet Worth = Total Assets Total LiabilitiesNot a measure of self-worth!!Want it to be positiveIf its negative youre insolvent As a student, its probably negativeWant it to grow over timeUntil retirement yearsBalance Sheet Net WorthTracks your money over a period of time
Cash accountingRecord when the cash changes hands
Easier to do on a monthly basis (usually)Then do it on an annual basis
Helps Identify ways to reduce spendingProject a budget for the futureDetermine how much you can save/invest per monthIncome StatementList all sources of cash income
Gross salary or wages (before taxes)Tips, commissions, bonusesScholarships, grants, welfare, GI bill, giftsInvestment incomeInterest earnedDividends (cash or stock)Any other incomeYard sales, selling blood, gambling, bank robberiesIncome Statement - IncomeTotal all income-based taxesLocal, state, and federal income taxesFICA Social Security (6.2%) Medicare taxes (1.45%)FUTA unemployment taxes
Gross Income Inc. Taxes = Take-Home PayMoney available to pay your expensesFor first job, estimate Take-Home Pay:Gross Income x (1-25%) Income Statement Income TaxesList the amount that you have added to your savings account throughout the periodAutomatic deduction, electronic bankingList the amount that you invested that periodRetirement accountsIRA, 401(k), 403(b), 457, SEP, SIMPLE, Keogh, .Non-retirement accountsBrokerage accounts, taxable accounts
Shoot for saving & investing 10% of your gross income
Income Statement Savings & Inv.List all household expenses
Several ways to classifyVariable vs FixedDiscretionary vs Non-discretionary
Lets keep it simple just list em!Income Statement - ExpensesHousing Rent or P&I, repairs, utilities, property taxes, etc.
FoodGroceries, food away from home, meal plan
Clothing & personal careClothes, toothpaste, hair care, TP
TransportationAuto loan payments (P&I), rental/leaseGas, repairs, licensing, inspections, maintenance
Income Statement - ExpensesMedicalCo-pays, prescriptions, tests, etc.
Insurance premiumsAuto, life, health, disability, LTC, homeowners, etc.
Recreation!!Need to classify what you consider recreation
Other anything not listed aboveGifts, donations, interest on credit cards, etc.Income Statement - ExpensesHeres the main mistakes:
Dont double-count credit card payments!Include under the proper expense category
Dont forget non-regular paymentsInsurance premiums (every 6 months)
Dont include investments as expenses!!Savings, investments, retirement, etc.
Expenses BEWARE!!CRUCIAL for your financial future!!!
Relatively simpleBut few people do it
Review your goalsReview your income statementTake your best guessesBudgetingIt only takes 15 freakin minutes of your life, people!Estimate your income for the upcoming monthGross income or Net of income taxesDont double count income/payroll taxes
Build savings & investments into your budgetBefore you look at your expenses!Pay yourself first!BudgetingPAY YOURSELF FIRST, Dawg!Estimate your expenditures for the monthBased on experience and income statementIncorporate your desired lifestyle (goals)Incorporate a fudge factor of 10-20%I guarantee you will forget or underestimate something!!BudgetingAfter you develop your projected budget
Track your expensesDaily Expense TrackerFind the leaks in your wallet
Compare actual expenses to budgetWhere did you screw up? its gonna happen!!
Revise budget and/or revise lifestyleBudgetingWhat if it comes out negative?Is your math correct (always check this!)
Can you reduce any of your expenditures?Look at the major ones (top 5)Smart shopping, generic vs name brand, etc.
Do you need to change your lifestyle?Revise your goals, your lifestyle
Do you have savings to fall back on?BudgetingWhat if it comes out positive?
Congratulations!!
Increase your savings and/or investmentsInvest for retirementPay down your debts fasterDonate to church or charityIncrease your living expenses a littleDo more of the things you want
BudgetingUncle Als Excel spreadsheetStationery stores, Office Depot, etc.Quicken, QuickbooksMint.comFree serviceAllows you to set up a budget & track expendituresSends you texts, emails, reminders, warningsYou are $10 over your gasoline budget.You have a credit card payment due in 5 days.You need to give them your bank account digits!Budgeting HelpAlex is not affiliated with any of these businesses, products, or websites.Used to gauge your financial condition
Compare to benchmarksLook for trends!!
Look at:LiquidityDebt repayment abilitySavings Financial RatiosMonths Living ExpensesMonetary Assets / Monthly Living ExpensesTells you how many months you can survive if you lose your steady incomeI use Monthly Living ExpensesDoesnt include savings or taxesBenchmark:Standard: 3-6 monthsIf its low do you have a source of emergency funds?Financial Ratios - LiquidityDebt Payment/Income RatioTotal Debt Payments / Gross IncomeBenchmark:Less than 38-40%Note: some people use take-home pay instead of gross incomeI use Total Debt Payments plus HO Insurance and Property TaxesThere are several offshoots of this ratioConsumer Debt Payment/IncomeFannie Mae or Front-end RatioFinancial Ratios Debt PaymentSavings RatioSavings & Investment / Gross Income
Benchmark:Greater than 10% (usually)
Depends on stage of life
Note: some people use take-home pay instead of gross incomeFinancial Ratios - SavingsNeed to look at everything:Balance sheetIncome statementFinancial ratios
Track changes over timeIdentify potential problems correct em!Impact of change in goalsFinancial HealthWhy?Prepare your taxesTrack your finances over time control spendingCYA in case of lawsuit, etc.Emergencies & the 5 DsDisease, disability, divorce, disasters, deathDrugs, Dependence, Dumbness, etc.HowFile cabinet, envelopesComputer Quicken, etc.Accounting service
Record KeepingWhat to keepTax recordsInvestment recordsInsurance recordsRetirement recordsEstate planning documentsDebt records - credit card info, mortgage, auto loanReceipts for major purchasesBalance sheet, income statementWarranties, contracts, deeds, titles, leasesHousehold inventoryRecord KeepingWhere:Home file cabinetFire-proof safeSafe deposit box (at a bank)
How long:Tax records 3-7 yearsDebt records for life of debt, plus 3 yearsInvestment records for life of investment + 3Real Estate records for lifeEstate planning records for life, until revisedRecord KeepingGreat industryFun, ever-changing, and pays pretty well!Help people achieve their goals in life
All levels of planningBasic vs complexSingle aspects vs comprehensiveMay include sales of productsFinancial Planning ProfessionalsHow they charge:Fee onlyPer hour or per projectFee and commissionFee offsetFees reduced by commissionsCommission only
Bottom linesWork with someone you trustWork with someone who understands your goalsWork with someone you understandThe Pros