Personal Finance: Turning Money
into Wealth
Ninth Edition
Chapter 2
Measuring Your Financial
Health and Making a Plan
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Learning Objectives
2.1 Calculate your level of net worth or wealth using a
balance sheet.
2.2 Analyze where your money comes from and where it
goes using an income statement.
2.3 Use ratios to identify your financial strengths and
weaknesses.
2.4 Set up a record-keeping system to track your income
and expenditures.
2.5 Implement a financial plan or budget that will provide for
the level of savings needed to achieve your goals.
2.6 Decide whether a professional financial planner will play
a role in your financial affairs.
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Introduction
• Where does your money go?
• Planning and budgeting require control.
• Evaluate your financial health.
• Develop a plan of action.
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Figure 2.1
The Budgeting and Planning Process: Evaluating Your
Financial Health and Developing 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
• A balance sheet details:
– Assets you own
– Debt or liabilities you owe
– Your net worth or equity
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Figure 2.2
Personal Balance Sheet
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Assets: What You Own (1 of 2)
• Assets are your possessions even if you owe money on
them.
• List assets using their current fair market value.
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Assets: What You Own (2 of 2)
• Monetary assets—cash or other liquid assets
• Investments—including common stocks, mutual funds, and
bonds
• Retirement plans—I RA s, 401(k) or 403(b) plans, company
pension plans
• Tangible assets—physical assets
– House, vehicles, furniture, jewelry, collectibles, etc.
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Liabilities: What You Owe
• A liability is debt that must be repaid in the future.
• List only the unpaid balances for:
– Current liabilities (must be paid off within the next year)
—utility bills, insurance premiums, or credit card
balances
– Long-term liabilities (due over a period longer than a
year)—home, car, or student loans
– Other loans—other installment loans, bank loans, or
insurance policy loans
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Net Worth: A Measure of Your Wealth
• Net worth total assets total liabilities
• If liabilities assets, negative net worth and insolvent
• If liabilities assets, positive net worth
• Good level of net worth depends on your goals and your
place in the financial life cycle.
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Figure 2.3
A Balance Sheet for
Kamala and Larry
Tate, December 31,
2021
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Using an Income Statement to Trace
Your Money
• Financial motion picture—tells you where your money has
come from and where it has gone over some period of time
• Reflects net income (income less expenditures)
• Record on the cash basis
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Figure 2.4
A Simplified Income Statement
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Income: Where Your Money Comes
From
• Income or cash inflows:
– Wages, salary, bonuses, tips, royalties, and
commissions
– Other sources: family income, government payments
(veterans benefits, welfare), retirement income,
investment income
• Subtract federal, state, social security taxes from earnings
to calculate your take-home pay.
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Expenditures: Where Your Money
Goes
• Cash transactions may not leave a paper trail.
• Classify your expenditures by category.
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Figure 2.5
How Americans Spent Their
Money in 2020
Note: Because some family units spend
more or less than their income, totals
may exceed 100%.
Source: Consumer Expenditures (U.S.
Department of Labor, U.S. Bureau of
Labor Statistics, December 2020).
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HOUSEHOLD GROSS INCOME IN
MALAYSIA 2019
At state level, W.P. Kuala Lumpur recorded the highest median income with
RM10,549 followed by W.P. Putrajaya (RM9,983), Selangor (RM8,210), W.P.
Labuan (RM6,726), Johor (RM6,427), Pulau Pinang (RM6,169) and Melaka
(RM6,054).
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Household Expenditure Survey Report 2019
Households in the urban areas recorded the highest percentage of expenditure in
the Housing, water, electricity, gas & other fuel at 24.0 per cent. Meanwhile, the
highest expenditure of households in rural areas was in the Food & non-alcoholic
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beverages expenditure group (24.4%).
Figure 2.6
A Personal Income
Statement for Kamala
and Larry Tate
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Using Ratios: Financial
Thermometers
• Financial ratios allow you analyze raw data in the balance
sheet or income statement and 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?
monetary assets
current ratio
current liablities
• Should be greater than 1.0
• Aim for above 2.0
monetary assets
month’s living expenses covered ratio
annual living expenditures /12
• Should aim for 3 to 6 months of liquid assets
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Question 2: Can I Meet My Debt
Obligations?
• Should decrease as you get older
total debt or liabilities
debt ratio
total assets
total income available for living expenses
long-term debt coverage ratio
total long-term debt payments
• Red flag if less than 2.5
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Question 3: Am I Saving as Much as I
Think I Am?
• Effective saving is by paying yourself first.
income available for savings and investment
savings ratio
income available for living expenditures
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Record Keeping
• Without records, it’s difficult to prepare taxes.
• By tracking expenses, you know how much and where you
are spending.
• It’s also 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.
– The best system is one that you will use.
– Credit card and check expenditures are easy to track,
but cash expenditures are more difficult to track.
– Consider Mint, Goodbudget, or Quicken.
2. File and store your financial records so they are readily
accessible.
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Figure 2.7
Web-Based Financial
Planning with Mint and
Goodbudget
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Putting It All Together: Budgeting
• Evaluate your financial health by using the balance sheet
and income statement:
– To set financial goals
– To 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 Budget
• Estimate anticipated after-tax income or take-home pay
from most recent annual personal income statement
(updated with expected changes for the current year).
• Estimate fixed and variable living expenses.
• Estimate income available for saving and investing:
subtract anticipated living expenditures from anticipated
take-home pay.
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Implementing the Cash Budget
• Try it for a month.
• Compare actual expenditures in each category with budget
amounts at the end of the month.
• Evaluate whether you should change budget estimates or
exert self-control.
• Stick your desired budget for a month within an envelope
system.
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Love & Money
• Communication, especially about money, is one of the
keys to a good relationship.
• Money talk involves sharing goals, personal feelings, and
intimacies.
• Pick a “happy time” to start the conversation.
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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 Planner
• Check accreditations:
– Personal financial specialist (PF S)
– Certified financial planner (CF P)
– Chartered financial consultant (ChF C)
• Check experience
• Referrals
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How Financial Planners Are Paid
• Fee-only planners
• Fee-and-commission planners
• Fee offset planners
• Commission-based planners
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Summary (1 of 2)
• 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 (2 of 2)
• A sound record-keeping system 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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