HACE 3200 1st Edition Lecture 4 Outline of Last Lecture I Evaluate your Financial Health II Assets III Liabilities IV Expenditures V Developing a Budget Outline of Current Lecture I Using Ratios A Financial Thermometer II Current Ratio III Month s Living Expenses Covered Ratio IV Debt Ratio V Long term Debt Coverage Ratio VI Savings Ratio VII Financial Planners Current Lecture Chapter Two Part 2 Using Ratios A Financial Thermometer o Analyzes the raw data from your balance sheet and income statement to identify your financial strengths and weaknesses o Allows you to answer the following questions Question 1 Do you have adequate Liquidity o Liquidity the relative ease and speed with which you can convert noncash assets into assets Ratios o Ratios to determine whether or not you have enough Monetary Assets 1 to pay for an unexpected large expense or 2 to tide you over during periods of reduced or eliminated earnings These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute Liquidity Ratios o 1 Current ratio o 2 Month s living expenses covered ratio Current Ratio o Monetary assets current liabilities o Shows whether you have enough liquid assets to cover expenses currently due o Ratio greater than 2 recommended Monetary Assets o Cash or other assets that can be easily liquidated o Examples cash checking accounts savings accounts Your Liabilities What you Owe o Current Liabilities are liabilities that must be paid off within the next year Examples credit cards and utility bills Calculate Current Ratio o Frank has 4 000 in checking 8 000 loan due 12 14 14 15 000 in Money Market Acct 2 000 cash 15 000 attorney payment due 9 07 14 3 000 therapy installment payment due 10 18 13 Monetary Assets o 4000 checking o 15000 Money Market o 2000 cash Current Liabilities 8000 loan 15000 attorney 3000 therapy Answer 21 000 26 000 ratio 0877 multiply by 100 Is this a good ratio NO Can only pay off 80 of current debt Month s Living Expenses Covered Ratio o Monetary assets annual living expenses Divide annual living expenses by 12 o The rule of thumb 3 to 6 months of expenses Calculate Month s Living Expenses Ratio o Monetary Assets 3 000 savings 1 000 Money Market 600 Checking o Expenses 6 000 annual rent 5 000 yrly medical ins 4 000 yrly liability ins 3 000 annual food 9 600 annual debt Answer o 4 600 in monetary assets divided by 2 300 or 27 600 12 in living expenses o Results in enough liquid monetary assets to cover only 2 months of living expenses o Book says this IS NOT adequate Calculate Month s Living Expenses Ratio example 2 o Monetary assets 13 000 savings 10 000 Money Market 600 checking o Expenses 6 000 annual rent 3 000 yrly medical ins 4 000 yrly liability ins 5 000 annual food 9 600 annual debt Answer o 23 600 in monetary assets divided by 2 300 or 27 600 12 in living expenses o Results in enough liquid monetary assets to cover 10 26 months of living expenses o Book says this is adequate Question 2 Can you meet your debt obligations o Ratios to determine whether or not you can meet current or long term debt obligations Debt ratios o 1 debt ratio o 2 long term debt coverage ratio 1 Debt Ratio o total debt liabilities total assets o this ratio tells you whether you could payoff all your liabilities if you liquidated all your assets Liabilities o 4500 car loan o 26000 student loan o 112000 house loan Assets o 277000 house o 15000 car o 54000 jewelry 142 500 346 000 o 4118 or 41 18 of their assets are financed through their debt and yes they could pay the debt off if they needed 2 Long Term Debt Coverage Ratio o total income available for living expenses total long term debt payment this ratio tells you how many times you could make your debt payments with your current annual income Ratio of 2 5 or greater recommended o Income available for living 56 510 o Debts Mortgage 19 656 Auto loan 2 588 College loan 1 600 Tv loan 230 56 510 24 074 2 35 times Anything less than 2 5 Red Flag Question 3 Are You Saving As Much As You Think o Ratio to determine if you are saving as much as you think Savings Ratio o Income available for savings income available for living expense This ratio tells you what proportion of your after tax income is being saved o Income available for saving 4 276 o Income available for living 56 510 o Ratio 076 or 7 6 Interpretation U S rate typically 3 8 Varies with stage of the financial life and goals Managing Your Own Affairs Versus Hiring A Professional o The 3 options Go it alone make a plan and have it checked by a professional Work with a professional and develop a plan Let the professional do it all WORST OPTION Paying Your Financial Planner o Fee only planners develop income from charging the client for the service provided or for a financial plan o Commission based planners derive income from the sale of financial products o Some planners charge a combination of fees and commissions