Wealth Management Module 2 - Using Financial Statements and TVM

Net Worth

Assets - Liabilities

Assets

Fair Market Value - estimate | Actual Market Value - should be simple for investment assets

Liabilities

Current - Amount you owe that is due within one year | Long-term - Amount you owe that is due more than one year from date

Fair Market Value

What you can sell your asset for, often called net realizable value. Take for example my house. If I sold my house today, Zillow.com says it would be worth $448,800, this is an estimate of the fair market value.

Replacement Cost

What it would cost you to replace the asset. If my house were to burn down, it would cost me $310,000 to rebuild my house, this is the replacement cost of my house.

Market Value

The amount of money the market is willing to purchase an asset for. If I actually did sell my house and received $401,999 for the sale, this is the market value.

Income

is Earnings received as wages, salaries, bonuses, commissions, interest and dividends, or proceeds from the sale of assets.

Expenses

are money spent on living costs and to pay taxes, purchase assets, or repay debt (i.e., liabilities).

Cash Surplus

is an excess amount of income over expenses that results in increased net worth. Keep in mind however that there can be a varied definition of this. Simply put, if you have money left over at the end of the month after you pay your bills, you have a cash surplus. However, if you are a zero-based budgeter, you may not have extra cash left over at the end of the month...but some of your income was sent to a retirement account which DOES increase your net worth.

Solvency Ratio

Total Net Worth / Total Assets. The solvency ratio measures how much cushion you have before insolvency. If your solvency ratio is 33.4%, then you could withstand a 33.4% decline in your assets (e.g., a market decline) before you would be insolvent. Higher the Better.

Liquidity Ratio

Total Liquid Assets / Total Current debt (liabilities within one year). Liquid assets can include Cash, Savings Accounts, Money Market accounts, and Certificates of deposit. The Liquidity ratio shows how long you can continue to pay current debts with existing liquid assets. If your ratio is 13%, then you have around 13%*365 days = 47.45 days = 1.5 months of coverage.

Savings Ratio or Rate

Cash surplus / Net Income

Debt Service Ratio

Total monthly loan payments / monthly gross income. Provides a measure of the ability to pay debts promptly

Rule of 72

The number of years it takes to double your money = 72 / annual compound interest rate. Example: You have $1,000, how long to double this money if earn 10% per year? 72 / 10 = 7.2 years. The Rule of 72 starts to fall apart the higher the interest rate.