Financial statements easure your financial health and progress

Financial statements are compilations of personal financial data designed to communicate information on money matters. They are used often along with other financial data to indicate the financial condition and behavior of an individual or family. The two most useful statements are the balance sheet and the cash-flow statement.
balance sheet (or net worth statement) describes an individual’s or family’s financial condition on a specified date (often January 1) by showing assets, liabilities, and net worth. It provides a current status report and includes information on what you own, what you owe, and what the net result would be if you paid off all of your debts. It answers the question “Where are you financially right now?” A cash-flow statement (or income-and-expense statement) lists and summarizes income and expense transactions that have taken place over a specific period of time, such as a month or a year. It tells you where your money came from and where it went. It answers the question “Where did your money go?”

The Balance Sheet Is a Snapshot of Your Financial Status Right Now
To benchmark where you are on the wealth-building scale, determine your net worth. If you are indeed serious about your financial success, then you will sit down soon with pencil and paper or at your computer to see exactly where you stand. You do so by preparing your balance sheet, which summarizes the value of what you own minus what you owe. Your balance sheet should be updated at least once each year so that you can assess your progress. Net worth grows slowly. If you are successful in your career and follow the basic principles outlined in this book, there is no reason why you cannot have a net worth of $1 million, or $2 million or more, later in your life. Net worth typically peaks for people in their 60s and declines thereafter as they live off theirfinancial nest egg in retirement

Components of the Balance Sheet

A balance sheet consists of three parts: assets, liabilities, and net worth. Your assets include everything you own that has monetary value. Your liabilities are your debts amounts you owe to others. Your net worth is the dollar amount left when what is owed is subtracted from the dollar value of what is owned that is, if all the assets were sold at the listed values and all debts were paid in full. Your net worth is the true measure of your financial wealth.

What Is OwnedAssets

The assets section of the balance sheet lists items valued at their fair market value—what a willing buyer would pay a willing seller, not the amount originally paid or what it might be worth a year from now. It is useful to classify assets as monetary, tangible, or investment assets.Monetary assets (also known as liquid assets or cash equivalents) include cash and low-risk near-cash items that can be readily converted to cash with little or no loss in value such as checking and savings accounts. They are primarily used for maintenance of living expenses, emergencies, savings, and payment of bills. Tangible (or use) assets are personal property whose primary purpose is to provide maintenance of one’s everyday lifestyle. Tangible assets, such as furniture and vehicles, generally depreciate in value over time.

Investment assets (also known as capital assets) include tangible and intangible items that have a relatively long life and high cost and that are acquired for the monetary benefits they provide, such as generating additional income and appreciation (or increasing in value). Examples include stocks and bonds. Investment assets generally appreciate and are dedicated to the maintenance of one’s future level of living. Following are some examples of each kind of asset.

Monetary Assets
• Cash (including cash on hand, checking accounts, savings accounts, savings bonds, certificates of deposit, and money market accounts)
• Tax refunds due
• Money owed to you by others
Tangible Assets
• Automobiles, motorcycles, boats, bicycles
• House, condominium, mobile home
• Household furnishings and appliances
• Personal property (jewelry, furs, tools, clothing)
• Other “big ticket” items
Investment Assets
• Stocks, bonds, mutual funds, gold, partnerships, art, IRAs
• Life insurance and annuities (cash values only)
• Real property (and anything fixed to it)
• Personal and employer-provided retirement accounts

What Is Owed Liabilities

The liabilities section of the balance sheet summarizes debts owed, including both personal and business-related debts. The debt could be either a short-term (or current) liability, an obligation to be paid off within one year, or a long-term liability, debts that do not have to be paid in full until more than a year from now. To be accurate, record debt obligations at their current payoff amounts (excluding future interest payments). Following are some examples of items to include in the liabilities section of a balance sheet, with some suggested subheadings.

Short-Term (or Current) Liabilities
• Personal loans owed to other people
• Credit card and charge account balances
• Other open-end credit obligations
• Professional services unpaid (doctors, dentists, chiropractors, lawyers)
• Taxes unpaid
• Past-due rent, utility bills, and insurance premiums

Long-Term Liabilities
• Automobile loans
• Real estate mortgages
• Home equity (second mortgage) loan
• Consumer installment loans and leases (although a lease is technically not a debt)
• Education loans
• Margin loans on securities

Net Worth—What Is Left

Net worth is determined by subtracting liabilities from assets, as indicated in Equation (3.1), the net worth formula

This formula assumes that if you converted all assets to cash and paid off all liabilities, the remaining cash would be your net worth. For example, if your items of value had a fair market value of $8000 and the amount you owe to others is $4500, your net worth, or wealth, is $3500 ($8000 $4500). Figure 3.2 shows household net worth figure by age group. Calculating your net worth will give you a reading on where you stand and point out any trouble spots on your balance sheet.

Sample Balance Sheets

The total assets on a balance sheet must equal the total liabilities plus the net worth. Both sides must balance, which is the source of the name “balance sheet.” You decide how much detail to include to show your financial condition accurately on a given date.The balance sheets shown in Table 3.2 the degree of detail that might be included for a traditional college student and a couple with two children, respectively. Notice that Table 3.2 includes very few items. This pattern is typical of single people who have not acquired many objects of value. Observe also the excess of liabilities over assets. This situation is not unusual for college students, for whom debts often seem to grow much faster than assets do. In this case, the person is technically insolvent because he or she has a negative net worth