1. How would you measure Louise Tate's financial position with regard to their net worth and their total dollars available cor savings and investment?

2. Reflect on what you learned by examining the Tate's personal balance sheets, invome statements, and by applying the the financial ratios (current ratio and debt ratio).

3. Indicate how you might apply this knowledge to your own life.

Debt Ratio Arti aimed at determining whether you have the ability to meet your debt obligations defined as total debtor liabilities dvided by total assets Long-Term Debt Coverage Ratio A ratio aimed at determining whether you have the ability to meet your debt obligation defined as total income available for living expenses divided by total long-term debt payments Question 2: Can I Meet My Debt Obligations? A second question that ratios can answer is "Do you have the ability to meet your debt obligations?" In other words, you saw it, and you borrowed money and bought it, now can you pay for it? To answer this question, you need to look at the debt ratio and the debt coverage ratio. The debt ratio tells you what percentage of your assets has been financed by borrowing. This ratio can be expressed as follows: total debt or liabilities debt ratio - total assets Looking at the rates balancesheet, we see that the level of their total debt or liabilities is $175,500 (line Nof Figure 2.5), while their total assets or what they own is $300,190 (line H of Figure 2.3). Thus, their debt ratio becomes $175,500/$300,190 = 0.5846. This figure means that just over half of their assets are financed with borrowing. If you are managing your finances well, this ratio should go down as you get older. The long-term debt coverage ratio relates the amount of funds available for debt repayment to the size of the debt payments. In effect, this ratio is the number of times you could make your debt payments with your current income. It focuses on long-term credit obligations such as home mortgage payments and auto loan payments. If credit card debt has reached the point where you cannot pay off the balance, it, too, represents a long-term obligation. The denominator of this ratio rep- resents your total outstanding long-term debt payments (excluding short-term bor- rowing such as credit cards and bills coming due). The numerator represents the funds available to make these payments. total income available for living expenses long-term debt coverage ratio total long-term debt payments For the Tates, total income available for living expenses is found on line C of their income statement (Figure 2.6) and is $56,510. The only long-term debt obligations they have are their mortgage payments of $19,656 (under Housing in Figure 2.6), their auto- mobile loan payments of $2,588 (under Transportation in Figure 2.6), and their college loan payments of $1,600 (under Other Expenditures in Figure 2.6). Thus, their debt coverage ratio is ($56,510/($19,656 + $2,588 + $1,600)] = 2.37 times. In general, a debt coverage ratio of less than approximately 2.5 should raise a caution flag. You should also keep track of your long-term debt coverage ratio to make sure it does not creep downward. The Tates are at their limit in terms of the level of debt PART 1 - Financial Planning By reviewing all your expenses and spending pattems, you can decide on specific ways to cut back on purchases and increase savings. This process of setting spending Budget goals is referred to as setting a budget. As you will see later in this chapter, a smart Aplan for cooling show and budget includes estimates of all future expenses and helps you manage your money cathflows on your and functions, but to meet specific financial goals. But before you can design and implement a budget plan. you first need to ana- lyze your balance sheet and income statement using ratios to better understand any financial shortcomings or deficiencies you discover LO3 Useration to identify your financial strengths and weaknesses Using Ratios: Financial Thermometers The next step in creating your personal financial plan is to take the temperature of your finances. By themselves, the numbers in your balance sheet and income state- ment are helpful and informative, but they don't tell you everything you need to know about your financial well-being. You need a tool to help you glean all the meaning you can from these numbers. That tool is ratios. Financial ratios allow you to analyze the raw data in your balance sheet and income statement and to compare them with a preset target or your own previous performance. In general, you use ratios to better understand how you're managing your financial resources. Specifically, you want answers to these questions 1. Do I have enough liquidity to meet emergencies? 2. Can I meet my debt obligations? 3. Am I saving as much as I think I am? Question Eugh Liquidity to Meet Emergencies? If your TV died in the middle of the playoffs or that miniseries you've been watch- ing would you have enough cash on hund to buy another one immediately? To judge your liquidity you need to compare the amount of your cash and other liquid assets with the amount of debt you currently have coming due. In other words, you need to look at your balance sheet and divide your monetary assets by your current liabilities. The resultant measure of your liquidity is called the current ratio: monetary assets current ratio current liabilities We can see from the balance sheet for Larry and Louise Tate that their monetary assets total $3,590 and their current liabilities (current bills and credit card debt) total $1,500. Thus, the Tates' current ratio is: Current Ratio Artomed termining whether you have adequate liquidity to meet e defined as monetary se divided by one bel current ratio 53,590 -2.39 $1,500 Although there's no set rule for how large the current ratio should be, it certainly should be greater than 1.0. Most financial advisors look for a current ratio above 2.0. More important than the level of the current ratio is its trend: Is it going up, or (of more concern) is it going down? If it is going down, you have to try to find the cause. To do this, you have to see what changes have caused the ratio to decrease. One problem with the current ratio is that people generally have a number of monthly expenses that are not considered current liabilities. For example, long-term debt payments such as mortgage payments and auto loan payments may not be con- sidered current liabilities, but they still must be paid on a monthly basis. Therefore