Page 546 - Introduction to Business

520 PART 5 Finance

reality Do you need to plan your personal finances?
CH ECK

Key Concepts

LEARNING OBJECTIVE 2
Define concepts such as net worth.

Personal financial planning requires some fundamental knowledge. Key concepts
include how to compute net worth, how to set financial objectives, how to evaluate
spending patterns, how to identify your stage in life, and from whom to seek expert
advice.

Computing Net Worth
Preparing a personal balance sheet is necessary to determine how much money
you now have, so you can estimate how much more you will need to reach your
personal balance sheet A balance short-term and long-term financial goals. Preparing a personal balance sheet
sheet that lists what an individual owns enables you to identify what you own, your assets, and what you owe, your liabili-
(assets) and what she or he owes ties. Assets are listed in order of liquidity, and liabilities are listed in order of claim.
(liabilities)
The difference between the two, assets minus liabilities, is your net worth. Several
net worth The difference between what
an individual owns (assets) and what other terms that you need to know in order to properly complete and analyze your
she or he owes (liabilities) personal balance sheet include the following:

appreciating assets Assets that have • Appreciating assets are assets that have the possibility of increasing in value
the possibility of increasing in value over their lifetime.
over their lifetime
• Depreciating assets are assets that usually decrease in value over their lifetime.
depreciating assets Assets that usually Diversification is allocating your money among many different types of assets
decrease in value over their lifetime
rather than concentrating it in one asset. Diversification reduces the danger
that you will lose the overall value of your investments.
portfolio of assets All the assets an • Portfolio of assets includes all the assets you possess.
individual possesses • Return on your portfolio includes both the cash generated from your invest-
return on your portfolio Cash generated ments and the annual increase in the fair market value of investment instru-
from an individual’s investments and the ments, such as stocks and bonds.
annual increase in the fair market value
of the investment instruments, such as A sample personal balance sheet form is provided in Exhibit 15.1. Assets are
stocks and bonds
basically those things that you own or will eventually own once they are paid for.
Examples of the most common types of assets include cash, houses, stocks, bonds,
and cars.
liquidity How easily an asset can be Liquidity refers to how easily as asset can be converted into cash. Personal
converted into cash assets, such as a house or car, are much less liquid than stocks or bonds. In other
words, the less liquid an asset is, the longer it usually takes to sell and thus provide
you with its market value in cash. A good idea is to evaluate whether your assets are
those that you believe will appreciate in value or those that won’t. There is an obvi-
ous advantage in having assets that will go up in value as opposed to having assets
that will either maintain value or decrease in value. A house is often considered an
appreciating asset, but today it may just maintain its value or even decrease in value.
Liabilities are items that represent a future outlay of cash. Exhibit 15.1 lists some
of the more common liabilities. Don’t forget to include liabilities connected to
assets on which you still owe money. For instance, you might still owe half the value
of your auto. In this situation, include the unpaid portion of your auto loan (the part
you are still paying off) under car loans in the liability section of your personal bal-
ance sheet, and the fair market value of the car in the asset section.

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