Hello in this presentation we are going to take the financial statements that we learned about last time, and now talk about how we utilize them, how we analyse them, what are we going to look at and what questions are we trying to answer by creating them. So, remember with financial ratios in particular we're going to go deeper into our statements. They serve as a great place to be organized, but we want to answer some specific questions about ourselves. Can we meet our current obligations? How is our debt doing relative to our cash flows, right ,relative to our income or relative to our overall assets that we have. And then we also want to analyse our productivity. How our savings is doing? How our change in net worth? How we're growing in terms of that. So let's explore some of these options then. We're going to put a case study family in here. I've chosen an, an active duty military family to help presents this for us here. We've got Brett and Brittany Johnson, Brett's 28 and Brittany is 25, they live off base ,they have a home they have a son name Sam who's two and a dog name fluffy who's ten. Brett's on active duty in the armed forces and Brittany's a nurse in a local hospital. So, just to kind of set the stage then, we've established a balance sheet for them, we can see some of their different assets that they have right over here. Whoops. Cash on hand, checking, savings, investment assets, personal use assets, all those same types of categories we've talked about. Our current liabilities, or short-term liabilities as they are often called, long term liabilities as well, in this case they don't have anything in the intermediate term. So mortgages, car loans. So, a lot of the things that we talked about that would go on statements we're seeing examples of. Now you may be noticing these JT's next to a lot of the assets and liabilities. This refers to it as joint tenancy, meaning that these are jointly held. Whether it's an asset, it's jointly owned, or if it's a liability, it's also jointly owned. So it means they're both liable for those as well. Always a nice way to kind of represent those. One of the things I didn't mention last time, but I want to mention as we're looking at statements today. Is that it's often beneficial as we start exploring these down the road, is that balance sheets are one thing that we can look at, over time. Remember a balance sheet can be thought of as a snap shot. A picture at one specific instant of what you own and what you owe. So, the best way often times to look at the family's progress, is by then starting to keep these balance sheets and analysing them over time. So we're going to show how two balance sheets can help to add to that our, our picture of this family's well-being together. We also have a statement of income and expenses for the family, so right up at the top over here we've got income. Some of the different things that they're receiving. The savings that's coming out of their income available, so the amount that's available for expenses for them. Then we've got the different types of expenses. Ordinary living expenses, debt insurance premiums, taxes, so on and so forth. And so all of these then represent the different things that families have to pay for. And again, a big list for it. We wanted to show a nice, robust example for you. In addition, we have the budget. Right? So the budget, is going to be the other side of this, this is what they had anticipated coming, and so one of the things that we often will take a look at. It, too, is just whether or not what they've projected, how that's going to line up for what they've done. So, and that's a nice point of comparison as well. So the key to ratio analysis then, is that does the ratio get to the answer for the question that we're being asked. And also very importantly, is what's the standard or benchmark associated with that ratio? In other words, is there a better number? A worse number when it comes to these ratios? We don't use the words right or wrong, it's going to be a moving target. But the question is where's our baseline? Where do we want to try and aim for for some of these ratios? So let's begin, by taking a look at what those different ratios did again. So we had liquidity ratios, right? Emergency fund ratio and the current ratio were two ones we tend to emphasize, and we'll explore those. We've got debt ratios. There's a whole list of them. We're going to explore some of the more common ones, that are most relevant for us. And then also some performance ratios that can exist as well in terms of how we're doing, especially in terms of savings, which I tend to think is one of the most important ratios, we can look at too, next to debt. So, let's begin on the liquidity side. The first thing we kind of ask ourselves is, is where do we want to be? So we've often talked about the notion of having sufficient liquidity as in that path to financial security. The emergency fund ratio takes the amount of the current, or liquid, assets that we have. So this would be our checking account, our savings accounts, cash on hand. In other words, money that we can actually get to. And we divide this by our monthly non-discretionary expenses. In other words, the expenses that we would have to pay every month no matter what happened. If we lost our job, we'd still have these expenses. So, that would include things like rent most of our utilities and any other number of types of fees we may have to have. When we divide these, we tend to get different types of answers. The target we're looking for and the, the dig, the unit of analysis for this is going to be in months. So, we're looking for a number somewhere between three to six months. Six months is great, right? Three months is often times acceptable for some families, especially if they have sick leave, or they have other resources, they might be able to tap into as well. But six months tends to be that really important number. Now, what if you had ten, what if you had 20? Well, there becomes a point where we have too much liquidity, where our money could be doing other things for us as well. So, really, that three to six month benchmark is really appropriate, and that six month really being kind of the ideal range. So, how's our case study family doing? So. Right, we take a look we add up a bunch of different expenses that we had that we couldn't avoid, they had about $1,600 in assets, liquid assets that we have. So, when we take all of their annualized expenses here that they couldn't not spend. And we'd of course divide those by 12, because we want to think of this in monthly terms. That gets us to 1600 divided by 3344.5, and that gets us to 0.478. We said this should be between three and six months. This is critically low. Right, this means that this family has not a great deal of resiliency, to any type of major resource shock. That would interfere with them receiving income, because after all that's what we're concerned about, what if we couldn't receive any income for a few months? Could we still make ends meet? And that's what the emergency fund ratio really measures for us. The current ratio kind of looks at overall, when we said we want to meet our ongoing obligations. The current ratio really does that, so we have our short, our immediate assets, the cash assets, the things that we can spend right away, and we divide those by the liabilities that we have due currently. We refer to these as short term, or current liabilities. So, these short term or current liabilities again mostly consist of the bills we have due. We're looking for this to be between one and two. If it's less than one, then what it really says is that right now we don't have sufficient cash on hand for our immediate needs. If it's about one that's good. Again, closer to two means that we're in good shape, right? That we've got enough to meet all of our obligations and then some, but as always, do we want this number to be higher and higher and higher? No, because too much liquidity is, can be inefficient, is the best way to put it. It's not necessarily bad, just not really efficient. So, for our case study again, taking a look here where we were and this is taking a look across the different the different numbers we had 1,600 divided by 10,275 right or 1,600 divided by 4,045 depending on how we estimated that. No matter how you look at this, right, we said this should be between one and two, this is way too low,right? So, how do we interpret this, it's way too low this family right now currently does not have sufficient liquidity. To me that's on going needs and so, we would want to make sure that we think about, how would we make a difference that? If we were looking at this for ourselves, which we will, we would say, where do I need to be? What changes can I make? Or how do I get more cash on hand? So that's a little bit of the liquidity side. Let's take a look at the debt side for a few moments, because this can also be a source of concern. While there is a big laundry list of debt ratios, we're going to highlight just a few of them. The first one is the total liabilities to total assets. So here, we're looking at the amount of things that we own that we owe versus the things that we own. The ratio, that we're looking for, should be less than 40%, or less than 0.4. Right. This just kind of, this will show, of course, that it means we have more assets than liabilities. If this is getting much higher than that, and if it gets above one, then right, what we're saying, if this was 1.5, for example, then, we're saying we have $1.5 of debt for every dollar of assets we own. We'd rather be looking at that the opposite way, right? That we have only 40 cents of debt for every dollar of asset that we own. Little bit better position there. So again, we want to be on the positive side. So if the number is less than one, we're certainly also going to be looking at having a positive net worth. If the number is greater than one, we're going to be having a neg, a negative network as well. So, for our case study and again taking a look across several years here, we just picked a few years for this family. If we just take a look from the balance sheets that we had 210364 divided 260828, that's 80%. Now, if we go to the next year 215535 divided by 330534, 65%. These numbers are both above that 0.4 that we want it to be. But, one of the reasons we look at things like this over time is what is it we do see about this family, it's getting better. And that's why having a longitudinal measurement of something like a debt measure is helpful. Because, if the debt is going down, if the problem is getting better, then the family's working the problem. Most things involving debt repayment aren't going to be overnight solutions. So we're looking for evidence of progress. This would be evidence of progress going from 80 to 65% in one year. We'd like to make as much progress as possible, but we certainly want to see signs of some. So that helps us a little bit to think about the effective debt on our wealth, but we also want to think about the effective debt on our cash flows, on our spendable income. So what we're looking for here, is if we take the annual consumer credit payments. So what we're meaning by this is. We don't want to include a mortgage in this particular calculation. There's other ratios that can be used for housing specifically this is really just going to focus on the types of consumer credit, and instalment loans you might have non mortgage debt to be specific. We're going to divide that by after tax income. So, here we're looking at, if you will, the amount of service that our income has to pay to our debt. So, this debt-to-income or often, often referred to also as a debt service ration. We're looking for this number to definitely less than 15 less than ten ideally. Because again this is saying, for every after tax dollar I bring home, I would be spending 15 cents, on just repaying debt. Now if I'm repaying debt, I'm not buying food. I'm not paying for my rent. I'm not going out and having a good time. Right? I'm not paying for my healthcare. I'm not doing a lot of these other things. I'm paying back things I did. So again, this notion of looking at these particular measures. So, where do we want to be? Less than 15% for sure. Where's this family at? So we're going to count their car loans, their credit cards. We're going to count student loans too. But again, not the mortgage. So the debt-to-income ratio for this family, 17.99. Is this overwhelming? It's probably not super comfortable, but it's not too challenging yet. If it goes up, it's going to continue to become more and more burdensome. What we'd be looking for, right, if this was us, would be to say how do we start getting this to be in a better position? Is it just going to take time, as we reduce and eliminate some of the debt? Do we need to look at restructuring the debt, so that our cash flows are more manageable. The challenges is that if debt takes up too much of our income, it really can impede our progress to our other financial planning goals. And that's something we want to avoid as much as possible, right? So debt isn't always a bad thing, but too much debt usually is. Let's talk about the savings ratio. One of my favourites. So, here we're looking at the rate of annual savings divided by annual gross income. The old rule of thumb is one that I still apply here. Thinking that there should be at least 10%, absolutely a reasonable benchmark for people to have. Should it be more than that? It can always be more than that. Savings isn't a bad thing, it's paying yourself. So if you wanted to be more than 10%, you won't get any argument from me. But we like to set 10% as sort of a nice minimum benchmark for people to consider. This can include your own contributions to accounts. Or if an employer is making contributions as well, you can consider those as part of the package. Personally, I aim for 10% of my own contributions, when possible. And, I encourage everybody to think about doing the same especially if you don't have employer provided contributions. So, for our case study, where were we at? Again, taking a look at the various contributions that they were making to their accounts. The ones that were being matched by the employer. Right divided by their income. This put us at 7.4%. Is this okay? Well how do we interpret some of these numbers? It's better than nothing. Which is nice. It's not 10%. But we'll find that too that savings ratios even though we aim for 10%. Can be dictated a lot by where we are in life, there's a life cycle notion of it if you will. So, as we grow up as we have kids, as we, as the kids move out of the house, as our life changes as our life course changes we'll find that our ability to save will certainly change with that. So, we will certainly save more in some years then in others, but we're aiming for this overall guide line of 10% at least on average. The more we can save right earlier in life, the better we're going to be. Remember that magic of compound interest that we've talked about before. So, let's summarize where we're at with this particular family then. So, this is the way we kind of want to think about these. We ran these numbers. The math is tricky sometimes. But the truth is, what we're really interested in is the interpretation. Different types of software, we may use for money management may actually calculate the ratios for us. So, what we're interested in is what do the ratios mean. So the family right now has insufficient capital to meet its current obligations. That's of concern to us for sure. They're not adequately prepared for an emergency, at least in terms of assets. Now how would we interpret that otherwise? Well, maybe there's additional support they have, or resources others would have. Maybe they have family that could step in and help out. Maybe they would utilize credit in the case of an emergency. So there may be other options, should something really happen to the family. But the idea is that we're looking for this notion of self-sufficiency as much as possible. Now the family definitely has a high debt load, too. This presents issues on two fronts. It's certainly concerning with the level of debt, relative to assets. The amount of debt relat, the amount of debt payments relative to income is concerning, not as concerning as we see the level of debt being. But that may mean that we have to start increasing our payments or finding ways to think about debt, so that we don't continue it to be a problem. One thing's for sure, this family doesn't have a lot of room to take on any more debt. So, that's one of the things we can look at from these ratios. Their debt to asset ratio's too high. And their debt service, or their debt payment to income ratio, is definitely higher than it should be. Not dangerously high, but any more debt piled onto that, is going to be of concern, for sure. Now investments are doing okay for them but they probably need to be saving more. So as we looked, if we looked at the two balance sheets, we saw that their investment assets definitely went up, And you know, we could see that a family potentially could be saving more, but this is a difficult balance, right? Because, here, they have a lot of money going to debt, they need, they need to pay off their debt, so, it'll be a tricky question. Do they want to save, and invest more? Do they want to take that money they might save and it, use to save and invest more, and use it to pay down their debt? You'll find, with me, that, right, they're both kind of two sides of the same coin, in some ways. Right? Reducing debt increases our net worth. Saving more money increases our net worth. So, in either case, right, there can be simple reasons why we do one or the other. How much the debt costs us, if it, if it, the debt costs us more, for example, than what we're earning on our investments, then that can be sort of an easy question for us to answer. So, we can tend to look at some simple analysis for that. And use a little bit of logic and common sense to try and figure out the best course of action would be for a family. Now, we're going to then look at this notion of what we call SWAT analysis, then, for just a minute. This is the strengths, weaknesses, opportunities, and threats that a family faces. From the strength standpoint there is productive investments, we saw that in the balance sheets. There's a commitment to savings, right? They are saving money regularly even in the face of their debt, that's a great behaviour to have, as I mentioned, doesn't mean they should increase it right now, just to get it to ten percent with that much debt. On the other hand, remember Ron and John. They want their money working for them as much as possible. So having some money invested is good. Weaknesses, they're carrying a lot of consumer debt. When we looked at the balance sheet and, of course, as we looked at the ratios we see they have a high level of debt for sure. And a lot of that was consumer debt oriented. Which we often refer to as not strategic in nature. There's little discretionary cash flow. So, they don't really have a lot of leftover money either. That is something we would have seen on the income expenditure statement. That means there isn't a lot of extra capital right now, to deal with the debt issue or the savings issue. So, one of the things we would say to this family is, we may have to go back to the budget. And see is there room in the budget, can we make changes to the budget and stick to it to make a difference for this? And of course, earnings growth has been pretty minimal for this family as well. So trying to get a sense of how can they potentially get a handle on increasing their level of income. So those are some strengths and weaknesses. Opportunities, well there is an opportunity to invest more. Certainly and over time that'll become easier for this family to do. They can trim expenses potentially to improve their discretionary cash flows. And that's something that we often kind of say is important to, go back through and look and see, where was our money going? Remember last time, we talked about this notion of vertical analysis, of using, loo looking at percentages of what people are spending their money on, and getting a sense, can we do a little better in this category, can we spend a little less? And right now, this family does have stable income, which represents an opportunity as well. It means they can plan, they can count on certain things in terms of making recommendations, making strategies, and following through with them, because the income is pretty stable. The threats are pretty clear. There is a heavy debt load. This is definitely of concern to the family. It means that they're not in the position to really borrow any more. So if anything else comes up, car gets damaged, they need a new one, so on and so forth, that's a threat to the family. And we know that debt represents a threat to assets as well as to cash flows. Though there's also this severe, severe lack of liquidity, which creates an extreme vulnerability for this particular family, to both income and resource shocks. So in this case, we would be very concerned. So a SWOT analysis, right, helps us to understand what, what's going well financially for ourselves. And, what is it that we need to potentially address? And what is it that should be an actual concern to us? So, remember, we, while we've talked about creating these statements. Using those statements, analysing these statements as we, as we've just done, is really the next step. We don't just want to create our financial statements, put them on a shelf, leave them on a hard drive and not pay attention to them. What we want to actually take a look at them, and discuss the implications for them as well so that we can really make sure that we're moving forward on the path to financial security.
