How strong is your personal balance sheet?

Balance Sheet

Balance sheet analysis is the staple of fundamental analysis for a stock. A healthy balance sheet let’s their owners know the stability of the company. However, what I rarely see are investors that analyze their personal balance sheet. I am going to draw out several sample balance sheets of people in various situations and run some simple analysis on it.

A typical personal balance sheet should look like this:

Current Assets
Cash, Checking & Savings Account
Short Term GICS
Money Owed By Friends & Family
Non-Current Assets
All Stocks & Mutual funds
Total Real Estate
Cars
Total Other Investments
Total Assets
Current Liabilities
Credit Card Debt
Average Monthly Bill
Money Owed to Friends & Family
Long Term Liabilities
Total Mortgage
Line of Credit
Home Equity Line of Credit
Other Long Term Loans
Total Liabilities  
Shareholder’s Equity (Networth)

Definitions

Current Assets (Short Term Liquid Assets): They are assets that can be used to pay liabilities within 12 months. From our perspective, current assets would be your checking account, savings account, short term GICs. You know, they are the stuff which you quickly move money around to pay off a vacation or monthly credit card.

Non-Current Assets (Long Term Assets): They are assets which take longer than 12 months to pay a liability. In a personal balance sheet, stocks, mutual funds, long term GICs, homes, cars, collectibles would be considered long term assets.
*Note that even though stocks can easily be liquidated and converted to cash within a day or 2, from an investor’s perspective, its purpose is for long term growth. The worst thing you can do is liquidate your stocks during a crash and sell at the bottom. Therefore, I am putting it as Non-Current Asset (Assets that take more than a year to convert into cash)

Current Liabilities (Short Term Debt): They are liabilities which need to be paid within 12 months. From the rational investor’s perspective, credit card debt and monthly spending is considered current liability.
*Even though the credit card debt can be stretched to over many years, I consider it a very short term loan because of the awefully high interest rate. In other words, pay off your credit card debt ASAP!

Non-Current Liabilities (Long Term Liabilities): They are liabilities which can take over 12 months to pay off. In our case, mortgages, line of credit, home equity line of credit, and other long term low interest loans all qualify as long term liabilities.

Shareholder’s Equity: This is your total assets subtracted by your total liabilities. In other words, it is your net worth as you own 100% of yourself!

Formulas

I will be using a few simple accounting metrics to evaluate one’s personal balance sheet.

Current Ratio or Working Capital Ratio = Current Assets / Current Liabilities
This formula measures how quickly you can use your short term assets and pay off your short term debts. A typical healthy quick ratio for a corporation is 1.5. If the number is above 1.5, it means the earnings is less predictable and you want to keep a higher percentage of earnings liquid. If the number is below the ideal, it means your earnings are predictable in the market and you can afford more risk and take on a less liquid position.
If a company’s current ratio is over 4, you should be concerned because they have too much cash on hand.

For a personal point of view, you should take on a low number of your job is secure and your monthly spending is generally predictable. You should have a high quick ratio if your working as a contractor and like sometimes splurge on big ticket purchases.

Debt to Equity Ratio = Total Liabilities / Networth
This ratio measures how much debt is used to finance its assets. A high number indicates that the company is not generating enough cash to meet its debt obligations. However, low debt-to-equity ratios may also indicate that the company is not taking advantage of leverage to bring more profits. Generally, capital intensive companies like automotive corporations have ratios over 2. Software companies have that number as low as 0.5.

Generally, as a personal investor, you want low debt to equity ratios unless you have the guts to stomach high fluctuations of the stock market.

Cash To Debt Ratio = Operating Cash Flow / Total Debt
This is your total income divided by your total outstanding debt/liabilities. If this number is increasing, it means the company is stabilizing. Contrarily, if the number is decreasing, it means the company is taking on more risk.

Reference

:
http://beginnersinvest.about.com/od/analyzingabalancesheet/a/current-ratio.htm

http://www.investinganswers.com/financial-dictionary/ratio-analysis/operating-cash-flow-ratio-2802

http://en.tradimo.com/learn/stock-trading/debt-to-equity-ratio/

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