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  • CFE - FinancialPlanning_150

    Finance and You

    By Jerry Taylor, Full-Time Faculty, Kaplan University 
    Published June 2014



    Your family has it, your church and school have it, and every enterprise has it: capital structure.

    We all have assets such as homes, cars, appliances, clothing, jewelry, toys, savings, and food in the pantry. Organizations have similar assets that are perhaps used for different purposes. An enterprise uses assets to generate income for its owners/investors. Think about what schools, churches, and other community organizations do with their assets.

    Assets used by any of the above groups must be purchased somehow. For all of us we say they are purchased with "capital"-the bottom line in this context is capital is money. My definition of a capital market is a place where people with money meet people who need money. Take that as a given in a free market society … capital is money.

    Capital structure means how the family, company, or organization came by the money it needed to purchase its assets. Capital structure is really the liabilities and owners' equity side of the balance sheet.

    You may operate your family finances without any debt -thereby only with "equity." That would be unusual. Most families have a mortgage, a car loan, retail installment loans, credit cards, and family loans, etc.  And they have the money they have "invested" in their family over the years which looks a lot like retained earnings.

    You might want to construct your family balance sheet listing all your assets on the left side; think hard, do not forget savings.  Then on the right side list all you debt: credit cards, mortgages, car loans, etc. If your assets total more than your debt, you have a "positive net worth"-you have "owner's equity."

    For instance, if you have $100,000 in total assets and $65,000 in total debt, your net-worth is $35,000. Your capital structure would consist of 65% debt and 35% equity. It is a measure at a moment in time.

    Leverage is the ratio of debt to equity. A reference to being "highly levered" or using a lot of leverage has to do with using more debt to fund your assets. Our example ratio of 65/35 = 1.85, so we have $1.85 of debt supporting our assets versus $1.00 of equity. If we increase leverage, we would be increasing debt as a source of funding.

    You might ask, "Where did I get that equity, that net worth?"  It comes from your wages.  Instead of using debt to purchase every asset you have, you used wages to purchase assets or retire debt that had been used to purchase assets.

    Why am I saying all this? I want you to begin to really understand finance by understanding your family unit. The financial events surrounding it are the same as a company. Two things may come from this. You may understand finance better, and you may do a better job of managing your family budget, income statement, and balance sheet (especially capital structure).

    You should create a budget, start working on your income statement (inflows and outflows) and create and manage your balance sheet. Make it your objective to improve your balance sheet a little (or a lot) each year.  Companies plan…we can all plan. We can build budgets and understand variances; we can manage our income statement by controlling costs and improving income. You can manage your assets too, and reduce leverage or use leverage effectively to improve your situation (like investing in a home, which may increase in value over time).

    Remember your savings, your 401K, your IRA, your checking account, and your stocks and bonds all go on your balance sheet in the cash or near cash section. You can grow those assets by saving money from your income and placing it in any of these financial instruments.  Here is an example Balance Sheet:

    Assets

     

    Liabilities

    Outstanding Balance

    Cash, Savings, Investments

    $ 14,000

    Credit Cards, Retail Lines, Bank Links

    $ 12,000

    Household Goods

    $ 5,000

    Car Loan

    $ 10,000

    Cars

    $ 19,000

    Mortgage

    $ 125,000

    Home

    $192,000

    Total Liabilities

    $ 147,000

    Other Assets

    $           0

    Net Worth/Owners Equity

    $ 83,000

    Total Assets

    $230,000

    Total Liabilities + Equity

    $230,000

    It is a balance sheet because for every asset purchased there was (is) a source of funds-either debt or equity. So the left side always "balances" with the right. If it does not, you forgot something! The right side is how you paid for the left, same for any corporation or organization.

    If you begin doing these things for yourself, you will continue to learn, you will prosper, you will know where you stand and hopefully have a better handle on where you are going.

    To summarize:

    • Create a family financial plan (a budget) both for the short and long term
    • Create a family income statement at least annually to assess the inflow and outflows of money
    • Create a family balance sheet at least once per year and mark of how your financial position is changing,  good or bad, over time.

     The objective is to know where you are so you can impact where you are going.

    Jerry Taylor is a full-time faculty member at Kaplan University. The views expressed in this article are solely those of the author and do not represent the view of Kaplan University.

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