Introduction to Personal Finance

Introduction to Personal Finance
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  • 0:02 Overview of Personal Finance
  • 0:35 Assets
  • 1:40 Liabilities
  • 2:25 Net Worth
  • 3:03 Cash Flow
  • 4:31 Lesson Summary
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Lesson Transcript
Instructor: Dr. Douglas Hawks

Douglas has two master's degrees (MPA & MBA) and is currently working on his PhD in Higher Education Administration.

While not all of us aspire to careers as accountants, a lack of interest in or understanding of basic financial concepts could cost you money. In this lesson, we'll examine four concepts associated with personal finance that will help you keep track of your money and may even help you build wealth.

Overview of Personal Finance

According to some lifestyle polls, financial stress is one of the highest sources of anxiety and tension for Americans. In some instances, financial management can quickly turn into a reactive exercise of finding money to pay for bills. Reacting to financial situations is never as effective as proactively planning for financial needs and emergencies. But before you can plan for financial changes, you'll need to become familiar with some basic concepts, which include assets, liabilities, cash flow, and net worth.

Assets

Assets are the things you own that have some monetary value. Cash is an asset, and so are old baseball cards or the china and silver you inherited from your grandparents. The difference between cash and the other physical assets is their relative liquidity, which refers to how easily something can be turned into cash.

For example, if you have a U.S. Treasury Bond, you can easily take that to a bank and get its face value in cash. By comparison, you might find it more difficult to sell your old baseball cards or grandma's china and silver. Regardless of how liquid your assets are, you can estimate their market value. That value should be based on some reasonable benchmark, such as what comparable items are selling for at a retail or second hand store. Adding those values up can serve as one measure of your financial health.

Now, if you're making payments on a car or a house, do you really 'own' it? Well, most likely, you own part of the value of that asset. By taking the market value of that car or house and subtracting how much you owe, you'll be able to determine your equity.

Liabilities

Liabilities are the individual loans that make up your debt. If you owe money to someone, you have a liability. Liabilities also include financial commitments you've made, even if they aren't associated with a specific asset. These can include a cell phone contract, a cable television bill, or even the costs associated with clothing and feeding your family.

Some of your liabilities may be cash-flow liabilities, and some will be asset-related liabilities. While all asset-related liabilities are cash-flow liabilities, not all cash-flow liabilities are asset-related liabilities. Asset-related liabilities are those paid to increase equity in an asset, while cash-flow liabilities are those associated with living costs.

Net Worth

The term net worth refers to your assets minus your asset-related liabilities. If you sell everything you own, or partially own, and then pay off all of your debt, the amount of money left over would be your net worth. This may be a negative number, especially if you're new to the workforce.

A negative net worth isn't necessarily a bad thing, as long as the mitigating conditions are based on investments in your future, not a lifestyle financed by debt. Negative net worth may be the result of a mortgage or student loans. As you pay off your home and your student loans, your net worth should turn positive.

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