It is important to have an objective and transparent view of one's financial health. Financial ratios like liquidity ratio, debt service ratio, solvency ratio, savings ratio and investments to net worth ratio help to understand the true picture one's personal financial health and evaluate the strengths and weaknesses of the financial portfolio. This will aide in better financial planning.
Financial ratios are commonly used by market analysts and investors to understand and predict performance of a company/stock.
Similarly financial ratios can be used to measure and analyse your personal financial status. These ratios can throw some light on your money management skills. They can help in better financial planning. We present 5 personal finance ratios that can help to understand your financial health better -
Similarly financial ratios can be used to measure and analyse your personal financial status. These ratios can throw some light on your money management skills. They can help in better financial planning. We present 5 personal finance ratios that can help to understand your financial health better -
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1. Liquidity Ratio -
Definition - The liquidity ratio determine the cash status or the liquidity of a person. It is important to have emergency cash and some investments that can be converted to cash quickly and conveniently.
Formula - Liquid Assets/ Monthly Expenses
Liquid Assets – Cash, Cash in Current and Savings Accounts, Fixed Deposits and Liquid MFs, Equity
Monthly Expenses – Expenses incurred by you on a monthly basis on food, rent, utilities, EMIs, entertainment etc.
Ideal Value - The ideal value depends on family circumstances and financial status. Usually a value between 3 and 6 is considered good. It might be required to be higher if you have large loans or too many dependents.
2. Debt Service Ratio -
Definition - It is the ratio of the total debt of a person to his/her total income. Debt includes monthly instalments on personal loans, home loans etc. It means how much of the income is used to pay off loans.
Formula - Total monthly debt payments/ Monthly Gross income
Monthly Debt Payments – Monthly outgoings to service debts (e.g. Loan EMIsMonthly Gross Income – Total income earned by the household
Ideal Value - The debt should not be more than 30%-40% of the total income under normal circumstances meaning if the amount used for repaying debt is higher than this percentage, it might be better to revisit one's finances or approach a professional to help in the management of one's finances. It can be higher if one is a HNI.
Definition - The liquidity ratio determine the cash status or the liquidity of a person. It is important to have emergency cash and some investments that can be converted to cash quickly and conveniently.
Formula - Liquid Assets/ Monthly Expenses
Liquid Assets – Cash, Cash in Current and Savings Accounts, Fixed Deposits and Liquid MFs, Equity
Monthly Expenses – Expenses incurred by you on a monthly basis on food, rent, utilities, EMIs, entertainment etc.
Ideal Value - The ideal value depends on family circumstances and financial status. Usually a value between 3 and 6 is considered good. It might be required to be higher if you have large loans or too many dependents.
2. Debt Service Ratio -
Definition - It is the ratio of the total debt of a person to his/her total income. Debt includes monthly instalments on personal loans, home loans etc. It means how much of the income is used to pay off loans.
Formula - Total monthly debt payments/ Monthly Gross income
Monthly Debt Payments – Monthly outgoings to service debts (e.g. Loan EMIsMonthly Gross Income – Total income earned by the household
Ideal Value - The debt should not be more than 30%-40% of the total income under normal circumstances meaning if the amount used for repaying debt is higher than this percentage, it might be better to revisit one's finances or approach a professional to help in the management of one's finances. It can be higher if one is a HNI.
Just like the analysts use ratios to analyse stocks and companies, you can use personal finance ratios to assess your financial health and improve your financial plan.
3. Solvency Ratio -
Definition -It is the ratio of the total assets and liabilities to the total assets. It shows the capability of a person to pay off liabilities if required.
Formula - Total Assets + Total Liabilities/Total Assets
Total Assets – Liquid and Illiquid Assets like house, cash, investments in stocks, MFs etc.
Total Liabilities – Loans and Other outstanding amount
Ideal Value - Total assets should be such that it is more than the total liabilities by a comfortable margin so that one is able to pay off liabilities in unforeseen circumstances.
4. Savings Ratio –
Definition - It is a simple ratio that compares the actual amount saved to the total income. It helps to determine how the budget is managed. It throws light on the expenditure which can further be analysed as to how appropriate it is.
Formula - Monthly Savings/Monthly Income in Hand
Monthly Savings – Savings at the end of each month
Monthly Income in Hand – Income received by the household in cash/bank account
Ideal Value - The higher the value, the better it is. Experts say that savings should be around 25% of the income in hand. The savings can be used to invest and generate returns and increase wealth.
5. Investment Assets to Net Worth Ratio -
Definition - This ratio compares the assets that are investments to the net worth. Investments are typically assets that appreciate in value and give you returns so that your wealth increases and you have different sources of income even after you stop working. Assets like the house you are staying in should not be included in the investment assets. Such assets are already assigned for particular purposes.
Formula - Investment Assets / Net Worth
Investment Assets – Assets like bonds, MF schemes, stocks where one has invested to earn returns and get capital appreciation
Net Worth – Difference between Total assets and Total Liabilities
Ideal Value - The investment assets should be about 50% of the net worth. As you grow older the proportion should be higher so that you can retire comfortably.
These ratios give an insight of a person's financial situation. The ideal values might differ from person to person but this kind of analysis helps to take prudent financial decisions.
Definition -It is the ratio of the total assets and liabilities to the total assets. It shows the capability of a person to pay off liabilities if required.
Formula - Total Assets + Total Liabilities/Total Assets
Total Assets – Liquid and Illiquid Assets like house, cash, investments in stocks, MFs etc.
Total Liabilities – Loans and Other outstanding amount
Ideal Value - Total assets should be such that it is more than the total liabilities by a comfortable margin so that one is able to pay off liabilities in unforeseen circumstances.
4. Savings Ratio –
Definition - It is a simple ratio that compares the actual amount saved to the total income. It helps to determine how the budget is managed. It throws light on the expenditure which can further be analysed as to how appropriate it is.
Formula - Monthly Savings/Monthly Income in Hand
Monthly Savings – Savings at the end of each month
Monthly Income in Hand – Income received by the household in cash/bank account
Ideal Value - The higher the value, the better it is. Experts say that savings should be around 25% of the income in hand. The savings can be used to invest and generate returns and increase wealth.
5. Investment Assets to Net Worth Ratio -
Definition - This ratio compares the assets that are investments to the net worth. Investments are typically assets that appreciate in value and give you returns so that your wealth increases and you have different sources of income even after you stop working. Assets like the house you are staying in should not be included in the investment assets. Such assets are already assigned for particular purposes.
Formula - Investment Assets / Net Worth
Investment Assets – Assets like bonds, MF schemes, stocks where one has invested to earn returns and get capital appreciation
Net Worth – Difference between Total assets and Total Liabilities
Ideal Value - The investment assets should be about 50% of the net worth. As you grow older the proportion should be higher so that you can retire comfortably.
These ratios give an insight of a person's financial situation. The ideal values might differ from person to person but this kind of analysis helps to take prudent financial decisions.
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