Andrew
Do you want to get a better sense of your financial health now?
Personal financial ratios can give you a picture of your proper financial health and progress relative to your goals These benchmarks can help you develop better financial habits in these areas: savings, retirement, spending, investing, and debt management.
Your personal financial statements, specifically net worth and the monthly budget, use your financial data to describe an individual’s or household’s financial condition. With some number-crunching, you can calculate personal finance ratios as tools designed to evaluate your financial strength and position.
- Liquidity Ratio
Liquidity refers to your ability to quickly convert assets into cash with little to no loss of principal. When you are liquid, you have the financial ability to pay for unexpected costs such as a loss of a job, death in the family, or your roof is leaking.
Monetary assets are the most liquid assets. These assets include cash, cash-equivalent securities or money markets, savings bonds, savings, and checking accounts.
Use your liquid assets to support your fixed monthly expenses for six months.
Liquidity Ratio= Monetary Assets/ Monthly Expenses
Your monetary assets should support your fixed monthly expenses such as groceries, rent or mortgage, utilities, and a car loan for six months.
A six ratio means that your monetary assets can pay for your basic needs of food, rent, utilities, and a car loan for the next six months, if necessary.
- Emergency Fund Ratio
The liquidity ratio is linked very near to the emergency funds.
You should use this emergency cushion for unforeseen events. Such events may mean job loss, family death, unexpected surgery, or immediate house repair. The emergency fund ratio works by using a targeted number of months that you believe is ample to support you through emergencies.
If you are looking for six months or higher (and this is highly recommended at a minimum) to set aside in one fund, invest the money in high yield savings account or money markets. Then:
Emergency Funds Ratio= 6*Monthly Expenses
This ratio will give you a targeted amount of monetary assets needed to be comfortable for a possible emergency.
- Net Worth Ratio
Your balance statement measures your net wealth at a point in time. As you add to your assets, hopefully outpacing your liabilities, you will be getting wealthier.
Net Worth Ratio= Total Assets Less Total Liabilities
As discussed earlier, your total assets are what you own at their current market value. Your total liabilities are what you owe based on your debt obligations, notably the balances on your credit card debt, mortgage, car loan, and any other loans you have. The higher the positive number you have, the better off you are.
- Targeted Net Worth Ratio (The Millionaire Next Door)
One of my favorite personal finance books, The Millionaire Next Door, is an oldie but goodie.
I have read it at least twice and refer to it when teaching my college students about overspending —the book advocates saving and investing money. The high savers do a better job of maintaining and building your wealth. They use age as a factor in the calculation, as some other ratios do.
Targeted Net Worth Ratio= Age x (Pretax Income/10)
Your targeted net worth provides you with an indication of what you should be worth after liabilities. As a 30-year old making $95,000 annually, your net worth should be US$285,000.
The calculate is 30 x (95000/10). This guidepost can help you reach your goals, particularly financial security.
- The Current Ratio
Several ratios may seem familiar to you. The current ratio is a common one when analysing the strength of a company’s balance sheet and its ability to meet its short-term obligations.
A current personal ratio is essentially the same.
The current ratio is the best benchmark to determine liquidity in your household. It measures the household’s ability to repay a short-term debt in an emergency.
The calculation matches short-term monetary (i.e., liquid assets) assets to short-term liabilities.
Current Ratio = Short term Cash Assets/ Short Term Liabilities
Liabilities are the debt payments owed in the current year. Current liabilities would include your monthly credit card balances and other debt payments owed that year. A ratio of one or higher indicates you have more short-term assets than debt, a sign of good financial health.
- Debt-to-Asset Ratio
The Debt-to-asset ratio is a standard ratio for companies. This ratio focuses on the borrowing ability of the individual or household. Industrial firms tend to be more accustomed to higher debt levels because they are capital intensive. Individuals should not have high debt levels.
Total Debt-to-Asset Ratio= Total Liabilities/Total Assets
If you have a high debt-to-asset ratio, you should reduce your debt. It is essential to lower your overall costs for maximum financial flexibility long term. Particular loans are common to most of us. Total liabilities may include balances on the student loan, mortgage, car loan, and credit card debt.
Your liabilities should not go over 50% of your total assets. A 10% ratio or as little debt as possible is a great goal. Avoid high debt, or consider a debt reduction plan.
- Debt-To-Income Ratio
A better way to look at whether your debt burden is too high is to compare it to your gross income, that is, the amount you make.
Debt-To-Income Ratio = (Annual Debt Repayments/Gross Income) x 100
Typically, when you are in your 20s-30s, your salaries are at the low end of your career. You may be borrowing for a home or a car while still paying student loans. Your ratio should be no more than 36% of gross income and decline as you command higher salaries.
- Debt-To-Disposable Income
It is worthwhile to look at monthly non-mortgage debt relative to monthly disposable income. Monthly disposable income is net of costs and taxes; and what is available for paying down debt, saving, and spending by the household.
Debt-To-Disposable Income = monthly non-mortgage debt payments/ monthly disposable income
The percentage should be 14% or lower. 15% or more is problematic and may reflect a household carrying too much debt.
- Personal Cost of Debt
Carrying too much debt relative to income is problematic. This ratio looks at your cost of debt influenced by your credit mix and FICO score. If you have high monthly credit card balances, you probably pay a high interest rate on that debt. Card companies notoriously charge high interest rates.
Also, your credit score matters. If you have a lower FICO score below 650, lenders will see you as a risky borrower and charge higher interest rates.
Pay Down High-Cost Debt
There are two types of debt reduction plans: Snowball Method (tackles the smallest debt first) and Avalanche Method (gets rid of the highest cost first). I prefer the Avalanche Method to get rid of the highest interest cost of debt first. Try eliminating your credit card balances by paying your bills in full.
- Solvency Ratio
Could you pay all of your debt using existing assets if you had to due to unforeseen events? This ratio helps you to determine if you can take care of your obligations. — https://thecentsofmoney.com/
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