Just like how we use financial ratios to analyze companies before investing in stocks, we can also use certain ratios to do a closer examination of our money.
Here are eight important personal finance ratios everyone should know to identify potential financial risks and help us make smarter financial decisions in the long run.
tl; DR: Get your money in order instantly with these 8 personal finance ratios
|descent||Definition of||Equation||Acceptable public domain|
|Basic Liquidity Ratio||Indicates how strong a person’s financial resources are to deal with emergencies||Cash or cash equivalent / monthly expenses||Three to six months|
|Liquid assets to net worth||Determines the amount of an individual’s net worth in the form of cash or cash equivalents||Cash or cash equivalent / net worth||at least 15 percent|
|savings ratio||Calculate how much income a person sets aside as savings||Monthly savings / gross monthly income||at least 20 percent|
|Debt to Assets Ratio||Evaluates whether a person’s debt level is high||Total Liabilities / Total Assets||50 percent or less|
|solvency ratio||Another way to learn about potential long-term solvency issues||Total Net Wealth / Total Assets||The more the better|
|Debt Service Ratio||Calculates the amount of net income used to pay off regular debt||Total monthly debt payments/monthly income from home||35 percent or less|
|Non-real estate debt service ratio||Similar to the previous but excludes repayment of mortgage debt||Total monthly non-real estate debt repayments/monthly income taken from home||15 percent or less|
Net investment assets to net wealth ratio
|It reveals how much an individual’s assets are used for long-term capital accumulation, excluding place of residence||Total invested assets / net wealth||50 percent or more|
1. Basic Liquidity Ratio
The basic liquidity ratio, also known as the emergency fund ratio, indicates how strong your money is to handle emergencies such as job loss or unexpected expenses.
When the asset is liquid, it can be converted into cash quickly without losing value.
The basic liquidity ratio is calculated by comparing cash (or semi-cash) to monthly expenses.
Basic Liquidity Ratio = Cash or Equivalent / Monthly Expenses
The higher the number, the more liquid a person’s assets will be.
The general guideline is three to six months of expenses should be cash or semi-cash to cover any emergency needs.
2. The ratio of liquid assets to net worth
It may not be easy to convert one’s assets into cash in case of emergency, so it is necessary to have some assets in liquid form.
The ratio of liquid assets to net worth determines the amount of net worth an individual has in the form of cash or cash equivalents.
Net worth is simply the difference between the things you own versus what you owe.
Here is how to calculate the ratio of liquid assets to net worth:
Liquid Assets to Net Worth Ratio = Cash or Equivalent / Net Worth
In general, a minimum of 15 percent is considered safe.
3. Savings Ratio
The savings ratio calculates the amount of income a person sets aside as savings, which can be used to achieve financial goals.
The formula behind the savings ratio is:
Savings Ratio = Monthly Savings / Gross Monthly Income
Gross income is what we get before the mandatory CPF contribution.
In terms of savings, 20 percent is healthy according to the 50-30-20 rule that you can follow as a general guideline:
4. Debt to Assets Ratio
The debt-to-assets ratio determines whether a person’s debt level is high.
Thus, it highlights the issues of solvency in the medium to long term.
Solvency refers to the ability to pay off debts when they fall due.
The debt to assets ratio is calculated by comparing total liabilities with total assets.
Debt to Assets Ratio = Total Liabilities / Total Assets
Generally, a number of 50 percent or less means that there are enough assets to cover the liabilities.
5. Solvency Ratio
Another way to detect potential long-term solvency problems is to use the solvency ratio.
This ratio reveals the probability of a person’s bankruptcy or bankruptcy.
The math behind the solvency ratio is:
Solvency Ratio = Total Net Wealth / Total Assets
The higher the ratio, the better, because this means that the person has a strong financial position.
6. Debt Service Ratio
The debt service ratio calculates the amount of net income used to pay regular debt payments.
Net income is known as “taken home” income, which is the income after CPF contributions.
This is how we calculate the debt service ratio:
Debt service ratio = total monthly debt payments / monthly income from home
Typically, any 35 percent or less shows that there is enough income to pay the monthly debt payments.
7. Non-real estate debt service ratio
The non-real estate debt service ratio is similar to the previous ratio but excludes the debt repayment installments for the mortgage loan.
This ratio shows how much a person of their income goes into the home to pay off non-real estate debts.
Non-real estate debt service ratio = Total monthly non-real estate debt repayments / Monthly income taken from the home
In general, 15 percent or less is considered safe.
A very high ratio may mean that a person has borrowed excessively because most non-mortgage loans tend to be related to lifestyle expenses rather than long-term investments.
8. Ratio of net investment assets to net assets
This ratio reveals how much of an individual’s assets are used for long-term capital accumulation, excluding place of residence.
As a person approaches retirement, the ratio should go up because the goal is to have enough assets for retirement.
Net investment assets to net worth = Total invested assets / Net worth
In general, 50 percent or more is healthy.
Also Read: How Much Do You Really Need To Buy Your First Condominium In Singapore?
This article was first published in seed.