Did you think that financial ratios only apply to companies? Think again. These personal finance ratios can help you determine whether you're in the pink of financial health - or headed down a slippery slope. They're really quite simple - you can calculate them yourself!
Manish Shah, Founder & CEO, BigDecisions.com believes that Financial Ratios tell a better story than absolute numbers. "For instance, an EMI of 1 lakh on a 5 lakh income is a lesser of a worry than an EMI of Rs 25,000 on a Rs. 75,000 income", he says.
Reserve - SurplusSimply put, your 'Reserve - Surplus Ratio' is the proportion of your monthly total household income that you aren't spending each month. What's a good number? At least 20%, say the experts. If it's lower, you're probably spending too much and need to relook your lifestyle.
"Ideally, you want to be able to save 20% of your net income, not including your PF deduction. At least that's what I aim for, sometimes successfully, sometimes not!" says Shah of BigDecisions.
A wise man once said - "The rich save first and spend later, whereas the poor spend first and save later". Keeping that thought in mind, you should resist the urge to upgrade your lifestyle at the very instant that you receive a bump up in pay. From a long term Wealth Creation standpoint, it would be prudent to use this opportunity to run a higher reserve-surplus ratio for some time instead.
The worst mistake would be to let your reserve-surplus ratio slip into the red - which implies that you're spending more than you're earning. This is an emergency situation from a personal finance standpoint and calls from some urgent fiscal consolidation!
Saving to Surplus RatioIt's not enough to simply run a high reserve-surplus ratio each month. Equally vital is the act of channelizing this surplus amount on auto mode into inflation beating investments.
Your Saving to Surplus ratio is an indicator of how well you're channelizing your reserves. In a nutshell, this ratio is the percentage of your monthly surplus that you're saving on autopilot each month (through SIP's, recurring deposits and the like). Any number below 50 per cent isn't healthy - ideally, you should aim for a number closer to 80 per cent.
Debt to Income RatioMost of us have at least one EMI running at any given point if time (for instance, a car loan, a home loan or a loan taken on your credit card). These EMI's impact what is known as your "Debt to Income Ratio". Your Debt to Income ratio is calculated as "your cumulative monthly EMI's divided by your monthly income".
A healthy debt to income ratio is under 20 per cent. For instance, if you're earning Rs. 1 Lac per month, make sure your EMI's are under Rs. 20,000. Not ensuring this can affect your future goals and your ability to pay your EMI's consistently, which could further have a negative impact on your CIBIL scores and your subsequent ability to raise cash when you really need it.
Debts and EMI's have a sneaky ability to creep up over time. Left unchecked, they can begin to eat into significant chunks of your monthly income, and inflict long term damage on your personal finances. Shah believes that one should watch their debt to income ratio closely. "Overall, as a percentage of your income in terms of monthly outflows - if you're paying more than half your overall household net income on EMI payments, it's a red flag", he cautions.
Shah also believes that one needs to view an EMI towards a depreciating asset differently from an EMI towards a potentially appreciating asset. "The bigger red flag is if the EMIs are going to finance depreciating (like a car or durable goods) assets or lifestyle expenses (family functions, vacations) as opposed to a possibly appreciating asset like a house, which also doubles up in saving rent", he says.
Liquid To Net-worth RatioIt's vital to have a fair proportion of your net worth in liquid assets, so that you can raise money easily in case of emergency requirements. Your liquid net worth defines the amount of your net asset worth that you can convert to cash easily. For instance: Stocks, Most Mutual Funds, AAA rated bonds and Fixed Deposits are all liquid assets. Real Estate, Traditional Insurance Policies and Private Equity investments are not.
To arrive at your liquid to net worth ratio, calculate your net worth first (by subtracting your total liabilities from your total assets). Divide your liquid net worth by your total net worth. A healthy range is 20 per cent to 50 per cent, depending on your personal requirements for urgent liquidity.
Solvency RatioYour Solvency Ratio is a measure of your ability to pay off all your outstanding loans by selling your liquid assets.
To calculate your solvency ratio, simply divide your outstanding liabilities by your liquid net worth. A ratio of 1.5 or more is good as it shows your debts are under control vis-a-vis your assets. Any number below 1 should be setting off alarm bells. A solvency ratio under 0.5 indicates that you are overleveraged and unprepared for emergencies. It calls for an immediate reduction in outstanding liabilities, or transfer of holdings from illiquid to liquid assets.