The personal financial ratios aim to serve as warning signals and help detect any deterioration in my financial position. And if situation arises, I can take any necessary actions such as altering my expenditure pattern or evaluate my goals.
Here are some ratios to use which I have classified them accordingly:
1) Solvency
Purpose - indicates the probability that an individual will become bankrupt
Equation - net worth / total assets
Implication - the higher the ratio, the stronger is my financial position
Warning bell - negative = insolvent
2) Liquidity
Purpose - measures my ability to pay off the short-term liabilities
Equation - current (liquid) assets / current liabilities
Implication - the higher the ratio, the stronger is my current financial situation
Warning bell - lower than 1.0
3) Savings
Purpose - measures the proportion of my income saved in a year
Equation - cash surplus / total annual income
Implication - 40% of my net earned income which should translate to higher ratio
Warning bell - negative = over-spending (except for one-off, big-ticket items)
4) Debt Service
Purpose - measures my ability to service loan payment in a prompt and timely fashion
Equation - total annual cash loan payment / total annual income
Implication - the smaller the ratio, the better is my ability to service the loans
Warning bell - more than 0.4 = too highly leveraged
5) Gearing
Purpose - measures how much leverage I have undertaken to acquire my assets
Equation - long-term liabilities / total assets
Implication - the higher the ratio, the higher the probability of bankruptcy
Warning bell - current cash flow can't pay off monthly loan repayment
For myself, I use the ratios monthly when I consolidate my personal financial figures (of income, expenditure, cash budget etc.)
But I do make it a point as not to get too disappointed should one of the ratios fall below the benchmark due to specific circumstances. Otherwise, we will be living in a highly regulated personal system that literally adds more stress, just like a pressure-cooker.
My objective is to keep within the framework as much as I can while focusing on my financial targets. My achievements are documented when I exceed my expectation.
How about you? Did you try the ratios? If not, go on....take 15 minutes break and do a quick calculation. See the results personally.
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