What is Personal Finance Ratios
Specific net worth, financial statements, and your monthly budgets are the personal financial ratios or data to describe your household or individual financial conditions. Personal financial ratios are actual tools specifically designed to evaluate the position and strength of your finances. They are the benchmarks that can help you to identify and develop financial habits that are beneficial to you. These may include savings, spending limits, retirement, investing, debt reduction and accumulation.
These personal financial ratios calculations are relatively easy and provide you better insight into your financial progress and health in comparison to your desired goals. You will get a better sense of where you stand and where you want or intend to be.
Budget and Net Worth Are Primary Tools
The creation of your monthly budget, as well as net worth statements and keeping them updated, is the most critical element. These statements hold all the critical information to your current financial existence. Net worth provides a snapshot of your current financial condition, and you can calculate it using your total assets. That is what you owe or what you own less than your total liabilities. Hopefully, what you owe is less than what you own.
A monthly budget depicts your income statement. Your monthly budget is based on total sources of your income minus total expenses (both variable and fixed expenses). If your monthly income exceeds your expenditures and costs of living, then you have to look at ways to save excess money. You will need to add this money to your emergency funds, try paying down your debts and invest money for future financial safety. If your expenses are more than your income, then you will need either earn more, reduce spending, borrow to pay your debts and other costs or a combination of all of these strategies.
Ten Personal Finance Ratios
1. Liquidity Ratio
Liquidity defines your ability of how easily you are able to convert your assets into cash with minimum to no loss of its principal value. When you become financially liquid, you have the ability to take care of or pay any unexpected expenses such as a due to loss of employment, death of a loved one, or if the roof over your head starts leaking.
The most liquid of all assets are your monetary assets. They include cash, money markets or cash-equivalent securities, savings, savings bonds and checking accounts. Liquid assets can also help support your fixed monthly costs for three to six months.
2. Emergency Fund Ratio
Your emergency funds are closely linked to the liquidity ratio. They are essentially known as your cash funds reserves for emergencies due to unforeseen circumstances such as unexpected medical emergency, immediate house repairs, employment loss etc. You can set these funds aside by estimating a targeted period of time that you might believe are enough to support through emergency situations.
However, if you are looking for six months or more than we highly recommend you set aside some funds that can be invested in any high yield savers accounts or investment money market.
3. Net worth Ratio
A net worth ratio is actually a personal balance sheet that measures your net wealth at any point in time. As your assets increases and helpfully outpacing your current liabilities, it will identify that you are getting wealthier.
Your net worth ratio equals your total assets minus total liabilities
4. Targeted Net worth Ratio
The Millionaire Next Door is an excellent personal finance ratios books ever written. It is an oldie but still one of the most favorite books of many. Some of us have actually read it twice, and it is one of the most common referral books by teachers at college to their students on how to control overspending. The book focuses on high savers who are good at building their wealth and maintaining it.
5. Current Ratio
Several personal finance ratios may appear familiar to you. However, the current ratio is a very common ratio when it comes to analyzing the strength of your balance sheet and its capability to meet your short term financial obligations. It works by measuring your household’s ability to repay any short-term debts in case of emergencies or unforeseen circumstances.
Current Ratio is equaled to Short-term assets in cash/ Your Short-Term Liabilities
6. Debt-to-Asset Ratio
It is a very common ratio for industrial firms. Companies are generally more accustomed to the idea of higher debt levels due to being capital intensive in nature. However, individuals must not have high debt levels. The Debt-to-Asset ratio focuses mainly on the borrowing ability of you or your household.
7. Debt-To-Income Ratio
An excellent way to gauge whether your debt burden is getting too high is to run a comparison to the amount you make that is your gross income.
Your Debt-To-Income Ratio is equaled to Your Debt Repayments annually/Your Gross Income) x 100
8. Debt-To-Disposable Income
It is always worth looking at your monthly disposable income relative to your monthly non-mortgage debts. Your monthly disposable income usually means your net of taxes and costs plus what amount is available for you to pay down your debt, your savings and spending of your household.
Debt-To-Disposable Income ratio is equal to your monthly payments of non-mortgage debt / your monthly disposable income
This debt-to-disposable percentage must be 14 percent or lower. Anything more than that even 15 percent is a problematic indicator, and it may reflect as your household to be carrying way too much debt.
9. Personal Cost of Debt
If you carry too much debt in comparison to your income, it is problematic. The Personal Cost of debt ratio focuses on the cost of your debt, which is influenced by your FICO score and credit mix. For example, if you have a high credit card balance every month, then you may have high debt costs. Remember that credit card companies charge a notoriously extortionate amount of high-interest rates. Plus, your credit rating and scores do matter, so if you have a FICO score lower than 650, lenders will consider you as a risky borrower and more likely charge a higher interest rate.
10-Pay down High-Cost Debt
There are two types of plans when it comes to debt reduction. First is snowball methods that tackle your smallest debts, whereas, avalanche method targets to rid you of your highest costs firsts. Most prefer the avalanche method so that you can cut the cord from all your highest debt costs as soon as possible. You can try doing so by eliminating all the credit card remaining balances by paying them in full.
The main goal you must keep in mind is to reduce the higher debt costs. For example, if you have a $25,000 outstanding loan along with some smaller debts and costs. You would first target the $25,000 and try and reduce it or ideally eliminate it altogether as soon as you can.
Whether you are a business or an individual, the above method is effective for both. You can do so by investing in well-thought and evaluated opportunities and projects to guarantee a quick generation of revenues so they can pay off their debts quickly to avoid higher interest rates over many years. Think of your household as a business, and you would want to ensure higher returns on your investments to reduce your debts.