Assess Your Financial Health With These Ratios

In school, one could make out how a student was performing in studies on the basis of grades. In the corporate world, your performance can be assessed by your promotions, salary rise among other things. Basic Health indicators are sugar level, pulse rate, blood pressure. How do you know whether you are doing well in your finances? You might be getting a good salary and leading a comfortable life. But does that mean you are financially fit. The price to earning ratio (PE) and dividend yield of a company are used to evaluate valuation of company. Similarly there are some ratios that can be used to assess your financial health –

Financial Health

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1. Liquidity Ratio (or emergency fund) – Liquidity ratio measures your ability to pay for expenses with cash in hand. It is calculated as –

                                       (Cash + Bank Balance)/ (Monthly Living Expenses)

Typically you should have cash/ bank balance to pay for living expenses of about 3-6 months depending on marriage status, home loan etc. You should check this ratio when you are planning to quit your job or taking a new job with a start-up where financial and career risks might be higher.

2. Savings to Income Ratio – This ratio compares amount invested and the total income earned per month.

                                    (Amount invested per month) /(Total Income per month)

Savings can be in the form of cash, bank balance, FDs, PPF, Shares, Mutual Funds, Bonds etc. Minimum 20%-30% of gross income should go towards savings on a monthly basis.

3. Debt Service Ratio – This ratio shows the ability of a person to pay the loan instalments on a regular basis. It is calculated as –                                      

                                              (All EMIs & other debt payments) / (Family Gross Monthly Income)

It shows how much percentage of your monthly income is used for servicing loans. You will have to manage your investments and expenses with the remaining amount. The lower this ratio the better your debt management skills. It is advised that debt servicing should not take up more than 40% of your income.

4. Solvency Ratio – This ratio compares a person’s total assets and total liabilities to find if the person has the ability to pay off his debts.

                                              (Financial Assets) / (Total Liabilities)

 The ideal ratio depends on age and income earning capacity of a person. You should have a debt of up to 50% of your financial assets & if its above 100%, you need help. It means you can pay off your debts if required and you have a cushion to fall back on if value of assets go down or you have to take more loan.

Must Read: Net Worth – How to calculate & why its so important 

When you are younger or have a bright career ahead with the potential to earn a lot of money in a short span of time, the debt taken can be larger compared to a time when you are nearing your retirement or the scope for earnings increase is limited. When you have to take a loan, you should have a look at this ratio before finalizing the loan.

The personal finance ratios help you to evaluate your financial position and take next steps. I have given a generalized target for the ratios. You should calculate your financial ratios, consider your personal, professional and financial situation and take measures to improve your financial health.

Have you calculated these ratios for yourself. What steps did you take after that?

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{ 11 comments… add one }
  • ajay August 20, 2014, 8:31 PM

    beautiful!

    you did a fundamental analysis for a person instead of a company!

    isn’t free cash flow important?

    one should still have at least 5-10% of monthly income as surplus after loans, investments/savings, monthly expenses etc

  • Narayanan Venkateswaran August 20, 2014, 10:20 PM

    good and useful

  • anupam purwar August 21, 2014, 11:19 AM

    Very impressive and I immediateley start calculating my ratios. My expenses, investment need to be modify little bit.
    Thanx for eye opening article.

  • Tohid Surti August 21, 2014, 11:20 AM

    These ratios are good way to introspect and separate the truth from perception as in the financial world; decisions are driven more by emotion than numbers and logic.
    Mr Hemant; thanks for putting this together and reminding us’ I will print this stick it near my cupboard drawer to remind me everytime I pull out money 🙂

  • Debasish Paul August 21, 2014, 4:35 PM

    Hi Hemant,

    Really appreciate your article which is very useful and relevant. After go through your article, I think , we knew all this precaution but could not taken care of.
    Anyway, this is a commendable article as usual like earlier.

  • Rajiv Ahuja August 21, 2014, 4:45 PM

    Interesting article.

  • Rajanna August 23, 2014, 6:12 AM

    Hi Hemant,
    A very good article from you as usual. Also very important to evaluate one’s financial position considering the present day earnings and cost of living.

  • amarjeetsingh August 23, 2014, 10:29 AM

    Very Educative presentation

  • Arvind September 4, 2014, 11:23 AM

    excellent article!

  • Viren September 4, 2014, 12:08 PM

    Very educative!!

  • Chuimei Keishing September 15, 2014, 7:05 AM

    Thanks for enlightening with an excellent article. The parameters provided are very much relevant and realistic. Hope you will continue the nice work in the days to come.

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