Just like how we can use financial ratios to analyse companies before investing in stocks, we can also use specific ratios to do a pulse check on our finances.
Here are eight important personal finance ratios that everyone should know about to identify potential financial pitfalls and help us make smarter financial decisions for the long term.
TL;DR: Get your finances in order right away with these eight personal finance ratios
|Ratios||Definition||Formula||General acceptable range|
|Basic liquidity ratio||Indicates how robust a person’s finances are to handle an emergency||Cash or cash equivalents / monthly expenses||Three to six months|
|Liquid assets to net worth ratio||Determines how much of an individual’s net worth is in the form of cash or cash equivalents||Cash or cash equivalents / net worth||At least 15 per cent|
|Savings ratio||Calculates the amount of income a person sets aside as savings||Monthly savings / monthly gross income||At least 20 per cent|
|Debt to asset ratio||Assesses whether a person’s debt level is high||Total liabilities / total assets||50 per cent or less|
|Solvency ratio||Another method to find out about potential longer-term solvency issues||Total net worth / total assets||The higher, the better|
|Debt servicing ratio||Calculates the amount of net income that is used to make regular debt repayments||Total monthly debt repayments / monthly take-home income||35 per cent or less|
|Non-mortgage debt servicing ratio||Similar to the previous one but excludes debt repayments for mortgage loans||Total monthly non-mortgage debt repayments / monthly take-home income||15 per cent or less|
Net investment assets to net worth ratio
|Reveals how much of an individual’s assets are used to accumulate capital for the long-term, excluding the place of residence||Total invested assets / net worth||50 per cent or more|
1. Basic liquidity ratio
The basic liquidity ratio, also known as the emergency fund ratio, indicates how robust your finances are to handle an emergency such as job loss or unexpected expenses.
When an asset is liquid, it can be converted to cash quickly without losing value.