4 Ratios which can give a quick idea about your present Financial Health

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It is amazing how certain subjects we dread or find boring in our primary school days become interesting later on in life. Maths was not really my most loved subject in schooling years. As I started working, I realised I was using many of the concepts in my daily job. One of the most extensively used was ratios. Ratios help compare two or more numbers. I used it to analyse company balance sheets in my earlier job. In fact, knowingly or unknowingly, we all take help of ratios in our daily lives. Be it measuring in probabilities, in proportions while cooking, interpreting health diagnostic reports, etc.

Similarly, ratios can be used in your personal finance lives too. Ratios are a beautiful way to interpret your personal finances. It will give you some rough idea about where you stand financially.

Here are a few ratios which can give you a quick reality check of your current state of finances:

  1. Debt/Insurance ratio: In the event of your death, the first thing that your spouse has to think of is repaying loans. It is a priority even before considering planning for other financial goals like child education. So, this ratio is an interesting number for interpretation because it will guide you whether you have taken enough insurance to cover at least your liabilities. A ratio lower than one would spare your dependants the trouble in repaying any outstanding loans out of their own pocket
  2. Total Savings/Monthly Expenses ratio: This is my favourite one. This ratio will give a good awareness as to how vulnerable or well prepared you are financially when life throws those harsh bouncers at you. It indicates how adequate are your total life savings (accumulated so far) to survive if there is any kind of emergency which affects your income earning ability like job loss, substantial pay cut in job, critical illness, temporary disability, etc. This ratio is measured in months and will show you how financially prepared you are for such events. Total savings here include bank balance, fixed deposits, recurring deposits, postal saving schemes, equity, debt & gold investments, gold jewellery, insurance policies, etc. If your savings cannot last even for a good 6 months, then it is a cause for concern. Review this ratio before you decide to quit your job & take up a new one or when you start a business as the financial risks are high in such situations.
  3. Investment to Income ratio: Ultimately, the road to riches depends upon how much savings gets translated into investments on a regular basis. The higher the ratio, the better. Although there is no thumb rule here, I feel a ratio of 20 per cent or more is good. If you are unable to invest at least 20 per cent of your income, then there could be 2 reasons for it. Either you are not able to save enough in which case you need to introspect on your savings plan. You may need to have a hard look at your budget and analyse where a significant portion of your income is being spent on. It could be used up in paying EMIs or discretionary spending. The second possibility is that you may be earning a bomb and saving like a penny-pincher but a significant portion of your earnings is laying idle in savings account. A higher ratio would mean not only are you saving more but are channelizing those savings into investments in a disciplined manner.
  4.  Investment assets to Net Worth ratio: This ratio can give you a good insight into how truly wealthy you are! It would help to evaluate how much income generating assets do you have in your total net worth. Total net worth is the difference between your total assets and total liabilities. You may have a couple of properties and cars but these would all be dead assets. Ideally, you should have assets which earn income for you like your investments, house on rent, etc. The higher the ratio, the better.

When you introspect your personal finance data in the form of ratios, they start making a lot of sense compared to standalone numbers. Your spouse may be aware of certain things better than you do. So, involve your spouse in this exercise. This exercise would be an eye opener about your present situation and the weak spots in your financial life which you need to work upon.

What better time but to start now at the beginning of this new year. Wishing all my readers a very happy and successful 2019.

 

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