Implementation of Financial Ratio in Personal Finance

Prof. S. Thilak, Assistant Professor, SIMS

 

Financial Ratios in Personal Finance

            Financial Ratio is an essential part of a company’s financial statement which helps to compare the financial performance during the period of time. In the same way if an individual or a person wants to analyse his/ her own financial situation considering the net worth, cash flow, liability, liquidity etc., it can be determined by calculating Personal financial ratios. For better understanding few appropriate ratios are discussed below.

 Understanding the Financial Ratios

            Using data from the financial statement anybody can calculate the financial ratios which gives a clear idea on how far one can go.

 The following steps helps to assess the Financial Risk

• List down the resources like salary, savings, investment etc.,
• List down the Liabilities like outgoings and expenses.

With this information it is easy to assess the financial fitness for better understanding like Net Cash Flow position, Net Worth and Financial Ratio of an entities.

 The following ratios can be used to help  to understand the financial situation better.

Basic Liquidity Ratio

            The formula for the Basic Liquidity Ratio is Liquid Assets divided by Monthly Expenses. This ratio shows the number of months one can expect the liquid asset to sustain the monthly expenses. This is also known as emergency savings.

Savings Ratio

            The formula for the Saving Ratio is Total Savings divided by Net Cash Flow. This ratio reveals how well one is building up the savings for their future consumption.

Non-Mortgage and Mortgage Debt Service Ratio

            The formula for Non-Mortgage Debt Service Ratio is Total Monthly Non-Mortgage loan repayments divided by Total Monthly take home income (less CPF contribution). This ratio compares the monthly payments to service all debt, excluding the mortgage, with a person’s monthly take home pay. This ratio simply provides insight into what amount is going towards non-mortgage debt.

            The formula for Mortgage Debt Service Ratio is Monthly Mortgage Repayment divided by Gross Income. Gross Income refers to earned income inclusive of CPF’s employee contribution. This ratio reveals the percentage of monthly income that can be used to service the monthly property loan instalments.

Reserves Ratio

            The formula for Reserve Ratio is Reserve requirement multiplied by Banks deposits. This ratio tells how one can secure or create their Reserves for the present and future or during the times of uncertainty.

Debt to Asset Ratio

            The formula for the Debt to Asset Ratio is Total Liabilities divided Total Assets. This ratio helps the people to understand that Debt to Asset Ratio should be used while new taking fresh loans. If people have existing loan beyond the repayment capacity they are advised not to take anymore loans. This will increase the person’s liability and it is better to wait until time they settle a difference of existing loans.

Debt servicing Ratio

            The formula for Debt servicing ratio is Short term liabilities divided by Total Income.

In present world the payment is largely made by credit cards, it is important to control the debt. The debt serving measures the debt commitment against the monthly income.

Solvency Ratio

            The formula for Solvency ratio is net-worth divided by total asset. The solvency ratio will help a person to know whether the asset in a person’s portfolio is adequate to pay their debt. The net worth of a person is the difference between their total asset and total liabilities.

Life Insurance coverage Ratio

            The formula for Life Insurance coverage Ratio is Net worth plus existing life cover divided by post-tax salary. This ratio indicates a person’s no of years’ worth of expenses.

 Inflation Hedge

            Inflation hedge is a strategy which give a security during the time when the value of money falls. Inflation hedge usually involves investing in assets that has past rate of return more than that of Inflation. This will help the person’s portfolio but the factors like age, risk and financial goals also will be considered.