As you work to improve your money management and investment skills, there are a few personal finance ratios that you need to know. These ratios will help you to analyze your current financial position and figure out what you need to improve.
This represents your ability to meet all of your financial obligations should you lose your income for a period of time. In other words, your emergency fund. This ratio is calculated by determining your on-hand cash compared to your monthly responsibilities. You should have 3-6 months of expenses easily accessible.
Asset to Debt Ratio
This is a comparison of your assets against your current debts. Your assets should include liquid assets (easily accessible cash) as well as illiquid assets (investments, retirement, home, rental properties, etc.). Your current debt includes any loans (education, home, auto) and outstanding credit card balances. The perfect ratio depends on your situation. For a middle-income family in their 30’s just purchasing a new home, your ratio is lower meaning you will probably have more debt. If you make at least a six-figure salary, your ratio should be higher meaning less debt and more assets.
This ratio is your ability to manage short-term liabilities in case of a financial emergency. It’s calculated by comparing your cash and cash equivalents to your short-term liabilities. Your short-term liabilities would include any debt repayments for the current year including loan payments and credit card balances. This calculates your ability to manage your financial liabilities in the short-term, within the current year.
This ratio is a comparison of your monthly income and your monthly surplus; what’s left at the end of the month once all obligations are paid. Knowing this ratio provides good insight on how well you’re managing your money. The higher your ratio (the higher the surplus) the better your money management skills are.
Debt Service Ratio
This is basically a review of your monthly budget. It’s a calculation of the amount of your income being directed toward debt repayment and the percentage of your income left over to cover household and living expenses as well as savings. The lower your ratio (the lower the amount of debt repayment you have) the better your financial situation.
Investment Assets to Total Assets
This ratio is a comparison of your liquid assets to your investment asset to calculate your total assets. Investment stocks, bonds, and mutual funds can easily be converted to cash if need be so they are considered liquid assets. Real estate, retirement accounts, and other investments that can’t be easily converted are illiquid assets. Your liquid assets should account for at least 20% of your total assets.
This is a comparison of your total net worth to your total assets. Your net worth is calculated by the difference between your total assets and your total liabilities. If your assets are more than your liabilities, your net worth is in the positive. If your debts are more than your assets, you need to take a serious look at your financial picture.
Knowing your personal finance rations helps you have a clear understanding of the big picture of your financial health and gives you specific steps to take to improve areas of weakness.