Important Personal Finance Ratios

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Personal financial ratios

Important Personal Finance Ratios

 

The Personal Finance position of an individual predominantly indicates the ability to manage its current and future needs and expenses. The income of an individual may getting from a Job or Business or from the Created Assets to generate a passive income. Generally, Assets created by an individual are helpful to get an income and also for the Future Capital appreciation.

Assets are also used to meet the future expenses of a person or his family, if the regular income from a job or business as insufficient. So, we need a sufficient income with a efficient way like protecting our regular income, asset protection needs, prepare for the unexpected expenses.

Likewise, we are looking for the Insurance planning and Retirement planning to overcome the unexpected ones. There are so many financial ratios for the personal finance, but we are here to form some of the most important financial ratios.

Savings Ratio:

 

The Savings Ratio is a personal financial ratio that an individual is able to save a particular percentage of his annual income. We all have savings or might not, but this ratio gives an opinion how your savings are.

Formula,

Savings Ratio  =  Savings per year / Annual Income

If your annual income is Rs. 10 Lakhs and you can able to save an amount of Rs. 1,00,000 /-. Then the savings ratio is,

1,00,000 / 10,00,000  = 10 Percent savings on annual income.

When we are talking about the savings ratio, the savings are generally referred to Bank Savings and Deposits, Stocks, Mutual Funds, Provident Fund, Bonds, or any related to as a savings instruments. Even Real Estate, Gold, Cash on hand and any other form to this are also considered as savings.

Let’s see with another example,

If your income is Rs. 20,000 per month (Gross Salary) including your employer’s contribution to the Provident fund of Rs. 1000. After deduction of your (Employee) contribution of Rs. 1000 to the PF, you can get a net salary or take home salary of Rs. 18,000 /-. Your current monthly expenses are at Rs. 12,000 /- and you have an interest income of Rs. 500 monthly from the existing investments that you had. Now, we can see how the savings ratio are,

Savings = (Take home salary + Interest income + PF contribution both employer and employee) – Expenses

Monthly Savings are: Rs. 8500 /-

Monthly Savings Ratio = Savings / Total monthly Income

8500 / 20500 = 0.4146 X 100  = 41.46 %

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Expenses Ratio:

 

It is calculated as Annual Recurring Expenses to the Annual Income to find the expense ratio for the year. You can use this formula,

Expenses Ratio  = Annual Recurring Expenses / Annual Income

For example, XYZ has saved an amount of Rs. 50,000 out of his annual income of Rs. 5 Lakhs, then his annual expenses would be (5,00,000 – 50,000) = Rs. 4,50,000. Now, the Expense ratio will be calculated,

Expense Ratio = 4,50,000 / 5,00,000  = 0.9 X 100 = 90 Percent

The Expense ratio and Savings ratio can also calculated easily with another method,

Expense Ratio = 1 – Savings Ratio

Savings Ratio = 1 – Expenses Ratio

Leverage Ratio:

 

Leverage means use borrowed capital for an investment to make maximum profits or advantage. This is the ratio to measure the role of debt in the asset build up by the investor. It is computed as,

Leverage Ratio  = Total Liabilities / Total Assets

If an investor had an investments on shares and mutual funds worth of Rs. 10 Lakhs, Real Estate property valued at Rs. 40 Lakhs, PF balance are Rs. 5 Lakhs. The investor also had loan of Rs. 20 Lakhs on his real estate property and credit card due of Rs. 2 Lakhs.

Total Assets = Rs. (10 Lakhs + 40 Lakhs + 5 Lakhs)  = 55 Lakhs

Total Liabilities = Rs. (20 Lakhs + 2 Lakhs) = 22 Lakhs.

Leverage Ratio = 22 Lakhs / 55 Lakhs  = 0.4  X  100  = 40 %

Generally, if the Leverage is higher then the person’s personal financial situation is at more risky. Leverage Ratio less than 1 referred to as a good one and more than 1 indicates that the assets created will not be sufficient to meet the liabilities. Some times, Leverage is also used as debt servicing to create assets so that an investor can take maximum advantage.

 

Net worth:

 

We already mentioned that leverage to create assets is a healthy one, but leverage should be below 1 on its value. Similarly, an individual’s Net worth gives an indication how the person had on its asset position.

Net worth =  Total Assets – Total Liabilities

For example,   55 Lakhs – 22 Lahs = Rs. 33 Lakhs.

It is also used to measure how much worth the company had, Net worth can change over period of time.

 

Solvency Ratio:

 

On having assets, a person may be insolvent, if the liabilities are higher than the value of assets held. If the solvency ratio is higher, then the investor’s financial position will be stronger.

Solvency Ratio =  Net worth / Total Assets.

For example, 33 Lakhs / 55 Lakhs = 0.6 X 100 = 60 %

Solvency Ratio also be calculated as,

Solvency Ratio  = 1 – Leverage Ratio 

Leverage Ratio = 1 – Solvency Ratio

 

Liquidity Ratio:

 

Liquidity ratio is used to measure how well the family is equipped to meet its expenses from its short term assets.

Liquidity Ratio = Liquid Assets / Monthly expenses

If XYZ held shares of worth Rs. 3 Lakhs and liquid funds in mutual funds with the amount of Rs. 5 Lakhs, Savings account balance is Rs. 5 lakhs, Long term Bank FD at Rs. 5 Lakh, and loan repayments is Rs. 1.5 Lakhs.

Liquid Assets = Rs. ( 3 lakhs + 5 lakhs) = 8 Lakhs

Liquity Ratio = Rs. 8 lakhs / 1.5 lakhs = 5.33

Note that the fixed deposit (Rs. 5 lakh) is a long term investment so that you cannot liquidate immediately. The Shares are not considered here due to volatile value in the market. The Liquidity ratio of around 4 to 6 indicates a comfortable level for the household to meet his expenses for the next 4 to 6 months. If there was a loss of a job or decline in regular income, this will help to survive for the next 6 months.

Debt to Income Ratio:

 

We know that the Leverage ratio measures the extent of debt use in asset acquisition. But, however it does not directly measure the ability of individual’s income to service or meet the obligations arising from all debt outstanding. Hence, we are using the Debt to income ratio is an indicator for the individual’s financial situation.

D/I Ratio = Monthly Debt servicing commitment / monthly income

For instance, you have an income of Rs. 1 lakh per month and with a loan obligation of Rs. 50,000 per month. Then the Debt to Income Ratio like,

50,000 / 1,00,000 = 50 %

The Debt to income ratio higher than 35 to 40 percent is immoderate or excessive. A large portion of the income of the household is committed to meet these obligations and may affect their ability to meet regular expenses and savings.

Generally, Personal financial ratios are to be calculated once a year so that we can compare with the past value and make to improve our Personal Finance.

 

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