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Five Essential Financial Ratios

There are many parameters that you can use to gauge financial health. If you are willing to do some calculations, you should be able to determine how good you are financially. You should know how good you are in leading a healthy life financially. Ratios are good indicators to determine whether you perform well financially. Here are five ratios that you should know about:

Liquidity ratio = (Savings balance + Cash)/ Monthly expenses.

With this ratio, you can determine whether you can meet any emergency requirement. This ratio also tells you whether you can deal with any emergency situation. You should exclude non-liquid financial assets in this calculation, such as long-term investments. While there’s no fixed measure to determine a good liquidity ratio, your condition should be good if the ratio is 4 or higher. If your ratio is too low, then you need to reduce expense and save more money. It’s even better if you work harder to boost your income.

Idle Cash Ratio = (Savings Balance + Cash) / Take Home Pay

If you have too much cash lying idle, then it’s a lost opportunity. A ratio of 0.1 to 0.15 should be fine. But if it’s higher, then you are being lazy with your investments. You don’t make money work more efficiently for you. You should invest to gradually increase your financial portfolio.

Savings Ratio = Amount of money invested per month/ Take Home pay

You need to have bigger retirement corpus as your job-span is getting shorter and life span increase. Always accumulate your capital by saving more. It’s a simple logic. With savings, you can still enjoy a proper lifestyle. Define the amount of corpus that allow you to live comfortable starting from age 50 and you shouldn’t forget to factor in the effect of inflation. If your savings ratio is less than 0.1, then you may need to reduce spending and save more.

Debt Service Coverage Ratio (DSCR) = Total instalments of loans per month / Take home pay per month

Many people are relying on debts and loans to achieve comfortable lifestyle. You may have mortgage, student loans, car loans, personal loans and outstanding balances of your credit cards. They may add up to a significant amount if you are not careful. Your DSCR is acceptable, if it’s below 0.4 or 40 percent. Try to keep your DSCR at 15 percent if possible, so you can save more and prepare for your retirement. It’s also better to save before applying for a loan. With larger down payment, you can reduce the amount of monthly instalments.

Solvency Ratio = Total assets / Total loans and liabilities

If you sell all of your assets today, can you use them to pay off all your loans. If not, then you’re living a dangerous life financially. Your solvency ratio should be at least 1.5 or 150 percent. Higher solvency ratio will give you a good cushion for unexpected situations. Your financial condition is risky if solvency ratio is under 1.0 or 100 percent.

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