If we analyze companies using financial ratios, I believe we can adopt the same concept to keep track of our financial health.
The personal financial ratios aim to serve as warning signals and help detect any deterioration in my financial position. And if situation arises, I can take any necessary actions such as altering my expenditure pattern or evaluate my goals.
Here are some ratios to use which I have classified them accordingly:
Purpose - indicates the probability that an individual will become bankrupt
Equation - net worth / total assets
Implication - the higher the ratio, the stronger is my financial position
Warning bell - negative = insolvent
Purpose - measures my ability to pay off the short-term liabilities
Equation - current (liquid) assets / current liabilities
Implication - the higher the ratio, the stronger is my current financial situation
Warning bell - lower than 1.0
Purpose - measures the proportion of my income saved in a year
Equation - cash surplus / total annual income
Implication - 40% of my net earned income which should translate to higher ratio
Warning bell - negative = over-spending (except for one-off, big-ticket items)
4) Debt Service
Purpose - measures my ability to service loan payment in a prompt and timely fashion
Equation - total annual cash loan payment / total annual income
Implication - the smaller the ratio, the better is my ability to service the loans
Warning bell - more than 0.4 = too highly leveraged
Purpose - measures how much leverage I have undertaken to acquire my assets
Equation - long-term liabilities / total assets
Implication - the higher the ratio, the higher the probability of bankruptcy
Warning bell - current cash flow can't pay off monthly loan repayment
For myself, I use the ratios monthly when I consolidate my personal financial figures (of income, expenditure, cash budget etc.)
But I do make it a point as not to get too disappointed should one of the ratios fall below the benchmark due to specific circumstances. Otherwise, we will be living in a highly regulated personal system that literally adds more stress, just like a pressure-cooker.
My objective is to keep within the framework as much as I can while focusing on my financial targets. My achievements are documented when I exceed my expectation.
How about you? Did you try the ratios? If not, go on....take 15 minutes break and do a quick calculation. See the results personally.