Financial Analysis is a very important criterion for investing in equities. You look at different kind of ratios like PE ratio, Leverage etc. to arrive at a meaningful decision. These ratios tell you how healthy is the investment you desire to make and whether it has capability of meeting your expectation.
Personal Finance is no different. You desire to achieve your goals by making suitable investments. These investments need to be analyzed so that your decision making helps you in achieving your desired objectives.
How much saving is enough? Whether your debt position is good enough? How long your family will sustain if any mishappening takes place? are some of the questions around which most of our concern lies. Personal finance ratios can be very helpful in answering some if not all of these questions. If analyzed properly you can determine your financial situation effectively. But, as in financial analysis, the ratios are one of the tools for knowing financial health of an investments, similarly personal finance decision cannot be based only on these ratios.
These are some of the ratios which will enhance decision making process if:
Liquidity– There can be a situation when there is a decrease in income or a financial opportunity of which you want to take an advantage. A liquidity ratio tells you how long you will be able to sustain your expenses in case of income reduction or whether you have enough to cash in the opportunity.
Liquidity Ratio= Liquid Assets/Monthly expenses
If this ratio come to 3, it indicates that 3 months expenses you can sustain if there is a situation like a job loss.
Solvency Ratio=Liquid & Other Financial Assets/Total Debt
This ratio indicates whether your assets will be helpful in repaying of debt and is related to your life stages. A 30 to 40% figure will mean that you are in very good shape if a situation arises to repay all your debts.
There are certain other ratios like current ratio and Liquid asset leverage ratio which can prove handy in knowing your debt repaying situation.
Risk Exposure– Adequate protection for dependents in case of primary member demise? Adequate liability protection? What % of salary decides your cash flow budget? are some of the financial risk which should be covered in your life. However, most of the time we tend to ignore or are unaware on any of these. This ratio indicates how long beneficiaries of principal wage earner can support themselves.
Life Insurance Coverage Ratio=Networth + Death benefit/Salary of Principal Wage Earner
In no way this should be mistaken for any life insurance coverage estimates.
Networth – All of us are interested in growth of our financial assets so that we are able to achieve important financial goals. The primary reason for this is the inflation and change in tax provisions every year. This ratio will indicate whether our assets have been generating enough cash for us.
Net Cash Flow Ratio=1-(Realized Decrease in Net Worth/Realized Increase in Net Worth)
A ratio of .10 is very good for young couples as it signifies enough funds for investments. However, any negative value will indicates that your life is more on credit or most of your assets have been liquidated.
The ratios mentioned above are not an analysis of their own but can be very effective in managing your personal finance. These are being used by most of the financial planner to assess their client’s financial situation. As a consumer also you can use these ratios to get an insight on financial situation but remember to interpret it meaningfully to arrive at any conclusion.
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