Since we have discussed about personal cash flow statement and net worth statement, it is time to talk about the financial rates and ratios.
Ratios using data from cash flow statement
Savings ratio
Savings ÷ Gross income
It shows what percentage of your gross income is set aside for future consumption. The benchmark is at least 10%.
Debt service ratio
Total annual loan repayment ÷ Annual take home income
It compares your annual payment to service debt with your take home income. The benchmark is not more than 35%.
Non-mortgage debt service ratio
Total annual non-mortgage loan repayment ÷ Annual take home income
It compares your annual non-mortgage payment to service debt with your take home income. The benchmark is not more than 15%.
Ratios using data from net worth statement
Liquid assets to net worth ratio
Cash and cash equivalents ÷ Net worth
It shows the percentage of your net worth that is in the form of cash and cash equivalents. It helps in planning your estate. The recommended ratio is a minimum of 15%.
Net investment assets to net worth ratio
Total investment assets ÷ Net worth
It compares the value of investment assets with net worth. The recommended ratio is a minimum of 50%.
Debt to assets ratio
Total debts ÷ Total assets
It measures your ability to pay debts with your total assets available. The recommended ratio is 50% and below.
Solvency ratio
Net worth ÷ Total assets
It measures the extent you are exposed to insolvency. You are technically solvent as long as your net worth remains positive. The recommended ratio is at least 50%.
Ratios using data from both statements
Basic liquidity ratio
Cash and cash equivalents ÷ Monthly expenses
It shows the number of months you can settle your normal expenses from your liquid assets. The norm is a period of three to six months. This ratio corresponds to your emergency fund.
Standby liquidity ratio
Liquid investment assets ÷ Monthly expenses
It shows how many months you can pay your expenses if you are caught in a severe financial crisis that lasts longer than expected and the cash and cash equivalents are completely depleted.
Uses of personal financial ratios
These ratios quantify your financial situation. With these ratios and their recommended level, it will be very clear what can be improved. Without these ratios, there are no clear goalposts. Even if you know something is amiss, you would not know by how much and how far you are from the desired level.
I think the priority is the basic liquidity ratio. This represents your emergency fund. At a minimum, you should have a saving that could cover at least three months of your expenses. If you do not have a stable income, it would be better to have a 12-month emergency fund.
Once you have your emergency fund ready, then it is time to focus on the other areas. If your personal financial ratios are all within the recommended levels, you have done a good job in managing your finances.
How can a financial planner help you?
I will help you to construct your personal cash flow and net worth statement, and also compute the financial ratios. I can only rely on the client to provide the accurate information. If you really do not remember an item, I also cannot capture it in the statements.
With the information, I will give recommendations to improve your cash flow and your net worth. Depending on your objectives, I will provide a few suggestions but you are the ultimate decision maker. Even if the plan is perfect, it would not work if you do not implement it. So you should let me know your preferences and select a plan that you would implement wholeheartedly.
If you really cannot follow the plan, do not worry and inform me as soon as possible. I will come up with some alternatives. Nonetheless, if you always fail to adhere to the plan, perhaps the plan needs to be overhauled. I will help you with this.
If you are interested in working with me to improve your finances, just leave your details here. I will reach out to you and see if we would be a good fit for each other.
Disclaimer: This post is for informational purpose only. You should use judgment and conduct due diligence before taking any action or implementing any plan suggested or recommended in this article.