Financial Ratios
What are the benefits of financial check up?
We are advised by our doctor to do regular health check-up in order to know our current state of health and to take preventive actions to prevent some serious health consequences in the future. Likewise doing a financial check-up is equivalent to doing a health check-up. Most people had done a health check-up due to employment or buying a life or health insurance policy. However, not many people have done their financial check-up. Some of the reasons could be as follow:
· You have not done your comprehensive financial plan with your adviser
· You only did your insurance planning or retirement planning
· You are not sure how to do one or don’t see the importance of doing one
Financial ratios are used to evaluate the financial soundness and progress in money management. It gives you a perspective of your current and future financial situation. If you are the fortunate few that have learn money management skills from your parents or financial literacy during your school education, you probably have the millionaire mind-set and on track to achieve your financial independence in the future. Yes, I am talking about mind-set, money habits and money management skills. Any lack of one will affect your chances of achieving financial freedom. Doing a financial check-up with a certified financial coach is a good start towards your financial freedom.
What are the financial ratios?
Basic Liquidity Ratio = Cash or Cash Equivalent / Monthly Expenses
This ratio measures the number of months you can support your monthly expenses. A ratio of 3 to 6 months is recommended. A question you should ask yourself is how many months it will take you to look for another job in your industry, in the event you decide to quit your job or being retrenched. It is recommended that you should have at least 6 months of emergency fund before you invest your excess cash as you may have to hold on to your investment in a bear markets.
Savings Ratio = Net Annual Savings / Total Annual Income
This ratio measures how much of your annual income you can save in a year. A ratio of 10% is good start. This ratio will indicate whether you are spending within your means and whether you are practising the ‘pay yourself first’ wealth accumulation principle. It is important for you to know how much to save in order to achieve your financial freedom in the future. To do that you need to look into all aspects of your finances. Doing your comprehensive financial plan is a good place to start.
Debt Service Ratio = Total Debt Repayments / Total Take Home Pay
This ratio (TDSR) measures how much of your take home pay is use to service your debts like mortgage, car loan or credit cards. A ratio of less than 30% is desirable and above 50% is too excessive. You need to have some buffers in the event of bear markets where the valuation of your property will drop and the bank will require you to top up your monthly instalment. If you fall behind your mortgage payment for a few months, the bank may take legal action on your property. Our property is ours only when the loan is fully paid up and that require us to maintain the monthly instalments throughout the loan tenure of 20 or 30 years.
Solvency Ratio = Total Net Worth / Total Asset
This ratio measures how much of your assets belong to you. As Net Worth = Assets – Liabilities, a Solvency Ratio of 100% means that you own all your assets and has no liabilities. This ratio is useful to indicate whether you are making progress on your wealth accumulation and you can look forwards to improving your ratio each year.
Debt to Asset Ratio = Total Debt / Total Assets
This ratio measures how much of your assets are financed by debt. A ratio of less than 50% is desirable. A young family or working person may have a high 'debt to asset' ratio but it should decrease over time.
Liquid Assets to Net Worth Ratio = Liquid Assets / Net Worth
This ratio measures what amount of a person net worth should be in cash. A ratio of 20% is adequate. Your emergency fund should forms part of your liquid assets.
Invested Assets to Net Worth = Invested Assets / Net Worth
This ratio measures how much of your assets are wealth producing or income producing assets. A ratio of 50% or more is desirable. The above first four ratios are key money management ratios and you need to do well in those areas, in order to have savings for growing your money. Based on the rule of 72 and assuming that inflation is 5%, your purchasing power will be reduced by half in 15 years’ time. Therefore having savings alone are not sufficient to help you achieve financial freedom especially with banks interest rate at less than 0.5%. You need to know your risks profile and how much to save per year at the investment risks that you are comfortable with, in order to achieve your financial goals.
Health check-up is not meant to be a one off event but a regular and continuous exercise and likewise your financial check-up. You need to find a certified financial coach or financial adviser to follow through with you on a yearly basis; he or she will be your cheer leader to cheer you on. If you have the knowledge and discipline to do it all by yourself, do consider the saying that iron sharpen iron and you don’t have to be alone in your journey towards financial freedom.
We are advised by our doctor to do regular health check-up in order to know our current state of health and to take preventive actions to prevent some serious health consequences in the future. Likewise doing a financial check-up is equivalent to doing a health check-up. Most people had done a health check-up due to employment or buying a life or health insurance policy. However, not many people have done their financial check-up. Some of the reasons could be as follow:
· You have not done your comprehensive financial plan with your adviser
· You only did your insurance planning or retirement planning
· You are not sure how to do one or don’t see the importance of doing one
Financial ratios are used to evaluate the financial soundness and progress in money management. It gives you a perspective of your current and future financial situation. If you are the fortunate few that have learn money management skills from your parents or financial literacy during your school education, you probably have the millionaire mind-set and on track to achieve your financial independence in the future. Yes, I am talking about mind-set, money habits and money management skills. Any lack of one will affect your chances of achieving financial freedom. Doing a financial check-up with a certified financial coach is a good start towards your financial freedom.
What are the financial ratios?
Basic Liquidity Ratio = Cash or Cash Equivalent / Monthly Expenses
This ratio measures the number of months you can support your monthly expenses. A ratio of 3 to 6 months is recommended. A question you should ask yourself is how many months it will take you to look for another job in your industry, in the event you decide to quit your job or being retrenched. It is recommended that you should have at least 6 months of emergency fund before you invest your excess cash as you may have to hold on to your investment in a bear markets.
Savings Ratio = Net Annual Savings / Total Annual Income
This ratio measures how much of your annual income you can save in a year. A ratio of 10% is good start. This ratio will indicate whether you are spending within your means and whether you are practising the ‘pay yourself first’ wealth accumulation principle. It is important for you to know how much to save in order to achieve your financial freedom in the future. To do that you need to look into all aspects of your finances. Doing your comprehensive financial plan is a good place to start.
Debt Service Ratio = Total Debt Repayments / Total Take Home Pay
This ratio (TDSR) measures how much of your take home pay is use to service your debts like mortgage, car loan or credit cards. A ratio of less than 30% is desirable and above 50% is too excessive. You need to have some buffers in the event of bear markets where the valuation of your property will drop and the bank will require you to top up your monthly instalment. If you fall behind your mortgage payment for a few months, the bank may take legal action on your property. Our property is ours only when the loan is fully paid up and that require us to maintain the monthly instalments throughout the loan tenure of 20 or 30 years.
Solvency Ratio = Total Net Worth / Total Asset
This ratio measures how much of your assets belong to you. As Net Worth = Assets – Liabilities, a Solvency Ratio of 100% means that you own all your assets and has no liabilities. This ratio is useful to indicate whether you are making progress on your wealth accumulation and you can look forwards to improving your ratio each year.
Debt to Asset Ratio = Total Debt / Total Assets
This ratio measures how much of your assets are financed by debt. A ratio of less than 50% is desirable. A young family or working person may have a high 'debt to asset' ratio but it should decrease over time.
Liquid Assets to Net Worth Ratio = Liquid Assets / Net Worth
This ratio measures what amount of a person net worth should be in cash. A ratio of 20% is adequate. Your emergency fund should forms part of your liquid assets.
Invested Assets to Net Worth = Invested Assets / Net Worth
This ratio measures how much of your assets are wealth producing or income producing assets. A ratio of 50% or more is desirable. The above first four ratios are key money management ratios and you need to do well in those areas, in order to have savings for growing your money. Based on the rule of 72 and assuming that inflation is 5%, your purchasing power will be reduced by half in 15 years’ time. Therefore having savings alone are not sufficient to help you achieve financial freedom especially with banks interest rate at less than 0.5%. You need to know your risks profile and how much to save per year at the investment risks that you are comfortable with, in order to achieve your financial goals.
Health check-up is not meant to be a one off event but a regular and continuous exercise and likewise your financial check-up. You need to find a certified financial coach or financial adviser to follow through with you on a yearly basis; he or she will be your cheer leader to cheer you on. If you have the knowledge and discipline to do it all by yourself, do consider the saying that iron sharpen iron and you don’t have to be alone in your journey towards financial freedom.