In this podcast, Maya (@mayaonmoney) and Mapalo (@womanandfinance) discuss other personal financial ratios to help you evaluate your current financial strength and position. Doing these calculations at least once a year can give you a benchmark to help you work towards better financial health.
Doing these calculations at once a year can give you a benchmark to help you work towards better financial health.
- Net worth calculation
The net worth calculation is effectively your personal balance sheet, which measures your assets vs. your liabilities. The bigger your assets compared to your liabilities, the higher your net worth will be.
Net Worth= Assets – Liabilities
- Savings Ratio
Savings ratio is the level of savings as a percentage of your total income. This calculation indicates the amount one puts aside as savings for future use. To achieve this, you need to practice the principle of ‘paying yourself first’ – meaning that even before you pay for anything else, you save first.
Another brilliant way to make sure that you save is by not inflating your lifestyle, with every pay increase, at least 10% of that should go towards your savings and not expenditure.
Savings ratio = [Savings / Net Income] x 100
- Debt-to-income ratio
Data produced by Tymebank in 2019 into just how indebted our society is, showed that just 15 days after payday, a majority of South Africans have no money in their bank account and therefore need to use expensive debt to get through the rest of the month.
The debt-to-income ratio is a calculation that compares the amount of debt you have to your overall income.
Debt-to-income ratio =[Total recurring monthly obligations / gross monthly income]
The ratio is really a reflection of just how much of your income goes towards servicing your financial obligations. An acceptable debt-to-income ratio is anything below 36%.
There are two ways to lower your debt-to-income ratio:
Reduce your monthly recurring debt, or
Increase your gross monthly income – ask for an increase or start a side gig that gives you extra income
- Liquidity ratio
Liquidity is the ease with which you can turn your assets into hard cash. This includes money in your savings accounts including cash earmarked for Emergency funds.
When you are liquid, you can withstand financial shocks like retrenchments, illness etc. Another big advantage of being liquid is that when opportunities present themselves to you, you can swiftly take them without borrowing money.
When thinking of liquidity, the adage ‘cash is king’ rings true.
Liquidity Ratio = [Liquid Assets / Current Debt] x 100
- Solvency Ratio
The solvency ratio is an important ratio and one that you need to familiarize yourself with. This is because as one grows in their career and acquire more assets, often debt is used to finance these assets especially, property and cars (although I might add that cars are a depreciating ‘asset’).
This ratio lets you know if the assets in your balance sheet are enough to repay your debts. It is for this reason your solvency ratio should be at least greater than 1.
Solvency Ratio = [Net Worth/ Total Debt] x 100
- Financial Freedom Ratio
Unless if you follow the F.I.R.E (Financial Independence Retire Early) movement closely, you will not be too familiar with the Financial Freedom ratio calculation. The F.I.R.E movement advocates for saving and investing aggressively so you can ‘retire’ early.
While we sometimes dream of being able to stop working in our fifties or some as early as forties, how do you measure your readiness to do exactly that?
The Financial Freedom ratio measures how close you are for you to hand in your resignation, quit your job and live the financially free life you’ve been working hard for!
The ratio is effectively the current income which you could sustainably replace if you were to stop working today.
To get to this number, you will need to know:
- Your annual total expenses ~ monthly expenses X 12months (so you need to know your budget like the back of your hand)
- The total annual income you can generate from your assets/investments without depleting your principal amount.
Financial Independence Ratio (FI Ratio) = Passive Income ÷ Expenses
This ratio gives you an estimate of just how close you are to the seemingly elusive financial independence.
Although you can quickly and easily do these calculations, it is good to remember that tax has a big impact on these calculations but do not let that put you off the number crunching. Even getting just an estimate can shift how you currently view your finances and hopefully motivate you to improve and manage your finances better.