These financial ratios serve as essential tools to evaluate and improve your financial health. Use them to understand your liquidity, debt management, savings, and investment strategies.

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1. Liquidity Ratio

Formula:
Liquidity Ratio = Monetary Assets / Monthly Expenses
- Purpose: Ensures you can cover 6 months of expenses during emergencies.
- Ideal Ratio: 6 (6 months of expenses).

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2. Emergency Fund Ratio

Formula:
Emergency Fund Ratio = 6 × Monthly Expenses
- Purpose: Determines how much you should save for unforeseen events (job loss, medical emergencies).
- Recommended: At least 6 months of expenses in a high-yield savings account.

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3. Net Worth Ratio

Formula:
Net Worth Ratio = Total Assets - Total Liabilities
- Purpose: Measures overall financial health.
- Goal: A higher positive number indicates better financial stability.

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4. Targeted Net Worth Ratio (Millionaire Next Door)

Formula:
Targeted Net Worth = Age × (Pretax Income / 10)
- Purpose: A benchmark to assess wealth accumulation.
- Example: A 30-year-old earning $95,000 should aim for $285,000 in net worth.

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5. Current Ratio

Formula:
Current Ratio = Short-Term Cash Assets / Short-Term Liabilities
- Purpose: Measures ability to meet short-term obligations.
- Ideal Ratio: 1 or higher, meaning you have more assets than short-term debt.

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6. Debt-to-Asset Ratio

Formula:
Debt-to-Asset Ratio = Total Liabilities / Total Assets
- Purpose: Assesses debt levels relative to assets.
- Goal: Keep the ratio below 50%, ideally closer to 10%.

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7. Debt-to-Income Ratio

Formula:
Debt-to-Income Ratio = (Annual Debt Repayments / Gross Income) × 100
- Purpose: Evaluates debt burden relative to earnings.
- Target: 36% or less; lower as income rises.

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8. Debt-to-Disposable Income Ratio

Formula:
Debt-to-Disposable Income Ratio = Monthly Non-Mortgage Debt / Monthly Disposable Income
- Purpose: Examines non-mortgage debt relative to take-home pay.
- Recommended: 14% or less; avoid exceeding 15%.

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9. Personal Cost of Debt

Formula:
Weighted interest rates on all loans:
[ \text{Personal Cost of Debt} = \sum \left( \frac{\text{Loan Amount}}{\text{Total Debt}} \times \text{Loan Interest Rate} \right) ]
- Purpose: Identifies high-interest debt to prioritize repayment.
- Tip: Use the Avalanche Method to pay off high-interest loans first.

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10. Solvency Ratio

Formula:
Solvency Ratio = Net Worth / Total Assets
- Purpose: Determines if you can repay all debt using existing assets.
- Ideal Ratio: A higher ratio indicates better financial stability.

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11. Investment Assets-to-Total Assets Ratio

Formula:
Investment Assets-to-Total Assets = Investment Assets / Total Assets
- Purpose: Tracks progress toward wealth-building goals.
- Target: 10% in your 20s, increasing over time with investments in stocks, bonds, etc.

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12. Savings Ratio

Formula:
Savings Ratio = Savings / Gross Income
- Purpose: Encourages disciplined saving habits.
- Goal: Start at 10%, aim for 20% or more.

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13. 50-20-30 Budget Ratio

Formula:
- 50%: Essentials (housing, utilities).
- 20%: Savings (investing, debt repayment).
- 30%: Wants (entertainment, vacations).
- Purpose: Balances spending and savings.

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14. Mortgage Ratio

Formula:
Mortgage Ratio = 2.5 × Primary Income
- Purpose: Helps avoid over-borrowing for home purchases.
- Example: $120,000 annual income $300,000 mortgage maximum.

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15. Total Debt Service Ratio (Front-End Ratio)

Formula:
Total Debt Service Ratio = Monthly Housing Costs / Gross Monthly Income
- Purpose: Measures ability to manage housing debt.
- Recommended: 28% or less, avoid exceeding 36%.

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16. Life Insurance Ratio

Formula:
Life Insurance Ratio = 10 × Primary Income
- Purpose: Ensures adequate coverage for dependents.
- Example: $100,000 annual income $1,000,000 policy recommended.

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17. Investing Ratio

Formula:
Investing Ratio = 120 - Age
- Purpose: Allocates portfolio between stocks and bonds.
- Example: A 25-year-old could have 95% stocks, 5% bonds.

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18. Retirement Savings Ratio

Formula:
Retirement Savings = 25 × Primary Income
- Purpose: Ensures adequate retirement funds.
- Example: $100,000 annual income $2.5 million retirement savings goal.

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Additional Personal Finance Ratios Explained

Here are detailed explanations of four essential financial ratios to help assess your financial health:

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19. Debt Servicing Ratio

Formula:
Debt Servicing Ratio = Short-Term Liabilities (EMIs) / Total Income

• Purpose: Measures how much of your income is being used to pay off debt obligations (e.g., EMIs).
• Recommendation: Keep your ratio below 40% of total income to avoid financial strain.
• Concerns: High debt servicing ratios, coupled with rising interest rates, can erode lifestyle quality.
• Long-Term Goal: Transition from high debt and low savings to minimal debt and substantial savings as your income grows.

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20. Inflation Hedge Ratio

Purpose: Evaluates your ability to protect wealth against inflation by investing in assets that historically outpace inflation (e.g., equity, gold).

• Key Insight:
• Fixed income instruments like FDs may offer post-tax returns below inflation, leading to a loss of purchasing power.

• Hedging Tools: Equity and equity mutual funds are common inflation-hedging investments.

• Investment Strategy:

• Young investors with higher risk tolerance can allocate more to equities.
• Older investors or those with low risk appetite should strike a balance between equities and safer instruments.

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21. Solvency Ratio

Formula:
Solvency Ratio = Net Worth / Total Assets

• Purpose: Assesses whether your total assets are sufficient to cover all liabilities.
• Net Worth: Total assets minus liabilities (e.g., bonds, equities, property, savings, cash).
• Ideal Ratio: 50% or higher is considered healthy.
• Example:
• Total Debt =50 lakh
• Total Assets =35 lakh
• Solvency Ratio = -42% (negative), indicating financial instability.

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22. Life Insurance Coverage Ratio

Formula:
Life Insurance Coverage Ratio = (Net Worth + Existing Life Cover) / Post-Tax Annual Salary

• Purpose: Determines if your life insurance coverage is sufficient to support your family in case of your untimely demise.
• Example:
• Assets:50 lakh
• Liabilities:25 lakh
• Life Cover:30 lakh
• Net Worth:50 lakh -25 lakh =25 lakh
• Post-Tax Salary:5 lakh

• Coverage Ratio: (?25 lakh +30 lakh) /5 lakh = 11 years

• Insights:

• A ratio of 11 means Mr. Kuberan's family can sustain 11 years of expenses based on current income and coverage.
• Note: This ratio doesn’t factor in inflation or the time value of money.

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Summing it up

• Debt Control: Prioritize keeping your debt servicing ratio below 40%.
• Inflation Hedge: Invest in assets like equities to preserve and grow purchasing power.
• Solvency Check: Aim for a solvency ratio of 50% or more to ensure financial stability.
• Life Insurance: Adequate coverage ensures long-term security for your family, aiming for a higher coverage ratio.

These ratios provide actionable insights to help you plan and secure your financial future effectively!

Final Thoughts

These ratios provide benchmarks to evaluate financial health and guide decision-making. Regularly assess your liquidity, debt levels, savings, and investments to stay on track for financial success. Start early, stay consistent, and adjust as your goals evolve.

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