Every market savvy person is aware of the importance of technical and fundamental analysis to evaluate a company. Graphs, charts and ratios form the crux of this analysis.
October 26, 2012 / 01:21 PM IST
A person can evaluate his personal financial position by using six different ratios
Every market savvy person is aware of the importance of technical and fundamental analysis to evaluate a company. Graphs, charts and ratios form the crux of this analysis. Financial ratios are an integral part of the financial statement of a company and it helps in comparing companies between different time periods, among companies and industries too. All these help investors in making the right investment decisions.
Similarly, if a person wants to evaluate his personal financial position based on his financial statements considering the cash flow or his net worth or whether he is over-borrowed or whether he has enough liquidity, he can gauge his position on the basis of basic financial ratios.
The components involved in reaching the appropriate ratio have been discussed below in detail.
Unlike company ratio analysis, personal financial ratio is quite simple. There are six ratios in all which help individuals to evaluate their financial position.
Basic Liquidity Ratio:
This ratio indicates an individual’s ability to meet his or her monthly expenses in case of an emergency or a catastrophe.
Basic Liquidity Ratio = Cash (near cash)/Monthly Expenses
Cash (near cash) includes all liquid assets like savings a/c, Fixed Deposit, cash in hand and Liquid Funds.
Monthly Expenses include mandatory fixed and variable expenses. An average of 12 months is taken into consideration while calculating mandatory variable expense and the expenditure tends to vary every month. It does not include voluntary expenses like those on entertainment, vacation or those that can be avoided, if needed.
Liquidity Ratio:
This ratio helps a person to know his financial liquidity. Maintaining a certain level of liquidity is essential to ward off any unforeseen financial hardships. Property can be considered as a good investment avenue but lack of liquidity is its biggest drawback and while equity is risky, its biggest advantage is liquidity.
Liquidity Ratio = Liquid Assets/ Net Worth
Liquid Assets include all cash (near cash assets), equities, Equity Mutual Funds (not Equity Linked Savings Schemes as they have three years’ lock-in period), Debt Funds (which include Short Term, Gilt Funds, Monthly Income Plans and other such funds except Closed-Ended Funds) and other assets which can be redeemed within three to four working days.
Net Worth is the amount left after deducting total liabilities from total assets.
The ideal liquidity ratio is 15%. At least 15% of one’s portfolio should have assets, which can be redeemed almost immediately in case of an emergency. Anything less is not healthy.
Savings Ratio:
This ratio indicates the amount an individual sets aside as savings for his future goals.
Savings Ratio = Savings/ Gross Income
Savings include any form of savings like Fixed Deposits, Liquid Funds, Mutual Funds, Equities, Debt, Bonds, PPF, Post Office Small Saving Schemes and others where the individual saves on a regular basis.
Gross Income includes income earned through business, profession or in the form of salary, bonus, EPF contribution, interest, dividend, rent/royalty and any other form of income.
The ideal savings ratio is at least 10%. At least 10% of a person’s gross income should go towards savings. Anything less might not be quite what one might want it to be.
Debt to Asset Ratio:
This ratio helps a person to understand whether he is over borrowed or is in a comfortable position, i.e., if he faces any solvency problems. This ratio should always be used when one is planning to take a new loan. If an individual is over borrowed, it is best to avoid getting into something new. Instead the person should wait until he has finished paying off his previous loan amount.
Debt to Asset Ratio = Total Liabilities/ Total Assets
Total Liabilities are all liabilities like personal loan, home loan, and car loan, any credit card outstanding, amount taken from private money lenders and any other form of loan.
Total Assets include all assets that a person has like investments, cash (near cash), home, car, jewellery and other assets.
The ideal debt to asset ratio is maximum 50%. The maximum debt any individual can take should not exceed 50% of his total assets.
Total Assets include all assets that a person has like investments, cash (near cash), home, car, jewellery and other assets.
The ideal debt to asset ratio is maximum 50%. The maximum debt any individual can take should not exceed 50% of his total assets.Source: Nirmal Bang's Beyond Market
Tags: #Basic Liquidity Ratio #Beyond Market #Debt to Asset Ratio #financial ratios #investing #Liquidity Ratio #Nirmal Bang #Nirmal Bang's Beyond Market #Savings Ratio
first published: Jun 14, 2012 05:26 pm
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