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Give your financial health a checkup with these 4 ratios

By James Yeo

You have probably heard the saying that “money is not the most important thing in life”.

I agree with that statement wholeheartedly. In fact, it took me long enough to realise that being contented with what you have is the key to happiness.

However, that being said, we should still learn how to ascertain our financial health, and take steps to improve it. You wouldn’t want to be old and penniless just because you are too focused on ‘enjoying the moment’ now, would you?

With that, I found these four financial ratios with which you can do a simple ‘financial health’ checkup.

1. Liquidity ratio/ Rainy day

Liquidity ratio refers to the measure of how liquid you are – the amount of cash or short-term cash equivalents (such as Singapore Savings Bonds) that you have on hand when you come across an emergency situation or any other unforeseen circumstances.

Liquidity ratio = Cash (near cash) / monthly expenses

If your liquidity ratio is of a higher value, you don’t need to worry about it because you are ready to deal with all emergencies that might come in your way.

For example, Ben has $10,000 in cash and spends around $1,500 a month. Thus, he is able to continue his original lifestyle for around 6.5 months. As a guideline, one should have a liquidity ratio of at least three to six months, which is roughly the amount of time it takes to find a new job.

2. Savings ratio

Many of us have financial goals, like buying a car five years down the road or holding the unforgettable wedding in three years’ time. It is critical to set aside money bit by bit for these big expenses, as you wouldn’t want to get knee deep in debt just because of these important life events.

Here, the savings ratio will help you to figure out whether you are on the right track to achieve those goals.

Savings ratio = Savings / Total income

Total income refers to your overall income that you gain out of your salary, bonus, interest income, dividends, or any other side hustles. The guideline is usually more than or equal to 10 per cent. Experts also say that you should push this savings ratio to even 50 per cent if you have no dependents to take care of right now.

3. Debt to asset ratio

The debt to asset ratio can help you to figure out whether you have over-leveraged on your assets, because that is an uncomfortable situation when the economy turns against you. It is also another useful tool to help review your current situation before you opt for another new loan.

Debt to Asset ratio = Total liabilities / Total assets

Simply put, you would want your liabilities including home loans, car loans, credit card dues and personal loans to be as low as possible. Thus, you wish to have this ratio as low as possible, preferably below 50 per cent.

4. Debt Servicing ratio

On top of measuring your debt position, it is also important to ensure you are not overly stretched month-to-month.

Debt Servicing Ratio = Loan Payments / Take Home Pay

A simple principle is to have the loan payments take up less than 35 per cent of your take home pay.

Here’s one simple example. Ben’s monthly salary is $3k and his take home pay after Central Provident Fund contributions works out to $2,700. Thus, his loan payments should be kept to a max of $945 every month. Any higher and he would probably have to scrimp on other areas like less entertainment or dining out – ouch!

Conclusion

To sum up, there are many dimensions to maintaining good financial health such as setting up a rainy day fund, budgeting your monthly income versus expenses and more. These financial ratios serve as a simple stepping stone for someone who wants to get a better understanding of his/her financial health.

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