Are you financially fit?

Check your personal financial ratios

If we want to determine how physically fit we are, we undergo blood tests, x-ray, ECG and other similar tests. Ideally, these tests are done twice a year so that any abnormal findings can be immediately treated and cured.

Isn’t it just right that we also undergo tests to check how financially fit we are?

Companies use financial ratios to evaluate their financial health. We can employ the same thing. Ratio analysis can help us analyze the success, failure and progress of our money management.

Current ratio

This ratio answers the question, “Do I have enough current liquid assets to meet my obligations?”

It is calculated by dividing your liquid assets, such as cash and cash equivalent, and receivables by your short-term payables such as credit card debts and personal loans.

The ideal ratio is 2 to 1, meaning you have P2 of cash for every P1 of debt. It can’t go lower than 1 to 1 otherwise, you have to result to borrowing to finance your debts or sell other assets to raise cash. The higher the ratio, the better.

If you’re ratio is low, you can raise this by:

  • Acquiring loans with a longer maturity or due date
  • Selling some assets or possessions

Liquidity ratio

This ratio measures your current assets against your monthly expenses. It answers the question, “How long can my savings sustain me in case I don’t earn a single peso for some time?”

This refers to our emergency fund – for when we get sick or unemployed. The ideal number for this ratio is 6 and above. It means your savings or liquid assets can sustain you for half a year without having the need to earn a single peso.  

If your ratio is too low, you can raise this by:

  • Cutting down on expenses
  • Increasing your savings

Savings ratio

This ratio measures how well you save. Savings ratio is calculated by dividing your savings for the year against your income. The ideal savings ratio is 10% to 20%, but this may vary depending on your circumstances. Savings means liquid assets or assets you can immediately access should the need arise.

Solvency ratio

This ratio measures your total assets against your total liabilities. The answer should be at least 1. Otherwise, you’re considered “bankrupt.” The difference between the solvency ratio and the current ratio is that the former includes your long-term debts or loans, which include home mortgages, car loans and other loans maturing more than one year.

To increase your solvency ratio:

  • Invest wisely to make your assets grow even if you cannot increase your savings ratio. Find ways to increase your income so you can pay off more of your debts

Knowing our financial ratios can help us determine how we are doing money-wise. It’s not enough we know how much we are worth, we need to understand how our finances can affect us. We are our own chief financial officers and we should run our finances like how any effective CFOs would – for profit and growth.  – Rappler.com

 

Kendrick Chua is a registered financial planner of RFP Philippines. He writes regularly about personal finance. He is also a Chinese language instructor, TV host, free runner and violinist. To learn more about RFP, you may email info@rfp.ph.

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