When valuing a business, there are several common ratios used to determine the financial health and performance of the company. We can (and should) use the same approach when determining our own financial health and the performance of our households. Data-driven decision-making is a critical component of a financially efficient household.
It’s critical that you understand these 5 personal finance ratios; savings ratio, emergency fund ratio, current ratio, debt-to-income ratio, and mortgage-to-income ratio. These financial ratios give you and others insight into the financial health and wellbeing of your household and play a role in your future financial options.
5 personal finance ratios
Your savings ratio is the percentage of your income you are saving each month. The savings ratio is calculated by dividing your monthly savings (including employer match) by your monthly gross pay. Ideally, you’ll have about a 15% savings rate but that’s entirely dependent upon your unique retirement goals and it’s best looked at over time. Our family’s savings ratio has been as low as 0% and as high as 40% over the past decade.
Savings ratio = (monthly savings + employer match) / (monthly gross income)
If your saving $500 and receive $200 in employer match (each month) and you earn $10,000 gross income, then you have a savings ratio of 0.07 or 7%. Learn how you can improve your savings ratio.
Emergency fund ratio
Your emergency fund ratio is a measure of available cash on hand to handle unforeseen financial expenses. Ideally, you’ll have an emergency fund ratio of 3-6 or more depending on the size of your family and your financial situation.
Emergency ratio = (cash + cash equivalents) / (monthly non-discretionary expenses)
If you have $10,000 in cash and $10,000 in gold coins with monthly non-discretionary expenses of $5,000, then you have an emergency fund ratio of 4 ($20,000/5,000 = 4).
The current ratio compares all of your current assets to your current liabilities. For this calculation, current means liquid cash or cash equivalents, and short-term debt. Ideally, you’ll have a current ratio of 1 or greater. This means that you can pay off your short-term liabilities at any time with liquid assets.
Current ratio = (cash or cash equivalents) / (short-term liabilities)
If you have $10,000 in cash and $10,000 in gold coins, but $40,000 in short-term debt, then your current ratio is 0.5. This means that you have twice as much short-term debt as you do liquid assets.
The debt-to-income ratio is the percentage of monthly income spent on debt payments. Debt payments may include but are not limited to student loan debt, mortgage debt, personal loan debt, auto loan debt, credit card debt, etc. Ideally, you’ll have a debt-to-income ratio of less than 36%
Debt-to-income ratio = (monthly debt payments ) / (monthly gross income)
If you have $4,000 a month in monthly debt payments and $10,000 of monthly gross income, then you have a debt-to-income ratio of 0.40 or 40% and may want to consider reducing your debt load.
The mortgage-to-income ratio is the percentage of monthly income spent on mortgage payments. This includes principal, interest, escrow, and HOA. Ideally, you’ll have a mortgage-to-income ratio of less than 28%.
Mortgage-to-income ratio = (monthly housing costs) / (monthly gross income)
If you have $2,500 in monthly housing costs and $10,000 of monthly gross income, then you have a mortgage-to-income ratio of 0.25 or 25%.
If you want to run a financially efficient family, then you must understand what a financially healthy household looks like. Similarly to valuing a business, you want to look at income, assets, debts, etc. to get an idea of what is coming in, what is owned, and what is owed.
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