5 Financial Ratios to Know Your Financial Standing
23 March 2020
Financial ratios are numerical yardsticks used to give a concise picture of your current financial situation. The ratios help you understand your current level of liquidity, debt and savings. They enable you to assess the strengths and weaknesses in your present finances.
1. Total Debt Servicing Ratio (TDSR)
Introduced in 2013, the TDSR measures all your monthly debt repayments against your monthly income. The higher your existing debts, the less you can borrow.
To qualify for a home loan, your TDSR cannot exceed 60%. That is, your total loan obligations cannot exceed 60% of your monthly gross income. This is to ensure prudent borrowing for property purchase.
Anything above 60% would be very risky as it indicates that there is potentially a danger that the customer will be unable to service the debt if liquidity is tightened due to unforeseen circumstances.
2. Liquidity Ratio
Liquidity ratio measures your ability to pay off your short-term debt obligations, by working out the amount of savings or cash equivalents set aside against monthly liabilities or expenses.
The ratio captures the number of months you can sustain your expenses in the event that all existing sources of income are lost temporarily. Rule of thumb: 3-6 months
Setting too much aside for rainy day may be counterproductive to your financial goals as this excess money could be better invested for better returns.
However, I highly recommend that you have emergency savings or funds which can be tapped in the event of contingencies, i.e. retrenchment, illnesses or accidents.
It may be prudent to allocate a higher amount if you have long-term commitments, such as a housing loan.
To save for the 3-6 months of emergency funds, start saving in small and consistent ways. It is also wise to monitor your expenses, especially if you are spending on large-ticket luxury items.
3. Liquid Asset To Net Worth Ratio
This ratio provides an indication of the proportion of a person’s net worth in cash or cash equivalents. A minimum ratio of 15% is considered adequate to meet short-term cash needs. This is because during an emergency, you need to be able to convert your assets into cash for urgent matters such as a medical condition that requires immediate hospitalization, It is advisable that you maintain some of your assets in liquid form such as bank savings, current account and fixed deposits.
4. Savings Ratio
This is the ratio of cash surplus or deficit to your disposable income. It refers to the monthly sum that is saved as a proportion of the monthly income. These savings can be allocated towards future financial goals and needs. You should have a savings ratio of at least 10%. 30% would be most ideal.
5. Debt To Asset Ratio
The debt to asset ration indicates the proportion of a person’s assets which is financed by debt or borrowing – so a lower ratio implies a lower monthly commitment towards repaying debt. The debt to asset ratio can be used to measure a person’s solvency or ability to pay debts. Generally, a ratio of 50% or less is considered safe.