Financial Checkup

It is important to perform some simple ratios at least once in a year your financial health.The group of Indian Consultant Group help its customers in maintaining the record in order to compare their financial standing and try to improve on areas where they have been lacking.

Personal financial ratios

There are six ratios which help you to do the analyses of your finances and determine your financial health. They are:

1. Basic solvency ratio (to be followed by the ratios mentioned below as five separate articles)
2. Liquidity ratio
3. Savings ratio
4. Debt to asset ratio
5. Solvency ratio and
6. Net invested assets to net worth

Basic solvency ratio

This ratio indicates your ability to meet monthly expenses in case of any emergency or catastrophe. It is calculated by dividing the near-term cash you have with your monthly expenses.

Basic solvency ratio = Cash / Monthly expenses (this ratio is not mentioned in percentage)

You can also call it as emergency or contingency planning ratio. This ratio helps you prepare for unforeseen problems.

Take for example, David, a 30-year-old business man whose wife underwent an emergency gall bladder surgery at a leading city hospital last year. Despite the fact that they had adequate mediclaims to take care of exactly such an eventuality, due to some administrative problems on the day of discharge, David informed that he would have to pay in cash as the bill could not be settled as cashless.

David had a tough time arranging the funds on an emergency basis. He was fortunate to have good friends and relatives who lent him the money. But not everybody have such great friends or relatives to bail them out at such short notice.

I am sure no one wants to be in the same shoes as David's.

Hence we have to be prepared for such situation. How? By maintaining an emergency fund!

Let's analyse how much money is enough. Here is where basic solvency ratio comes handy.

Near-term cash

The numerator of the basic solvency ratio formula, cash (near cash), would generally comprise of the following heads:

• Savings account
• Bank fixed deposits
• Liquid funds
• Cash in hand

The above components are liquid assets which come handy at the first possible hint of financial trouble. Liquid funds can be redeemed immediately. Same goes for fixed deposits as they can be broken and liquidated immediately in case of an emergency.

Monthly expenses

Only the mandatory fixed and variable expenses are taken here for simplicity. Any entertainment expenditure should not be taken as these expenses if need can be avoided.

Mandatory fixed expenses include the money you pay for EPF/ PPF contribution, loan EMIs, insurance premium, professional license fees and rent etc.

Mandatory variable expenses, on the other hand, comprise of food, transportation, clothing/ personal care, medical care, utilities, education expenses and miscellaneous compulsory expenses (the above expenses can vary depending on individuals).

The total of the above divided by 12 (that is 12 months) helps you arrive at the monthly average as your variable expenditure may vary. Assuming that you have cash of Rs 60,000 and average monthly expenses of Rs 25,000 your basic solvency ratio would work out to: 60,000 / 25,000 = 2.4.

But is it good?

Not quiet. An Ideal ratio should come to 3.

What does the number 3 signify?

It means that you must have money equivalent to or at least three months of your mandatory expenses in a contingency or emergency fund.

Why just 3 months?

This is because research shows that 3 months time is good enough to come out of any type of financial emergency. As people near their retirement age, they should make sure that this fund is kept up to 6 months of their mandatory expenses. The fund should be divided and kept in the form of cash, fixed deposit, or liquid fund.