Many people make mistakes when managing their money. They spend too much on things they don’t need and end up broke, or they save a little bit of their paycheck while living paycheck to paycheck.
Keeping track of your spending and saving habits can be challenging, but there are some tools that can help you.
Money ratios are important! You’ll find it difficult to measure the health of your personal finances without them. This is especially true when deciding how much of your budget to allocate towards wants versus needs, using credit cards, and figuring out how much debt is acceptable.
You can use money ratios to quickly determine your financial situation. You can evaluate your financial situation quickly by using money ratios. Formulas for calculating finance ratios offer insight into how to improve your situation and plan for the future.
The ‘money ratio’ can help measure a person’s ability to save and how much time they have left for retirement or emergencies. By keeping track of these percentages, you’ll have a better idea about where you stand financially so that you can create a plan for your future.
Example
A ratio of half a cup of rice to a cup of lentil, with four cups of water to cook it in, khichdi serves two people without fancy add-ons. The ratio remains the same. Sometimes there will be more lentils, but it depends on individual tastes.
You need ratios even if you forget the exact recipe – did you add cumin?
The same holds true for personal finance; if you are disciplined about it and follow a budgeting money ratio – the amount of money you spend each month under different headings – you will never go broke. Your retirement fund can grow significantly as a result.
Money ratio: what is it?
A money ratio consists merely of a rule of thumb, as opposed to a mathematical formula, which can be the basis for organizing one’s personal finances. Money ratios come in many varieties. Money Ratios refer to the financial perimeters which can be calculated based on the components of Personal Finances like debt, monthly expenditure, etc.
You can manage your finances in many ways. It’s not necessary to use a single method for managing your finances, but some people use a 50/30/20 ratio. It is important to develop a plan that is individualized for you and your life goals.
There are many ways to manage your finance
- The budgeting ratio
2. The ratio of emergency funds
3. The housing ratio
4. The ratio of credit utilization
5. Debt to Income Ratio
6. Liquidity Ratio
7. Solvency Ratio
By evaluating your financial situation using these ratios, you will gain insight into how you can improve it. For a better understanding, let us examine each one in detail.
1. The budgeting ratio (Money ratio)
You will be allocated pay on a 20:30:50 ratio for different heads, although each person’s allocation will differ. It is still the same fundamental principle. As a general guideline, the following are sound principles to follow (the order matters):
- 20% saved (Plans or retirement) or paying off personal debt savings (goals or retirement) or paying off debts equals 20%
- A maximum of 30% on housing (for rent or home loan EMIs)
- Every other item is 50% off
Written by US Senator Elizabeth Warren and her daughter Amelia Warren Tyagi, an entrepreneur, advocated for this form of personal finance management.
They, however, allocate their income differently:
- 50% of it goes to ”essential living” (rent or mortgage, food, and utilities like electricity, Internet, and phones).
- 20% to financial goals (investments).
- 30% to personal expenses (dining out, holidays, fancy clothes).
However, the underlying principles remain unchanged.
This ratio is important because it makes you save; 20% of your income saved (or invested, as per Warren’sWarren’s plan) puts you on the path to financial success.
2. The ratio of emergency funds
Standard emergency fund amounts do not exist; one can never predict the extent of a crisis or the financial resources needed to respond to it. Furthermore, it can differ from person to person based on their circumstances and way of life. However, on average, you need to save six times your monthly income for emergencies. Dining out and other frills can be cut out, but housing will be expensive.
A fund for emergency situations is essential if you lose your job, become ill, or need to make major repairs to your house. Investing in a pension plan enhances financial security, as it creates a safety net and reduces the need for high-interest debt.
3. The housing ratio
Earlier, we discussed how 30% should be the maximum amount dedicated to housing, which applies to mortgage payments and rent. As an example, in the West, 30-35% of housing is the thumb rule; in India, 25-40%.
In many cases, lenders will not approve a loan with an EMI greater than 40% of net monthly income, as it consumes such a large portion of the household resources; EMIs exceeding 40% of net income will generally put a strain on the budget. If, however, you
Keeping the EMI to 30% of your income is helpful; this limit is considered a “safe zone”, because you are likely to be paying rent along with the loan EMI, making saving difficult. If the house is under construction, a delay can be frustrating (this happens when it is being constructed).
4. The ratio of credit utilization
Limits on credit cards determine the extent of credit balances without attracting penalties. The utilization of the credit limit should not exceed 30%. If this limit is exceeded, banks will raise a red flag, affecting the borrower’s credit score.
Credit cards are the easiest way of acquiring a loan history. As long as you manage your spending within accepted limits and pay your dues on time, you can expect a CIBIL score of 750 or more, which is excellent and entitles you to other lines of credit if the need arises.
5. Debt-income ratio
The debt-to-income ratio (DTI) measures the ratio between your monthly recurring liabilities and your monthly gross income. For someone paying rent or a mortgage on a monthly basis, a healthy DTI should fall between 30% and 40%.
This metric helps creditors (including lenders of home loans). gauge your ability to pay your monthly payments and repay your debt. As a result, if you earn Rs 1 lakh per month, your debt repayments should be Rs 30,000 to Rs 40,000; if you are paying this much on your home loan, you should drastically curtail the use of your credit cards
6. Ratio of liquidity
In order to determine whether an individual can cover the monthly expenses in case of unforeseen circumstances, the liquidity ratio helps evaluate the cash position.
The calculation is as follows
Ratio of liquidity = cash / monthly expenditure
The liquidity ratio is an indicator of how much income can be accessed when needed to cover a shortfall. For individuals without a stable income, 5-7 Liquidity Ratio is optimal.
7. Ratio of Solvency
Having a Solvency Ratio can be beneficial to clients with debt (housing or otherwise). You can determine if your portfolio is solvent-based on your solvency ratio.
Calculate as follows
Solvency ratio = Assets / Net Worth
A company’s net worth can be calculated by subtracting its liabilities from its assets.
Suppose an individual owes Rs. 10 lakhs and owns a total of Rs. Twenty lakhs of assets as well as fixed deposits and real estate, the individual would have to repay the loan. For our example, Net Worth is the difference between 20 lakhs and ten lakhs. With a Solvency Ratio of 0.50, the assets can service the debts in full.
FAQs
What are some ways you can use financial ratios in your personal finances?
Insolvency/credit ratios, liquidity, savings, asset allocation, inflation protection, tax burden, housing, and expenses are commonly used. This information can be helpful when you’re budgeting, investing, and keeping your credit rating high.
What is the formula for the debt-to-asset ratio?
Total liabilities divided by total assets is how the debt to assets ratio is calculated. The percentage of total assets is calculated as part of the total debt. This is a very simple equation.
How much debt should you have over the long term?
A healthy long-term debt ratio should be, but 0.5 or less is usually considered a healthy number for a wide range of industries. Using this ratio, you can calculate how many assets your company would have to sell or surrender to settle all its debts at any given time.
What does 0.5 mean in terms of debt ratio?
A debt ratio indicates the percentage of assets provided by debt that a company has. Equity finances the majority of the company’s assets if the ratio is below 0.5. An asset-to-debt ratio greater than 0.5 indicates the company is heavily reliant on debt.
How much income should be spent on expenses?
Rent and car payments are examples of living expenses that should account for 50 percent of your income. You should save 20% of your income to build a rainy day fund or secure a down payment for a home.
conclusion
Money management ultimately boils down to how you control your expenses and save, which is where a thorough understanding of money ratios comes in. The following ratios define your financial fitness. set priorities according to them. Manage your finances more easily than ever before. You can create a budget based on money ratios that will maintain balance and peace in any type of financial situation. Everyone deals with money at one point or another in their lives. People might need an income plan for a variety of reasons – from finding stability after being laid off to saving for retirement.
