Stop Comparing Your Finances With Others. Five Financial Ratios To Keep You On Track.
January 31, 2007
Get Rich Slowly recently told Flexo’s story of how he’s become the Chief Financial Officer of his own life. Flexo tracks his finances with the same financial statements that businesses use, net worth and income/expense worksheets.
So as the CFO of your own life, how can you measure your financial progress against other people since everyone’s financial situation is a little different? Corporations have a similar challenge comparing their success against one another because no two businesses are exactly alike. Corporate executives and Wall Street use financial ratios to distill the numbers down to help compare apples to apples. We can use similar ratios in our personal finances.
My wife and I sat down with a financial advisor a few years ago and she pointed out 5 key ratios to keep an eye on. Below I give the formula, an example calculation, and a recommended target for each ratio.
Formula: Liquid Assets / Monthly Expenses
Our Example: $68,070/$6,892 = 9.9
Target: 3-6 months
Housing Payment Ratio
Formula: Monthly Housing Costs / Monthly Gross Income
Our Example: $825 / $7585 = 10.88%
Target: Less than 28%
Formula: Total Assets / Total Debt
Our Example: $265,570 / $146,654 = 1.81
Target: Greater than 1.0
Formula: Savings per Year / Annual Gross Income
Our Example: $18,000 / $91,000 = 19.78%
Target: 8-25% depending on age
Debt to Income Ratio
Formula: Annual Debt Payment / Annual Gross Income
Our Example: $9900 / $91,000 = 10.88%
Target: Less than or equal to 30%
As we read about other’s situations we often find ourselves comparing our finances to theirs. If someone else has a huge net worth it may seem intimidating, like you’ll never get where they are. If you’re ahead of most other people you might have a tendency to slack off financially. Rather than comparing yourself with others, measure your finances against these target ratios to help keep yourself on track.
Compute these ratios periodically and keep a record of the results so you can see your trend over time. I haven’t done a good job of this; the numbers I use in our examples are from 2003. In my defense, our expenses/debts haven’t gone up much since then while our salaries and savings rates have increased so our ratios should be the same or better. However, as we move to a one-income family a lot of things will change financially and I’ll need to stay on top of our ratios to make sure we’re still headed in the right direction.
If these ratios will help you keep better track of your finances, subscribe today for similar helpful tips.
Update, Flexo has started a series on personal finance ratios. Check out the first ratio in the series, the Working Captial Ratio.
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All posts by Ben Edwards