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.

Financial Ratios
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.

Key Ratios
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.

Liquidity 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%

Solvency Ratio
Formula: Total Assets / Total Debt
Our Example: $265,570 / $146,654 = 1.81
Target: Greater than 1.0

Savings Ratio
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%

Why Measure?
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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Ben

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Ben
Ben Edwards, the founder of Money Smart Life, saved up enough to buy a Nintendo back when he was 12 years old. When he used the money to buy shares of Wal-Mart stock instead, he knew he wasn't like the other kids... His addiction to personal finance has paid off for his family and now he's helping you to afford the life that you want. Check him out on the web at Google Plus, Twitter and Facebook.

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Comments

8 Responses to Stop Comparing Your Finances With Others. Five Financial Ratios To Keep You On Track.

  • Dave

    You do realise that the 2nd and 5th ratios are exactly the same right? One is monthly and the other is annually, that’s all.

  • Jay

    Nice post.

    Just wanted to share article on Ratio Analysis. It is good reference for Financial Ratio Analysis including Leverage Ratios, Liquidity Ratios, Operational Ratios, Profitability Ratios and Solvency Ratios.

    Financial Ratio Analysis

  • The Digerati Life

    Great post! I always wanted to apply these ratios to our own situation. I’ll be reviewing this as well as Flexo’s articles on this.

  • moneysmartz

    Excellent, I’ll keep an eye out for your ratios series. I added a link to your first one on the Working Capital Ratio.

  • Flexo

    Thanks for the mention! I just mentioned ratios yesterday, as well, with the intent of starting a series. Great overview… thanks for posting it.

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