No need to spend hours and endless spreadsheets to understand where you stand financially. With a few key factors and simple math, you can give yourself peace of mind. A clear picture of your finances will provide you with confidence and calculating the ratios of things like your debt & income will be a big help you plan for your future, Ratios are a comparison of certain numerical factors and how they relate to each other. Knowing which ratios can give you the most useful information about your situation financially is essential.
Which Ratios are Important?
When you apply for a home loan the ratio first calculated to see if you qualify for borrowing money is the Debt to Income ratio. This is the monthly payments on debt divided by your gross monthly income. Any time you are over 36% on this ratio, your chances of qualifying for a mortgage is doubtful. The numbers that make up the debt computation are your current monthly mortgage payment or rent, all debts including but not limited to, cars, student loans, credit cards, and child support. Then you will need your monthly gross income. Another ratio that can help you see where you are with your money is the basic liquidity ratio. This will let you know how prepared you are to meet your monthly obligations in case of emergency. To calculate this ratio, total all your cash assets and divide by monthly expenses. Include only your essential expenses in this number since a true crisis will cause you to change your spending habits.
Good to Know
Everyone knows that having a savings is a smart, responsible thing to have and continually fund for financial stability. So, a savings ratio can tell you if you are prioritizing that part of your financial life. Take the totals between all your savings accounts, divide by your gross income. A good range for this ratio is 10-20%. Another useful number to know is your income to expense ratio so you can see if you need to increase income to save or use for a future project. Alternatively, maybe redirect some of your disposable income to pay off debt faster or increase the amount you put in your retirement accounts. This, along with a budgeting framework, can empower your decisions about your money. If the thought of doing all the math for these calculations makes your head spin, there are plenty of online calculators available for free.
Challenge yourself to compute at least two of these ratios next time you go over your budget.