People are the most precious assets of any organisation. We help people realise their full potential through upgradation of skills and transfer of knowledge. We provide customised learning and consulting solutions post carrying out detailed contextualisation exercises for understanding the needs of our esteemed clients.

Ravinder Singh Chawla

Founder & CEO

The Full-body Health check-ups are becoming quite popular these days. There is growing awareness in people towards undergoing a health check-up, at least once in a year. But what about our Financial Health? Isn’t it important?

Unfortunately, this has been a highly neglected area thus far, esp. in India.

So, what are the top 5 personal finance ratios that one could analyse, to evaluate the personal financial health?

These financial ratios are as follows:

1. Liquidity ratio
2. Debt servicing ratio
3. Debt to assets ratio
4. Solvency ratio
5. Life insurance coverage ratio

Let us learn more about these ratios.

1. Liquidity ratio:

• It evaluates the ability of a person to meet personal expenses in case of any emergency
• Liquidity Ratio = Cash or near cash assets divided by the expenses per month.
• For example, if the expenses are Rs. 30,000 per month and the cash or deposits in Bank or liquid assets are Rs. 1,50,000 then the liquidity ratio = 5.
• It means that the liquid assets are enough to take care of 5 months of expenses, in case there is no new addition to the income.
• This ratio, ideally, ought to be minimum 6 in case of someone who is in a private job or self-employed and minimum 3 in case employed with Government or a Public Sector Undertaking (PSU).
• The liquid corpus (Rs. 1,50,000 in this example) is also referred to as Emergency Fund.
• The importance of this ratio becomes all the more critical in emergency situations (such as job loss or illness of some family member) or in uncertain times, similar to what many people around the world are facing in current unprecedented times, when the entire mankind is fighting the COVID-19 challenge.
• Liquidity ratio helps us know as to how long can we manage our monthly household expenses, in case of any emergency.
• The emergency fund ought to be kept in the form of fixed deposit (term deposit) or Liquid Fund schemes of Mutual funds.

2. Debt servicing ratio:

• It evaluates the debt obligations being serviced monthly (EMIs) in proportion to one’s gross monthly income.
• It could be described as the sum total of Monthly EMIs payable divided by the gross income p.m.
• For example, if the total of monthly EMIs is Rs. 20,000 per month and the gross income is Rs. 50,000 per month, then debt servicing ratio = 40%
• Debt servicing ratio helps one evaluate as to how much percentage of the gross monthly income is getting used for servicing loans.
• Ideally speaking, this ratio ought not to be more than 40%.

3. Debt to assets ratio:

• It evaluates the leveraged position vs. the assets.
• Total liabilities / Total assets
• For example, if the total liabilities are Rs. 10 Lakhs and the assets are Rs. 25 Lakhs, the debt to assets ratio is 40%
• Ideally speaking, this ratio ought not to be more than 50%.
• If only liquid assets (cash, bank balance) considered (instead of total assets), it is called ‘Liquid assets coverage ratio’.

4. Solvency ratio:

• It evaluates if the assets are adequate to service one’s debts.
• It is computed by dividing the Networth by total liabilities
• For example, if the total liabilities are Rs. 50 Lakhs and the assets are Rs. 40 Lakhs, the solvency ratio is -20%
• Higher the ratio, the better it is
• In any case, it ought not to be negative.

5. Life Insurance coverage ratio:

• It evaluates the adequacy of one’s Life Insurance cover.
• It could be described as (Networth – Existing Life Insurance cover) divided by Post-Tax yearly income
• For example, if the total networth (meaning total assets minus total liabilities) of a person is Rs. 1 crore and the post-tax annual income is Rs. 10 lakhs, the Life Insurance coverage ratio is 10 times (assuming zero Life Insurance cover).
• Ideally speaking, this ratio ought to be 20, 15 and 10, in case of age bands of up to 35, 36-50 and 50-60, respectively.
• Going by the example given above, if the person is aged 30, then he is grossly under-insured. He ought to have had been covered for a life insurance cover of Rs. 1 crore.
• Similarly, if the total networth of a person (aged 38) is Rs. 2 crores, the existing life insurance cover is Rs. 10 lakhs and the post-tax annual income is Rs. 20 lakhs, the Life Insurance coverage ratio is 9.5 times (as against the ideal 15 for his age). This person is also under-insured and ought to go for additional insurance cover of Rs. 1.1 crore more.

It is important that people assess their financial health on a regular basis. There are other important aspects as well. However, the purpose of this article was to discuss the five approaches to evaluating personal financial health.

So, how can one enhance the financial health. Well, there are some simple rules that one needs to follow.

Top 5 rules for good financial health

1. First save and then spend: Saving / investing has to be the first priority. Ideally, one must do that in a disciplined manner, systematically.
2. Building emergency fund: If emergency fund is not adequate, one needs to save to create the same.
3. Loans for building appreciating assets: One should take loans for appreciating assets (e.g. Home Loan or Education Loan) and avoid taking loans for depreciating assets.
4. Creating passive income: Focus on creating passive income (e.g. Rental income, Annuities, Interest income etc.) is critical.
5. Discipline to review financial health and investments: One needs to review the Financial Health as well as investments, at least once a year, in a disciplined manner.

It is important that we bear in mind that success is a function of design and cannot be achieved by default.

At https://skillbuilders.in we support individual investors and distributors of financial services enhance their knowledge and skills towards Financial Planning and Wealth Creation by:

1. i) Conducting seminars related to Financial Planning, Wealth Management, Tax and Estate Planning etc. in Corporates for their employees as well as open programs for the self-employed professionals.
2. ii) Conducting workshops for the distributors to enhance their knowledge and skills.

iii) Personalised performance coaching interventions for the IFAs and Agents / Financial consultants.