14 Most Useful Personal Finance Ratios And How To Apply Them

The term personal finance ratios might provide you with flashbacks to math class, learning various formulas, equations, and ratios. Back then, if students looked like they were zoning out, your teacher may need told you “listen, this might be useful to you later.” Well, this time, you don’t must wait—a number of the equations below might be useful to you immediately!

Let’s learn more about what ratios are and fourteen of the highest money ratios you need to use today!

What’s a private finance ratio?

In mathematical terms, a ratio is actually a strategy to compare two numbers. Since finance is all about numbers, that may turn out to be useful in some ways especially when making financial calculations!

You need to use ratios to maintain track of many alternative facets of your financial situation—from money flow to savings to suggestions for retirement planning and more.

A conventional ratio is expressed as a divisible number, but a number of the ones below use multiplication or subtractions as a substitute.

Ultimately, just consider it as a strategy to track your money and the way you utilize it. Keeping a record of your money ratios may also illuminate how these numbers change over time.

14 of essentially the most useful personal finance ratios

One of the best strategy to explain the ratios is just to start out showing you examples! So below, we’ll explain use each and why they could be helpful to your journey.

1. Monthly money flow ratio

Monthly expenses divided by monthly income

The monthly money flow formula helps you understand what percentage of your income is devoted to your monthly expenses. Think in regards to the money flow ratio as how much money flows in vs flowing out.

Start by adding up all of your regular income from jobs, side gigs, investment income, etc. You need to use a gross figure or your actual take-home pay (aka net income) after taxes.

Then, create or consult with your spending journal or a budget template or tool to see how much you spend every month. Don’t include savings or investments in your spending calculations (that has its own personal finance ratio)! Every part else is fair game: necessities, automotive payments, fun money, gifts, monthly debts, etc.

For those who spend around $2,000 monthly and make $2,500, your money flow ratio could be $2,000 / $2,500 = 80%. It tells you that 80% of your income is spent on expenses.

2. Savings ratio

Monthly savings divided by monthly income

This is largely the flip side of the one above. As an alternative of telling you ways much you’re spending monthly, it tells you your savings rate.

Include every kind of savings here. Whether you’re putting money in a savings account, your organization’s 401(k), your personal IRA, an investment account, and even setting aside physical money, it qualifies.

Using the identical monthly numbers as above, let’s say you’re putting the remainder of your money ($500) towards savings and investments.

Your monthly savings ratio could be $500 / $2,500 = 20% savings rate. You can too do the identical to search out your annual savings ratio. That way, you’ll be able to determine if you would like to save more to live higher or if the quantity you save is smart.

3. Emergency fund ratio

Essential monthly expenses x 6

An emergency fund exists to guard you within the event of unexpected expenses or job loss. It’s money you would like to keep easily accessible so you need to use it as soon as needed.

As a full-time freelancer, I’ve had months where I even have a ton of clients and projects, in addition to months where business is just a little slower. My emergency fund gives me peace of mind that I won’t be in a dire situation if my work schedule changes.

For the reason that common wisdom is to save lots of 3-6 months of expenses in your emergency fund, this ratio reflects that. Simply multiply your essential monthly expenses by 6 to return up together with your goal for a totally stocked emergency fund.

After I say “essential,” I mean you could be cutting out a few of your “fun” budgets for this one. Just include the things you’ll be able to’t live without (housing, utilities, food, medical health insurance, etc).

Our example person may normally spend $2,000 a month, but let’s say that they will pare down their essential expenses to $1,500. $1,500 * 6 = $9000 could be the goal for his or her emergency fund.

Keep this money in an interest-bearing account—ideally, a high-yield savings account. That way, it can remain accessible at any time when you wish it, however the interest will make it easier to grow your money while it’s there! 

4. Liquidity ratio

Liquid assets divided by monthly expenses

The liquidity ratio is certainly one of the private finance ratios closely tied to your emergency fund since they each revolve around the concept of liquidity. Put simply, liquid assets consult with (A) money or (B) other financial assets you’ll be able to quickly convert into money.

Money in a checking, savings, or money market account is extremely liquid. If you may have savings bonds you’ll be able to money in any time, they’re liquid.

If you may have stocks, bonds, index funds, and other “money equivalents” or other highly liquid investments that you would be able to easily sell in the marketplace, they might qualify as liquid, too. (Nonetheless, their value fluctuates more, so it’s not a stable number).

After all, you’ll be able to’t just sell your home on a whim for quick money, in order that’s an amazing example of a non-liquid asset. Money stored in retirement accounts can also be illiquid since withdrawals are subject to a number of rules and take time.

Once you may have these figures, running the liquidity ratio formula will reveal what number of months your liquid net value could support you. So for somebody with $20,000 in liquid assets who spends $2,000 a month, it’s $20,000 / $2,000 = 10 months of covered expenses.

5. Debt-to-assets ratio

Total liabilities divided by total assets

Now we’re stepping into some potentially less fun territory: a few debt ratios. Don’t be scared in case your numbers are higher than you’d like at first. It’s all a part of your debt reduction journey!

For those who don’t know where you’re ranging from, you’ll just be stumbling around at the hours of darkness, hoping your debt might be gone someday.

It’s possible you’ll also hear the debt-to-assets ratio called a solvency ratio. (Typically, “solvency ratio” is a term used for companies more often than individuals.) It’s a strategy to see whether you’ll be able to repay your debts by selling your assets.

Start by adding up your college loans, any consumer debt like bank cards, personal loans, automotive loans, and whatever other type of debt you carry.

Then, calculate the worth of your key assets, including all savings and investment accounts, paid-off vehicles, and private valuables.

If you may have $10,000 in total liabilities and $40,000 in total assets, you may have $10k / $40k = 25% as much debt as assets.

Is a house counted as an asset or liability?

What about your house? Is a house an asset or a liability? It’s each! Unless your mortgage is paid off, you may have equity in your home and debt at the identical time.

Homeowners can select whether or not so as to add their remaining mortgage balance as debt and residential equity as an asset on this ratio. 

Take into account that since mortgages are the biggest loans most individuals can have of their lives, including it will possibly make your ratio seem skewed. For those who like, you’ll be able to run the numbers with and without the house factored in to see the difference.

6.  Debt-to-income ratio

Annual debt payments divided by annual income

That is certainly one of the private finance ratios that may make it easier to work out how much of your income is being funneled toward your debts annually. 

To begin your equation, have a look at the debts you gathered above. But this time, add up your yearly payments towards each of them.

One exception is that when you’re a house owner, it’s best to exclude mortgage debt from this equation—that’s a surefire strategy to kill your ratio! (Plus, housing payments fall more into normal expenses than debt payoff.)

Next, you’ll divide your annual debts by your annual income. Normally, people use their gross income somewhat than net income for this calculation. Include any income from side gigs and alternative sources as well.

As your debts shrink, the results of this ratio will, too! But when you’re adding latest debts or paying things off too slowly, compound interest might increase your debt payments and, subsequently, this ratio.

Someone making $15,000 in annual debt payments while earning $50,000 a 12 months is paying $15k / $50k = 30% of their income to their debtors.

For firms, an identical ratio called the “debt servicing ratio” helps lenders assess a business’s debt repayment ability.

7. Net value ratio

Total assets minus total liabilities

The online value ratio goes to be short and sweet! Grab the identical numbers you utilized in #5, but as a substitute of dividing, we’ll simply subtract.

Assets minus liabilities make it easier to calculate your net value! It’s motivating and fulfilling to observe this number grow over time.

$40,000 assets – $10,000 liabilities = $30,000 net value.

8. Debt to net value ratio

Total liabilities divided by net value

This may be very much like the debt-to-assets ratio.

Nonetheless, you aren’t just comparing total debt to total asset value with this one. As an alternative, you’re comparing your debt to the web value figure from #7—where debt has already been subtracted out of your asset value.

The ratio is supposed to make it easier to determine how much debt you’ve taken on relative to your net value.

In case your ratio is over 100%, you might feel over-leveraged and struggle with payments. The lower the result, the more comfortable you’ll feel together with your debt levels.

$10,000 liabilities / $30,000 net value = 33% debt to net value ratio.

9. Housing-to-income ratio

Monthly housing costs divided by monthly income

You’ve probably heard some advice for spending a certain percentage of your income on housing. Prior to now, the rule of thumb number was 30%. Now, there’s a rather more detailed model called the 28/36 rule.

The primary part (28) means it is best to aim to spend not more than 28% of your income in your total house payment, including taxes and insurance.

The second part (36) adds your mortgage payment to all of your other debt payments and recommends that this total not exceed 36% of your income. It’s effectively the identical thing as your debt-to-income ratio from #6 (but a mortgage-inclusive version).

The 28/36 rule is a strategy to make it easier to weigh whether your house purchase would put you in an excessive amount of debt.

As an illustration, if a possible home purchase would bump you too far over the 36% debt-to-income figure, you would possibly want to take a look at cheaper properties. Otherwise, you run the danger of becoming house poor!

For those who’re spending $1,000 a month on housing while making $3,500, you’re spending $1k / $3.5k = nearly 28% on housing.

10. Needs/wants/savings budget ratio

50/30/20, 60/20/20, or other

Need a personal finance ratio that provides you a fast guide on dividing your expenses? There are several ways to do that.

Often, the best methods involve breaking down your expenses into needs, wants, and savings. Needs are the whole lot you’ll be able to’t live without, wants are the nice-to-haves, and savings are what you set aside in your future.

The 50/30/20 rule

One common budget ratio known as the 50-30-20 rule. On this formula, 50% of your income goes to necessities, 30% is reserved for discretionary income, and 20% gets saved.

Let’s see how this might work for somebody who makes $3,000 a month. The 50/30/20 ratio would mean $1,500 goes to needs, $900 to wants, and $600 to savings/investments.

Other percentages

All of those numbers could be tweaked depending in your situation.

So when you’re spending 60% of your income on necessities, it is advisable to aim for more of a 60 20 20 breakdown and even the 70-20-10 budget.

11. Retirement ratio

25x your annual expenses

Ever end up asking, “Can I retire yet?” When you stop working, you would like to be confident that your savings and investments will find a way to proceed funding your life.

It’s a tried-and-true method for understanding what you wish in retirement. It’s also based on something called the 4% rule, which refers to the concept that a retiree can safely withdraw 4% of their savings annually with little risk of running out.

Calculating your retirement expenses

Take a look at your current annual expenses and check out to work out in the event that they’ll be higher or lower in retirement. Perhaps you’ll have a paid-off house by then and eliminate rent/mortgage expenses.

On the flip side, it is advisable to try full time traveling or have extra for medical care. It never hurts to pad the numbers, however the 25x expenses formula is an amazing place to start out.

Someone who spends $50,000 a 12 months would ideally want $50,000 * 25 = $1.25 million to retire confidently.

12. Credit utilization ratio

Sum of bank card balances divided by total available credit

Your bank card utilization ratio helps show how effectively you manage your available credit. High utilization could signify that you may have an unhealthy reliance on debt. 

Utilization can also be an enormous think about determining your FICO credit rating, so it’s value being attentive to when you’re attempting to improve your credit. Understanding and managing this ratio can positively impact your creditworthiness and financial well-being.

Determining your credit utilization 

To calculate it, take the present sum of your revolving credit account balances and divide it by the full credit limits across all of your accounts.

A lower credit utilization rate helps your credit rating. Avoid going over a 30% credit utilization ratio—keeping it at or below the ten% range is right. Deal with paying off outstanding debts and limiting the balances you carry from one month to the following. 

Consider a scenario where your bank card balances amount to $2,000, and your total credit limits across all cards are $10,000. The credit utilization ratio could be $2k / $10k = 20%. This means that you just’re using 20% of your available credit. 

The advantage of utilization is that it essentially changes every month. Even when you may have a high ratio for one month, you’ll be able to pay down your balances and return to a low utilization very quickly.

13. Student loan debt to starting salary ratio

Total amount of student loan, divided by expected starting salary

College is notoriously expensive. And unless get a full ride scholarship or have a university fund, it will possibly be hard to stare those student loan offers and rates of interest within the face and ask yourself, is it value it?

The debt-to-salary ratio provides an easy guide for faculty students and their families to assist answer this query. Will your degree be definitely worth the debt in the long run?

This formula helps you establish the utmost loan amount to borrow for a selected degree program.

How do I tell if my college degree might be value it?

Since you’ll be able to’t predict the longer term, it’s unimaginable to calculate the precise ROI (return on investment) for a university degree. But you’ll be able to have a look at the job market in your goal field and determine what starting income you’ll be able to expect after graduation. Websites like salary.com can help with this research.

Your results can even make it easier to plan a sensible debt repayment schedule in your college loans. As a rule of thumb, students should limit their debt-to-starting-salary ratio to lower than 100% to repay the loans over roughly a 10-year period. (After all, rates of interest can affect the precise timeline.)

So, let’s say you’re taking out $30,000 in loans, and your anticipated starting income is $50,000. The debt to starting salary ratio could be $30,000 / $50,000 = 60%. The result indicates that your debt could be 60% of your expected starting salary, which is comparatively conservative and reasonable.

However, borrowing $60,000 for a level that results in a median starting salary of $30,000 doesn’t make as much financial sense. That may put the ratio result at 200%—double the really helpful amount.

Regardless of what your degree costs, enroll in our free student loans 101 course bundle to make sure you clearly understand how they work.

14. Loan-to-value ratio

Remaining mortgage amount on a property, divided by its appraised value

The loan-to-value (LTV) money ratio is an important metric within the realm of real estate financing. Lenders reference this ratio as an element of the mortgage approval process. In addition they consider it for refinancing and residential equity line of credit (HELOC) applications. A low LTV is nice since you owe less on the loan.

Whether you’re a current homeowner or a prospective first time home buyer, this personal finance ratio might be relevant to you.

How the LTV ratio works for brand new home buyers

For those who’re buying a house, your initial LTV will rely on the dimensions of your home down payment. Let’s say you set 20% down on a house valued at $200,000, so your down payment is $40,000 and your mortgage is $160,000. 

That makes your LTV ratio equation $160,000 / $200,000 = 80%.

For those who only put 10% down, you’ll be left with an LTV of 90%. Higher LTVs on latest home purchases can include additional costs, like higher mortgage rates of interest and personal mortgage insurance (PMI). 

The larger your down payment is, the smaller your LTV might be, and vice versa. Saving up no less than a 20% down payment will get you essentially the most favorable terms.

How the LTV ratio works for homeowners

For current homeowners, the LTV represents how much equity has built up in your house, i.e. how much of the mortgaged property you own. This figure also determines whether you can refinance at a lower interest rate or access a home equity line of credit.

Your LTV will decrease as you pay your mortgage, but it will possibly also change in case your appraised property value changes. 

In some cases, LTV can increase if a property’s market value drops. It could occur if there’s property damage (e.g. from flooding) or a recession hits. But it surely’s far more common in your LTV to diminish as your real estate value grows, which is a useful change.

Let’s say you got our example home when it was valued at $200,000. After five years, you continue to owe $125,000, but your property value has appreciated to $250,000. That latest value is the figure you’ll use for the ratio: $125,000 / $250,000 = 50% as a substitute of $125,000 / $200,000 = 62%. It’s like getting extra equity at no cost!

Expert tip: Consider money ratios inside the context of your life

Okay, you’ve just undergone a number of math—take a breath! Now’s the time to recollect these math equations are most insightful once you put them into context. A single ratio isn’t going to supply a comprehensive view of your financial health. 

You need to never feel bad if a few of your ratio results are above or below the best numbers. You don’t must live and die by money ratios! They’re only a guide, and there’s all the time room for exceptions and suppleness based in your unique situation. 

Possibly your required college degree doesn’t include an incredible starting salary…but it surely’s a field you’d love working in, with great future growth opportunities. Don’t rule it out due to a math equation.

Consider all of them inside the context of your personal core values, needs, and goals to make them be just right for you.

Why are personal finance ratios vital for you?

These ratios are great ways to distill tried-and-true financial wisdom into easy formulas that anyone can use.

If you would like to know whether your savings are on target—there’s a ratio for that. Curious when you’re spending an excessive amount of on housing? There’s a ratio for that.

Knowing your financial numbers can make it easier to improve your life

Moreover, keeping a record of those numbers enables you to reflect on where you got here from. As you learn latest frugal life hacks, you’ll be able to pare down your expenses and improve your money flow ratio.

As your income grows and also you repay debt, those debt ratios shrink in front of your eyes while your net value swells.

They’re some satisfying little equations that provide you with one other strategy to track your funds and set latest goals.

What are crucial ratios for money?

Finance is a highly individualized journey, so the importance of specific ratios can vary based on individual circumstances and financial goals. But usually, there are a number of ratios that everybody must be being attentive to.

The emergency fund ratio is certainly one of my top recommendations for the start of your financial journey. Life can throw curveballs at anyone, anytime.

Having no less than six months of expenses squirreled away helps provide you with a runway to figure things out when you get laid off, must pay for a surprise home or automotive repair, etc.

I’ll also highlight the savings ratio, which incorporates traditional savings and investments. Savings are essentially your key to the longer term. They put all of your goals in reach, whether it’s buying a house, paying off your loans, or early retirement.

What’s a very good debt to net value ratio?

A great debt to net value ratio strikes a healthy balance between leveraging debt for wealth-building and avoiding excessive indebtedness.

You would possibly think it’s best to strive for no debt.

Nonetheless, while which may be a worthy goal for some people, it isn’t all the time the case. In some situations, debt generally is a tool to make it easier to higher your financial health. 

It ties into the concept of kinds of debt, like good debt vs. bad debt.

For instance, student loan debt or business debt can make it easier to earn extra money throughout your lifetime. But bank card debt will eat your income with its high-interest rates.

You may give it some thought by way of these ranges:

• Safest range: A ratio below 50% is usually considered healthy—indicating that your net value is no less than twice your total debt. 
• Moderate range: Ratios between 50-100% can still be manageable, depending on the situation. Evaluate the kinds of debt you may have, its purpose, and whether it contributes to your overall financial well-being.
• Cautionary levels: Ratios exceeding 100% indicate that your total debt surpasses your net value. It signals the next level of economic risk, so proceed fastidiously and ensure you may have a solid debt repayment strategy.

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Calculate your personal finance ratios!

Now it’s officially your turn!

To be able to start crunching the numbers, you’ll need some key pieces of data in front of you. The fundamental belongings you’ll need include:

• Total annual income
• Total monthly income
• Total debts/liabilities
• Monthly expenses (broken down by category)
• Total asset value
• Liquid asset value (aka money or things you’ll be able to quickly turn into money)
• Credit limits in your cards
• Real estate value (for property owners)

Once you may have these figures in front of you, the remainder is just plug-and-play. You may recalculate these personal finance ratios as often as you wish—say, once a month, once 1 / 4, or every year—to remain on top of your personal financial statement. Over time, when you stay the course, you would possibly even learn turn out to be wealthy!