Need to Compute Personal Financial Ratios
Investors analyze stock ratios such as Price earnings multiple, book value per share, dividend yield, earnings per share, plough back ratio, etc in order to assess the financial health of a company. The most common usage of such ratios for prospective investors is for comparing them with some benchmark ratios.
Similarly, personal financial ratios are used to assess one’s progress towards achieving his financial goals and his financial health as well. Just as stock ratios are based on the company’s earnings and other financials, the personal financial ratios are based on an individual’s income, spending and other financial factors.
The simple logic behind such personal financial ratios is that there is a fundamental relationship between income, savings and debt levels. One ratio will affect the other and investors need to have their finances in proper balance.
Analysis of personal financial ratios will involve various factors, as adequate ratio will be different for each client depending on:
- Life Cycle stage
- Wealth Cycle stage
- Financial Status of the family
- State of Economy
- Number of Dependants
- Number of earning family members
When a person is young and in the accumulation stage, he will have more debt as assets will be built by taking loans.
When a person reaches transition/reaping stage, his debts will be paid off and he will have large asset balance as well.
Financial Status of the family is also a major consideration while evaluating ratios.
A person may earn ₹50,000 per month as salary, another may be earning ₹1,00,000 as salary or business income per month.
In the above case, occupation and income levels will determine their ratios. These factors are crucial to consider while assessing personal financial statements
The state of the economy is also to be considered while evaluating ratios. If the rate of inflation is low, then a nominal rate of return at 9% will fetch reasonable real returns. In case of high inflation rate, a higher nominal rate of return is required to beat the inflation rate.
If return is less than inflation rate, then there will be negative real returns, the net worth will also decrease instead of increase.