8 financial ratios to tell which way the wind is blowing

Apr 21, 2024 | Insights

Use FREE templates to develop key financial ratios from your financial statements and understand why your money raises powerful emotions in you.
Last week, I introduced Amy, and described how she grew calmer after the hard but satisfying work of preparing financial statements and discovering her financial situation.

But these statements were just a list of items and figures.

Amy needed to dig deeper and do some maths to understand the implications and inform fully her decisions about her money and life.

So Amy, under my guidance, used the figures to calculate eight critical financial ratios. At the same time, we discussed which way the financial wind was blowing for Amy and what ratios she felt would be acceptable in light of her life’s goals.

Goal ratios

These ratios tell you how close you are to achieving key goals and reflect the degree to which you are financially independent.

Savings Ratio
Monthly savings / gross monthly income
A high percentage may mean you emphasise long-term security at the expense of living life to the full today. Do you want to live for today, tomorrow, or somewhere between? Plan to bring this ratio into line with your goals.

Savings to Income
Total savings and investments / annual gross income
You would expect this to grow during your working lifetime, especially if you run a good to high savings ratio. You must ask yourself how much is enough to meet your long-term goals.

Asset mix
Readily realisable assets / illiquid assets
Readily realisable assets can quickly be turned into cash in the bank without significant tax. Illiquid assets include unconventional investments and property. This ratio will tell you if you are asset-rich and cash-poor, which can be uncomfortable.

Security ratios

These ratios tell you about your short-, medium- and longer-term security. They will flag areas where you might be vulnerable to shocks and changing circumstances. Debt and liquidity feature strongly here.

Cash / monthly core expenditure
Do you have a security fund that you can draw on within 24 hours? How many months of core expenditure does it cover? Is this sufficient?

Debt to income
Total debts / gross annual income
What is the size of your debt relative to your income? This figure should fall throughout your life.

Debt to assets
Total liabilities / total assets
What are your liabilities relative to your total assets? In other words, how much equity is available? Are you comfortable with this, or should you fix another figure to aim for?

Debt servicing costs
Gross monthly income / total monthly debt servicing costs
What is the cost of servicing your debt relative to your income? How much of your income is allocated to debt payments, and how much do your debt repayments leave for you to live?

Debt servicing reserve
Cash or liquid assets / total monthly debt servicing costs
How many months’ debt servicing costs are covered by cash and liquid assets?

The magic is in the story

Notice how the key ratios exercise is helping Amy relate her money to her life. The math here is essential, but you will see that we are also asking questions about Amy’s relationship with money and the emotions around money, such as, “Are you happy with this figure?” or “Is this enough or too much/too little?” It is only a short step to looking at the story the figures tell, and this is where the magic of money happens.

Photo attribution

Photo by Jordan Ladikos on Unsplash

Audio link


Other attributions and references

Farrell, Charles. Personal Financial Ratios: An Elegant Roadmap to Financial Health and Retirement. Journal of Financial Planning, January 2006.

Taking it further

Use these templates to help you make a start. It will take a bit of work, but the outcome will be a sense of peace and calm from knowing where you stand. Even if it is bad, you can make informed decisions and draw up a plan to deal with the situation.

Family financial statements template: https://shrtm.nu/wAm

Family key ratios template: https://shrtm.nu/wAl

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My name is Jeremy Deedes. I am a coach with a background in business development, financial planning, and life coaching. I was the first person in the UK to qualify as a Registered Financial Life Planner, and I specialise in helping clients appreciate how their ideas and beliefs about money influence their every decision.

I created my unique FUTURE process, a combination of life coaching and financial planning, to help independent consultants in their 40s and 50s write a new life story through a better relationship with money and reorganise their money to achieve personal and financial freedom. In so doing, they achieve calm by making sense of their money, confidence from clear goals and plans, and a new clarity of purpose.

Discover your money maturity score by taking the Money Maturity Quiz at https://shrtm.nu/n2D. It’s free, takes only a few minutes, and you will get your score and recommendations by email immediately.

Then, use the link below to schedule a free 20-minute call with me so we can start you on the path to understanding your money and creating a new story to tell your family and friends.

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