Financial Ratio Analysis – Liquidity & Debt Ratios
Numbers in statements are just data. Ratios turn data into information. Just as a doctor checks BP and Pulse, we check these ratios to diagnose financial health.
1. Liquidity Ratios (Survival)
Can you handle an emergency?
A. Basic Liquidity Ratio
- Formula:
Liquid Assets / Monthly Expenses - Meaning: How many months can you survive if income stops?
- Ideal: 3 to 6.
- Example: Liquid Assets ₹1.5L / Expense ₹50k = 3. (Good).
B. Liquid Assets to Net Worth
- Formula:
Liquid Assets / Net Worth - Meaning: What % of wealth is cash?
- Ideal: 15% minimum. Too high means low growth; too low means cash crunch.
2. Debt Ratios (Leverage)
Are you drowning in debt?
A. Debt-to-Income Ratio (DTI)
- Formula:
Total Monthly EMI / Gross Monthly Income - Meaning: How much of salary goes to banks?
- Ideal: < 35-40%.
- Danger Zone: > 50%. Banks may reject new loans.
B. Solvency Ratio
- Formula:
Total Net Worth / Total Assets - Meaning: How much of your assets do you actually own?
- Ideal: > 50%. If 10% (Solvency), it means you have huge debt against assets.
3. Performance Ratios (Growth)
Are you growing?
A. Savings Ratio
- Formula:
Savings (Surplus) / Net Income - Meaning: What % of take-home pay do you save?
- Ideal: At least 20%. Super-savers aim for 50%.
- Example: Earn ₹1L, Save ₹25k = 25% Ratio.
B. Investment Assets to Net Worth
- Formula:
Invested Assets / Net Worth - Meaning: Are your assets productive? (Investment assets grow; Car/Furniture depreciate).
- Ideal: > 50%.
Case Study Analysis
Mr. Raj's Profile:
- Income: ₹1,00,000.
- Expenses: ₹40,000 + EMI ₹45,000 = ₹85,000.
- Liquid Assets: ₹2,00,000.
Analysis:
- Liquidity: 2L / 85k = 2.35 months. (Weak, needs improvement to 3-6).
- Debt-to-Income: 45k / 1L = 45%. (High leverage, avoid new loans).
- Savings Ratio: (1L - 85k) / 1L = 15%. (Below ideal 20%).
Diagnosis: Raj is earning well but high EMI is hurting his saving and liquidity.
Summary
| Ratio | Formula | Ideal Target |
|---|---|---|
| Liquidity | Liquid Assets / Monthly Exp | 3 to 6 months |
| Debt Service | EMI / Income | < 35% |
| Savings | Savings / Income | > 20% |
| Solvency | Net Worth / Assets | > 50% |
Quiz Time! 🎯
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