FINANCIAL RATIOS ANALYSIS

Transcription

1 1 FINANCIAL RATIOS ANALYSIS Financial Ratio Analysis enables you to spot trends in of your financial status and to compare its performance and condition with the benchmark. In this lesson, you are going to calculate some important financial ratios. Then you will compare this ratio to the benchmark. I will show you what the ratios mean to you. If you have completed your Money Flow Tracker (MFT), you can easily locate the important ratios on Column O. Passive Income Ratio Passive income ratio shows how near you are achieving financial freedom. Of course the ultimate goal is to have 100% passive income ratio. However, 50% is good enough to allow you to stop your active work if you choose to. With the extra time on hand when you quit your active job, you will be able to work more on creating a bigger passive income stream. When you hit the target of 50%, you can really consider quitting your active job. Passive Income Ratio Total Passive & Semi-passive Income Target Annual Gross Income 50% or higher Example (RM 25,346 + RM 36,700) RM156,800 = 39.57%

2 2 Your Passive Income ratio What s your main passive or semi-passive income source? List three actions that can increase your passive income ratio Savings Ratio Savings ratio is the proportion of income which is saved. Referring to your MFT, all the amount you put in Surplus section can be regarded as savings. Many experts suggest that you at least have a 10% savings ratio. Looking at the situation in Malaysia, most employees contribute to EPF. Since they are contributing 11% and the employers match the contribution with another 12%, that is a total of 23% saved in EPF. However, most EPF retired members found that there is not enough fund left. If 10% savings ratio is adequate, that means an average worker doesn t need to worry about her retirement because it is mandatory to contribute to EPF. Does this mean that you as an employee don t have to save already? Of course not. That s why the target here is elevated to 30%. As mentioned in my book Top Money Tips for Malaysians, a savings ratio of 30% will enable you to be financially free very soon.

3 3 Savings Ratio Total savings Target Annual Gross Income 30% or higher Example RM25,866 / RM156,800= 16.50% Your Savings Ratio What s your main savings and why? List three actions that can increase your savings ratio Wants Spending Ratio It is reasonable to spend on wants. Wise expenses on wants items keep you motivated and make your life an enjoyable one. Every one of us has different values and interest. I like to spend money on books, gadgets and musical gears. You might spend a lot on your hobby while Mat Rempit loves to dress up his car. Since spending money on these things make us happy, it is advisable to allocate a certain budget so that you won t be feeling guilty. At the meantime, it keeps you away from hurting your wallet.

4 4 Wants Spending Ratio Total Spending on wants Annual Gross Income Target 10-20% Your Wants Spending Ratio List down top three spending on wants Luxuries Spending Ratio Sometimes, you blur the line between wants and luxuries. Just ask yourself this question to make clear of it, Does this spending make me happy, for a really long time? If yes, it may qualify as a want. If not, you should definitely stop spending another dollar on it. In ideal case, you shouldn t have any spending on luxuries item. That s simply a waste of your money to keep up with the Joneses. Luxuries Spending Ratio Total Spending on luxuries Annual Gross Income Target 0% Your Luxuries Spending Ratio

5 5 List down top three spending on luxuries if there is any. Housing Payment Ratio A housing payment ratio is the percentage of your housing payment (principal and interest) to your monthly gross income. Lenders use this ratio to qualify you for a loan. In normal case, 28-35% is acceptable for banks to provide you the loan. However, you shouldn t use up all the debt payment commitment for the house you are staying in. That ll deplete your ability to loan more for investment purposes. Target: Less than 15% Housing Payment Ratio Monthly Housing Installment Monthly Gross Income Target Less than 15% Your Housing Payment Ratio If your ratio is more than 15%, list down three actions in order to reduce the ratio Let s move on to another related financial ratio that you should keep your eyes on.

6 6 Debt Service Ratio The debt service ratio is calculated by dividing your fixed monthly debt expenses (including the mortgage payment, hirepurchase installment, personal loan and credit card payment) by your gross monthly income. As a basic rule, the debt ratio should not exceed 36%. Please note that if you clear of your credit card balance every month, you shouldn t include the amount when calculating Debt Service Ratio. Only if you are paying barely the minimum required, then you are in a position of not being able to pay off your credit card debt in short term. Then you will need to add that amount in the calculation. Debt Service Ratio Monthly Debt Payment Monthly Gross Income Target Less than 30% Your Debt Service Ratio Debt Ratio Barometer: 30% or less: debt level within acceptable range for most people. 31%-40%: debt level a little high, need to take corrective action to bring debt level down. You may consider paying off or consolidating some of your debt. 41%-50%: danger level, need to take immediate action before you lose control of your financial situation. 51% or more: excessive debt loan, may need to seek credit counseling services.

7 7 If your ratio is more than 36%, list down three actions in order to reduce the ratio to healthy level Non-Mortgage Debt Service Ratio Non-mortgage debt service ratio is calculated by dividing your fixed monthly debt expenses excluding mortgage by your gross monthly income. Total debt service ratio = housing payment ratio + nonmortgage debt service ratio Non-mortgage Debt Service Ratio Total monthly non-mortgage loan repayments Monthly Gross Income Target Less than 15% Your Nonmortgage Debt Service Ratio Non-mortgage Debt Ratio Barometer: Identify the top three nonmortgage loan payment = Debt service ratio housing payment ratio = 15% or less: debt level within acceptable range for most people. 15% or more: you are financing your current lifestyle excessively with your future earning capability

8 8 Protection Premium Ratio It is always arguable whether it is worth to get insured. Frankly speaking, nobody knows. If a person stays healthy without getting into any accident until he dies at old age, buying insurance is a waste of money. He might be better off to invest the money elsewhere. But in reality, nobody can guarantee that someone can stay healthy and accident-free for his whole life. That s why insurance give you peace of mind. To calculate the protection premium ratio, you must identify only the policies that are bought mainly for protection purposes. This type of policy includes: Whole life policy (participating or non-participating) Investment-linked plan (protection type which is low premium and high protection) Hospitalization and surgical plan 4. Personal accident plan You shouldn t take into account policies solely for saving purposes such as children education plan, retirement saving plan or endowment plan. Protection Premium Ratio Total insurance premium (only protection type) Gross Income Target Less than 10% Your Protection Premium Ratio Protection Premium Ratio Barometer: 10% or less: adequate protection can be obtained if you get the right plan 10% or more: insurance premium may be a burden