Setting Your Financial Priorities
Financial capability is about learning how to improve your financial intelligence. Many people have no idea precisely where or how they spend a good portion of their income. How many times have you realized on payday, that you have already spent what you have earned? It’s hard to remember how precisely you spent the money, and frequently, this money is wasted on frivolous buys.
So, what is the starting point? Where do you begin in making your financial future a priority?
Well, let’s begin with answering a few questions?
- What major fiscal challenges do you face?
- How do you think you arrived at this point—and what would you like to see altered?
- How well organized are you for a financial emergency? Write it out now: The amount we have put away an emergency fund is __???___.
- How is the subject of money addressed in your family: emotionally or rationally?
- Who makes the money decisions? Why is this the person handling the money?
These questions help you to gain clarity and sets you on a committed path to accomplishing your money goals. Financial professionals agree that before crunching the numbers, families need to scrutinize their financial wellness—and the best chance of success comes from having both partners on board.
Here we will explain to you the basic principle of personal financial ratio and its analyses. This will help you keep a tab on your personal finances.
Personal finance ratios deal with your personal riches, assets or cash on hand. Simply put, it is the understanding of liabilities and assets, or what is paid out versus what is earned or owned. If you are spending more than you are bringing in, there could be a problem.
Basic Solvency Ratio
This ratio signals your power to meet monthly expenses in case of an emergency. It’s calculated by dividing the near-term cash you have with your monthly expenses.
Basic solvency ratio = Cash / Monthly expenses
You are able to also call it emergency or contingency preparation ratio. This ratio helps you prepare for unexpected troubles.
Here’s an example; a 30-year-old businessman whose wife had an emergency gall bladder surgery last year thought they had enough insurance to take care of the expense. Due to a few administrative problems on the day of discharge, he was informed that he would have to pay in cash as the bill couldn’t be settled. He was fortunate to have a few reliable friends and family to lend him the money. But not everyone has a safety net in place on such short notice and it is a good idea to have an emergency fund.
Let’s examine how much money would be needed for an emergency fund. Here is where basic solvency ratio comes handy.
The numerator of the basic solvency ratio formula, cash (near cash), would commonly comprise of the following things:
- Savings account / CDs / 401ks /
- Liquid funds – Typically, cash.
The above elements are liquid assets which are the first action of recourse in an emergency situation.
Mandatory fixed expenses include the income you pay for; loans, insurance premium, mortgage/rent, etc.
Mandatory varying expenses, on the other hand, comprise of food, transit, clothing/personal care, medical care, utilities, education expenses, etc.
The total of the above divided by 12 months will give you a monthly average.
An ideal ratio should come to 6. What does the number 6 mean?
It means that you must have money equal to or at least 6 months of your mandatory expenses in a contingency or emergency fund.
How come just 6 months? This is because research shows that 6 months is enough time to emerge from any type of financial pinch. This fund is best kept in the form of cash, fixed deposit, or liquid fund.
A suggestion would be to make a determination of your basic solvency ratio at the end of the month, before all the monthly bills are due on the first.
Tips to help you start building your contingency or emergency fund:
- Determine which required expenses need to be taken care of and then add a category to include “Emergency Fund”. Set aside a small amount at first, and then increase the amount over time.
- Never use the fund outside of an actual emergency. This could create a bigger problem if you actually need the money.
- If the emergency fund is held in a joint account, set the account up to require two signatures for withdrawal. In this case, have three signatures on file and have the bank require two of the three. This way if something happens to one of the parties, there are still two signatures that can withdraw.
If you would like to learn more about creating a financial legacy, and mastering your money game, book a free 15-minute consult with Kim Harris.
Until next time…
Here’s to your remarkable life & legacy!