Measuring your financial health is a lot like measuring your physical health: it’s complex but looking at several key factors can give you a good idea of your overall situation. A fairly simple three-step process can help you gather some measurements and assess them:
- Create a personal balance sheet (assets – liabilities)
- Create a personal cash flow analysis (income – expenditures)
- Analyze your finances using financial ratios (don’t worry—it’s just simple division and multiplication)
This is even easier than budgeting since you don’t necessarily need to break everything down into categories or try to figure out monthly averages that you can stick to. It might be helpful to do those things, but this is about measuring your overall financial health at a specific point in time.
Creating a personal balance sheet
Almost every business maintains a balance sheet because it’s a clear, concise way to communicate a lot of information to people who need it, and its simplicity and readability make it an equally effective diagnostic tool for your personal finances.
Balance sheets are typically formatted with assets on the left, liabilities on the right, and net worth (assets minus liabilities) on the bottom right. A program like Excel or Google Sheets can make these easy to change and maintain.
Your assets are anything you have with monetary value, including things you’d have to sell to get spendable cash. This can be a lot of different things, but for most people, adding the following assets will be the most significant:
- Cash, including any bank accounts that are fairly liquid, like checking, savings, and money-market.
- Investments, like stocks, bonds, real estate, retirement accounts, et cetera.
- Home resale value.
- Resale value of other assets, like your car, jewelry, collectibles, appliances, et cetera.
- Any outstanding loans made to other people/businesses.
It’s also a good idea to add a line that totals up your liquid versus your illiquid assets, as this will come in handy when you analyze your finances later. A liquid asset is anything that can be easily converted into a spendable form, like cash, bank accounts, or stocks. Most investments are also considered liquid, as selling stocks and bonds is relatively quick and easy. Things like houses, cars, and some long-term investments are more on the illiquid side of the spectrum since it takes some time and effort to exchange them for the money you can spend.
A liability is any money you owe to someone else. Some liabilities may be long-term, like a mortgage, while others you may have to pay back as soon as possible, like credit card balances. Either way, they all go on the right side of your balance sheet.
- Your mortgage balance
- Credit card balances
- Student loans
- Auto loans
- Personal loans
- Medical debt
- Any other debts you may have
You don’t need to calculate the future interest for any of these debts—just use the amount you owe today.
Once you have your total assets and liabilities mapped out, you can find your net worth. Simply add up your total assets and your total liabilities, then subtract the liabilities from the assets:
Total Assets – Total Liabilities = Net Worth
Ideally, this number will be positive, but negative net worth doesn’t necessarily mean you have financial health problems. If you owe a large student loan balance, for example, your short-run net worth may be negative but your long-run earning potential may be higher than it would otherwise be. Getting out of debt should be your focus, but it generally shouldn’t stop you from building an emergency fund and starting to save as well.
Similarly, positive net worth doesn’t necessarily mean you’re doing well. If you have low debt but you’re not saving and don’t have an emergency fund, you’re probably not financially secure. That’s where looking at your cash flow can help.
Creating a personal cash flow statement
Analyzing your income and expenditures can be a bit of a process, but you need to get a sense of inflows and outflows to see how they affect your financial health.
Cash flow statements are simply relative to budgets, as they’re just looking at total inflows and outflows over a certain period. Itemizing every income source and expense isn’t strictly necessary here, as long as you have a sense of the totals and a few key metrics. You may want to look at your cash flow over several different months, though, to get a sense of your average situation.
To find your income, add up the following sources:
- Salary/average monthly take-home pay
- Interest on savings
- Investment dividends
- Capital gains from selling stocks or bonds
- Any other income, such as from gifts or from selling possessions
You don’t necessarily have to include things like interest and dividends if they don’t make up a notable percentage of your cash flow.
There are a lot of things you can spend money on, but adding up the following categories will probably get you close to a total figure. Checking the changes in your bank account balance over time is also a good way to estimate these.
- Utility bills
- Medical expenses
Net cash flow
Finding your net total cash flow is easy:
Total Inflow – Total Outflow
If you come up with a negative number, it means you’re spending more than you take in every month, meaning your assets are shrinking and/or your liabilities are growing. Getting to positive cash flow should be a priority.
Analyzing your health with financial ratios
Working out your balance sheet and cash flow should already give you some idea of your financial health, but if you want to get even more serious about it, you can use financial ratios, similar to those used in the corporate world, to get an idea of where you stand.
Liquidity Ratio/Emergency Fund
Liquidity measures how easy it is to convert assets to cash, ideally without losing much value, and is important when looking at how well you can sustain financial shocks. Unexpected issues, like losing a job or getting hit with a large expense, require enough liquid funds to cover them.
Dividing your liquid assets (generally the sum of your cash and investments) by your monthly expenses shows you how many months’ expenses you can meet in the short term. It’s a good idea to calculate this figure twice, once with your emergency fund included in your liquid assets and once without it, as this will give you an idea of how much of a cushion you’ve built up to protect your savings.
Worst-Case Scenario Fund
Even if you have a good liquidity ratio and an emergency fund, catastrophic issues can still come along that end up wiping out your short-term liquidity. In that case, it may be worth knowing how long you could survive if you had to liquidate everything you own.
To find that figure, just divide your total assets by your monthly expenses. Hopefully, you’ll be able to survive at least a year on this—ideally more.
Your savings ratio is just the percentage of your income that you’re saving, and it’s fairly easy to calculate: just take your total savings over a certain period (say, a month) and divide it by the income you had in the same period.
You should typically aim to save a minimum of 10% of your income for emergency funds, retirement, and other goals. 20% is a commonly recommended goal, and saving, even more, is advisable if you can afford it. This is a good ratio to track over time as you increase your savings rate.
Whether you’re paying rent or a mortgage, a good rule of thumb is not to let it exceed 28% of your monthly income. You should also include expenses like taxes, insurance, and utilities in this calculation, as these are all part of your housing costs.
The U.S government counts anyone paying over 30% as cost-burdened, but 28% is the maximum that many lenders use when deciding whether to issue credit. It’s part of the “28/36 rule,” which states that housing should be no more than 28% of monthly income, and total debt payments (explained below) should not be more than 36% of income.
Either way, the lower your housing-to-income ratio, the better.
If you’re paying mortgages, car payments, credit card debt, or any other loans, that counts as a debt payment. Adding up all your debt payments (usually on a monthly basis) and dividing them by your income over the same time frame will yield your debt-to-income ratio, which is something lenders look at before deciding if they’ll give you a loan.
A debt-to-income ratio of 36% or less is ideal, but the closer to 0% it is, the better. If it’s over 43%, your odds of being approved for something like a mortgage are low.
Your debt ratio measures how much of your assets are being eaten up by your liabilities, like the total remaining balance on your mortgage, auto loan, or student loan debt. If it’s 100%, that means you’d have to sell all of your assets to pay off your liabilities. If it’s 0%, it means you have no debt.
Your liabilities shouldn’t add up to more than 50% of your assets. The closer it is to zero, the better! When you’re just starting out with large loans like mortgages or student loans, the ratio will unavoidably be high, and you should focus on bringing it back down with regular payments.
Regular Financial Health Checkups
Just as with your health, tracking your financial situation is important. Once you have your initial balance sheet, cash flow statement, and ratio calculations, updating the numbers a few times a year isn’t too much work, and keeping track of your progress helps you gauge how much you’re improving or regressing. Your net worth, cash flow, and the above financial ratios (among others) are key metrics of your financial health and should be on your radar whether you’re trying to make significant financial progress or just keep an eye on your money.