- Use these key performance indicators to analyse your financial status and monitor the progress toward wealth creation.
- These KPIs are useful to evaluate your financial strengths and areas that need improvement.
- These benchmarks can help you understand and develop better financial habits in saving, spending, and budgeting.
Table of Contents
1. Post Tax Income
Thumb Rule
Divide your CTC by 12, then multiply it by the number you get on subtracting your tax slab from 100 and divide that by 100.
For instance, on a CTC of Rs. 12.5 lakh when the applicable slab rate is 20%, the monthly post-tax income will be: Rs. 12,50,000/12 X (.8) = Rs. 83,334.
The post-tax income is the money you are left to take home after paying taxes, which are deducted by your employer. These may also include certain payments towards provident fund, health insurance and pension. Simply put, this is the actual amount of pay that you get—the total income minus total taxes and is a true indicator of the cash available for spending.
Practical Tip
The tax that you eventually will pay doesn’t end here, because what you receive as post-tax income is also subject to certain other taxes. While GST (Goods and Services Tax) is a reality on most things one spends on, there are municipal taxes to consider, if you own a property, and other taxes to consider based on your savings and investments.
2. Cash Flow
Thumb Rule
Use the 50-30-20 budgeting trick.
You put 50% of your income towards necessities, such as rentor home loan, groceries, transportation and internet etc. The next 30% goes to your wants, which may include entertainment, clothes, eating out and travel; with the remaining 20% towards savings and long term investments.
Cash flow refers to your total income minus total expenses over a set period and for most, this figure should be measured each month. You can determine cash flow by creating a budget—write down your monthly income, including sources of passive income if any, and then subtract all your expenses. Instead of focusing on a single month, you should track your expenses for at least three months to have a more accurate picture of them.
Practical Tip
You should ideally have a positive cash flow, to leave you with savings. But, there could be instances when you have a negative cash flow, where expenses exceed your income, which is not a healthy sign, but could be due to unexpected expenses. Often one forgets to budget for yearly expenses, such as yearly premium of insurance or annual fees of new school/class.
3. Savings Ratio
Thumb Rule
You should have a minimum 10% savings ratio, with anything above 20% considered a good figure. Anything under 10% is a cause for worry and indicates you are depending on debt to fund your lifestyle. With age, your savings ratio should go up.
Instead of knowing how much you are spending, you get to know how much you save each month as a per cent of the income you earn. Calculate your savings ratio by dividing the monthly savings by the monthly income. Add up all your savings—the one in the bank, your contribution to investments, PF and even cash that you may be keeping aside. For instance, if you save Rs 23,000 from your monthly income of Rs 95,000, the savings ratio works out at 24.21 per cent.
Practical Tip
You can work out your annual savings rate too in the same manner, which will help you save more to reach your financial goals.
4. Average Monthly Expenses
Thumb Rule
70-80% of your average monthly expenses should come from the fixed expenses to make your household budget work for you.
Expenses are of two types—fixed and variable. Fixed expenses include rent, phone bills, insurance premiums, school fee and any loan repayment. These usually cost the same amount month on month. These help you plan for and factor into your budget clearly. On the other hand, variable expenses includes groceries, because their price varies each month, expenses towards eating out, medical expenses, personal care, annual premium of insurances, and so on. Then there are cer tain fixed annual expenses such as a fixed increase in rental value and similar variable expenses under new heads and so on.
Practical Tip
You can arrive at the average monthly expenses based on the combination of fixed and variable expenses. The main idea to know this expense head is to understand how much you spend to make better budgeting decisions. For instance, you could allocate an average grocery budget of Rs 12,000 including fruits and vegetables and then moderate consumption to stick to this budget. Likewise, by knowing your fixed expenses you know the minimum sum you need to save to make sure you are not dipping into savings and investments. At the end of the month, the surplus, if any, will help you to plan better or carry forward it to the next month to accommodate better for variable expenses.
5. Emergency Fund
Thumb Rule
Note the essential expenses (that you can’t do without). Now, multiply this figure by 6 to arrive at a reserve for expenses that you could tide over six months if you met with an emergency.
Think of this as a cash reserve that is set aside specifically to manage unplanned expenses and financial emergencies. Emergencies and unplanned expenses include home repairs, loss of income, car battery replacement or a visit to meet parents due to unforeseen circumstances. While you may wish to borrow money to tide over emergencies, remember that these come at a cost. It is like a personal insurance you have created with your own funds to cover large and unanticipated expenses.
Practical Tip
As your income and financial responsibilities go up, the quantum of emergency fund needed will go up. You can spread this sum across financial instruments that you can access to meet the emergency without facing delays.
6. Net Worth
Thumb Rule
The formula for net worth, according to the book "The Next-Door Millionaire", can be arrived at by multiplying your age by your pre-tax annual household income from all sources (except inheritance) divided by 10. The Indian context works better when one divides the number by 20.
To find your net worth, you simply add up the value of your assets and subtract your liabilities at a given time to arrive at a snapshot of your financial worth. Net worth changes with time because the value of assets and liabilities keeps changing.
The net worth could be positive or negative. In an ideal situation, as you earn and save, your net worth will grow over time.
Practical Tip
Liabilities are of two kinds—good and bad. For instance, borrowing to fund your education or purchasing a home is a positive debt. Chances are with a good education you will be able to increase your earnings and in the case of a house purchase, its value will go up over time making the debt to fund it a good choice. In contrast, a loan to fund a car or a phone is not good as the asset loses value soon after purchase.
7. Debt-to-Total Assets Ratio
Thumb Rule
A lower ratio indicates a healthier financial position, with more assets than liabilities.
At a time when borrowing seems to be the easiest way to achieve financial goals, families need to keep their overall debt under check. To arrive at this figure, start by adding up your total debts, including outstanding loans, credit card balances, and other financial obligations.Next, sum up the value of your assets which should include savings, real estate, investments and any other valuables. Finally, divide your total debts by your total assets. A figure of more than 1 means that your debts are more than your assets.
Practical Tip
Often debt-to-total assets ratio is highest in younger people and should decline as one ages.
8. Debt-to-Income Ratio
Thumb Rule
DTI ratio of 35% or less is a very good number whereas a DTI ratio of between 35% and 45% may be just about manageable. Anything above 45% is a matter of concern to creditors as well as you.
As the name suggests, this ratio measures the amount of your monthly income that goes toward servicing debt. It tells you the amount you owe with respect to the amount you earn as a percentage.
For instance, if your monthly take-home income is Rs 1 lakh and your monthly payments towards loans (car and personal loan) is Rs 35,000, your DTI (debt-to-income) works to 35 per cent.
Practical Tip
This indicator is also used by lenders other than checking your credit score, as it gives them a picture of how much loan you have and how much you are paying each month towards them.
9. Personal Cost of Debt
Thumb Rule
Personal Cost of Debt = (Amount of Loan 1/Total Debt) x (Interest Rate for Loan 1) + (Amount of Loan 2/Total Debt) x (Interest Rate for Loan 2) + so on...
This ratio comes handy in deciding whether to first repay the debt or invest. The cost of debt is interest expense, which is the total interest component of the loan that you pay. Your annual interest rates determine your debt cost. If you are earning from investments/savings above this value, it makes sense to continue the loan and repay it in time. However, if the earnings are below this figure, you are better off servicing the loan first than to stay invested.
Practical Tip
Prioritise loan repayment by paying high-interest loans first to become debt-free fast.
10. Life Insurance Ratio
Thumb Rule
Start your insurance cover with the 10 times annual income rule. Make it a point to revisit your cover at important milestones such as marriage, birth of a child, borrowing for a home loan and so on. As you increase your debts, you need to factor the insurance cover as backup for contingencies.
If you have dependents on your salary and also have financial goals that are yet to be met, having life insurance is an important consideration. An elaborate calculation is the best way to arrive at the amount of life insurance you need. So, if you have young children who will need to attend college, or if you have a larger family home and fixed expenses, a fullfledged needs analysis is a must.
Practical Tip
A quick way to arrive at the amount you need is to multiply your annual income by 10 times. However, treat this thumb rule as a minimum cover to start.
Action Items
- Calculate your total income from all the sources.
- Note down the average figure of your monthly expenses from the last 3 months’ expenses.
- Calculate your savings margin (Expense – Income).
- Target for atleast 20% of savings from your income.
- First thing to do from yor savings is to create an emergency fund (6x the monthly expense figure).
- Second thing to do is to note down the interest rates of all your loans/EMIs.
(Any credit interested more than 10% p.a. should be targeted to foreclose.) - Buy a term cover for you (and/or of an earning member of the family) with an amount of at least 10x your annual income.
- Buy a family floater health insurance.
- Follow Ankur Warikoo for money management tips.
This article was originally published in India Today.
