A personal finance blog dedicated discussing such topics as budgeting, asset allocation, 401K, IRA, cash flow, insurance, financial planning, portfolio management, and other areas in personal finance.


Friday, April 08, 2005

Analyzing Your Financial Statements with Ratios

Now that we have a couple of model financial statements to look at, it is time to use ratios to analyze those statements. You may want to print out the posts with the model statements so that you can look at them while studying the ratios.

Here are links to the two posts:

Net Worth Statement

Cash Flow Statement

Liquidity Ratios

When an asset is "liquid" it means it can be turned into cash quickly. Cash is the most liquid asset. Real estate, on the other hand, is illiquid.

Basic Liquidity Ratio (BLR)

BLR = liquid monetary assets ÷ average monthly expenses

From the Net Worth Statement, the liquid monetary assets would be:
  • Cash - $200
  • Checking - $3,000
  • Money Market Accounts - $7,000
  • Savings - $6,000

From the Cash Flow Statement, the average montly expenses would be the sum of the fixed and variable expenses:

  • Total Fixed Expenses - $30,500
  • Total Variable Expenses - $31,700

The sum of the fixed and variable expenses is $62,200.

Here's what the BLR would look like:

BLR = $16,200 ÷ ($62,200 ÷ 12)
BLR = $16,200 ÷ $5,183
BLR = 3.1 months

This ratio tells us that this couple could live on their liquid assets for 3.1 months based on the average monthly expenses and their liquid assets. Since it is common knowledge that a person should have 3 to 6 months worth of living expenses in liquid assets, the ratio of 3.1 months is on the lower end of acceptability.

With my next post, I'll go into more detail regarding liquid ratios.