Let’s take a moment to conduct a Financial analysis for a couple with two kids.

To accurately assess your financial strength, one must have a basic understanding of accounting financial statements and more importantly, financial ratios. Financial ratios are numerical analysis of simplifying a process of evaluating your financial condition. Let’s take an example of a married couple Aaron & Ashley who currently have two kids Dan & Jessica.

Also, below is the Balance Sheet for the couple Aaron & Ashley who currently have two kids Dan & Jessica

Balance Sheet
Jan 1, 2018 – Dec 31, 2018
	Dollar ($)
ASSET
Cash	300
Savings	1,500
Aaron & Ashley, Checking Acct.	600
Tax Refund	600
Rent receivable	1,000
Total Monetary Assets	4,000
Tangible Assets
Home	200,000
Personal Property	10,000
Automobile	12,000
Total Tangible Assets	222,000
Investment Assets
Fidelity funds	5,000
Mutual funds	4,000
Stocks	3,000
Bonds	2,000
CVLI	6,000
IRA	7,000
Real Estate	90,000
Total Investment Assets	117,000
Total Assets	339,000

LIABILITIES
Short Term Liabilities
Doctor’s Bill	200
Credit Card Debt	2,000
Total Short Term Liabilities	2,200
Long Term Liabilities
Auto Finance	3,000
Real Estate Loan	100,000
Total Long Term Liabilities	103,000
Total Liabilities	105,200
Net Worth	233,800
Total Liabilities & Net Worth	339,000

Below is the Statement of Cash flows for the couple.

Statement of Cash Flows
Jan 1, 2018 – Dec 31, 2018
	Dollar ($)
INCOME
Aaron Salary	45,000
Ashley Salary (Part-Time)	18,000
Interest	2,000
Bonus	1,000
Tax Refunds	500
Rental Income	12,000
Total Income	$78,500

EXPENSES (FIXED)
Mortgage	21,600
Personal property taxes	1,200
Homeowners Insurance	700
Auto Loan Payment	4,000
Auto Insurance	1,200
Life Insurance	1,200
State, City, Federal Taxes	14,000
Real Estate Taxes	2,500
Total Fixed Expense	$46,400
EXPENSES (VARIABLE)
Food	5,000
Utilities	2,500
Gas	3,000
Clothing	2,000
Entertainment	3000
Church	1,000
Personal Allowance	2,000
Social Security Taxes	4000
Miscellaneous	500
Total Variable Expense	$20,500
Total Expense	$66,900
Surplus/(Deficit)	$11,600

Given the above financial statements, lets’s take a moment in assessing the financial strength’s/weaknesses of our couple Aaron & Ashley and get a better understanding of how well they are doing financially.

Can I pay for Emergencies?

The liquidity ratio gives a good indication if you have enough assets to convert into cash in case of an emergency. If in the event of an emergency, your entire income freezes and you are unable to work, the liquidity ratio would help determine the number of months you will be able to meet your expenses. In the case of Aaron & Ashley, we can calculate the liquidity ratio as follows.

Liquidity Ratio = Monetary Assets / Total Monthly Expenses

= 4,000 / (66,900/12)

= 4,000 / 5,575

= 0.72

The liquidity ratio suggests that Aaron & Ashley do not have enough funds to support themselves for even a month is they face an emergency. Ideally, one must have enough monetary assets to save at least three months’ worth of monthly expenses.

Do I have enough Assets as compared with Liabilities?

The assets to debt ratio compare the total assets with total liabilities. It measures solvency and the ability to pay debts. In case of Aaron & Ashley, we can calculate the Asset-to-Debt ratio as follows.

Asset-to-Debt ratio = Total Assets / Total Debt

= 339,000 / 105,200

= 3.22

The ratio mentioned above is a favorable ratio for Aaron & Ashley as they have ample assets compared to their debts because they own items worth three times more than their debt. Now, If hypothetically you owe more than you own then you will be deemed insolvent, if you are in a similar situation and are insolvent, then you should seek credit counseling immediately as you may be at risk of filing bankruptcy.

Can I meet my Total debt obligations?

The total debt service to income ratio gives you an idea of the amount of money spent on gross annual debt with the amount of your gross yearly income. Ideally, Lenders prefer a debt-to-income ratio smaller than 36% (Here’s why?)with no more than 28% of the debt going towards your mortgage. So in case of Aaron & Ashley, the rate is calculated as follows.

Debt service to Income ratio = Annual debt repayments / Gross Income

= (21,600 + 4,000) / 78,500

= 25,600 / 78,500

= 0.32 or 32.61%

Although the ratio of 32.61% is less than 36% it is very close to that mark. The ratio does imply that the couple’s gross income is ideal to make their debt repayment including housing-related costs, but they will have to be careful as they are at the verge of mitigating their flexibility in budgeting other business expenses. The ratio should decrease as time goes.

Can I pay my Debts?

Debt to disposable income ratio divides the monthly personal disposable income into monthly debt repayments. Let’s take a look at Aaron & Ashley debt to disposable income ratio.

Debt to disposable income ratio = Monthly Non-mortgage debt payments / Disposable income

= [4,000/12] / [($78,500 – $14,000 – 4,000 – 1,200) / 12]

= 333.33 / [59,300 / 12]

= 333.33 / 4,941.66

= 0.067 or 6.74 %

Ideally, a debt payments-to-disposable income ratio of 16% or more is considered as being problematic because the person making an increased amount of debt payments and that too at a faster pace would be regarded as questionable financially if there is a loss in income.

As a best practice, it is always ideal to be proactive and manage your finances. One way to accomplish this is by conducting a ratio analysis as presented above. Financial ratios provide you with a review of your present finances. Maintaining an Emergency fund requires for you to have at least 15% to 20% of your assets in a monetary form and to make sure that as you get older the percentage keeps growing.

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