Financial Ratios Part II: Debt Ratios
Debt Ratios can help determine what percent of assets are offset by debt and whether or not you can meet your current and long-term debt obligations.
Debt Ratio = Total Liabilities / Total Assets
The debt ratio tells you what percentage of your assets is financed with borrowed money. For example, if the only asset you owned was your home and you purchased it for $100,000 by borrowing $95,000 and putting $5,000 down, your debt ratio would be 95% ($95,000 (total liabilities) / $100,000 (total assets)). In essence, 95% of your assets have been financed through debt. The remaining 5% would be the “equity” you own in the home. If the ratio is ever above 1, it means you have negative networth. Having a negative networth means that if you were to sell all of your assets for what they are worth, you would not have enough to cover your debt.
As you track this ratio, you should see a downward trend. The closer the ratio is to zero, the better. When the ratio hits zero, you are debt free. Many investors may argue that you don’t want this ratio at zero because that means you’re not using the power of leverage. I agree there is a time and place for debt and the use of leverage, however, I also know there is nothing that can substitute freedom from debt.
Long-term Debt Coverage Ratio = Monthly Living Expenses / Monthly Debt Payments
The long-term debt coverage ratio tells you how many times over you could pay debt obligations based your monthly living expenses. I think a more useful way of looking at this ratio is to reverse the positions of the two expenses in the equation (Monthly Debt Payments / Monthly Living Expenses). This calculation actual gives you a percentage of your current monthly expenses that are made up of long-term debt.
For example, if your total monthly expenses equal $4,500 and your monthly payments on long-term debt obligations equals $1,950, your Long-Term Debt Coverage Ratio would equal (4,500/1,950) 2.31. Perhaps better said, 43.33% (1,950/4,500) of your monthly expenses are made up of long-term debt obligations.
Referring to the original equation, the higher the ratio the better. A higher ratio indicates that you could cover debt payments for a longer period of time if you had a loss of income. As you track this ratio you should see an upward trend. If you look at the ratio by the 2nd method you’ll want to see it as low as possible.
*For an explanation of the other ratios I use, check out my other financial ratio posts (Liquidity Ratios, Debt Ratios, Saving Ratios, & Networth Ratios).
June 2009 Spending Report
Another month past and a pretty ordinary month at that. Here are a few of the highlights.
Taxes – Because of the bonuses I relieved during the first couple months of the year and the requirement to tax them at the highest individual rate possible (35%) I thought I may have paid-in enough taxes. I ran a projected income to tax calculation and figured I didn’t need any more payroll tax withholding for the rest of the year. I made the adjustment to my W4 in May claiming “exempt” so my employer would stop withholding.
However, when I took a look at this month’s spending report and saw my taxes still at 6% it made me think. Although they are no longer withholding for Federal and State income tax purposes, I am still required to have taxes withheld for FICA purposes (Normally just above 7% for employee portion). I can’t believe that I am still paying 6% of my paycheck towards a program that I will never be able to participate in (that’s a discussion for another post). There are a lot of people that think if their effective tax rate is zero, they aren’t paying any taxes. As you can see, this isn’t the case.
Charity – We have been able to keep our giving at just above 10% which has been great considering the current economic conditions. We’d love to increase this in the future, but with our current situation this is what fits in the budget 
Freedom Week 2009
If you’ve missed it in the past, now’s your chance to get any of Dave Ramsey’s collection of just $10. It seems like this may be an annual event, as last year he had a very similar promotion. He is basically offering his entire collection for just $10 and under. They are also offering free shipping for orders over $65. If your order is less than $65, shipping is based on your State and zip code.
This is usually when I stock up on his New York Times Bestselling “The Total Money Makeover”. It may be lame, but I’ve found it to be a perfect wedding and graduation gift. Most people have very little knowledge as to how to manage their money and financially prepare for the future. In “The Total Money Makeover” Dave lays out a very simply to follow, 7 step plan, to eliminate debt and become financially independent. It’s not a get rich quick system, but if followed, it will lead you to financial freedom. I don’t necessarily agree with every concept in the book, but he does have some good points and lays out a plan anyone could follow.
Credit Karma Review
If you’ve ever done a google search for the term “Free Credit Report”, you’ll find dozens (if not hundreds) of sites offering a free credit report or free credit score. The only catch is, to get your free score, the sites require you to sign up for their credit report monitoring service. This monitoring services on the other hand, is not free. It usually carries a monthly service fee of anywhere between $5 – $20.
Credit Karma has decided to pull a 180 degree turn and truly offer a free credit score as well as a credit monitoring service. The approach they have taken to make this possible is similar to that of Mint.com and MoneyStrands.com. Rather than a monthly service fee there are affiliate offers presented based on your demographics/credit situation.
Because I’m a credit score nut and love to have a pulse on my own credit score I decided to give it a try and see what the buzz is about. It turns out the sign-up process was was a 3 Step process that was extremely simple and straight forward. Start by clicking the “Get Your Free Credit Score” button.
Step 1: Create Your Account – Enter your name, e-mail, a screen name and password.
Step 2: Confirm Your Email Address – After completing step 1 you will receive an email with a verification link to activate your account. Simply click the link to finish your account setup.
Step 3: Create Your Account – By clicking on the verification link you will be taken to step 3 of the account setup process. Here you will be required to enter somewhat personal information that allows them to pull your credit report from one of the 3 credit bureaus. They require a current address, phone number, birthday and social security number. I think the best part of the whole thing is that the don’t require a credit card.
In less than 5 mintues you’ll have an account setup and access to your current credit score.
After browsing through the site and the different tools available with an open account I saw a number of tools that may be useful. I think it could be a great tool for someone looking for a way to immediately improve their credit score.
However, one of the biggest disadvantages was that you can’t see your actual credit report. They break it down and show you what they think is most important, but I couldn’t find a way to download it myself. Also, I am not sure which credit bureau they requested my report from since I am only allowed one report per bureau per year..(I have already requested one from annualcreditreport.com myself this year).
Call me old fashion, but I think I am going to stick to pulling my credit score myself 3 times a year and doing my own monitoring. I will however, compile a few posts over the next week or so explaining some of the tools available within Credit Karma.
$50 Cash for Opening a Checking Account
1st Bank is currently running a promotion offering $50 for opening their free checking account. After seeing the offer I was expecting to see the regular stipulations when an offer like this is being promoted (i.e. direct deposit requirements, minimum balance requirements or a required number of debit card purchases each month).
However, after reading the fine print there aren’t any major stipulations. They require that you open the account with at least $50 and keep the account opened for a minimum of 6 months. The $50 bonus will be credited immediately upon opening the account. The account has no monthly balance requirements and no monthly services fees. One downfall may be that the free checking account is a non-interest bearing account so this won’t be a place to store much money. But for me it will work great, I will “invest” $50 for six months and get a 100% return on my money….not bad.
Here is a link to application
May 2009 Spending Report
It was another pretty standard month when it came to the budget and spending. After looking at the spending breakdown I realized that we are only living off of 18% of our monthly gross income. I guess with all things considered that is pretty good. I have never really looked or thought about it that way.
We have been doing good at keeping our savings over our goal of 15% of our monthly gross income. The bulk of the savings are actually going into our HSA account in preparation of our baby coming this fall. We also have my 401(k) contributions with my career.
May 2009 Financial Ratios
Another month past with no complaints here…
Month’s Living Expenses Covered Ratio: On goal that we would like to focus on over the next 3-6 months is getting our MLECR over 12 months. Although I’ve only got our goal (recommended) at 3-6 months we have decided that since we’ll be buying a bigger car in the future it’d be best if we could get this over 12 months since we’ll be taking a big chunk out to get a car. Starting in July we are switching health plans at my work so we will no longer have contributions to our HSA, but rather regular savings.
YTD% Growth: We are right on pace to hit our goal of 50% networth growth for the year. With 7 months to go we are more than halfway there. However, we are going to have to find a way to get another nice increase since we won’t have a tax refund during the second half of the year 
*For an explanation of my ratios and how they are calculated check out my 3 Financial Ratios posts (Liquidity Ratios, Debt Ratios, Saving Ratios, & Networth Ratios).
(+0.42% Month / +26.28% YTD) May 2009 Networth
May has come and gone and another month has past of minimal growth to the networth…
May Highlights
- We had about a $2,000 decrease in our savings account this month because we needed a little more cash to finish the backyard. This should be the last time that we’ll need to dip into savings for a while. We have finally finished all of the major fix-ups at the house and it’s finally starting to feel like home. I think the next major withdrawal from savings will be for the purchase of our new car….well, not new, but our new-used car.
- It was a decent month for the stock market so we saw some decent growth in our IRA accounts. I don’t really think this is going to last, but I’ll take it while it’s there. The bulk of my IRA is still cash and I am still trying to debate how to re-allocate and invest the funds so if you’ve got any ideas please feel free to suggest.
– The giant increase in our credit card debt this month was due to the fact that we were finishing up the backyard. Like always we will be paying it off in full at the end of the payment cycle, so it is a little deceiving.
To see the path to our current networth position check out the “Networth Page“
April 2009 Financial Ratios
Another great month. The ratios are exactly where we like to see them
YTD% Growth: We are now more than half way of hitting our goal of 50% networth growth for the year and we are only 4 months into the year. Granted a big portion of that is because of the enormous tax return we got, but it is still nice to see such high growth so early in the year. Also, we saw a second straight month of gains in our IRA and brokerage acconts which has been a good change from months past.
Emergency Fund Ratio: A.K.A. Month’s Living Expense Covered Ratio, is still growing steadily. Although we are well above our goal of 6 months we are now shooting for a emergency fund of 12 months. This means we will probably need to increase our emergency fund to about $30,000, but it will be a good security blanket if we are ever faced with a layoff or family emergency. I’ve always felt like the more you’ve got set aside, the less likely something is to happen. Or maybe it just seems that way because what would have been considered an “emergency” is now just a minor setback.
*For an explanation of my ratios and how they are calculated check out my 3 Financial Ratios posts (Liquidity Ratios, Debt Ratios, Saving Ratios).
(+3.65% Month / +25.76% YTD) April 2009 Networth
April Highlights
- Finally the financial markets have decided to give back a little of the massive losses we have been suffering over the past year. It was nice to have a second month in a row of increases in our equity accounts. I may be a pessimist, but I don’t think we are quite out of the woods yet. We may have bottomed out when the Dow hit around 6,500, but I think it’ll be a quite a few years before we are back above 10,000 levels.
- I have been keeping our house value constant since our purchase last December, but I think I may start to change the value every quarter or so. This is one of those assets that is extremely hard to value until you actually sale it. Right now I have simply valued it at what it appraised for which was about $20,000 more than the purchase price. This may be a little aggressive so I’ve been looking at some different value models and may start using one of those in future months. However, in the end it will still be just a guess, but I would assume it will be much more conservative than my current valuation.
– We did see a significant decrease in our cash account this month, but that was because we had a pretty decent size credit card balance that we had to pay off. We are still trying to finish up the last few fix-ups around the house, so hopefully in the next couple of months we’ll have a lower outstanding balance at the end of each month. Our last major project is the backyard and if all goes according to plan I’ll have that done, by the end of May. We’ve decided on a budget of around $2,500 to finish the backyard. This seems reasonable considering I’ve got to pretty much do everything from sprinklers and drain pipes to laying edging and sod.
- We hit the halfway mark of our goal to increase our Networth 50% for the year and we are only 1/3 through the year. With a little help from the markets and continuing to follow our plan, we should be able to hit our goal.
To see the path to our current networth position as well as our other monthly statements check out the “Networth Page“
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