Financial ratios

Financial ratios are numerical yardsticks used to give a concise picture of your current financial situation. The ratios help you understand your current level of liquidity, debt and savings. They enable you to assess the strengths and weaknesses in your present finances.

Let's take a look at the couple's financial ratios after the property purchase in 2009.

TOTAL DEBT SERVICING RATIO (TDSR)

Introduced in 2013, the TDSR measures all your monthly debt repayments against your monthly income. The higher your existing debts, the less you can borrow.

To qualify for a home loan, your TDSR cannot exceed 60 per cent. That is, your total loan obligations cannot exceed 60 per cent of your monthly gross income. This is to ensure prudent borrowing for property purchase.

Mr Alfred Chia, chief executive of SingCapital, said: "Anything above 60 per cent would be risky as it indicates that there is potentially a danger that the customer will be unable to service the debt if liquidity is tightened due to unforeseen circumstances."

For those whose TDSR exceeds 60 per cent, Mr Brandon Lam, Singapore head of financial planning group, DBS Bank, suggests increasing the loan term, reducing the amount borrowed and repaying existing debt to reduce TDSR.

Of course, the couple were not subject to the TDSR regulation back in 2009 but in any event their ratio stood at a healthy 35 per cent.

"It indicates that they are capable of servicing their monthly financial obligations," said Mr Chia.

LIQUIDITY RATIO

Liquidity ratio measures your ability to pay off your short-term debt obligations, by working out the amount of savings or cash equivalents set aside against monthly liabilities or expenses.

The ratio captures the number of months you can sustain your expenses in the event that all existing sources of income are lost temporarily. Financial advisers usually give a guide of three to six months.

"Setting too much aside for a rainy day would mean there is excess money that could be invested for better returns," said Mr Chia.

But it is highly recommended that you have emergency savings or funds which can be tapped in the event of contingencies, for example, retrenchment, illnesses or accidents.

It may be prudent to allocate a higher amount if you have long-term commitments, such as a housing loan, said Mr Lam.

"To save for the three to six months of emergency funds, start saving in small and consistent ways. It is also wise to monitor your expenses, if you are spending on needs or wants, especially large-ticket luxury items," he added.

The couple's liquidity ratio was 6.4 months, which is healthy, signalling that they have the funds to cope with short-term expenses.

LIQUID ASSET TO NET WORTH RATIO

This ratio provides an indication of the proportion of a person's net worth in cash or cash equivalents. A minimum ratio of 15 per cent is considered adequate to meet short-term cash needs.

This is because during an emergency, you need to be able to convert your assets into cash for urgent matters such as a medical condition that requires immediate hospitalisation. It is advisable that you maintain some of your assets in liquid form such as bank savings, current account and fixed deposits.

The couple's liquid asset to net worth ratio was 12 per cent, which is lower than the recommended ratio of 15 per cent.

Mr Chia said it is important that the couple work to increase the ratio to be prudent in the event of short-term emergencies.

SAVINGS RATIO

This is the ratio of cash surplus or deficit to your disposable income. It refers to the monthly sum that is saved as a proportion of the monthly income. These savings can be allocated towards future financial goals and needs, said Mr Lam.

He recommends that Singaporeans should have a savings ratio of at least 10 per cent while Mr Chia would prefer an even higher ratio of at least 30 per cent.

The couple's savings ratio was somewhere in between at 22 per cent.

DEBT TO ASSET RATIO

The debt to asset ratio indicates the proportion of a person's assets which is financed by debt or borrowing - so a lower ratio implies a lower monthly commitment towards repaying debt.

The debt to asset ratio can be used to measure a person's solvency or ability to pay debts. Experts generally consider a ratio of 50 per cent or less to be safe.

The couple's debt to asset ratio was 67 per cent.

Mr Chia said that while their debt to asset ratio is on the high side, the debt is a housing loan, which means the ratio will improve when the property value appreciates.

Lorna Tan

A version of this article appeared in the print edition of The Sunday Times on June 18, 2017, with the headline 'Financial ratios'. Print Edition | Subscribe