Last week, we started a series on personal financial ratios. Like companies, individuals too need to maintain certain personal finance ratios to ensure financial health. As part of the series, last week we discussed debt service ratio and basic liquidity ratio. Today, we discuss leverage ratio. To know more, read on.
There was a time in the Indian society when debt was lookeddown upon. But today, an average urban Indian can easily have four-five debts -- home loan, car loan, education loan, personal loan and credit card dues. Leverage ratio helps you understand the level of debt you are into in relation with your assets.
Remember, to calculate this ratio you will have to divide your total liabilities (not monthly) by the total assets you have made. So, if your total liabilities is Rs 8 lakh and the value of your total asset is Rs 10 lakh. So when expressed as a percentage, your leverage ratio in this particular example will be 80 percent.
This shows that 80 percent of your assets are currently financed by debt.
What's the red flag: Like it or not this ratio gives you a reality check on your current financial position. A high leverage ratio simply means you are in a dangerous red zone financially. Take for instance, if your leverage ratio is 80 percent, it means that 80 percent of your assets are currently financed by debt. And any future increase in interest rates on your debt could land you in deep trouble.
Do keep tracking this space as we impart more financial literacy on various personal finance ratios. Next we will cover risk exposure ratio.