Money Matters: What's your solvency ratio?

Firstpost has been running a series on personal finance ratios for a couple of weeks now. In this series, we have taken you on a tour which explains why, like companies, individuals too need to watch certain finance ratios to ensure good financial health. So far we have covered the Life Insurance Coverage Ratio , basic liquidity ratio , debt service ratio , leverage ratio and savings ratio .

Today we help you understand yet another important ratio that you need to take very seriously when it comes to your finances: the solvency ratio.

[caption id=“attachment_103772” align=“alignright” width=“380”]  This ratio will let you know if the assets in your financial portfolio are enough to repay your debts.[/caption]

Solvency ratio: Simply put, this ratio will let you know if the assets in your financial portfolio are enough to repay your debts. As we progress in life we acquire assets, on one hand, and use debt to acquire those assets. But, at times, the amount of assets is lower than the amount of debt we take on. The Solvency Ratio helps you understand if your assets are sufficient to repay all the debts you’ve taken on.

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Calculate: To know your solvency ratio, you need to know your total financial assets and divide it by your total debt. Financial assets in this case includes fixed debts, bonds, equities, mutual funds, PPF and the like. This also includes your the liquid assets like cash in the savings account - or even moolah under the matress.

Solvency Ratio= All financial assets/ Total debt

So, if your total financial assets are Rs35 lakh and your total debt is Rs 50 lakh, your solvency ratio is 0.7.

What’s the Red Flag? At any point, if your solvency ratio is less than 1, you should worry.This can happen when the market value of assets bought with debt depreciate in value. This can happen not only to shares and mutual funds, but also to safe assets like bonds - which depreciate when interest rates rise.

If you solvency ratio is less than 1, it’s clearly shows you are in a danger zone, and it continues moving down, you could be heading into a debt trap. In such a case, we suggest you get in touch with debt counsellors as soon as possible. Bank of India’s Abhay debt counselling agency and ICICI Banks’s Disha debt counseling centre offers their services free of cost.

Keep tracking this space. Next week we bring you an article on Savings rate to income ratio.