| First of all, I have to consider that there are two | | | | personal balance sheet for the same period. My |
| kinds of debt, good debt and bad debt. A bad debt is | | | | balance sheet records all my assets and liabilities. The |
| one that needs to be paid off by me. In good debt, | | | | difference between my total assets and my total |
| someone else is paying off my debt as learned from | | | | liabilities is my net worth. If my net worth is already |
| the Rich Dad's series by Robert Kiyosaki. Good debt | | | | negative, then that mean I am already seriously in |
| can be used to invest in assets that generate | | | | debt. I should start reducing my debt. |
| positive cash flow. | | | | Divide my net worth by my total assets I will get the |
| For example, I can borrow money to invest in a | | | | 'solvency' ratio. This ratio indicates how much decline |
| piece of real estate and rent it out. As long as my | | | | in value of my asset before I become insolvent. The |
| monthly rental income is more than my monthly | | | | higher the ratio, the better position I will be in. Being |
| mortgage repayment amount, then I do not need to | | | | insolvent means that my total liabilities will be more |
| pay the mortgage myself. My tenant will be the one | | | | than my total assets. |
| paying for my debt. | | | | In addition, I will also look at 'debt to assets' ratio. To |
| If I keep repeating the process of investing in real | | | | derive this ratio, I need to divide my total liabilities by |
| estates by using good debt, then potentially I can | | | | my total assets. This ratio measures my solvency or |
| earn a lot more money and gained a lot of properties. | | | | my ability to pay debt. My 'debt to assets' ratio |
| But there is a catch. I will have a lot of good debts | | | | should be lower than the advisable limit of 50%. It is |
| that can potentially turns into bad debts anytime. This | | | | possible to have enough current income to pay my |
| can be due to the fact that my tenants quit renting | | | | bills but not enough assets to cover all my debts. If |
| the properties from me. | | | | this is the case, I am excessively in debt and |
| In other words, there is always a risk that I will | | | | technically insolvent, which can eventually lead to |
| become overstretched by bad debts. As a result of | | | | bankruptcy. |
| overstretching, I will not be able to pay off my debts | | | | The last ratio that I will look at is the 'basic liquidity |
| and need to be declared as bankrupt. Since there is | | | | ratio'. This ratio is calculated by diving my total cash |
| such as risk, I need to prevent it by not becoming | | | | or near cash assets by my total expenditure. My |
| overstretched by debts. | | | | total cash or near cash assets is available from my |
| How to determine whether I am overstretched by | | | | 'income and expenditure statement'. This ratio shows |
| debts? | | | | the number of month that I can continue to meet |
| Based on my understanding from financial education, I | | | | my expenses from cash or near cash assets if all of |
| feel that I can use a few personal financial ratios to | | | | my sources of income are lost. |
| evaluate whether I am overstretched. The first ratio | | | | As a thumb of rule, I should have a ratio of around 3 |
| that I will use is the 'debt service' ratio. This ratio | | | | to 6. That is my cash or near cash assets can sustain |
| measures my capability to service my debt. | | | | me at between 3 to 6 months. And I can look for |
| To calculate the 'debt service ratio', I need work out | | | | alternative source of income during this period. |
| my income and expenditure statement. My 'income | | | | Please note that the usage of the above ratios to |
| and expenditure statement' records all my income | | | | gauge whether I am overstretched by debts is |
| and expenses for a year. From the statement, I will | | | | purely based on my personal opinion. I am not |
| know my total income. | | | | providing any financial advice here. If you study more |
| Next, I can derive my total debt repayments from | | | | about financial planning, you probably can find more |
| the 'income and expenditure statement'. They are | | | | ratios or ways to decide whether you are |
| recorded as expenses such as mortgage repayment, | | | | overstretched by debts. That is why financial |
| car loan repayment and so on. | | | | education highlighted in the Rich Dad series by Robert |
| Lastly, I will divide 'total debt repayment' by my 'total | | | | Kiyosaki as one of the three essential educations |
| income' to get the 'debt to income' ratio. If my 'debt | | | | that allow one to achieve financial freedom. |
| to income ratio' is less than or equal to 0.35 or 35%, | | | | * DISCLAIMER * |
| then I am considered to be carrying a healthy debt | | | | The author, publisher and distributors particularly |
| load. If my ratio is higher than 0.35 or 35%, then I | | | | disclaim any liability, loss, or risk taken by individuals |
| am overstretched. I should stop taking on any more | | | | who directly or indirectly act on the information |
| debt but start paying off the debt. | | | | contained herein. All readers must accept full |
| The next ratio that I will use will be 'solvency' ratio. | | | | responsibility for their use of this material. |
| The first step that I need to do is to work out my | | | | |