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