NOW i KNOW ! Cikaldana newsletter no. 02-2015 [on self financial diagnosis or checkup]

NOW i KNOW !

Newsletter No. 02-2015

Have you taken the annual medical checkup recently?

Do you know that just like physical health, ideally we need to regularly maintain a good health of our financials. Maintaining a financial health is in many ways similar to maintaining physical health; that we need to do a regular (financial) exercise, that we need to dispose bad habits deteriorating our (financial) health, that we need to conduct a regular (financial) health check, and that in some cases we need to see a doctor (expert) to have our (financial) health improved, or cured if unhealthy.

In this current article, we will go through on how we can do ourselves a financial diagnosis or a financial health check.

Why “financial health check�? A financial health check is the first and important step in determining what to do (or not to do) with our finances. The financial health check is an essential preliminary steps in a Financial Planning Process.

Self-Financial Diagnosis Understand how well my finance is.

There are quite a number of financial health check measurements that we can use. We will discuss three financial health check measures, they are: 1. Debt Service Check 2. Bankruptcy Check 3. Saving Performance Check Before going through the health check activities, we need to have a same understanding on terminologies to be used within the context of this financial health check. The terminologies are: income, debt services, debt, asset and savings.

Income is the money that we receive, whether regularly or not. It can be in a form of salary, bonus, allowances, etc. For the purpose of our discussion in this article, let’s say we have a regular income which comprised of a monthly salary of Rp 20 million and an annual bonus of about Rp 24 million; and assume no increase on the salary.

Debt Service is the amount of money that we regularly (usually, monthly) spend to pay-off our debt. For example, if we have to pay an monthly installment of Rp 4 million for paying a house loan, Rp 2 million for paying a car loan, and Rp 2 million for paying loan on a fancy motor-cycle; than it is said that we have a total debt service of Rp 8 million per month.

Debt is our total outstanding liabilities or amount of money that we owe to other parties. For example, let’s say we have regularly paid-off our debts by monthly installment for several years on the house, the car and the motorcycle; and right now, our outstanding or remaining debts are Rp 300 million for the house, Rp 100 million for the car, and Rp 20 million for the motorcycle. They made up a total outstanding debt of Rp 420 million.

Asset is the total value of our properties which can be converted into cash, examples are money, commercial papers, house, car, land, jewelry, art piece, etc. Asset can be classified into two: liquid assets and non-liquid assets. Example of the liquid assets are cash, savings, deposits; things that you can convert to cash in an immediate time. Nonliquid assets for example are house, land, and car.

Saving is the amount of money that we regularly (usually monthly) take from our income for the purpose of saving or investing.

The above terminologies will be used in the following financial health check activities that we are about to discuss.

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Financial Health Check No.1 – Debt Service Check The debt service check is a measure to check how well our capability to service or to pay our debt.

To do this check, we compare our Debt Service with our Income. As given in the example, we have a debt service of Rp 8 million per month and an income of Rp 20 million per month.

With this situation our Debt Service Check is a ratio between the debt service over the income, that is 8/20 which is equal to 40%.

Our Check

Debt Services 40%

Other Spendings 60%

An ideal and healthy value of a person’s Debt Service Check ratio is no more than 30%. A debt service check ratio below or equal to 30% is considered healthy, otherwise it is unhealthy.

In this example, we have a Debt Service Check ratio of 40% exceeding the maximum ideal number, it indicates an unhealthy financial conditions as it means that we have a greater risk of not able to service our debt, with the stated income level.

In this situation, we are strongly suggested not to add further debt which, will add to our existing debt service obligations. A recommended cure is by paying some of the debt’s principal in order to reduce the monthly debt payment. Reducing our monthly debt payment should reduce our Debt Service Check Ratio to a better or ideal ratio.

Ideal Debt Services 30%

Other Spendings 70%

Financial Health Check No.2 – Bankruptcy Check The bankruptcy check is a measure to check how close we are to be in a condition of financial bankruptcy.

Our Check One way to do this check, we compare our Debt with our Assets.

As given in the example, we have a debt of Rp 420 million and let’s assume that our current assets - including the cash, deposits, house, car, motorcycle, etc. – have value in total of Rp 700 million. Our Bankruptcy Check is a ratio between the Debts over the Assets, that is 420/700 which is equal to 60%.

An ideal and healthy value of a person’s Bankruptcy Check ratio is no more than 50%. A bankruptcy check ratio below 50% is considered healthy, otherwise it is unhealthy. Theoritically, we can only have debts in total of no more than the total assets we have.

In this example, we have a Bankruptcy Check ratio of 60% exceeding the maximum ideal number. It indicates an unhealthy financial conditions as it means that we are having a greater risk to a financial bankruptcy due to debt exposure.

Assets 40% Debts 60%

Ideal

Debts 50%

Assets 50%

In this situation, we are strongly recommended not to add further debt which will increase our existing liabilities. A recommended cure is by paying some of the debt’s principal in order to reduce the debt, in order to reach a better or ideal ratio.

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Financial Health Check No.3 – Saving Performance Check The saving performance check is a measure to check how good we are in saving (or investing) our money from our income. At the same time, this measurement could also give an indication on how good we are in controlling our expenses out of our income.

Savings / Investings 5%

To do this check, we compare how much money we can regularly save or invest from our Income. Let’s say we can take the money from our Rp 20 million income of Rp 1 million per month for the purpose of saving or investing. With this amount of saving or investing, our Saving Performance is a ratio between the saving over the income, that is 1/20 which is equal to 5%.

An ideal and healthy value of a person’s Saving Performance Check ratio is at least 10%. The higher this ratio indicates a better financial condition.

Our Check

Other Spendings 95%

Savings / Investings 10%

Ideal

In this example, we have a Saving Performance Check ratio of 5% below the minimum ideal. It is advisable that we should strive to increase this ratio to meet the minimum ratio of 10%.

In order to increase our saving performance, we are recommended to evaluate our spending to see if there are unnecessary expenses which can be taken out or reduced, where they can be then converted into saving or investment.

The result of our financial health check measure as described earlier is then summarized in a table below.

Financial Health Check Measure

Our Check

Ideal

Check Result

Debt Service Check

40%

Not more than 30%

Unhealthy

Bankruptcy Check

60%

Not more than 50%

Unhealthy

Saving Performance Check

5%

Not less than 10%

Unhealthy

Looking at the table, now we know our financial conditions, and the check results look all unhealthy.

So What?

If we are willing to make all the checks healthy, than we can plan for it. Ways to achieve it are infinite depending on our specific-unique conditions.

Let’s say we are willing to improve our financial health and pursuing to achieve the ideal check ratios. The following is one of the possible plan for improvement:

Other Spendings 90%

First, we envisage a period of one year to achieve financial health improvement. Understanding the time dimension in this planning is crucial for us to be able measure; and to ensure our commitment to achieve a financial health improvement. When we know the time we would be having, we know what we could do at our best.

Second, let’s look at our Debt Service. For sure we are not going to add more debt and consequently its installment, with our Debt Service Check ratio of 40%! Therefore that is what we will do for the next one year.

Next thing we need to do is to keep paying our debt installment of Rp 8 million per month. That way we can expect our total debt is to be reduced by around Rp 60 million one year later; Our current debt of Rp 420 million is then expected to go down to Rp 360 million one year later.

Notice that our debt service for the motor-cycle will also be ended ten months from now. Therefore our current debt service of Rp 8 million per month will also be reduced to Rp 6 million within the next twelve months.

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House

Car

Motor-cycle

With this plan being executed, one year later our financial measures would be expected to stack-up just like in the following table.

9 8

7 6

Financial Measure

Current Value (Rp)

A Year Later (Rp)

3

Income (monthly)

20 million

20 million

2

Debt Service (monthly)

5 4

1 0

M0

M1

M2

M3

M4

M5

M6

M7

M8

M9

M10 M11 M12

Chart: Monthly Debt Payments, in million Rupiah

415

409

404

399

393

388

383

377

372

Debt

M1

M2

M3

M4

M5

M6

M7

M8

M9

367

363

M10 M11 M12

Chart: Projection of Debt by Month, in million Rupiah

Finally and going further, we will also commit to reduce our monthly expenses by at least Rp 1 million a month by discarding expenses that are unnecessary. Doing so will enable us to save or invest that Rp 1 million, and making it a commitment of Rp 2 million monthly saving out of our income money. Subsequently, we expect an increase of asset by Rp 24 million one year later, making our total asset to around Rp 724 million a year later.

Assets

700

M0

702

M1

704

M2

706

M3

708

M4

710

M5

712

M6

714

716

718

344 million

Assets

700 million

724 million

1 million

2 million

720

722

And in other word we have planned our financial health on year later to achieve the following result.

Financial Health Check Measure

Current Check

Ideal & Target

A Year Later

Debt Service Check

40%

Not more than 30%

30%

Bankruptcy Check

60%

Not more than 50%

47%

Saving Performance Check

5%

Not less than 10%

10%

Now we can envisage an all healthy financial health check measure within a one year of execution.

These healthier financial conditions would be achievable with a strong commitment to improvement and – in this example – just by executing the following actions:

344

M0

6 million

420 million

Saving (monthly)

Remember that we are expecting to receive an annual bonus of about Rp 24 million within the next one year. Remember also that we are committed to improve our financial health and therefore we are to allocate a larger sum from the bonus to pay-off debts. Let’s say we allocate two-third of the bonus to reduce debts in the amount of Rp 16 million, and for example it will goes to pay-off the house debt.

By doing so, we expect to roughly reduce further our debt from Rp 360 million down to Rp 344 million a year later. The remaining of the bonus will be spent on shopping items in our craving list.

420

8 million

Debt

1. Determine a clear time target; 2. Not adding more debt; 3. Keep paying the current debt services; 4. Allocate two-third of bonus to pay-off debts; 5. Reduce monthly expenses by Rp 1 million, and convert it to additional saving.

We all can do this self-financial diagnosis to understand how well our financial health. We should always do our best to improve all aspects of our life, including financials. With a strong willingness and commitment, an aggressive improvement target to our financials is not unachievable.

724

By Iswin Hudiarto The writer is Principal Financial Planner and Director of Cikaldana Financial Advisory.

M7

M8

M9

M10

M11

M12

Chart: Assets Growth by Month, in million Rupiah

PT Cikaldana Korpora  Sovereign Plaza 21st Floor, Jl. TB Simatupang Kav.36, Jakarta 12430 P: +62 21 2939 8727  F: +62 21 2939 8898  www.cikaldana.com  E-mail: contact@cikaldana.com

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