Can I Pay for Emergencies?

24 08 2010

With the turn of the economy, many Americans right now are wondering if they have enough money each month to pay for their expenses.  To dissect this thought even further, many are wondering how long it is before exhausting disposable income (personal income minus personal taxes – a/k/a take home pay) to pay their monthly expenses.  Fortunately there is a calculation that does just that.

The Basic Liquidity Ratio calculates how many months you will have available to pay for your monthly expenses.  A high ratio is desirable because it indicates the number of months you will have before disposable income runs out.

Basic Liquidity Ratio = Monetary (liquid) Assets / Monthly Expenses

Example – Henry and Jackie’s monthly take-home pay is $4,420 and their monthly expenses total $5,399. 

$4,420   $5,399  =  0.82

Based on the answer, this couple has just under one month to pay their monthly expenses.  They will end up with a deficit (loss) each month because their expenses ($5,399) exceed disposable income ($4,420).

We cannot stress enough the importance of having an Emergency Fund.  Henry and Jackie’s expenses might be hefty this month because of unexpected emergency medical expenses.  However, if they had simply implemented an emergency fund with at least three to six months of expenses, they would be able to pay the bills this month without having to tap into their savings.  Or even worse, taking on consumer debt because of their lack of funds.

Fix It Tip.  Always ensure your income exceeds expenses.

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