After interviewing thousands of people over the years, we have devel oped a quick test to determine just how bad a person’s debt situation is. For lack of a better name, we call it the Quick Ratio. It is the rela tionship between your take- home pay and how much you owe, not counting your vehicle and house debt.
To work out your ratio, do the following (using the worksheet on page 84):
1. Take your paychecks and work out how much money you have each month after taxes, insurance, and retirement costs are deducted.
Money your employer is with holding for payments to a credit union for an unsecured debt and money you are putting into savings (for stock pur chases, a Christmas Club, etc.) need to be added back in. This gives you your net pay.
If you and your spouse both work, compute net pay for both of you.
2. Multiply your monthly net pay by twelve to get your yearly take home
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3. Add up the total of all your debts except what you owe on your house, vehicles, student loans, and taxes.
4. Divide your total short-term debt by your yearly income.
Quick Ratio Worksheet
1) My take home pay is 2) Add back:
a) Holiday account
b) Payment to credit union for signature loans c) Money to savings account
d) Stock purchase e) Savings program
Total
3) If you are paying spousal support, child support, or criminal restitution out of your take home pay, deduct these amounts
4) a) If you are paid weekly, multiply by 4.3
b) If you are paid every 2 weeks, multiply by 2.15 c) If you are paid 2 times a month, multiply by 2 d) If you are paid monthly, multiply by 1
Multiply your monthly income by 12
5) My total short term debt (the actual debt; not just
84 Bankruptcy for Small Business
a) Medical bills
b) Money owed after repossessions c) Credit cards
d) Bank loans
e) Department store debt f) Finance company loans g) Jewelry debt
h) Stereo and appliance debt i) Loans from family and friends
Total
6) Total from step 5 Divide by total from step 4 Quick Ratio
This quick test assumes you do not have unusually high housing, car, tax, or student loan payments. It also assumes your medical expenses and gifts to your religious institution are average. To get a very detailed debt to income ratio, all of these factors would need to be considered. But the Quick Ratio will give you a good starting point.
What the ratio means:
• If the ratio is .15 or lower, you are generally in good financial shape.
• If the ratio is .15 to .25, you are starting to get a little too much debt.
You should cut back your spending and pay down your debt.
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• If your Quick Ratio is over .25, you are showing signs of a dangerous debt situation. The larger the Quick Ratio, the worse your situation (of course, if your ratio is .26 you can fix things easier than if it is .65).
Generally speaking, people or couples whose ratio is between .35 and .85 are sinking deeper and deeper into debt. They may be able to make their minimum payments, but they are not taking care of the underlying debt. Even worse, they are slowly getting worse off. That is, if they add up their total debt from six months ago and their total debt today, today’s debt is likely to be higher. Further, without some drastic action, the total debt six months in the future will be higher than it is today. Many people in this situation do not really realize the danger they are in and even think they have perfect credit. They are probably getting preapproved credit applications in the mail.
However, people with this ratio are slowly sinking into debt. The fact that their total debt is getting larger means that they are in effect paying the monthly payments on their debt with borrowed money when all is said and done. As long as they can get borrowed money from their credit cards or other creditors, they can easily make timely payments. But, this cannot go on forever. Eventually even the most foolish creditors will stop making money available. Without more money to help live and pay the monthly payments, it becomes impos sible to stay afloat and a financial crisis occurs.
People with a Quick Ratio above .9 are very close to a financial crisis, if they are not already experiencing one.
There are two ways to get a high Quick Ratio. One is to borrow a lot of money either slowly or all at once. This increases the debt part of the equation. The other is to have a drop in personal or household income. This reduces the income part of the equation. If your household income is cut in half, you can go from a safe Quick Ratio to a very bad one overnight.
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What should you do if your Quick Ratio is over .9? Make an appointment at once with a bankruptcy lawyer or call Consumer Credit Counseling. The phone number for Consumer Credit Counseling is listed in the business white pages of most phone books, or you can refer to Appendix C. You can also call the lawyer referral line of your state bar for a bank ruptcy lawyer near you, or you can search on the Internet.