10 calculations you should know for managing finances

The first step towards financial security is taking control of your finances. Money management is an art which includes saving the right amounts and investing in the right instruments. However, there are several factors such as inflation and time that lower the value of money.

Therefore, it is necessary to learn how to calculate the worth of one's investment. Several financial planning calculators are available on the web. However, it is also important to know some basic formulae that you can use to do your own calculations. Given below are 10 such concepts that everyone should know.

1. COMPOUND INTEREST : You may have heard financial experts/advisers extol the power of compounding. Albert Einstein, in fact, called compounding "the greatest mathematical discovery of all time". Compounding is the process of earning interest on principal as well as accumulated interest. The longer the duration of the investment, the greater is the potential for gaining from compounding, which makes it a very powerful tool in finance. That is why compound interest is your best friend when it comes to investing. A longer tenure, coupled with higher frequency of compounding (quarterly, halfyearly), can work magic. So, the next time your financial adviser asks you to stay long and enjoy the ride, know that he/she is referring to the power of compounding.
2. POST-TAX RETURN: We invest thinking about probable returns that can be generated. But we forget that these returns will be much lower if we take into account taxes too. What you see on your fixed deposit certificate is the absolute figure. As per the income tax rules, any income from a bank deposit is taxable as per one's tax slab. So, if you fall in the 30 per cent tax bracket, the interest earned will fall by 30 per cent. This means that the effective interest earned after tax falls to seven per cent. It is always wise to calculate post-tax returns while investing in a financial instrument.
3. INFLATION: Inflation lowers purchasing power of the rupee. As a result, whenever a saving plan is being 10 financial calculations one should know for managing one's finances There are several factors such as inflation and time that lower the value of money. chalked out, inflation is one of the factors that has to be taken into account.
4. PURCHASING POWER: Conversely, if you want to determine the purchasing power of the same Rs 10,000 in future, keeping all the other parameter as before, there is a formula which can be downloaded from the Internet.
5. EFFECTIVE ANNUAL RATE: Generally, an investment's annual rate of return is different from the nominal rate of return when compounding occurs more than once a year (quarterly, half-yearly).
6. RULE OF 72: Rule of 72 refers to the time value of money. It helps you know the time (in terms of years) required to double your money at a given interest rate. That is why it is popularly known as the 'doubling of money' principle. The thumb rule is divide 72 by the interest rate. EXAMPLE: If you are assuming a 12 per cent return on your investment, the number of years in which the money will double is = 72/Interest rate= 72/12 = 6 years
7. COMPOUNDED ANNUAL GROWTH RATE (CAGR): This is used to indicate the return on an investment over a period. It is also the best tool to compare returns of two different asset classes-for instance gold/equity or equity/real estate. The benefit of using this parameter is that it provides a smoothed-out return over a period ignoring volatility. There are three components that make up CAGR-beginning value, ending value and number of years. Hence, if you have to compare the performance of any two asset classes or check returns from an investment over different time frames, CAGR is the best tool as it blocks out all the volatility that can otherwise be confusing. 
8. LOAN EMI: Equated monthly instalments (EMIs) are common in our dayto-day life. At the time of taking a loan, we are shown a neat A4 size paper explaining the EMI structure in a simplified manner. It is generally an unequal combination of principal and interest payments. We absorb these details and move on with life. But have you ever wondered about the calculation behind these numbers? If you are curious, then here is the formula Formula: EMI= (AxR) (1+R) ^N/((1+R) ^N)-1) Where A = Loan amount R = Interest rate N= Duration This equation helps you check if the bank is charging the right amount.
9. FUTURE VALUE OF SIP: We all save small amounts at fixed intervals for a goal. It may be in a mutual fund SIP or PPF. But how can we know the possible savings ten years down the line? That is where the future value of SIP formula comes into the picture.
10. LIQUIDITY RATIO: Even though it may look like one of the jargons that analysts use to talk about a balance sheet, it is equally important in personal finance. This ratio indicates the overall health of one's finances. It helps see if one is prepared to face a liquidity crunch.
    

Liquidity Ratio = Total liquid assets\Total current debt

The value of this ratio should ideally be above one. A less figure indicates that your liabilities are greater than your assets and so your financial stability is under threat.

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