I recently watched Brian Feroldi's insightful video, "Warren Buffett: How To Analyze a BALANCE SHEET," It made me wonder: What if we took Buffett’s brilliant approach to evaluating companies—and applied it to our own personal finances?
Warren Buffett, the legendary investor with over 80 years of experience analyzing businesses, has developed a remarkably simple yet powerful system for evaluating financial strength. By focusing on just five key balance sheet indicators, Buffett can quickly determine whether a company is worth his investment. The beauty of his approach isn’t complexity—it’s simplicity.
As I looked through Buffett's five rules, I realized these same principles translate directly to personal finance. While most people track dozens of metrics or none at all, Buffett's framework offers a smarter middle ground—a handful of core indicators that reveal your real financial health.
This article breaks down each of Buffett's five balance sheet rules and shows you exactly how to apply them to your own finances—with practical metrics, specific thresholds, and actionable tools to measure your progress.
Buffett's 5 Rules for Financial Health
1. Cash Should Exceed Debt
Buffett looks for companies with more cash than debt. Why? Because financially strong businesses generate enough cash on their own—they don’t need to depend on borrowing to survive.
Personal Finance Application: Your liquid savings (emergency fund + checking account) should exceed your high-interest consumer debt (credit cards, personal loans, payday loans). This doesn't include mortgages or student loans—focus on debts above 8% interest.
How to Measure This:
- Calculate total liquid cash available within 24 hours
- Sum all consumer debt balances (excluding mortgage and student loans)
- Target: Cash Ă· Debt > 1.0
Understanding your debt structure is the first step. Start by calculating your total debt obligations and payment schedule to pinpoint which debts are costing you the most. A Debt Payoff Strategy Calculator can help you map it out.
2. Keep a Low Debt-to-Equity Ratio
Buffett's rule of thumb: the debt-to-equity ratio should be below 0.8. Companies (and individuals) who primarily finance themselves with equity rather than debt demonstrate stronger financial fundamentals.
Personal Finance Application: Your total debt should be less than 80% of your net worth. Net worth = Assets (home equity, investments, savings) minus Liabilities (all debts).
How to Measure This:
- Add up all assets: home equity, retirement accounts, investment accounts, savings
- Add up all liabilities: mortgage, student loans, car loans, credit cards
- Calculate: Total Debt Ă· Net Worth
- Target: Ratio < 0.8
Many people don’t realize how much their debt-to-income ratio influences big financial decisions like getting approved for a mortgage. It’s a simple metric that shows how lenders judge your capacity to manage more debt. You can check yours using this Debt-to-Income Ratio calculator
3. Avoid Preferred Stock (The Financial Powerhouse Test)
Buffett's rule: Preferred stock should equal zero. Strong companies never need to issue preferred stock—they can raise regular debt or equity instead. Preferred stock is a hybrid instrument that companies only use when they're financially weak or desperate for capital.
Personal Finance Application: Financially strong individuals never need to use desperation financing options like payday loans, title loans, or 401(k) loans. These products are the personal finance equivalent of preferred stock—they signal financial distress.
Desperation Financing Red Flags:
- Payday loans or cash advances (400%+ APR)
- Car title loans (risking your vehicle for emergency cash)
- Pawn shop loans (selling assets at huge discounts)
- Rent-to-own agreements (paying 3x retail price over time)
- 401(k) loans (borrowing from your retirement savings)
- Credit card cash advances (25%+ APR plus immediate fees)
- Subprime personal loans from predatory lenders (20%+ APR)
How to Measure This: Add up ALL outstanding balances in desperation financing products.
- Target: $0 (zero tolerance)
- Any balance > $0 signals financial distress and underlying structural problems
Why This Rule Matters:
Just like a company issuing preferred stock reveals financial weakness, using desperation financing reveals that you've already broken Rules #1 and #2:
- You don't have adequate cash reserves (violating Rule #1: Cash > Debt)
- You're overleveraged and can't access normal credit (violating Rule #2: Low debt-to-equity)
If you find yourself considering a payday loan or 401(k) loan, it's a symptom of deeper problems. A financially strong person has enough emergency savings (Rule #1) and low enough debt (Rule #2) that they never need these expensive, desperate options.
The typical payday loan borrower pays $520 in fees annually to repeatedly borrow $375—an effective APR of 400%. Over five years, that's $2,600 in fees alone, creating a debt trap that prevents building real financial strength.
Start by figuring out how much you currently owe through high-pressure, short-term financing options. Then focus on building an emergency fund so you’re not forced to rely on them in the future. If you can keep your desperation financing at zero for a full year, you’re well on your way to becoming a financial powerhouse. You can estimate how much you need to save using this Emergency Fund Calculator
4. Focus on Growing Retained Earnings
Buffett looks for companies with consistently growing retained earnings, even during recessions. Retained earnings represent the cumulative profits a company has kept and reinvested rather than paid out as dividends. This metric excludes market valuations and asset appreciation—it measures only the company's ability to generate and retain profit.
Personal Finance Application: The equivalent is your savings rate—the portion of income you keep and invest each month. This measures your ability to generate surplus cash, independent of how your existing investments perform in the market.
How to Measure This:
- Calculate monthly savings: Income - Expenses
- Calculate savings rate: Monthly Savings Ă· Gross Income
- Track cumulative contributions to investments (not portfolio value)
- Target: Maintain 15-20% savings rate consistently
- Success metric: Positive savings in at least 11 out of 12 months
Calculate Your Savings Capacity
5. Deploy Capital Wisely (Treasury Stock Principle)
Here's something interesting about treasury stock—when Buffett sees a company buying back its own shares, he's not just looking at the transaction. He's watching how management handles excess cash. The smart ones return value to shareholders. The wasteful ones blow it on poor acquisitions or empire-building.
Personal Finance Application: It's not about whether you're saving money—Rule #4 already covered that. This is about what happens after you've saved it.
Think about it: you've done the hard work of setting aside $1,000 this month. You cut expenses, resisted impulse buys, and managed to retain those earnings. Now what? Where does that $1,000 actually end up?
This is where most people stumble without realizing it. They'll save diligently, then turn around and pour half of it into things that lose value the moment they buy them. A new car. The latest phone. Upgrading to a bigger apartment they don't really need.
Buffett would look at this the same way he views a company wasting shareholder capital—poorly allocated resources.
The question isn't complicated: what percentage of your saved money flows into things that grow in value versus things that shrink?
Let's break it down simply. When you save money, it generally goes one of three places:
Things that build wealth: Your 401k. IRA contributions. Index funds in a brokerage account. Real estate down payments. Maybe a course that genuinely increases your earning power. These grow over time.
Things that destroy wealth: New cars (lose 20-30% driving off the lot). Luxury purchases with no resale value. The newest tech that'll be outdated in two years. Upgrading your lifestyle just because you can afford it.
Short-term reserves: Emergency fund contributions. Savings for a specific near-term goal. This doesn't grow much, but it's not wasteful either.
Here's a real example: you save $1,000 this month. Solid 20% savings rate—you're crushing Rule #4. But then $500 goes to a new car payment, $200 to luxury purchases, and only $300 reaches your investment accounts.
You saved $1,000, but only $300 is actually building wealth. That's a 30% investment rate. By Buffett's standard, you'd be failing Rule #5.
Now imagine the same $1,000 saved, but this time $800 goes to retirement accounts and investments, with $200 to your emergency fund. Same effort to save it, but 80% is now working for your future. That's passing.
Calculate Your Savings Allocation
Buffett's five-rule framework provides the blueprint. The tools to measure your progress are readily available. The only variable remaining is your commitment to applying these principles systematically.