Money Metrics
I was the third wheel in a business meeting the other day. It was an executive talking to my manager about the company’s most recent revenue growth, return on invested capital, and operating income. A year ago, all these money metrics sounded like another language, but now it’s all starting to make sense. Everyone was surprised, including myself, when I broke in to the conversation and explained how each $1 we reduced operating expenses, was equivalent to $2.40 of revenue growth based on our most recent public financial filing.
I guess you just start to absorb the fancy money metrics speak when you hear it often enough, but the reason I’ve been interested in understanding business financial metrics is because I believe they are rather applicable to personal finance. So here are a few of my money metrics that have been the key to optimizing my savings and investment strategy.
Revenue Growth:
It’s my opinion that businesses and individuals alike focus too much on revenue growth. I know that it’s necessary in order to grow your market share and continue to keep investors interested, but it’s not the only way to way to drive profitability.
The personal equivalent of this would be income growth (raises). It’s awesome that you got a raise at work, but if your fundamental savings strategy isn’t strong, you’re just going to end up blowing the extra money instead of saving it.
About 98% of my revenue (income) is from my work paycheck, and I have certainly focused on growing it. I’d like to average a 4% raise each year for the next ten years, and I’m putting in the extra time and effort to get that next promotion. Hopefully that will take care of itself.
Passive Income to Expense Ratio:
While I’m on the topic of passive income… A while back I was looking around at Leigh’s Financial Journey and I saw a metric I’d never seen before in her financial stats. It was the P/E ratio. She’s tracking how much money her passive income is bringing in relative to how much she spends each year.
This metric is the bread and butter of anyone questing after financial independence like I am. Once you hit 100% you are officially financially independent. In 2011, I had $0.00 passive income, so this metric was at 0%. When 2012 was all said and done, my P/E was 5.14% and my goal for 2013 is 10%. The largest chunk of this comes from stock market increases, so I might actually go negative if we have another year like 2008.
Return on Assets:
Your total return on assets is simply your net income for the year divided by all of your assets. If you are just starting out, like I am, your ROA should be fairly high because your salary is much larger than your assets. This money metric captures how good you are at using your skills/cash/assets to make even more money.
In 2011, my ROA was 206% (meaning I earned more than 2X what I was worth). In 2012 it was down to 97%. As my assets grow, I’d like this money metric to level off around 10%-20% as more and more of my income comes from my investments instead of my work.
Debt to Income Ratio
The debt to income ratio is a favorite money metric of anyone looking to give you a loan. Mortgage brokers and credit card companies want you to take on debt and pay them interest, but they also know that if this ratio gets too high, you’ll have a large chance of defaulting. The typical guidelines tell you to keep your D/I ratio under 30%.
With the exception of my credit card purchases, which I pay off in full every month, I don’t have any debt right now, so I’m at 0% and I hope to stay that way until I take on a mortgage to purchase property.
Savings Rate
The savings rate is quite possibly your most important money metric. The only way to get rich is to spend less than you make, and that’s the heart of your personal savings rate. It’s simply the % of your annual income that you actually hold on to. If this money metric is under 0%, you are on a one way train to the poor house.
Most traditional financial planners will tell you to keep your savings rate at about 15%, so you will have built up enough assets to support yourself when you retire at 65. Other more aggressive bloggers, like Mr. Money Mustache will tell you to save 75% of your income and retire in 7 years.
I’d love to be like MMM, but I’ve only been able to achieve about 50% so far. in 2011 my savings rate was 20%, and my 2012 savings rate jumped up to 47%. It will be tough to make such an aggressive leap forward with this money metric again, but hopefully I’ll break the 50% seal this year.
What money metrics work best for you? Did I leave any out? When was the last time you calculated your passive income to expense ratio?
“The only way to get rich is to spend less than you make, and that’s the heart of your personal savings rate”
Bingo!
Holly, thanks for stopping by. It’s a little cliche, but it’s so true!
I don’t count stock market increases or dividends in my tax-advantaged accounts in my passive income – just interest, credit card dividends, and stock market dividends in my taxable account. I also track my 4% monthly SWR and the number of months expenses my investments total to separately.
For fun, I calculate my W/E ratio as well – W-2 income divided by expenses. That one is usually pretty amusing.
My goal for my savings rate is 50% of my base pay. I’m doing better than that now, so perhaps I should shoot for 55% or 60% instead! I also save 100% of my bonuses, which inflates my overall savings rate a bit.
Oh man, sorry I got your metric wrong. I just took a look at the 4% safe withdraw rate. I’ve got about $100/mo, haha. I’m working to grow that over time. What’s your W2/expenses come out to? Mine is about 200%.
W2/expenses was close to 300% the last couple of years. So far this year it is > 1000% lol, but that’ll even out a bit as I have more months with expenses and fewer months with bonuses.
1000%, haha! I love it. I’m always impressed by how high your salary is. If your company ever needs more mechanical engineers, I’m all ears
Great ideas but we don’t calculate any of these! Well, savings rate (loosely), and debt-to-income and revenue growth are pretty easy for us. I should run these numbers once per year or something. Good compilation!
Thanks Emily! It’s super interesting working at such a metrics-driven company. Good for reflecting on progress at least.
Nice. Rather than rates and ratios, though – I prefer to look at the hard numbers. Mr. PoP likes the ratios. He likes knowing what percent our portfolios grew by, etc. Me, I care more if the growth is something I can use, or just useless appreciation that’s going to eventually cost us more in taxes. =)
Yea, I suppose appreciation of real estate isn’t always a good thing if you’re not looking to sell it. Although I agree that hard numbers like my net worth are more satisfying to calculate.
Good post. I am about to pay off the last my student debt and I plan on saving and investing my money this year. Good looks on the P/E ratio I plan getting this one day to 100% and quitting my day job!
Thanks Kevin. Shouldn’t hitting a P/E of 100% be everyone’s goal? I’m always surprised when folks talk about how they plan to work the rest of their lives… Thanks for dropping by.
P/E ratio is a new one for me and I won’t bother calculating it for a few years because I made less than $100.00 in passive income last year.
Ratios like these help to keep me enthused about saving because I like to track all numbers and see things grow.
It may not be worth calculating now, but who knows about next year. It’s always encouraging to see real growth in these metrics.
I love the savings rate one. I haven’t calulated things like that yet, but I’ll give it a go. Thanks!
Thanks for stopping by Econowiser! Of all the metrics I’ve got, I think the savings rate tells you the most about how long you’ll have to work. If you save a quarter of your earnings each you, you need to work 3 years to build up enough cash to cover one year’s expenses. If you save 75% of your earnings, you work one year and you have enough cash for 3 years expenses. A simplification, I know, but powerful to think about.