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.
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.
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?