We are in some really difficult economic times. People are faced with some very tough questions and are trying to figure out what to do. The real benefit of accounting is that it helps you make decisions. Accountants have enormous amounts of financial data at their finger tips. The point of accounting is to review, interpret, and communicate that data so that everyone knows what is going on in the world. This is one of those moments in time when understanding accounting is more important than ever. So in this video, we are going to talk about an incredibly important financial metric that nobody knows about. WATCH NOW!
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Imagine I were to walk into a room full of accountants and I asked them this question “What is the most important financial metric?” I would probably get a lot of different answers.
Here is a list of metrics I think people would say:
- Return on Investment (ROI)
- Return on Assets (ROA)
- Stock price
These are all very important financial metrics. And you should be tracking all of these closely in your business. But in my opinion, these are not the most important financial metric you should be tracking. The problem with the first four metrics is that they are all trailing indicators. Accounting in general is historical. Depending on when you publish financial statements, you could be evaluating these indicators months after the fact. Month old metrics are not going to helpful for the decision you have to make today.
Modern accounting software advertises that it can generate these metrics in real time. Any efficiency in accounting is good, but you have to be careful to not minimize the manual month end closing process. This is when accountants make manual adjustments to generate accrual accounting statements. This is important to ensure you have the most accurate financial records. The benefits to try and speed up this process may be minimal when the whole point of accounting is to generate historical documents.
I think it is better not to try and improve these metrics, but add a brand new one. The goal would not be to use trailing indicators, but find a current indicator that would provide you with additional information.
Stock price is interesting, because it is not trailing, it should be a forward indicator. It is supposed to be a valuation based on projections of future cash flow. It is a financial metric based on the future. But stock price can be very misleading. Stock prices can fluctuate wildly, or be over or under valued based on market demand, or economic forces that have nothing to do with your company. So you have to be careful making decisions based on stock price.
So what metric would I recommend? I would propose using a metric that nobody knows about. I have been in accounting a long time and nobody talks about this metric accept for me. The most important financial metric is the second derivative of the change in Net Income. In more simpler terms, the acceleration of growth.
The most important thing in business is growth. If you are not growing, you are dying. We all exist in an economic ecosystem, and the job of a business is to identify the areas of growth in the system, and generate a value proposition to capture that growth.
So if you are in your business and you are looking around, you will be more successful if you look around, identify areas of growth, and focus your resource on those areas. This works because you are servicing the economy, and money flows to areas of high productivity.
Let me describe this in a more practical way. If you have a really good accountant in your business, it is almost like they can smell money. It is like a good hunting dog. They can go out and find the money. What they are doing is pouring over financial reports and identifying areas of high growth and then taking action to take advantage of those opportunities.
How to you identify growth? It is not just the change in metrics, but the acceleration of the change that is the sign that growth is occurring. Fortunately, we know a lot from science on how to calculate acceleration, which is the second derivative in the change of net income. Now I know that sounds like scary, complicated Calculus that they do not even teach in business school. But this is something you can learn. I have written a whole book on this that is available on Amazon. But you do not even need to read the book, or understand the complex math, because the concept behind this is really simple. You should be making financial decisions based on signs of growth. And it does not matter that your accounting statements are historical, because the metric of acceleration is a description of action over time, which you can extrapolate forward to the present moment.
So here we are today. The economy is falling apart. A lot of you out there are trying to make decisions on what to do with your money. Should you invest your money? Should you save your money? What should you do? First, you need to identify if prices are reasonable, because right now prices in financial markets are all over the place. But second, if prices are reasonable, your decisions should be driven on whether or not there are signs of growth. Unfortunately, I see a lot of people right now pouring a ton of money into purchasing stocks of bankrupt companies. And a lot of people are going to get hurt. Eventually, the economy will work through its issues, and money will flow to areas of growth.
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Neither Zach De Gregorio or Wolves and Finance shall be liable for any damages related to information in this video. It is recommended you contact a CPA in your area for business advice.