Check out this explanation of Financial Performance Metrics. I have been so excited about this video and discussing the theoretical importance of metrics!
Financial performance metrics are data that describes whether you are doing a good job with your financial decisions. So whether you are an investor, or a business, it is helpful to get this feedback on whether you are doing a good job.
Let’s start out with why performance metrics are important. The human species has this innate desire to score things. We all want to know who is winning and who is losing. This ability is one of the ways that we make sense of this world. So we want to take all the financial professionals in the world and be able to rank them from best to worst, and put a score on each. Unfortunately, reality is much more complex than that. So when we start looking into the science of performance metrics, we find that there is not just one score we can give everyone. And that is the main concept I want to start from. There is not one unified financial performance metric, but many different metrics. This is a very important idea to understand.
So you might say, Zach, what about rate of return. Isn’t that all that matters? And I would tell you, that it all depends. And I will give you an example why.
Let’s say you sold a stock and you got 20% return. Now tell me, is that good or bad? I would suggest you have to look at a lot of different factors:
- What was the risk of the stock? What it high risk or low risk?
- How much money was invested? 1k or 1B
- What was the performance compared to the rest of the portfolio? Did diversification help or hurt?
- What was the performance of other similar stocks? Could you have bought something else and did better?
- What was the performance compared to the sector?
- What was the performance compared to the time frame? 1 month or 1 year?
- Was there an economic recession or an economic boom period?
- What was the performance compared to other asset classes? Could you have done better in real estate or starting a business?
So rate of return doesn’t tell the whole story. It is more complex than that.
So I want to discuss why this is such a difficult problem, to assess performance. What you are trying to do is predict the future. So you are making an assumption about the future. You make a business decision based on your assumption, and then wait to see if it pays off. The problem is, once you make the decision, you can’t reverse time to compare it against different alternatives. So you will never truly know if you ultimately made the best decision. So if you are the head of a company and you have a choice between rolling out product A or product B. If you choose product A and you make a 20% return on your investment. There is no way to go back in time, choose product B and see if that would have been a better decisions. So in putting a performance metric to show how good your financial decisions are is very difficult.
So this isn’t to say that performance metrics aren’t useful. They definitely are. You just have to understand how to use them and what they mean. There is not just one metric. What you end up with is a whole list of metrics. And you use the data to get a sense of whether your performance is positive or negative. Now I know there are some companies that are really intense about performance metrics, and making your numbers each quarter is critical. But it is important not to lose sight of what is going on. What you are doing is looking at life, and trying to reduce it down to a number. And life is more complex than that. Look at the people in your life. Can you really rate them on who is successful and who is not successful? Maybe you could use credit score? Maybe annual income? How accurate would your ratings be? And would your ratings be reflective of where people would be ten years from now?
My goal with this is just to start you thinking about performance metrics. This is a whole field of study and it is another tool to understand to help you make better financial decisions.
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Neither Zach De Gregorio or Wolves and Finance Inc. 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.