I was going over the financial feasibility study with a client today. When the conversation turned toward financial ratios, I brought up return on equity as I usually do.
However, something eye opening hit me during the conversation.
Before I talk about my discovery, let me mention topics we hit on first. You’ll want to pay attention this today if you are interested at all in making money on your investments, etc. If not, both you and future generations to come will miss out too.
When determining if the business was worth doing, we looked at cash flow. Cash flow statements are very easy to understand and it’s this simple…money coming in versus money going out. You can look at a personal checking account just as a business looks at their statements.
Next we discussed income statements. Income statements show business the items such as depreciation of assets on and other tax write-offs which reduce the taxable amount of income. The income statement, however, does not affect cash flow – money spent does. The income statement gives an idea about the net profits which are taxable.
From there, we reviewed return on equity. A difference between return on equity and return on investment is different, but in short, the return shows how hard the money is working. In just a minute, I’ll demonstrate some simple math; but first, let’s look at the Rule of 72 as it relates to how hard your money is working.
The Rule of 72 will tell you how fast the money will double in value.
To figure the time, you will only need the calculator between your ears. If you know the rate of return, which is mentioned on the feasibility study ratios page – or a CD at the bank, simply divide 72 by that number. The answer will be the number of years for your money to double.
For example, if you earn 6%, take 72 and divide it by 6. The answer is 12. Your money will double every 12 years.
Now comes the eye opening part.
I was looking at a money market account paying .01%. That’s right, 1/100th of a percent. At this rate, money will double every 7,200 years!
Without reinvesting the interest earned and simply setting it aside, in order to double the money, 11,920 years will pass.
Looking at interest rates on CD’s at .25%, which are not uncommon rates, money will double in 288 years. Can you and your family wait this long? Mine can’t.
Don’t blame banks for offering low rates, there is more to the story and you can read about it in “Barking With The Big Dogs” which is soon to be released.
