"When we entrepreneurs started our own businesses, we believed we would finally have control of our lives. No longer would we be confined by the grind of 8-5.
Sadly, the joke was on us. Freedom? Hah! Virtual umbilical cords tether most business owners to their laptops, Smart Phones, and office demands."
David A. Fenton explains in his book Freedom Ratio to determine your Freedom Ratio, you need two numbers.
1. Your personal expenses as a monthly amount.
2. Your monthly cash flow from investments. (This figure does not include client driven revenues. This is true passive income, coming solely from investments such as rental income, dividends, interest, income from businesses you are not actively involved in and anything that does not require your day to day energy)
Freedom Ratio = Monthly Investment Income / Monthly Expenses
The goal is to have your ratio be 1. Meaning your passive monthly income from investments should exactly equal how much you spend.
How do entrepreneurs who are so busy focused their growth of their company, client satisfaction, COGS and ultimately, EBITDA have any time to focus on the Freedom Ratio? This 10 step list can help you stay organized and keep your eye on the big picture.
Focusing on items 1 - 8, will ultimately increase item 9 and over time you will be achieving the freedom ratio that you desire.
1. Business Revenue
Your choices and behavior as a business owner can have direct influence on your business revenue per month. This is a number you can watch weekly and monthly.
2. Business Expenses
This number is also influenced by your decisions and behavior. Pay attention to your business expenses and try to keep them at a minimum in order to increase your profit.
3. Business Profit
EBITDA (Earnings before interest, taxes, depreciation and amortization). The magic number. Ultimately, this is the number that will be used to value your business should you want to sell one day. Increasing this number is not only important for your short term cash flow, it is also important for your long term business valuation. This is directly influenced by the choices you make to increase your revenue and decrease your business expenses.
How much will you (the business owner) pay in taxes and what strategy will you choose each year. It is important to have a good CPA who can help with your tax planning. Doing it on your own is not the best use of your time as an entrepreneur.
5. Personal Income
After your business expenses and taxes are paid, you will decide on how much of your profit you will take home as your personal income. If you have a spouse, you can add your two numbers together.
6. Personal Expenses
How much do you (and your family) spend each month. This is an important number to know on an ongoing basis. Be careful that your lifestyle inflation is not moving faster than the growth of your personal income.
Keep your expenses per month to a minimum. See what the smallest amount of dollars you can live off of in a month is, and get used to it for awhile.
7. Savings/ Investments
How much money do you have left over after you after your personal expenses are paid? You get this number by subtracting your personal expenses from your personal income.
A good goal is to have 30% of your personal income left over after your expenses are paid. The more the better.
8. Rate of Return
Advise the right team to decide how you will invest your left over money and focus on increasing your rate of return every year.
9. Investment Income
How much cash flow do you receive from your investment income? After all is said and done, this is the number that you want to increase overtime. Focusing on items 1 - 8 will ensure that this cash flow number is high.
10. Freedom Ratio
Again, your freedom ratio is calculated by dividing your investment income (#9) by your personal expenses (#6). The goal is to get 1.
This can be overwhelming, or you can make it into a game and check in on your numbers monthly to see where you stand. Being hard on yourself doesn't get you anywhere. Focus on your decisions and behaviors, tweak them until you get the results you want.
Keep in mind that the freedom ratio is not intended to be a retirement goal (although it can be for some people). It's simply a way to create freedom and space in your life, so you can engage your creativity, soul and create more products and services that the world wants (and craves) from you.