Return On Effort: Can This Formula Improve Your Life?

THE IMPORTANCE OF ECONOMICS

Economics, whether we like it or not, drives the world, and is primarily concerned with the distribution of scarce resources—a problem faced every day in healthcare systems. Microeconomics, invented essentially by Adam Smith, is a subject of bewitching beauty, and knowing nothing about economics leaves you almost as disadvantaged as somebody who is illiterate or knows nothing about history, science, or geography. Similarly, it’s increasingly important in a world of large organisations to be able to read a balance sheet and an operating statement, something familiar to managers but unfamiliar to many doctors.(Smith)

THE DuPONT METHOD

 

 The three components

1. Asset turnover (AT) – how successful a company is at generating sales from what they own = sales/assets
2. Operating efficiency (OE) – profit margin = operating profit/sales
3. Leverage (L) – debt = assets/shareholder equity

Let’s take an example of a company with the following financials:

1. Sales: 25,000
2. Assets: 10,000
3. Shareholder funds: 10,000

Therefore:

• OE = profit margin (profit/sales) = 10% = 0.1
• AT = 25,000/10,000 = 2.5
• L = 10,000/10,000 = 1

According to the DuPont Method:

• ROE = AT x OE x L
• ROE = 2.5 x 0.1 x 1 = 0.25 = 25%

This is a great return on equity and is much better than what a typical bank account generates. For example, Apple, Inc. (NASDAQ: AAPL) reported net income of $53.4 billion on $115.5 billion of average shareholders’ equity for the 12 months ended September 2015, a 46.25% return on equity (ROE).

 

THE 'REGE' RETURN ON EFFORT FORMULA - MEASURING OPERATING PERFORMANCE FOR OUR OWN LIVES

Let me introduce you to the ‘Return on Effort’ formula.

By modifying the DuPont Formula, you come up with the ‘Rege formula’.

The three components are:

1. Turnover from physical and mental assets (TPMA) – What can the assets generate?
2. Operating Efficiency (OE) – how well are the assets used?
3. Stress (S)

 1. TPMA

The assets depend on what the individual is trying to achieve. For a professor, the assets may be knowledge, while for someone in the sporting industry, health and fitness would be an asset.

In psychiatry, one would argue that assets are related to the knowledge of psychiatry.

On the other hand, as I mentioned previously, knowledge of psychiatry is not enough – and, one requires a broader skill set to generate a greater return from the asset base.

The expectations of return differ from individual to individual. Time, money, self-esteem and life satisfaction are all parameters of return.

2. Operating efficiency

Could I do things better in my daily life to maximise the use of my assets?

For example, use of software in private practice to increase the amount of time I focus my patients. For e.g. The use of a dictation service to ensure that I can spend more face-to-face time with patients and less time typing my letters.

Here, my aim is quality of care and patient satisfaction.

3. Stress

Stress often conjures up a negative connotation, but this is not always the case. Stress can be divided into positive or negative stress. A certain amount of positive stress, such as mental exertion on a task, is required for optimum performance (eg Yerkes-Dodson’s curve). On the other hand, excessive stress has detrimental effects.

 

Read more about managing stress for doctors and medical students and looking after one’s own mental health here.

KEY MESSAGE

Let’s take a step back and evaluate both formulas.

• DuPont: ROE = AT x OE x L

• The ‘Rege’ Return on Effort Formula: ROE = TPMA x OE x Stress

In order to maximise a company’s return on equity, the company could purchase more assets, make improvements to processing efficiency (eg introducing technology) or take a large amount of debt. But if these steps do not lead to additional sales, then there is no impact (possibly negative impact) to the ROE.

Using the same analogy for the Return on Effort equation, one can focus on three important aspects to improve their quality of life.

1. Return on physical and mental assets

According to Richard Feynman, it takes approximately 10,000 hours to become an expert in one’s field.

Thus, time and learning are important assets that are required to improve one’s asset base – but are often under recognised in busy lives.

2. Operating efficiency

Imagine if you were to organise your day to focus on the important aspects that help you to work better, for example: using technology to make things easier, delegating tasks to people who perform better, and reducing your perfectionism.

The second part of the equation will increase automatically – which then contributes to an increase return on effort.

3. Stress

Negative stress can play spoilsport in this entire equation, which will not only affect the operating efficiency part of the equation but also results in poor asset health – reducing return on effort overall.

If the equation is applied appropriately, return on effort – using the above equation – compounding over several years can result in a phenomenal wealth of knowledge.

This results in a wealth of life satisfaction and improved quality of life overall.

I constantly see people rise in life who are not the smartest, sometimes not even the most diligent, but they are learning machines. They go to bed every night a little wiser than they were when they got up and boy does that help, particularly when you have a long run ahead of you.(Charlie Munger)

SUMMARY

The post is intended to achieve three aims:

1. Help you recognise the importance of multidisciplinary learning
2. Use return on investment/return on equity as an important parameter in your financial and working life; and
3. Recognising that the ‘Rege’ formula, when used appropriately, can generate an improved you.