|
The time value of money is a critical concept in handling personal finances. The same basic premise can be applied in making decisions for your business.
Here is how it works: Typically, the money you currently have in your hands is worth more than it would be years from now. That is because you are able to spend or invest the funds now instead of waiting to receive them. In other words, there is an “opportunity cost” attached to any delay. |
Image courtesy of Sira Anamwong at FreeDigitalPhotos.net
|
For example, let us say you are entitled to a $100 payment. If you receive the $100 now and you are able to invest it at a 5% annual interest rate, you will have $105 after one year. Assuming you do not need the money for expenses, it will be worth $110.25 after two years, and so on. This amount is known as the “future value” of the money.
Similarly, you can compute the “present value” of money. Suppose you won’t receive the $100 payment until one year from now. The value of the money must be discounted due to the opportunity cost. Using the same 5% interest rate, the present value of the $100 you will receive a year from now is $95.24 ($100 value divided by 1.05).
It is easy to see how this concept can affect your business. Accelerating payments from customers will enable you to better meet your current obligations and provide reserves for investment.
On the other hand, delays hamper cash flow and reduce the opportunity for investment. Computing the time value of money may also encourage you to lease, rather than buy, assets.
To benefit the most, make time to review your business situation to see where you can increase the time value of your money.
Similarly, you can compute the “present value” of money. Suppose you won’t receive the $100 payment until one year from now. The value of the money must be discounted due to the opportunity cost. Using the same 5% interest rate, the present value of the $100 you will receive a year from now is $95.24 ($100 value divided by 1.05).
It is easy to see how this concept can affect your business. Accelerating payments from customers will enable you to better meet your current obligations and provide reserves for investment.
On the other hand, delays hamper cash flow and reduce the opportunity for investment. Computing the time value of money may also encourage you to lease, rather than buy, assets.
To benefit the most, make time to review your business situation to see where you can increase the time value of your money.
RSS Feed
