Time-value of money is a big consideration when it comes to making a decision. When you have a business, this will be one of your areas of focus before you make a financial move. Understanding this concept and putting it into action will help you ensure financial success.
What Time-value of Money Means
Time-value of money is an idea that because of interest, invested money goes up in value over time. Another way to put it is a bird in the hand is worth two in the bush. If you can invest in the bird that is in your hand, it can work for you. Money has future potential, much like the two birds in the bush. If you put your money in an investment now, it could be more valuable later on if you make good decisions.
Investments Grow Over Time
A wise investment will grow over time. For example, a savings account with a 3% annual interest rate will be worth $1,030 in one year. If interest is compounded more frequently, your total will be a little higher at the end of the year. If you have access to daily compounding of interest, you’ll get the best possible return. Not all banks offer this type of return.
Why Time-value of Money Is Important
Most business owners aren’t funding big savings accounts. Instead, they’re investing in their businesses. You have to decide what is a priority and what can wait a while. You prioritize the items that have the potential for the most growth. You’ll have to make decisions on buying assets, launching products, opening new locations and more. Every decision you make will have a financial time-value money aspect to it.
How Is Time-value of Money Important?
Time-value of money is important in all aspects of running a business. If you’re budgeting for a capital investment, it helps you manage your cash flow. It also influences decision-making for personnel, supplies, purchasing and accounts receivable. It will play a role in every decision you make, from the small ones to the big ones. For example, you may have to decide on whether or not to offer items on credit to customers. If you provide a service, and the customer doesn’t end up paying, you’d have to go to court to get your money. The time-value money decisions also play a role in the pricing of your products and services.
You will also need to consider the time-value of money when buying on credit from your own suppliers. Cash flow will be part of your decision, as will your ability to negotiate pricing. If you can get a discount to make it worthwhile to purchase equipment without credit, and you have the cash on hand, that’s an excellent option. However, most business owners need to keep their cash liquid. If you’re one of those business owners, you’ll have to negotiate a good loan term and interest rate for the purchase of what you need.
Deciding on Buying Versus Leasing
Acquiring new equipment impacts your cash flow. On the other hand, new equipment that replaces old, slow or obsolete equipment could boost your production or expand your range of services. You’ll have to balance these issues. Some questions to ask yourself include whether or not a down payment is required, what the interest rate is, how long the loan term is and how long it will take for this purchase to impact your sales and profits. If you take this opportunity, will you be disappointed if you can’t afford to take the next one? As a small business owner, you may have to lease some items and buy others.
Analyzing Time-value Money With a Total Cost Approach
A total cost approach is a good way to decide on a time-value money decision. It involves adjusting income and expenses for each option. You then compare them. Any outcome with a positive net is a good choice. The greatest net will be the most profitable for you. This is also true for hiring someone. There are costs for hiring and training, and it takes a while for a new hire to get up to speed. You will have to pay them wages, benefits and maybe bonuses. As a for-profit business, time-value money will be a huge consideration for every decision you make. Even non-profit business owners have to take into account time-value money. Donations are limited, and grants are competitive. There’s no guarantee that your income will increase next year, so you have to plan carefully.
There’s a risk to making decisions based on assumptions about the future. However, that’s what a risk is. You use the best information you have to drive your decision. A data-driven, objective approach is what you need to use. Time-value money helps you prioritize and gain insight for the decision-making process.
