Time Value of Money – Your Money is Worth More NowPerhaps on a long road trip, you too have discussed what you might do if you won the lottery. Sure, you’d pay off your mortgage and buy your mother a car, but inevitably, the discussion meanders into the harder parts of the lottery fantasy. The options are typical to enjoy the instant gratification of the lump sum or defer payment over a period of time, but for reasons of this discussion, let’s assume a third option, which is a choice to receive the money now or to receive the money in five years. The answer often depends upon the type of person you are, but also what you know about the time value of money.
For most of us, the phrase feels vaguely important, but somewhat meaningless without context. Humans are hardwired to look out for the self that exists in the present, in which case we’d all be eligible to receive the money now. At a basic level, the time value of money asserts that, assuming that nothing about the money changes in those five years, it would appear better to have the cash in hand now instead of later. Having your money in hand right now allows you to grow it via real estate, stocks, or other investments. But, while this is the time value of money at its most basic level, there are some intricacies and complications worth noting. Time value of money is a core principle of finance, even if people outside the industry aren’t intimately familiar with it, and it represents significant potential for business owners because of something called factoring–but more on that later.
The case for making your money work
If you have $10 in hand now, it is hypothetically the same as having $10 in hand in five years–or is it? Money doesn’t remain in hands long, instead of embarking on a number of potential futures, which include, among others, spending it, saving it, or investing it. A wise investment may mean that the same $10, over five years, isn’t $10 at all, but much more. And say your money doubles in five years, leaving you with $20. In another five years, assuming your money has the same rate of growth, you’ve got $40–well above your initial $10.
If you’re going to forgo having access to your money, you probably expect something in return. This is true for the individual, but it is especially true for business owners who are dealing with larger amounts of money. Most people wouldn’t lend money to someone without interest, and it is no different when we’re talking about formal investments. Simply storing your money without being able to spend it as you choose probably doesn’t appeal to many–there’s got to be a payoff waiting on the other side. Smart investments help soothe the loss of the immediate gratification of having cash, especially when the time value of money means you’ll end up with more down the road.
Time value of money for companies
Because money has the potential to grow over time, the time value of money works exceptionally well for businesses in which the extra money in hand can be reinvested into the company, resulting in stronger companies that more easily achieve their business goals. Large or even small investments in a business can often pay off more quickly than personal investments due to the profit-driven nature of business and the financial savvy required and displayed by many business owners.
An important consideration in the time value of money equation is inflation, which is simply the idea that everything rises in price over time. Your money ten years ago was worth more than the same dollar amount is worth today. So how exactly can we oppose the inevitable inflation? The easiest and probably most productive way is through investing, which may even exceed the inflation rate, leaving you even more ahead. But to invest, we need that cash in hand.
How the time value of money can guide investment decisions
Obviously, the higher the dollar amount, the more the time value of money stands to make a difference. $1 million, for example, will yield considerably more in five years, and businesses are in a position to deal with larger amounts of money. In these cases, investing the money (and therefore allowing it to essentially be absent for five years) might make sense. Alternatively, you may consider investing the money in your own company (for something like new equipment or a new product). Ultimately, the time value of money can help you determine which decision is more profitable. Will your investments within your company yield the dividends that a safe, traditional investment would? It depends. For large businesses, considering the time value of money can help guide your decisions and grow your business.
If you run a smaller business, it may make more sense to take the cash in hand and invest in your business, since you’ve likely got a good idea of what the future holds. Your potential to grow may be greatly helped by an investment in the business now, rather than putting that same money elsewhere, although, if you can hold off until your money becomes more money through investment, it will almost certainly be worth your time.
There is no one right decision for individuals or businesses of any size. The time value of money equation certainly offers guidance, but your own knowledge of your business and industry should also help inform your financial decisions.
How to invest in your business
Say you’ve got some cash in hand, either because your clients are reliably and mysteriously always paying on time or you’ve taken advantage of all you’ve learned about the time value of money and, with your cash, made some great investments a few years ago. Now, you decide to invest in your business.
Before you jump it, it is important to meet with a financial professional who can evaluate and give advice on your business finances, your personal finances, and what you hope to accomplish as you move forward. This will give you some hard numbers to move forward with, allowing you to better hone in on how exactly you’d like to invest to meet your goals.
Then, you’ll need to strategize about what exactly will help your business in the most significant way while staying within your budget. New equipment, additional hires, and advertising are all great ways to invest that can vary in cost, fitting budgets big and small. No matter the route you decide on, remember that maintaining other investments will allow you to continue to pursue such investments in the future.
How customers utilize the time value of money
Business owners aren’t the only ones positioned to make use of the time value of money, of course. If you, the business owner, send out an invoice to a customer, they frequently don’t pay you immediately upon receiving it. They’ll likely sit on it for a few months, taking advantage of the time value of money by keeping cash in their own hands.
What does this mean for you? The time value of money works against you here–you’ve completed your service, but are at the hands of your customer. Until they pay up, you can’t invest in your business or anything else.
How you can utilize the time value of money
To make the most out of your dollars, make them work harder. With the money that you’ve got in hand, you can increase your savings for your business and yourself, ensuring a comfortable retirement down the road. If you invest wisely, this money will work for you even after you’re no longer working yourself. The earlier you invest, the more money you stand to make. Even though investing can feel scary because of its volatile nature, there are smart, safe ways to invest that offer less risk and good, stable rewards.
For business owners, purchasing power is also important, and it often decreases as inflation occurs. Your money buys more today than it will in 15, 30, or 50 years, so spend reasonably to provide future security.
An easy way to make investment possible
As we discussed, customers don’t hesitate to use the time value of money by keeping it in their pockets for a month or two. But money in their hands, especially after you’ve completed a service, means less money is yours. While most customers aren’t intentionally delaying payment, life gets in the way.
Luckily, Sekady is here to make paying invoices easy for you through factoring, a simple process that leaves the hassle of invoicing to someone else, getting you paid quickly and easily. Learn more on our blog, or contact us today!
