Some people will imply that a dollar is worth a dollar whether you get it today, next week or next year. These people are often the ones who are behind in making payments.
The concept of Time Value of Money disagrees with this idea. This concept says that the value of money is worth more today than in the future. Some reasons for this include:
- Money that you or your business currently has can be invested, providing the opportunity for growth by earning interest. Any time that payments are delayed the amount of time potential interest can be earned is reduced.
- On the other side of the coin, delayed payments can result in a cash shortage in your own business requiring you to borrow money to meet your own obligations. This results in interest being paid to a lender. In some situations, you may not be able to make purchases that are critical to your business which can result in lost sales and unsatisfied customers. All of these can have damaging effects on your bottom line and your overall business.
- Inflation needs to be considered as well. Will the dollar received in a year have the equivalent purchasing power that it has today? Likely not. Although occasionally prices on specific items may go down, overall prices continue to rise.
For these reasons it is so important to consider the Time Value of Money when making business decisions, especially credit decisions.
Although trying to calculate the overall impact of delayed payments may be challenging, there are formulas that can help you calculate reasonable and generally accepted numbers. You can find many of them on the internet.
Remember, today’s dollar may be worth only ninety cents next year.
by Jo Anne Mills, CCE, Deseret Book Company