How time value of money can affect a construction project and its quantum analysis?
The financial atmosphere today is uncertain. Each company is required to act wisely and when it comes to construction companies, they need to act more smartly. They need to consider the time value of money when they choose a project to work on.
Those who are not aware of what time value of money in construction management means, should read this post. They should keep on reading it to understand it, the present value of money versus the future value of money, and how such information can be used to help them make the best choices for business.
Time value of money – an overview
The time value of money is the concept. It explains that an amount of money right now is worth more than the same amount will be worth in the future. Due to the money’s earning potential, it is wise to have cash at hand instead of expecting that amount at a certain date in the future.
Money can grow if and only if it has been wisely invested. Those who delay the investment are losing an opportunity to let the money grow for the future.
Here are the variables considered by the formula for calculating the time value of money:
- The amount of money.
- Money’s future value.
- The amount which the invested amount can earn in the best possible manner.
- Time frame needed.
At times, the time value of money is also referred to as the present discounted value of money.
The importance of understanding time value of money in construction
In all honesty, construction project managers must understand the concept of time value of money. The reason being is that most construction projects have cash flows occurring in the future.
Most general contractors desire making payments at a later date because money in the future costs less than the amount of money today. Meaning, their objective is to keep as much cash as they can. Those who have retention money at around ten percent should know that it will cost them less to pay that amount of money within a year.
The time value of money and evaluation of construction projects often go together. Understanding how much cash needs to be laid out over time, or when to expect a return on investment can help construction project managers, construction claims experts and other construction professionals understand if the construction project work is worth their time and finances.
A comparison of present value and future value
Present value of money and future value are concepts which aid construction managers in deciding whether or not they should invest in a particular project. Both concepts of money are dealing with the fact that the value of money changes over time due to interest, inflation and numerous other factors.
For instance, given today’s exorbitant inflation rate, no one will be able to buy as much as $1000 as they could a decade ago. Meaning, that amount of money has more purchasing power today than it will have a decade from now.
In simple words, the present value of money is what the future’s money is worth today. Whereas, the future value of money is what today’s money will be worth in the time to come. In financial matters, it is wise to consult a project advisory panel before making the investment in a particular project.
Formula for calculating present value of money
To determine the present value of the amount of money a construction company would invest in a project today, they must subtract the assumed interest which will accumulate from the amount of money invested. This can be done by discounting the future payment amount by the interest rate for that time period.
Here is the formula: PV = FVx(1+i)-n
Here are the meanings of the equation’s variables:
- PV = present value of money (original amount).
- FV = Future value of money.
- I = interest rate per period.
- N = number of time periods.
Formula for calculating future value of money
The formula for calculating money’s future value explains that interest is added for the money received upfront. Here is the formula: FV = PVx(1+i)n
- PV = Original amount of money.
- FV = future value of Money.
- I = Interest rate for that period.
- N = number of periods.
Professionals providing expert services in construction usually take the time value of money in consideration because of the uncertain economic climate and industry uncertainty too. The COVID-19 pandemic rocked the whole world negatively and construction companies should be very careful in this regard too.