In the world of IT we like to make up new acronyms all the time. Outsiders often don’t fully understand what our acronyms stand for and so they feel like they don’t know what’s going on. Well guess what, other departments in your company can do the same thing and it will make you feel like you don’t know what’s going on. How about if we talk about ROI and what it really means…
What Is The Time Value Of Money?
Money is money, right? It comes as a bit of a surprise to many IT managers that the value of money changes over time. No, we’re not talking about something complicated like inflation. Rather we’re talking about one of the simplest concepts in finance that the rest of the company already knows.
It comes down to a very simple phrase that everyone already knows. “A dollar today is more valuable than a dollar tomorrow.” What this means is that the longer that you have money in your hands, the more valuable that money is in comparison to money that someone has promised to give you at some point in time in the future.
In the world of business, the rest of the company likes to talk about what they can get money to do for them. In order to have conversations like this, they talk about what is called the return on investment (ROI) that they can get for the money that they have. A simple way to calculate ROI is to take a look at what you spent on something and then subtract that value from how much you ended up selling / making on the thing that you spent money on. The difference is often called the ROI.
How Do You Calculate A Return On Investment?
The problem with calculating ROI this way is that it’s not really providing you with a true estimate of the return on your investment. The reason for this is because it fails to account for the timing of cash flows.
In order to calculate the true value of money by taking in the account of when you are getting that money, then you need to provide some additional information. You need to know 3 of the following four values in order to calculate the fourth value:
- Present Value: This is the value of the money that is being discussed today.
- Future Value: This is the value of the money that is being discussed at a specific point in time.
- Periods: This is the number of periods of time between now and when you want to measure the future value.
- Rate: This is the interest rate that you could get if you took the money today and put it in to an interest bearing savings account.
There are a number of different ways to calculate this value, the easiest way is to use a calculator, an Excel spreadsheet, or just use an online tool to calculate the value that you are looking for.
What Does All Of This Mean For You?
In order to be able to interact with other parts of the company, IT managers need to be able to speak the same language that they do. One important term that is used a great deal is Return On Investment (ROI).
Money has a different value depending on when you can get your hands on it. Money that you can get today is more valuable than money that you can get tomorrow. In order to be able to determine the value of money at any given point in time, you need to know how to calculate ROI. The correct calculation of an ROI requires that you know the present and future value of the money, the number of periods involved and the interest rate.
The company that you work for is always trying to get the most for its money. Because of that, it has developed a vocabulary around how it wants to talk about money.
As an IT manager, because you are part of the company, you need to learn how to use the language that the company uses to talk about the money that your IT team needs in order to do its work. This will include having a good understanding of what return on investment means and how to calculate it.
Most IT professionals don’t know that much about the time value of money. Take the time to learn how to determine the true value of money at any point in time and your value to the company will increase dramatically!
– Dr. Jim Anderson
Blue Elephant Consulting –
Your Source For Real World IT Management Skills™
Question For You: Do you think that including a discussion about the ROI of your project would improve its chances of being funded?
P.S.: Free subscriptions to The Accidental IT Leader Newsletter are now available. Learn what you need to know to do the job. Subscribe now: Click Here!
What We’ll Be Talking About Next Time
The good news is that IT managers are often able to quickly wrap their heads around the concept that a dollar (or a euro, or a rand, or a…) in an IT budget that they are given today is more valuable than a dollar that they are given tomorrow. However, things get a bit more trickery when we try to determine the net present value of money that we might get tomorrow…