What is Time Value of Money (TVM)? And can you make beer puns to make this easier?

Pun alert!

The longer the payment is delayed, the lower the Net Present Value (NPV)

What is Time Value of Money?

Let’s say I offer you $100 right now, or $100 one year from now. Which one would you prefer? Most people pick the $100 right now. This is the Time Value of Money (TVM).

Simply put, the idea basic concept is the $100 bill right now is worth more to you than that exact $100 bill tomorrow, in a week, or in a year. So the value of $100 right now is…$100. But the value of that $100 in one year is less than $100. Why is that?

Think of everything you can do with your $100 bill

With $100 (or a whole briefcase full of them), you can buy malt, hops, equipment, buy an ad, a really expensive glass of beer, or any number of things. If you have to wait to get your $100, you either have to wait patiently to do these things, or you need to find the $100 some other way, perhaps by borrowing it. If you borrowed that money, you’d probably have to pay an interest rate, so by the time you’re paying it back, you’ve ‘lost’ money compared to having it in your hand right now. Remember this borrowing rate, because it’s important in the next post about Discounted Cash Flow (DCF).

Think of inflation

Things get more expensive over time. CocaCola was famously only a nickle for many years, but now a Coke will run you $1 or more. So future money is worth less than current money because all the things you buy with it will be (on average) more expensive.

Inflation is also relevant to DCF, but it will often get built in to other factors.

Think of how likely it is you’ll actually get paid

If someone promised you $100 in 1 year, there’s a chance they may be lying. Even if they’re completely trustworthy, there’s a whole number of things that can happen to prevent them from paying you. They can go bankrupt, they can misplace your information and not know how to contact you, they may pay you late, it’s even possible that in a year, we’re no longer using US Dollars (not remotely likely, but not impossible). All of these factors can be combined into ‘risk.’ Essentially the riskier the entity offering you the $100 bill, the less it’s worth right now. So if your friend who’s bad with money makes the offer, it’s worth less than if your savvy, rich friend makes the offer.

So how does this affect my brewery, bar, or business?

Every day, you’re investing your money. Each time you buy ingredients, a case of beer, new furniture, or anything else, you’re hoping there will be a payoff in the future. You’re spending today’s dollars for the hope of even more of tomorrow’s dollars. But how many of tomorrow’s dollars do you need to make today’s investment worth it? If you’re cellaring a beer that costs $10 today, how much should you charge for that beer 1 year from now? Or what if you don’t have enough money right now to invest in everything you’d like to invest in? This is where Time Value of Money helps. TVM is the conceptual foundation of the ‘Discounted Cash Flow,’ a tool that helps you figure out what all of these opportunities are worth right now.

The next post will dive into DCF and how it pertains to your business.