Categories: value management
I thought it was time to look at some more financial concepts. Last time I looked at depreciation, and today it’s the turn of Present Value and Future Value.
I write them with capitals because they also stand as abbreviations: PV and FV.
The basic idea behind them both is that they talk about how much an amount of money is worth at any given time. From a project management perspective (and in life in general), it’s better to receive the money now than get exactly the same amount of money in the future. Because of inflation and cost of living rises, £10 today doesn’t buy you what it did 10 years ago. And when I think of what my parents paid for their house…!
If someone offers you £10 today or £10 next year, you’d take it today. And that’s what underpins the concepts of PV and FV.
Understanding Present Value
Present Value is a way of ‘levelling out’ how much money is worth, so you can compare its earning/spending power today and in the future. This lets your calculations account for inflation (or deflation). You can use the calculation to compare cash flow across the lifespan of a project or the benefit cycle, and you’ll be comparing on a more even basis. And by using a standard formula, everyone can clearly see how the information has been reached.
(Note: PV is not the same as Net Present Value, which in my experience is far more likely to be found on a business case. Net Present Value is useful for working out whether a project is worth doing, so it’s commonly used as a metric for project selection. There’s a worked example I found useful for calculating value in projects here.)
Present Value tells you how much the money of the future is worth today.
Understanding Future Value
Future Value tells you how much the money of today is worth in the future. I found this a lot easier to understand than Present Value – it’s pretty easy to understand that with interest and/or inflation, you need more money in the future to buy the same things. Anyone who has seen the cost of newspapers rise will get that basic idea.
For those of you who are interested in what this means for your exam prep, pop your figures into this formula:
PV = FV / (1+r)n
In real life you aren’t going to be calculating this by hand. Your Finance team will do it for you, or you’ll have some kind of project assessment spreadsheet with the formulae built in. The benefit of understanding the formula in your day job is to be able to have informed and intelligent conversations with your project sponsor and colleagues about project cost, and to be able to input into the debate about whether the project is worth doing or not.
A note on NPV
The other thing to know is how all this relates to NPV. NPV, as I noted above, is more likely to be the measure your organisation uses to determine whether to move forward with a project.
Here’s what you need to know, at a high level:
- NPV > 0 — the project is going to be profitable
- NPV = 0 — the project will break even
- NPV < 0 — the project will not be profitable.
You want your project to have a high NPV and you should discourage your sponsor from trying to pursue projects where the NPV is less than zero unless there is a really, really strong business reason to lose money on an initiative!
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