| There is a frequent diversion between value and cost | | | | Another way of looking at value and cost is to regard |
| when it comes to meaning in a business context and | | | | a transaction from the point of view of the seller - the |
| we need to understand how value relates to what an | | | | seller has a price they are prepared to accept from |
| asset should cost. When is cost irrelevant and value | | | | you as the buyer. To the seller, the price they receive |
| more meaningful for use in a business decision? How | | | | is the value they place on the asset being sold. The |
| do you use value as a concept for basing purchasing | | | | buyer will look to increase the value of that asset to |
| decisions on rather than the hard, accounting numbers | | | | realize further on in the process, and this brings time |
| which a set price or cost gives you? | | | | into the equation. |
| Defining Cost | | | | Net Present Value and Internal Rate of Return |
| Cost is defined in numerous ways but, for practical | | | | Time passing impacts value - a dollar today is worth |
| decision making it typically is the price paid to acquire | | | | more than the promise of a dollar in a year's time. The |
| an asset. This is certainly what an accountant would | | | | reason is because of the operation of risk - how |
| consider to be cost, though we should note that cost is | | | | certain are we that a dollar will be paid to us at a |
| not just the price to buy an asset it is also the | | | | future date? Nothing is certain which is why the value |
| associated costs to put the asset into effective use | | | | of a dollar today has got to be worth more than the |
| within the business. In this case, cost includes the asset | | | | promise of a dollar paid to us at any future date. |
| price, the cost of transportation and implementation | | | | Inputting risk and time into the present value concept |
| along with costs of training how to use the item. | | | | gives us Net Present Value (NPV) and Internal Rates |
| Defining Value | | | | of Return (IRR) techniques for evaluating asset |
| This is a difficult concept to define compared to cost. | | | | purchases. |
| What should cost x may in fact be worth y and the | | | | These techniques attempt to show the true value in |
| two numbers are going to be very different. A way of | | | | today's terms of what an asset purchase means to |
| defining value of an asset has been taken to be what | | | | the business. In this respect, cost or price is not |
| someone is prepared to pay for the asset. Thus the | | | | important as the determinant, but what value will be |
| market definition of cost and value are the same. | | | | created by your use of the asset which is being |
| However, rational decision making implies that a | | | | bought. Negative NPV or below-threshold IRR mean |
| business does not simply buy an asset which will | | | | the project should not be pursued, but more |
| simply maintain its value, but that the business is using | | | | importantly, they give us a tool to compare multiple |
| the asset to create something more valuable. In this | | | | projects which are competing for the limited resources |
| instance, do you value the asset at what you paid for | | | | of our businesses. |
| it, or do you value the asset at what it is worth to | | | | Next time you look at a quote for work to be done, |
| you? | | | | cost is going to be a headlining issue for you, but the |
| This is the concept behind what economists term, | | | | real question you should be asking is not how much |
| "present value" - the actual economic benefit of an | | | | cost this will incur, but how much value will be created |
| asset to your company. | | | | by acquiring the asset in question. |