In the small business community, even more so if that business is a micro-enterprise, a persistent problem is the problem of cost vs. value. In this writing I will try to differentiate the two concepts and explain why it is more important to worry about value versus costs.
Costs is the price you pay for goods and or services. Cost is the hurdle point for a project, if you will. That means if a project costs $10,000, then it needs to make at least $10,001 in order to be beneficial to your organization.
Many clients spend more time concerned about costs, than what the value of that project returns to the company.
Value is not what you pay for the project but the value that it returns to the company. If we take our example from before and analyze the results of the project we see that we get a project value of $1.
The way we derive our value is by subtracting cost from, additional income, so to speak. So if we deduct the $10,000 project cost, from our project income of $10,001 then we get $1.
Value, in this instance, in the finance world is known as Net Present Value or NPV for short. Corporations use NPV to determine if a project is worth undertaking.
VALUE VS. COSTS
Knowing how much something Costs is an important, but knowing its value is even more important. Many times micro-businesses miss key opportunities to expand their business by not knowing where and when to invest in a project. Most entrepreneurs spend years working in a small shop struggling to keep the doors open, and picking the wrong projects to invest in. They invest in increasing inventories when they need to increase marketing, the buy more PPC ads when they need to validate their customer. The result is that they spend money in the wrong places and achieve little results. Maybe a small bump in revenue here or there but nothing that increases the value of the company long term.
Using NPV large corporations mitigate this risk by have a stringent and data-driven approach to choosing the right opportunities to pursue. Small Business can do the same, by switching to value based management. That’s not say that small business owners shouldn’t worry about costs, but if the benefits outweigh the costs then you know over time you should increase your company’s cash flows and by virtue its value. Which means more profit, and who doesn’t need that?