By Brad MacLiver
When a ND pharmacy is considering selling a cash flow instrument such as the pharmacy’s receivables, or a pharmacy business note, the price the North Dakota pharmacy owner receives will reflect how much time is involved before the Buyer/Investor/Funder of the cash flow instrument will recoup his principal investment and the desired rate of return the Investor needs to make it desirable to take the risk of buying the pharmacies cash flow instrument.
To entice an Investor to shift the risk of holding the cash flow instrument from the pharmacy owner in
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Time Value of Money:
The concept of cash being more valuable to have a dollar today instead of tomorrow is based on the Time Value of Money (TVM). Most business people are aware of the TVM and how it is fundamental to both personal and corporate decision making, but to make sure we are on the same page, we will cover the basics of TVM.
TVM assumes that money earns interest over time. Therefore, as the cliché says time is money, and because of this we can compare money at different points in time that have different values and call them equal.
An example: If $2.00 today earns 8% interest, it will be worth $2.16 at the same time next year. Therefore, $2.00 today = $2.16 next year = $4.31 ten years from now.
Using the same reasoning, the reverse case is also true. An investor will refuse to pay $1.00 today for a dollar that won’t be collected until next year, or even 10 years from now. Today’s dollar will be discounted to reflect any risks, inflation, economic conditions, etc.
Along with interest rates and principal amounts, a cash flow instruments such as Pharmacy Business Notes in ND, are originated with a certain time period. The TVM can be looked at, as if it were on a sliding scale. The earlier in time the Note is paid off, the smaller the amount becomes. When the Note is paid early, you don’t get to collect the compounded interest amount, which would have accumulated if you had waited the full time period. The Note has already been written and the terms set. Unlike a loan where the rate of return needed to cover the risk is added to the loan amount. An investor cannot go back to the buyer of your business and change the terms of the note. Therefore, the investor looks at the portion of the note, which is going to be purchased and subtracts the rate of return needed to justify the risk. This is called Discounting. The amount of the discount is contingent on the risk.
Example:
If you sell something for a $3.50 with 11% interest, equal payments received over a 7 year period, you would expect to receive $7.27. However, should the note be paid in full in 3 years you will only have collected $4.79. You are not collecting the other $2.48 because you are no longer risking anything (you are not earning it). If you want an investor to advance you the $7.27, you will no longer have any risk because you have transferred it to the Investor. To compensate the Investor for accepting the risk of holding the note, the Investor will discount the note, and pay you an amount equivalent to the time and risk involved.
The price you receive when selling your note will be the discounted rate according to the basic TVM principals minus the amount that allows an investor to justify the risk.
If a note is a length of 3, or more years, it may be beneficial for you to sell only a portion of the note. Because the payments from a month in the 5th year will hold less value than payments collected this year, it is beneficial to you to only sell the number of months that you need to obtain the cash that meets your current financial needs. You can always sell more payments at a later date if you need additional funds. Determine what cash you really need and we will calculate the number of months we will purchase to meet your needs.
Although it involves a much shorter period of time, understanding discount rates is the same when selling a pharmacy’s accounts receivables in ND.
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