Net present value (NPV)

Net present value (NPV)

Net present value (NPV) is the value today of future cash flows from a project, minus the cash you invest. It discounts each cash flow using a chosen rate to reflect risk and the time value of money. A positive NPV means the project is expected to create value; a negative NPV suggests it would destroy value.

Small businesses use NPV to compare investments like equipment, product launches, or contracts. The discount rate usually reflects your required return or the return you could earn elsewhere. Because money now is worth more than the same amount later, earlier cash flows count more in NPV.

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Simple example

Pay 1,000 today and expect 600 in one year and 600 in two years. Using a 10% discount rate (used here as a constant for this example), the NPV is about 49, so the project slightly adds value.

You can test different scenarios by changing the discount rate or the timing of cash flows. If the project is financed, include loan payments as cash outflows in the calculation.

Key inputs that drive NPV:

  • Expected cash inflows and outflows (use cash, not accounting profit).
  • Timing of each cash flow (earlier is more valuable).
  • Discount rate that reflects risk and your required return.
  • Project length and any final resale or salvage value.
  • Taxes and working capital changes if they affect cash.
  • Consistency between cash flows and rate (both nominal or both real).
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