Lump Sum Versus Payments
When looking at business finance and management, it is important to understand the distinction between lump sum versus payments. As the name implies, lump sum payments are paid at the beginning of a financial transaction. The value of each transaction is different depending on the individual situation. For instance, the cash value of a short sale transaction is based on the time value of money; a typical security will be based on the present value of cash flow over time. Because cash is an integral part of the value of any transaction, cash payments are a popular choice for many financial managers and investment professionals.
On the other hand, when comparing lump sum versus payments, you must also compare the amount of equity owners have in their businesses. When owners put their money into a business, they do so in part with the expectation that their profits will be used to pay off their outstanding obligations. However, if the company’s assets are simply sitting there without any significant profit potential, then there will not be any significant equity built up. If a company has purchased goods or services from another firm that has liquidated its accounts, then owners could lose the entire value of what they have invested in the company.
When comparing lump sum versus payments, it is also important to take into consideration the effect of dilution on capital structure. Dilution refers to the gradual loss of value that occurs as financial obligations spread out over time. For example, suppose you financed a major construction project for a town hall. Over the course of several years, the amount of debt acquired, the number of working phases, and the length of time the project was expected to run could have diluted the initial capital structure. In order to protect the capital structure and ensure the success of the group project, the town hall should have received a set amount by the end of the initial period of time that the project ran.
This would have been a good choice for the town hall because it would have ensured that enough money was available each year to pay off its obligations. Unfortunately, this option does not work well when comparing lump sum versus payments. The number of years it takes to pay off a debt will have largely hidden costs. After all, a single payment may initially look lower, but it will eventually have to be made with interest and fees tacked on.
In addition to this, the value of each individual payment will be much less than the total value of the payments over time. If the town hall receives three separate payments instead of one lump sum payment, then the annual cost of paying the debt will be much higher. It would be more efficient and economical for the town hall to receive a payment plan that pays the debt off once a predetermined number of years has been reached. Once the predetermined number of years has been reached, then a payment can be made in one lump sum, with interest and fees included.
It is easy to see how payments work when you consider them in terms of flexibility and convenience. When someone wishes to sell their house or other property, they will almost always opt for a lump sum payment. This allows them to pay the entire debt off quickly, with one single payment. When choosing to pay in this manner, it is important to factor in the cost of interest. If the payment amount is too low, then the owner could end up paying an exorbitant amount in interest over the years. When you calculate the costs and benefits, it makes sense to shop around for the best value of your lump sum payment.