Business and Financial Functions
An asset is an object of value. It could be a person, a car, a piece of jewelry, a refrigerator. Anything that has a value is an asset. In the accounting world, an asset is a piece of/or property whose life span can be projected, estimated, or evaluated. As days, months or years go by, the value of such an asset degrade.
When an item is acquired for the first time as “brand new”, the value of the asset is referred to as its Cost. The declining value of an asset is referred to as its Depreciation. At one time, the item will completely lose its worth or productive value. Nevertheless, the value that an asset has after it has lost all of its value is referred to its Salvage Value. At any time, between the purchase value and the salvage value, accountants estimate the value of an item based on various factors including its original value, its lifetime, its usefulness (how the item is being used), etc.
The Double Declining Balance is a method used to calculate the depreciating value of an asset. To get it, you can use the DDB function whose syntax is:
Function DDB(cost, salvage, life, period, factor) As Double
The first argument, cost, represents the initial value of the item and it is required. The salvage argument is the estimated value of the asset when it will have lost all its productive value. This argument also is required. The cost and the salvage values must be given in their monetary values. The value of life is the length of the lifetime of the item; this could be the number of months for a car or the number of years for a house, for example. The period is a factor for which the depreciation is calculated. It must be in the same unit as the life argument. For the Double Declining Balance, this period argument is usually 2.
Microsoft Excel provides another method used to calculate the depreciation of an item. This time, the depreciation is considered on one period of the life of the item. The function used is SLN and its syntax is:
Function SLN(cost, salvage, life) As Double
The cost argument is the original amount paid for an item (refrigerator, mechanics toolbox, high-volume printer, etc). The salvage, also called the scrap value, is the value that the item will have (or is having) at the end of Life. The life argument represents the period during which the asset is (or was) useful; it is usually measured in years.
The Sum-Of-The-Years’-Digits provides another method for calculating the depreciation of an item. Imagine that a restaurant bought a commercial refrigerator (“cold chamber”) for $18,000 and wants to estimate its depreciation after 5 years. Each year is assigned a number, also called a tag, using a consecutive count. This means that the first year is appended 1, the second is 2, etc. This way, the depreciation is not uniformly applied to all years.
Year => 1, 2, 3, 4, and 5.
The total count is made for these tags. For our refrigerator example, this would be
Sum = 1 + 2 + 3 + 4 + 5 = 15
Each year is divided by this Sum, also called the sum of years, used as the common denominator:
This is equivalent to 1. As you can see, the first year would have the lowest dividend (1/15 ≈ 0.0067) and the last year would have the highest (5/15 ≈ 0.33).
To calculate the depreciation for each year, the fractions (1/15 + 2/15 + 3/15 + 4/15 + 5/15) are reversed so that the depreciation of the first year is calculated based on the last fraction (the last year divided by the common denominator). Then the new fraction for each year is multiplied by the original price of the asset. This would produce (this table assumes that the refrigerator will have a value of $0.00 after 5 years):
Overall, Microsoft Office uses the following formula to calculate an item depreciation using the Sum-Of-The-Years'-Digits:
The function used to calculate the depreciation of an asset using the sum of the years' digits is called SYD and its syntax is:
Function SYD(cost, salvage, life, period) As Double
The cost argument is the original value of the item; in our example, this would be $18,000. The salvage parameter is the value the asset would have (or has) at the end of its useful life. The life is the number of years the asset would have a useful life (because assets are usually evaluated in terms of years instead of months). The period parameter is the particular period or rank of a Life portion. For example, if the life of the depreciation is set to 5 (years), the period could be any number between 1 and 5. If set to 1, the depreciation would be calculated for the first year. If the Period is set to 4, the depreciation would calculated for the 4th year. You can also set the period to a value higher than life. For example, if life is set to 5 but you pass 8 for the period, the depreciation would be calculated for the 8th year. If the asset is worthless in the 8th year, the depreciation would be 0.
Microsoft Excel provides a series of functions destined to perform various types of financially related operations. These functions use common factors depending on the value that is being calculated. Many of these functions deal with investments or loan financing.
The Present Value is the current value of an investment or a loan. For a savings account, a customer could pledge to make a set amount of deposit on a bank account every month. The initial value that the customer deposits or has in the account is the Present Value. The sign of the variable, when passed to a function, depends on the position of the customer. If the customer is making deposits, this value must be negative. If the customer is receiving money (lottery installment, family inheritance, etc), this value should be positive.
The Future Value is the value the loan or investment will have when the loan is paid off or when the investment is over. For a car loan, a musical instrument loan, a financed refrigerator, a boat, etc, this is usually 0 because the company that is lending the money will not take that item back (they didn't give it to the customer in the first place, they only lend him or her some money to buy the item). This means that at the end of the loan, the item (such as a car, boat, guitar, etc) belongs to the customer and it is most likely still worth something.
As described above and in reality, the Future Value is the amount the item would be worth at the end. In most, if not all, loans, it would be 0. On the other hand, if a customer is borrowing money to buy something like a car, a boat, a piano, etc, the salesperson would ask if the customer wants to put a "down payment", which is an advance of money. Then, the salesperson or loan officer can either use that down payment as the Future Value parameter or simply subtract it from the Present Value and then apply the calculation to the difference. Therefore, you can apply some type of down payment to your functions as the Future Value.
The Number Of Periods is the number of payments that make up a full cycle of a loan or an investment.
The Interest Rate is a fixed percent value applied during the life of the loan or the investment. The rate does not change during the length of the Periods.
It is very important to understand how these two arguments are passed to a function. The period could be the number of months of a year, which is 12; but it could be another length. Suppose a customer is getting a car loan that would be financed in 5 years. This is equivalent to 5 * 12 = 60 months. In the same way, a cash loan can stretch from 0 to 18 months, a carpenter truck loan can have a life financing of 40 months, and a condominium can be financed for 15 years of 12 months plus an additional 8 months; this is equivalent to (15 * 12) + 8 = 188 months. Here is the tricky part, especially as far as Microsoft Excel deals with its finance functions. If you pass the number of Periods in terms of years, such as 5 for a car loan that stretches over 5 years, then you can pass the Rate as a percentage value, such as 8.75%. If you pass the number of Periods in terms of months, for example you can pass it as 44 for a car that is financed in 3 years and 8 months, then you must communicate this to the Rate argument by dividing the Rate by 12. In other words, a Rate of 8.75% would be passed as 8.75%/12. If the Rate was typed in a cell named B2 that displays 8.75%, you can pass it as B2/12.
For deposits made in a savings account, because their payments are made monthly, the rate is divided by the number of Periods of a year, which is 12. If an investment has an interest rate set at 14.50%, the Rate would be 14.50/12 = 1.208. Because the Rate is a percentage value, its actual value must be divided by 100 before passing it to the function. For a loan of 14.50% interest rate, this would be 14.50/12 = 1.208/100 = 0.012.
The Payment is the amount the customer will be paying. For a savings account where a customer has pledged to pay a certain amount in order to save a set (goal) amount, this would be the amount the customer would pay every month. If the customer is making payments (car loan, mortgage, deposits to a savings account, etc), this value must be negative. If the customer is receiving money (lottery installment or annuity, family inheritance, etc), this value must be positive.
The Payment Type specifies whether the payment is made at the beginning or the end of the period. For a monthly payment of an item financed like a car, a boat, a guitar, or a house this could be the end of every month.
To calculate the future value of an investment, you can use the FV() function. The syntax of this function is:
Function FV(Rate, Periods, Payment, PresentValue, PaymentType) As Currency
To calculate the number of periods of an investment or a loan, you can use the NPER() function. Its syntax is:
Function NPER(Rate, Payment, PresentValue, FutureValue, PaymentType) As Currency
Here is an example:
The PMT() function is used to calculate the regular payment of loan or an investment. Its syntax is:
Function PMT(Rate, NPeriods, PresentValue, FutureValue, PaymentType) As Currency
In the following example, a customer is applying for a car loan. The cost of the car will be entered in cell C4. It will be financed at a rate entered in cell C6 for a period set in cell C7. The dealer estimates that the car will have a value of $0.00 when it is paid off.
When a customer is applying for a loan, an investment company must be very interested to know how much money it would collect as interest. This allows the company to know whether the loan is worth giving. Because the interest earned is related to the interest rate, a company can play with the rate (and also the length) of the loan to get a fair (?) amount.
The IPMT() function is used to calculate the amount paid as interest on a loan during a period of the lifetime of a loan or an investment. It is important to understand what this function calculates. Suppose a customer is applying for a car loan and the salesperson decides (or agrees with the customer) that the loan will be spread over 5 years (5 years * 12 months each = 60 months). The salesperson then applies a certain interest rate.
TheIPMT() function can help you calculate the amount of interest that the lending institution would earn during a certain period. In essence, you can use it to know how much money the company would earn in the 3rd year, or in the 4th year, or in the 1st year. Based on this, this function has an argument called Period, which specifies the year you want to find out the interest earned in.
The syntax of the IPMT() function is:
Function IPMT(Rate, Period, NPeriods, _ PresentValue, FutureValue, PaymentType) As Double
The Rate argument is a fixed percent value applied during the life of the loan.
The PresentValue is the current value of the loan or investment. It could be the marked value of the car, the current mortgage value of a house, or the cash amount that a bank is lending.
The FutureValue is the value the loan or investment will have when the loan is paid off.
The NPeriods is the number of periods that occur during the lifetime of the loan. For example, if a car is financed in 5 years, this value would be (5 years * 12 months each =) 60 months. When passing this argument, you must remember to pass the right amount.
The Period argument represents the payment period. For example, it could be 3 to represent the 3rd year of a 5 year loan. In this case, the IPMT() function would calculate the interest earned in the 3rd year only.
The PaymentType specifies whether the periodic (such as monthly) payment of the loan is made at the beginning (1) or at the end (1) of the period.
The FutureValue and the PaymentType arguments are not required.
While the IPMT() function calculates the amount paid as interest for a period of a loan or an investment, the PPMT() function calculates the actual amount that applies to the balance of the loan. This is referred to as the principal. Its syntax is:
Function PPMT(Rate, Period, NPeriods, _ PresentValue, FutureValue, PaymentType) As Currency
The arguments are the same as described in the previous sections.
The PV() function calculates the total amount that a future investment is worth currently. Its syntax is:
Function PV(Rate, NPeriods, Payment, FutureValue, PaymentType) As Currency
The arguments are the same as described earlier.
Suppose a customer comes to a car dealer and wants to buy a car. The salesperson would first present the available cars to the customer so the customer can decide what car he likes. After this process and during the evaluation, the sales person may tell the customer that the monthly payments would be $384.48. The customer may then say, "Wooooh, I can't afford that, man". Then the salesperson would ask, "What type of monthly payment suits you". From now on, both would continue the discussion. Since the salesperson still wants to make some money but without losing the customer because of a high monthly payment, the salesperson would need to find a reasonable rate that can accommodate an affordable monthly payment for the customer.
The RATE() function is used to calculate the interest applied on a loan or an investment. Its syntax is:
Function RATE(NPeriods, Payment, PresentValue, _ FutureValue, PaymentType, Guess) As Double
All of the arguments are the same as described for the other functions, except for the Guess. This argument allows you to give some type of guess for a rate. This argument is not required. If you omit it, its value is assumed to be 10.
The IRR() function is used to calculate an internal rate of return based on a series of investments. Its syntax is:
Function IRR(Values, Guess) As Double
The Values argument is a series (also called an array or a collection) of cash amounts that a customer has made on an investment. For example, a customer could make monthly deposits in a savings or credit union account. Another customer could be running a business and receiving different amounts of money as the business is flowing (or losing money). The cash flows don't have to be the same at different intervals but they should (or must) occur at regular intervals such as weekly (amount cut from a paycheck), bi-weekly (401k directly cut from paycheck), monthly (regular investment), or yearly (income).
The Values argument must be passed as a collection of values, such as a range of selected cells, and not an amount. Otherwise you would receive an error.
The Guess parameter is an estimate interest rate of return of the investment.
The NPV() function uses a series of cash flows to calculate the present value of an investment. Its syntax is:
Function NPV(Rate, Value1, Value2, ...) As Currency
The Rate parameter is the rate of discount during one period of the investment.
As the NPV() function doesn't take a fixed number of arguments, you can add a series of values as Value1, Value2, etc. These are regularly made payments for each period involved. Because this function uses a series of payments, any payment made in the past should have a positive value (because it was made already). Any future payment should have a negative value (because it has not been made yet).
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