Welcome to the fourth episode of the Engineering and Leadership podcast! This episode digs into why understanding money is incredibly important for engineers, and goes into the most important thing to know about money.
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I hope you enjoy the show!
Welcome to Episode 4 of the Engineering and Leadership Podcast, a show dedicated to helping engineers and engineering teams thrive through mastery of business, management, and leadership.
Head on over to engineeringandleadership.com/getstarted for a free 12-part mini-course on how to become an engineering leader. It offers easy-to-implement, actionable steps to help jumpstart your abilities as a leader. That address again is engineeringandleadership.com/getstarted.
In today’s episode, you’ll learn why money is important for engineers, and the most important thing there is to know about how money works in the world of engineering.
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Hello everyone and welcome to Episode 4 of the Engineering and Leadership podcast! I’m Pat Sweet.
On today’s show, it’s all about money.
In fact, the whole month of February was dedicated to money, finance, and accounting for engineers.
I’ve written all sorts for you over the last few weeks, but if you have any ideas on what you’d like to hear, just go to the show notes at engineeringandleadership.com/episode4
Today, we’re going to dig into why an understanding of money is so important for engineers, and the concept of the time value of money.
Why should engineers learn about money?
It may seem like finance and accounting are a bit outside of what an engineer should care about. If we have accountants and financial analysts, why would an engineer ever need to worry about money?
Well, as it turns out, there are plenty of reasons why an engineer should care about money. In the last few years, it’s become more and more clear to me how valuable it is to know how money works in a business.
For example, understanding money can help you:
- Make smarter design decisions
- Make your businesses more successful
- Make your clients happy
- Differentiate yourself from your peers and get promoted faster.
I can think quite a few examples of where I was thankful to have a solid grounding in the world of dollars and cents:
- project management,
- trade off studies,
- bids and project proposals,
Money is important to all of these areas.
If you want to move into management one day, you’ll need to know how to budget people’s time and other resources. Time and stuff have a common denominator: money.
Let me be clear – money is not all that is important in this world; however, it is the lifeblood of a business, and one of the most important measures of its success.
When you run out of money, it’s game over. On the other hand, a profitable company is able to keep its doors open, employ people, and do some good in the world. Sweet.
The time value of money
The first, and most important thing that you need to learn about money is that it’s value is dynamic.
A dollar today does not carry the same value as a dollar tomorrow.
This is referred to as the time value of money. This is probably the most important thing to know about money for an engineer, especially when it comes to evaluating something like the life cycle cost of a design.
For example, does spending more on high-grade insulation for a new building today save enough money down the road to justify the initial expense?
Every situation is unique, but understanding that the value of money fluctuates as a function of time is super important in making this kind of assessment.
Discount rates and interest rates
For now, I’d like to keep things simple and just say that an interest rate at which money changes value in time.
Think of your savings account. It has an interest rate that tells you how fast your money will grow in the future.
It’s the same idea here. There’s a lot that goes into trying to decide what the “right” interest rate is when doing certain calculations, but we won’t get into that now. If you ask your company’s accounting or finance department, they’ll be able to tell you what rate your company uses.
Also, you may have come across the term “discount rate” in the past. In reality, there’s no difference between a discount rate and an interest rate. You use the same number in the same places in financial formulas.
When you look forward to see how money you have today will grow in the future, you call it an interest rate.
When you look backward to see how much less a future value is in today’s dollars, we call it a discount rate (i.e. you “discount” the future value by a certain amount to determine it’s present day value.)
This will all make a bit more sense once you read through the following sections 😉
An example – Solving for the future value of $100
The most general formula for relating money in the future and money in the present is this:
FV = PV(1+i)^t
- PV = Present value
- FV = Future value
- i = interest rate (normally some decimal between 0 and 1)
- t = time
So, let’s say that you give me $100 today. If I invest that $100 for a year at 5% interest, what would the future value of that $100 be?
- FV = 100*(1 + 0.05)^1
- FV = $105
So now we can see that $105 a year from now is equivalent to $100 today. Why? If you give me $100 today, I can turn that into $105 in a year’s time. If you gave me $100 a year from now, that wouldn’t be as good for me as giving me $100 today, because I would have lost the opportunity to invest for a year and earn $5.
Solving for the current value of multiple future payments
Often, we want to know if payments we receive in the future are going to be worth some sort of investment today. In order to do that, we need to figure out when the future payments will be, and how much they will be.
Then we can compare the present value of those future payments to the initial cost. If the present value of the future payments is greater than the initial cost, then the investment today is a good one. Otherwise, it’s a bad investment.
This is the essence of Net Present Value analysis.
Let’s look at an example:
Say you could spend $100 today in order to save $40 in energy bills each year for the next three years. Do the savings make the initial investment worth it?
To start, we have to remember that we can’t just say $40 + $40 + $40 is $120, which is more than the initial $100 and is therefore a good investment.
This approach is wrong because we haven’t accounted for the time value of money for the future savings.
None of the $40 savings will be worth $40 in today’s dollars, therefore we need to transform them into today’s dollars to be able to compare the savings to the initial investment.
Let’s say we’re using an interest rate of 10%. Using the formula from above, we can calculate the present values of the three future payments independently, add them up, and see what the total savings are in terms of today’s dollars.
PV1 = 40(1 + 0.05)^-1 = $36.36
PV2 = 40(1 + 0.05)^-2 = $33.06
PV3 = 40(1 + 0.05)^-3 = $30.05
Total savings in today’s dollars = $36.36 + $33.06 + $30.05 = $99.47
So, in this case, the initial investment of $100 isn’t worth it because we will only save $99.47.
Using this in engineering
The concept of the time value of money comes up all the time in engineering. I work in the rail industry, and something we talk about all the time is whether it’s worth it to implement more advanced and more expensive subsystems on our trains in order to save us some energy or maintenance cost down the road.
Another example is in research and development. When you set a budget for R&D, you hope to see that the work you do today will result in either better sales or lower costs in the future – both result in increased profits for a company. In order to determine if the increase to profits is enough to justify running the R&D project in the first place, you need to take into account the time value of money.
Putting it into practice
The challenge this week is to sort out for yourself how you might actually put this knowledge into practice.
This is the part of the show where I read your mail, comments, tweets and messages and answer your questions. I promise to read everything you send me, and I may even share your note on the podcast here.
Khansa wrote me an email recently asking about cost-effective professional development:
Hope you are doing well. I had contacted you few years back asking you about online options for Masters in Engineering.
You suggested I go through Coursera and edx to see what I would like to study and then look for online universities. I have done that but the online universities are pretty expensive; their fees sometimes even more than but definitely at par with the on campus fees although I am not using the campus.
On the other hand people with an accounting or finance background can easily study at home and do certifications like CFA, CPA, CMA etc which cost next to nothing, are better than just any Masters Degree, and are recognized all over the world. Don’t we engineers have such certifications which are well recognized, require home study and give an exam at a proctoring center and be done with it?
These are fantastic questions, Khansa!
With respect to cost-effective, globally recognized certifications, there are a a few that are of interest for engineers.
The one that is most common among engineers is the Project Management Professional (PMP) designation that is provided by PMI. Many engineers work in project-based environment, and knowing how to manage projects is very useful.
Many professional associations have their own designations. For example, you can get designations in energy management, systems engineering, engineering management, risk management, etc.
Probably the most important question is to know what you’re interested in. What field would you like like to investigate? What are you passionate about? If you know that, then you can look at what industry training there is.
Wolfgang, Khadija, and Pratik ALL wrote me emails in the last week suggesting I tackle topics on helping engineers know their value in the market place and how to actually get a salary to reflect that value.
I thought that was an excellent idea and that it fit really well with the theme of the month, so I went a head and wrote an article for you called the Ultimate Engineering Salary Guide. Go check it out!
Thanks very much for the suggestion!
Finally, Deepali left a comment on the blog post “How to leave that corporate job that is making you miserable”:
Sir, I am in 3rd year of Computer Science engineering. But I am no more interested in it. I want to go for journalism. Journalism is something which gives me happiness. Also, I am a poet. I have written poems which have been praised by many. But, my passions are no where related to my degree. What should I do? What are the options available if I quit my college?
Deepali – This is a very good question.
I think this is something that many people struggle with. I would say that it’s OK to change course as you grow and realize what you are interested in and what makes you happy.
If you’d like to become a journalist, then that’s great. However, how do you know you love journalism? Have you ever worked as a journalist? If not, I highly recommend you try and get some experience as an intern or something before switching course. Otherwise, you risk running into the exact same issue you’re in now.
As for poetry, I recommend you keep writing and sharing your poetry, even if it’s not a full-time job. It’s amazing how much work you can produce in your spare time. If you want, you can even self-publish a book and sell it yourself. You don’t need anyone else’s permission to create and distribute your art – just do it!
Thank you very much to everyone who writes in. If you have something to say, just head-on over to Facebook.com/engileader and leave me a note, or go to engineeringandleadership.com/episode4 and leave a comment.
Up next, the engineering toolbox.
The engineering toolbox
In this part of the show, I’ll share with you some kind of tool or resource that I use that I find super helpful in my own engineering career, and that I think you might also find helpful in your quest to become an engineering leader.
Today’s useful resource is PDHengineer.com. This is a website I’ve used for years for professional development. They have an incredible amount of material here to teach you almost anything related to engineering. What’s best is that the courses are recognized by many engineering jurisdictions for professional development hours, so your employer might just foot the bill for you.
If you enjoyed this podcast and are interested in developing your own business skills, I highly recommend you check these guys out. Just go to engineeringandleadership.com/businessskills to see the available courses.
Again, that’s engineeringandleadership.com/businessskills.
That’s all the time we have for the show today.Like I said, last month was all about money for engineers.
If there anything you’d like to know about, I’d love to hear about it! I’ve already heard from some of you about wanting to learn more about engineering salary expectations, which is why I wrote an article about it here. If there’s more you’d like to hear about, just leave a comment at engineeringandleadership.com/episode4.
If you enjoyed the show, it would be awesome if you subscribe to it and leave a review on iTunes for me. If you have any ideas or thoughts on how to make the show better, please let me know that too!
Don’t forget to head on over to engineeringandleadership.com/getstarted for your free course on becoming an engineering leader.
Until next time, take care and we’ll talk again soon.
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