Time Value of Money
Time value of money is the concept of finance which describes the greater benefit of receiving money today rather than later. It is abbreviated as TVM. Time Value of Money principle explains why interest is paid or earned.
Time value of money gets affected by external market behavior or economic condition such as inflation or deflation. It is very important for a company to understand the idea of time value of money as it helps in taking critical decision of investment options. Incorrect decision will directly impact the company’s bottom line.
There are many reasons why future cash flows are worth less than current or present cash flows. For example if a firm does not have money at present will lose the opportunity to earn additional income in future. Also, receiving money in the time ahead preferably than now may bring in some risk and variability about its recovery. Time value of money concept tries to estimate the of cash flows while making financial decisions over different time periods and then convert them into present value and future value.
Time Value of Money principle is commonly in financial management to understand the financial impact of the timing of cash flows in business decisions.
Following terms are used while calculating TVM.
1.Present value : It is the amount of money in today’s date
Present Value = FV / (1 + i)n,
2. Future value: It is the future worth of the money invested today.
Future Value = PV * (1 + i)n
Where i is the interest rate and n is the number of time periods.