The (TVM) time value of money is the main concept in financial management. Moreover, the time value of money (TVM) includes the concepts of future value and discounted value. Therefore, a financial professional must know and operate the specific techniques of the time value of money.
The time value of money is an important financial concept, declaring that the current value of money is worths higher than its future value, given its potential to earn. Here, I will give you a detailed insight into the time value of money in a financial management.
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The time value of money is the concept that the sum of the money is now worth more than the same sum will be at a future date due to its earning potential in the interval.
Time value of money is based on a simple principle that a rupee received today has a greater value than a rupee received in future.
The time value of money is a crucial concept because if an individual invests a sum of money it can grow over a period of time. Investing in a savings account is an even better idea to earn compound interest. On the other hand, if an individual didn’t invest money it will only lose value because of inflation and loss of earning potential over time. Just take an example of yourself and think, are you able to purchase the same things for $ 50 now, which you purchased 10 years ago? You surely answer no, because this is what is called the time value of money. Therefore, a financial professional must know and operate the specific techniques of TVM.
PV = present value of money
FV= future value of money
I = Rate of interest or current yield on similar investment
T = No of years
N = No of compounding period of interest each year
Present value is the value of money you held today. It also presents the value of the sum of all future cash flow from an investment. The future cash flow is discounted at a discount rate. A lower discount rate suggests a higher present value of the future cash flow and vice versa.
Future value is the value of an investment at the end of the investment duration. Usually, it is expected that future value should be greater than that of present value because it grows over time and earns interest. So, for example, you can determine the future value for round sum investments and recurring investments like SIPs.
The time value of money concept detects the potential earning capacity of an amount in the future. It, therefore, help different financial sector to understand and compute the present value and compare the same with the future value of the particular amount. Then, based on the result obtained, they decide whether to invest in a specific asset, venture, or security.
Five components of the time value of money are.
Interest rate is the rate of return received during the lifetime of an investment.
It refers to the number of time periods for which we want to calculate a sum’s present or future value. These time periods can be annual, semi-annually, weekly, monthly, quarterly, etc.
We obtain the amount by applying a discounting rate on the future value of any cash flow.
We obtain the amount of money by applying a compounding rate on the present value of any cash flow.
Installments represent the payments to be paid periodically or received during each period. Therefore, the value is positive when payments are received and becomes negative when payments are made.