Time
is precious, and keeping in mind that a small part available today is more
important than a wholesome time available in the coming days. This suggests
that the value of money is counted by time.
Time value of money
For instance,
if you have bought 1-kilogram of silver coin for INR50 per gram 3 years before.
Today, silver is INR40, which means that your silver coin has decreased in
value. However, you can consider it otherwise, too. It is suggested to
concentrate on the present market value rather than the future value in
business.
Thus,
the time value for money is marked as the money available with a person
currently. Only the available money can be invested in the business for growth,
raw material purchase, payment of salaries, and more. The money due in the
coming time is just mentioned on the paper and it doesn’t add value to your
current money holding.
Time
value of money, also known as TVM by financial experts can be measured through
three parameters:
·
Inflation: It lowers
money’s purchasing power as the cost of goods and services rises. In short, you
can use the same money to buy lesser goods in the coming time.
·
Opportunity cost:
It is the loss and profit linked with investments made due to the money
commitment in another investment in a given time.
·
Risk: It is about
every investor's risk involved in investment.
Significance of Time Value of Money
·
The money you
have with you can help you invest and grow your business.
·
The time value of
money helps you evaluate the debt born by the business.
·
The future is
unpredictable, and hence, the time value of money in finance plays a major role
in handling finances and generating revenue from the business.
The formula of the time value of money:
FV = PV (1 +
(I/N)) NT
·
Where n represents
the years of compounding period
·
T represents the
number of years
·
I represents the
growth rate
·
PV is the present
available cash
·
FV is the future
value you will have
Concept of Time Value of Money
There
are two concepts, both are explained below:
·
Single-time
payment
Suppose
you invest 12000 INR for 4 years on a yearly interest of 10% and let it
compound. The future value of the next 4 years can be quickly estimated through
the simple interest formula. Add each rate to the principal to calculate the
simple interest for the next year, and you will get the cumulative interest.
Say,
you get a total value of 14000 at the end of 4 years.
But
the point here is, is your INR 12000 worth your INR 14000? It relies on several
factors such as inflation rate, interest rate and risks linked with it. If the
inflation is more, then you are at a loss. If the interest rate has fallen, you
are again at a loss. Hence, there isn’t any assurance that the 14000 you get
after waiting for 4 years is a profit for you or not.
·
Doubling the time
Let’s
consider an example to demonstrate when the time value of money can multiply
twice. It can be achieved by using rule
of 72. Considering the above example
of investing INR 12000 for 4 years at an interest of 10%, it may take around 8
or 9 years to double this money.
So,
the TVM is based on the concept that businesses should think about the money
they have in hand, not what they will have in the future.
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