The time value of money (TVM) is the idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity. For example, the idea that one naira today is worth more than one naira in the future, because the money, if received today can earn interest up until the time the future one naira is received. In addition, because of money’s potential to increase in value over time, you can use the time value of money to calculate how much you need to invest now to meet a certain future goal. Inflation has the reverse effect on the time value of money. This is because of the constant decline in the purchasing power of money; an uninvested amount of money is worth more in the present than the same uninvested amount of money will be in the future.
TVM is also referred to as present discounted value. TVM is based on the premise that an investor prefers to receive a payment of a fixed amount of money today, rather than an equal amount in the future, all else being equal. All of the standard calculations are based on the most basic formula, the present value of a future sum, ‘discounted’ to a present value. For example, a sum of FV to be received in one year is discounted (at the appropriate rate of r) to give a sum of PV at present. The concept holds that a specific sum of money is more valuable the sooner it is received. Time value of money is dependent not only on the time interval being considered but also the rate of discount used in calculating current or future values. This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received.
A fundamental idea in finance that money that one has now is worth more than money one will receive in the future. Because money can earn interest or be invested, it is worth more to an economic actor if it is available immediately. This concept applies to many contracts; for example, a trade in which payment is delayed will often require compensation for the time value of money. This concept may be thought of as a financial application of the saying, “A bird in the hand is worth two in the bush”.
References
Investopedia.com (2017). Time value of money. http://www.investopedia.com/terms/ t/timevalueofmoney.asp
Financial-dictionary (2017). Time value of money http://financial-dictionary.thefreedictionary.com/ Time+value+of+money
En.wikipedia.org (2017). Time value of money. https://en.wikipedia.org/wiki/Time_value_of_money
