If you won Prize money of, let’s say, Rs. 25,000, and you have alternatives to get the money. The First one is to get Rs. 25,000 in cash right now, and the second option is to get Rs. 26,250 after a year. Now, the general response will be to take the Rs. 25,000 right now. Because you can do much more with the Rs. 25,000 now than the Rs. 26,250 in a future date. This happens due to various factors like the returns you are getting on the previous example after waiting for a year is around 5% which is less than the average rate of inflation, i.e., 6-7%. This reduces the value of the money. What you can do with Rs. 25,000 right is much more than 26,250 in a year because money loses value with time.
Meaning Of Time Value of Money (TVM)
The time value of Money invesments refers to a basic financial concept that indicates that the amount of money today is worth more than the same amount in the future.
Let us understand this with another example, considering in the business, you are entitled to receive Rs. 50,000 from a customer. And you have two options, either to ask him for the payment right now or give him credit. Although businesses provide goods on credit to their customers, looking from a monetary perspective, getting cash right now is more beneficial than getting it after a year. Because that Rs. 50,000 won’t hold the same value as time passes.
This is called the Time Value of Money (TVM) in finance, also sometimes known as the Net Present Value (NPV) of money.
Formula to Calculate TVM:
When talking about the Time Value of Money, two important calculations happen, the present value and the future value of the money.
Present Value:
In Lehman language, present value is the current value of the amount that will be received in the future.
The formula to calculate the Present Value is:
Present Value = Future Value (1+i)n
Here ‘i’ is the rate of discounting, and ‘n’ is the amount of period.
Future Value:
This refers to the value of an amount of money at a future date.
Future Value = Present Value (1+i)n
Here ‘i’ is the rate of interest at which the investment is done and ‘n’ is the period.
The Time Value of Money is a financial concept applied in various areas of finance like Loans, EMIs, and Bonds. It is a very useful concept for both businessmen and individuals.