Understanding the Time Value of Money


Whether you are an entrepreneur or not, money is a very vital commodity in the everyday life of an individual or an organization. Just as the popular adage goes, “time is money”, it is important to understand the value of the time we are in to fully maximize the money at our disposal.

Money and commodities have the same time value, when you understand this philosophy then you know that the bed rock of most of the investments made falls under this notion. In time past, a 100% interest rate wasn’t a new thing in the sense that if you borrow an accessory you can be told to repay it back in its double fold.

Present value discounting is the most common approach used to know the future value of that amount when compared to its present value. While doing this factors, like the duration and discounting factor must be put into consideration.

The time value of money can be viewed in 2 perspectives:

  1. The money received now is of more value than the money to be realized later. This occurs most times because the cash presently can be kept on hold for an opportunity to arise and to be used for it such as investment.
  2. There is a likelihood of paying out money later rather than doing so sooner. For example, long term investments which has its interest rate for that period of time.

Present value of Money

This is a metric for determining the monetary value of a good or the cash itself wherein the future estimated cash flow is converted to the present value today through a process called discounting.

Discounting as a similar pattern to the compounding interest calculation in term of its formula but the difference is whether interest is being paid or received.

The basic formula for determining the present value of money is given by:

PV = FV (1+r)-t

Where PV= Present value of money

FV = Future value of money

t = Time

r = rate of interest

Future value of money

This is also a metric for determining the value of money after a period of time under an interest rate.

The basic formula for determining the future value of money is given by:

FV = PV (1+r)t  

Where FV = Future value of money

PV = Present value of money

r = rate of interest

t = Time

This is a metric that shows the value of an investment grow exponentially if the earnings are reinvested at the same rate but the down side of this is when you take a loan and the future value of that loan matures over the stipulated period of time.

Advantages of NPV of money as it relates with outcome quality

  1. It helps financial analysts know the present monetary value of a commodity such as money when the future estimate of that amount has been given stating the time period and the interest rates.
  2. It helps to show how much value a particular investment is for a company

Disadvantages of NPV of money as it relates with outcome quality

  1. One of the disadvantages of the net present value of money is that it comes with a lot of guessing in terms of the company’s future cash flows and also when determining the cost of capital of the company at a later time.
  2. This metric of estimation cannot be applied when you have different projects which have different life spans.
  3. This method is also not advisable to use when you have different projects with their differences in investment amounts. In details, if you have a project with more net present value, it doesn’t guarantee that such an investment is the best when compared to a project with a low net present value.

Komolafe Timileyin is a passionate entrepreneur that loves to solve entrepreneurial issues. He is also a blogger and an upcoming Engineer.

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