TVM (Time Value of Money) is a basic principle in financial studies. It states that the money earned today, or in the present has more value than the money earned in the future. This is mainly because of the earning potential of the money you have today is higher than it will be for the money you earn tomorrow.
In simple terms it means that the value of a rupee today is higher than the value of the rupee tomorrow, just the way the value of rupee was high decades ago. The money you have today has the potential to grow through investing, hence the more you can invest the higher will be the value of money. Another thing to consider is that when a person agrees to receive a sum of money tomorrow rather than today then he/she is effectively lending the money, lending money has its own set of risks like default risk and inflation. These can affect the amount of money you will receive tomorrow.
Today we have a plethora of tools to understand the Present Value (PV) and the Future Value (FV) of money. It is important to understand this concept as you may be making crucial financial decisions without having proper data. Time Value of Money can help you make meaningful financial decisions that can grow your money in the future so for this exact purpose let’s understand some important variables.
Present Value (PV)
This is the money you presently have at hand. If a series of future payments are discounted at interest rate with the time value then what you will be left with is the present value if money
Sounds complicated? To simplify it, just know that the money you have now, minus the future payments and interest rates is the current value of money.
Future Value (FV)
The money you will receive at a particular time in future, with enhancements, is the future value of money. This is the final amount that you will receive at the end of an investment period along with interest rate. The money should be more than what you invested initially.
Example: Suppose you invested Rs.1,00,000 in an FD with an interest rate of 10% the you must receive an extra Rs.10,000 as interest rate on your principal amount.
The number of periods (N)
This is time or duration of your investment. Time value of money changes according to the period of investment, Hence, time plays a crucial role in deciding the value of your money.
Interest Rate (I)
This is the growth rate of your money. Interest is what you get overtime on your investment period. It is the charge against the use of money from the borrower to the lender.
This is a series of evenly spaced cash flows.
So how do I use TVM practically?
TVM can help you make investment decisions. You can calculate the PV, FV and your end amount using TVM. You can compare the worth of cash flows at different point of time. TVM can also help you to approximate the amount of money you will require on making a particular investments and find the worth of your current investments so that you can prioritize accordingly.
You can calculate TVM online on various websites so you can start as soon as you can!