The most important topic in finance is time value of money. Someone said that time is money, and I truly believe in it. Why it is important to know the value of money? I will try to answer that in this article. Money is measure of value. It is a mode of exchange to buy something from the seller. Consider you have won a lottery of 1 million dollars, but the amount will be credited to you next year. How will you feel? You will feel like you are loosing the opportunity to utilise the money for your current consumption. Your dream of buying that exotic car will have to wait for one more year until the money is deposited in your bank account. But what happens if the car you want to buy today got expensive in the future because of inflation or any other economic reason. For any rational person, he will always want the money in the present moment, not in the future. This is what time value of money means. Money in the present moment has greater utility and value than in the future. The money you have today is worth more than the money you will have in the future. Since you have the option to either utilise the money or invest it to earn interest on it.

Next we will discuss the definitions of Present value and Future value and the process to calculate the value.

Future Value

Suppose you will receive money today, then what will be the future value of that money and how will you calculate it. Remember the exotic car that you had wanted to buy got expensive in the future, the reason for the price increase could be many. Factors such as inflation, government policies, taxes, etc. can affect the price of the car. Let’s just call all of these factors as interest rate. Assume the interest rate is 10%, so as per the interest rate calculation the future value of the money will be the amount multiplied by the interest rate(1.10).

For example

Present Value= 100 
Interest rate= 10%
Time= 1 year
Future value= 100*1.1=110

Suppose it is held for one more year, that is Time= 2 year, then compounding will come into picture
Future Value=100*1.1*1.1=121.
This is how you will calculate future value

Present Value

Present value is exact opposite of future value. Say you are getting money one year later and want to calculate its present value. In present value calculation we multiply the future value with a discount factor called as discount rate. The discount rate is actually a reciprocal of the interest rate used to calculate the future value.

Future value= 100
Discount rate= 10%
Time= 1 year
Present Value= 100/1.10=90.90
Time= 2 year
Present value =100/(1.1*1.1)=82.64

The calculations are very simple and easy to understand. This is a foundational topic for valuation which I will cover in the future article. I hope you have learned something new today.

Please feel free to share your feedback. Until next time. Peace.