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The Time Value of Money

  • 2017 College Interns
  • 2017 College Interns
  • One of the core principles of finance that is taught in every university, is the impact time has on the value of money; both for one’s personal finances and the finances of a corporation. Small business owners, who do not partake in the benefits of calculating and adjusting their financial statements to accommodate for the time value of money, have encountered bankruptcy as a result.

    The Time Value of Money is a simple concept to explain; money loses value over time. It is present in every Finance class and is imperative in understanding the true value of a business and where its value will be in the future. Inflation naturally occurs through the creation of money by the government, thereby increasing the Unites States money supply. This means that money slowly loses value over an extended period of time. In recent years, this has not been the case, but in previous decades double-digit inflation created havoc as people realized it took a lot more money to buy the same goods and services than it did previously.

    Money is also affected by the benefits of interest. Interest allows for a sum of money to grow and accumulate in value over time, and is frequently sought out by stock market investors as a personal finance strategy. Companies utilize the time value of money to adjust the money they owe, and the money they’re owed, with these loans frequently accompanied by payments of interest. From a personal perspective, when one chooses not to invest their money into the stock market, it creates an opportunity cost that is typically ignored, but crucial to minimize.

    To calculate the Time Value of Money, you would need information such as a future or past time period in which you would like to know the value, the current value of an asset or liability, and a required rate of return (how much you would like your current value to grow to in the future). Using current Future Value tables would produce a factor that you would multiply by the current value, to obtain an estimate of the future value of that cash amount. You can also determine the present value of a sum of money through the same method.

    It can be time-consuming to continue this process for every capital venture, but it provides decision-makers with a more realistic prediction of what their financial statements should look like. In a time where small companies engage exclusively in Financial Accounting practices and forget about Finance concepts such as the Time Value of Money, knowing the importance of this concept can make or break a company and its success down the line.

    To summarize; your money is worth the most in the present, and should be considered in every aspect of running a business, as well as the conduct of one’s personal finances. So, if you’re deciding between keeping all of your money in a checking account versus investing that money, and allowing it to grow over time, remember that it always loses its value when it sits idle.