Time value of money explained

Time value of money explained clearly and quickly. After all, time is money, right? What’s important about money, in the context of spending money, saving money, or investing money? First of all, how much are we talking about? Second, money when? We need to know both the amount as well as the timing of the money.

⏱️TIMESTAMPS⏱️
0:00 Introduction to time value of money
0:24 Money now or money later
1:27 Time value of money: equivalent amounts in time
2:08 Future value formula
2:37 Future value example
3:29 Present value formula
4:16 Time value of money summary

Time value of money is the idea that money that is available at the present time is worth more than the same amount in the future. With the rate of return, you can convert from present value to future value, and the other way around. Time value of money is also the underlying principle for concepts such as Net Present Value    • Net Present Value (NPV) explained   and Internal Rate of Return    • Internal Rate of Return (IRR)  

How about a choice of $100 today or $105 one year from now? Maybe you will say: I am fine either way. If that’s the case, then we have just found the equivalent amounts in time, and identified the time value of money for you!

The time value that we found for you in this example is that $100 today equals $105 in one year. $100 is the present value of $105 one year from now. $105 is the future value (one year from now) of $100 today. Now I am going mathematical on you. $105 equals $100 times 1 plus 5% to the power 1. The future value equals the present value times 1 plus the rate of return, to the power of the number of years. The present value equals the future value divided by 1 plus the rate of return, to the power of the number of years. That might be a big abstract mathematical leap, let’s review it with an example.

The future value equals the present value times 1 plus the rate of return, to the power of the number of years. Let’s expand our example to two years. $100 today, multiplied by 1.05, is $105 one year from now. That same $105 one year from now, multiplied once more by 1.05, is $110.25 in two years. Or if you want to go straight from today to the future value two years from now, $100 today times 1.05 times 1.05 equals $110.25 two years from now. 1.05 times 1.05 is the same as 1.05 squared, which is the same as 1.1025.

We can also work in the opposite direction. The present value equals the future value divided by 1 plus the rate of return, to the power of the number of years. $110.25 two years from now, divided by 1.05, is $105 one year from now. That same $105 one year from now, divided once again by 1.05, equates to $100 present value today. Or if you want to go straight from two years from now to today, $110.25 divided by 1.05 times 1.05 equals $100 today. 1.05 times 1.05 is the same as 1.05 squared, which is the same as 1.1025.

Philip de Vroe (The Finance Storyteller) aims to make strategy, #finance and leadership enjoyable and easier to understand. Learn the business and accounting vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better stock market #investing decisions. Philip delivers #financetraining in various formats: YouTube videos, classroom sessions, webinars, and business simulations. Connect with me through Linked In!