Did you know what TVM is?

Did you know what TVM is? Have you heard about TVM? TVM stands for Time value is money. This is one of the core concepts of finance and it means that the amount of money that you have with you today is worth more than an expected or promised identical amount in that you might get in the future. This is based on the idea that money could earn interest and it simply means that any amount of money is worth more when you get it soon. As per this concept, money has a specific time value attached. The money that you have in hand today can be invested to earn more money in the form of interest. Also, there are chances that the money that you are expecting to get in the future might not reach you as well.

There is a formula to calculate this time value for money which is as below:

PV = FV ÷ (1+I)^N

PV is the present value

FV is the future value

I is the required return

N is the number of time periods before receiving the money

Now let’s try to understand this using the simple example given below:

Say, your friend gives you two options: a) He would give you Rs. 1000 today or b) He would give you Rs. 1200 after five years. In this which option would you choose?

The best answer is, “It depends on the time value of money” or the rate of interest that money can earn.

In most cases, the money that you get today and invest will earn you more money over time. This interest amount that money earns is called the time value of money.

As for this example, the choice of taking the money today or after five years depends on how you invest the money and what is the interest rate. As long as the money that you decide to take today gets invested in an option that would give you a minimum of 5% interest per annum in a compounding manner, it is best to get the money today. This is because at the end of five years, Rs. 1000 that you had invested would grow up to Rs. 1276 on a compound interest rate. This is more than Rs. 1200 offered by your friend after five years.

This concept of time value of money is an important basis for making most business decisions. It is used to evaluate different investments, for setting credit limits, for the appraisal value of acquisitions and a lot more. These clearly show that time literally means money. The value of the money now will not be the same as it might be in the future and the same for vice versa. So, it is imperative to calculate the time value of money so that one can decide between the worth of investments and also the returns that it can offer at different times.

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About the author: MOHAMMAD REZA

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