A:

The time value of money (TVM) is an important concept to investors because a dollar on hand today is worth more than a dollar promised in the future. The dollar on hand today can be used to invest and earn interest or capital gains. A dollar promised in the future is actually worth less than a dollar today because of inflation.

Provided money can earn interest, this core principle of finance holds that any amount of money is worth more the sooner it is received. At the most basic level, the time value of money demonstrates that, all things being equal, it is better to have money now rather than later.

TVM can be broken up into two areas: present value and future value.

What Is Present Value?

Present value determines what a cash flow to be received in the future is worth in today's dollars. It discounts the future cash flow back to the present date, using the average rate of return and the number of periods. No matter what the present value is, if you invest that present value amount at the specified rate of return and number of periods, the investment would grow into the future cash flow amount.

Present value = (future cash flow) / (1+ rate of return)^number of periods

What Is Future Value?

Future value determines what a cash flow received today is worth in the future, based on interest rates or capital gains. It calculates what a current cash flow would be worth in the future, if it was invested at a specified rate of return and number of periods.

Future value = present value x {1 + (rate of return x number of periods)}

Both present value and future value take into account compounding interest or capital gains, which is another important aspect for investors to consider when looking for good investments.  

The Bottom Line

Time is literally money. The value of the money you have now is not the same as it will be in the future. Knowing how to determine TVM by calculating present and future value can help you distinguish between the worth of investments that offer returns at different times.

RELATED FAQS
  1. Why does the time value of money assume that a dollar today is worth more than a ...

    Learn about time value of money, or TVM, and how a present value calculator is used to determine the value of money received ... Read Answer >>
  2. What are the disadvantages of using net present value as an investment criterion?

    While net present value (NPV) calculations are useful when you are valuing investment opportunities, the process is by no ... Read Answer >>
  3. How Are Book Value and Intrinsic Value Different?

    Book value and intrinsic value are two ways to measure the value of a company. Find out which is known as the true value ... Read Answer >>
  4. How is terminal value discounted?

    Find out why investors use the terminal value, why the terminal value is discounted to the present day, and how it relates ... Read Answer >>
  5. What is the difference between present value and net present value?

    Understand the difference between the present value and net present value calculations and how these formulas are used in ... Read Answer >>
  6. What is the difference between economic value and market value?

    Learn about the differences between economic value and market value. Discover how they serve different purposes for businesses ... Read Answer >>
Related Articles
  1. Investing

    The Difference Between Enterprise Value and Equity Value

    Enterprise value calculates a business’s current value, while equity value offers a snapshot of that business’s current and potential future value.
  2. Investing

    Value Investing: Why Investors Care About Free Cash Flow Over EBITDA

    Examine value investing philosophy and methodology to see why free cash flow is more important than EBITDA in pure intrinsic value calculation.
  3. Investing

    Valuing Firms Using Present Value of Free Cash Flows

    When trying to evaluate a company, it always comes down to determining the value of the free cash flows and discounting them to today.
  4. Financial Advisor

    A Guide on the Risk-Adjusted Discount Rate

    When a project or investment faces higher amounts of risk or uncertainty, it may be appropriate to utilize the risk-adjusted discount rate.
  5. Investing

    How Value Investors’ Patience Has Been Tested

    Investors in value stocks are finding their patience tested. Does this strategy still work?
  6. Investing

    Investment Value Vs. Fair Market Value: How They Differ

    Learn about the differences between an asset's investment value and its fair market value, including why many think fair market value is unrealistic.
  7. Investing

    Analyze cash flow the easy way

    Learn the key components of the cash flow statement, how to analyze and interpret changes in cash, and what improved free cash flow means to shareholders.
RELATED TERMS
  1. Cumulative Interest

    Cumulative interest is the sum of all interest payments made ...
  2. Valuation Period

    The valuation period is the time period during which value is ...
  3. Net Present Value Of Growth Opportunities - NPVGO

    Net present value of growth opportunities is a calculation of ...
  4. Ending Market Value (EMV)

    The Ending Market Value (EMV) is the value of an investment at ...
  5. Discounted After-Tax Cash Flow

    The discounted after-tax cash flow method values an investment ...
  6. Rate of Return

    A rate of return is the gain or loss on an investment over a ...
Trading Center