The Time Value of Money

The time value of money (TVM) is a foundational concept in finance, and the best way to explain it is: a dollar today is worth more than a dollar in the future. Why? Because money has earning potential, it has opportunity cost, it can grow over time if invested, and it has less purchasing power in the future due to inflation.

If someone offered you $100 today versus $100 one year from now, you would likely prefer to receive it today. That way, you could invest it, earn interest, and end up with more than $100 a year from now. This difference arises because of two factors: opportunity cost (what you could have earned by investing) and inflation (the gradual decrease in purchasing power over time).

A practical example is calculating how much an amount of money today will grow in the future. We do this by growing a Cash Flow or compounding it over a specified number of years. In excel we use the FV function. On the flip side, TVM also helps to calculate the present value (PV) of money you'll receive in the future, by discounting those values to the present. Discounting is simply the inverse of compounding. We always want to compare dollar values in the same period so we either discount or compound dollars to a specific time.

Please download the PowerPoint I created for more information about TVM and to show the different ways to discount and compound money.