What is the Time Value of Money (TVM)?

The Time Value of Money (TVM) is a concept that states money today is worth more than the same amount in the future due to its potential to earn income over time.

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Simply put, one franc today has more value because you could invest it and earn interest, making it grow over time.

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The key elements of TVM are:

• Present Value (PV): the current value of a sum of money or income stream
• Future Value (FV): the value of a current sum of money at a future date, assuming it grows at a specific interest rate
• Compounding Periods (n): the frequency with which the interest is calculated and added to the principal amount, either annually, quarterly, monthly, daily, or other
• Interest Rate (r, in FV): the rate at which money grows over time using either 'simple interest' or 'compound interest'
• Discount Rate (r, in PV): the rate used to calculate the present value of future cashflows

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TVM helps in comparing cashflows received or paid at different times, which is crucial for financial decision-making in areas such as:

• Investment decisions
• Loan evaluations
• Retirement planning
• Business valuations

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To calculate the TVM, there are two common formulas to work out: the future value and the present value.

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Future Value:

FV = PV × (1 + r)ⁿ

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Future Value estimates how much a sum today will grow over time with a given interest rate (r).

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Present Value:

PV = FV / (1 + r)ⁿ

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Present Value calculates what a future sum of money is worth today, using a discount rate (r) to factor in opportunity cost and risk.