Time Value of Money

Time Value of Money is the idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity. This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received. Time Value of Money also referred to as present discount value.

As one of 10 Principles of Financial Management, time value of money is the most well-known principle in finance and business world. In accounting, time value of money is closely related to effective interest rate to measure financial instrument, notes receivables, notes payable, and other items. Accountants are must implement this standard in creating financial report.

Time Value of Money is also related to inflation. When inflation occurred, the value of money is decreased. People always mistake this phenomenon for the increasing prices. In fact, it’s not the price that increased, but the value of money itself has decreased. Why is this happening? Because the principle of time value of money makes its appearance.

The value of money this time is higher than the value of money in the future. For example, you can buy fuel now at $1 per litre. If you have lived for 10 years, you must be realized that the price of fuel ten years ago was cheaper. As time goes, in the future, maybe you can buy fuel in the range $2 - $3 per litre. Without enough financial educations, you must be thinks the price of fuel is increased. If you think like that, you are half right and half wrong. You are right because of scarcity has occurred in the commodity of crude oil energy source, and you are wrong because not only scarcity made the inflation, but also the value of money itself has decreased.