Home » Business & Finance » Small Business Managers » Time Value of Money

Time Value of Money

© Herb Wexler

A dollar today is not the same as a dollar a year from now. This is perhaps the most important concept needed to understand the world of business. Directly related to this is the concept of interest. If you can earn 10% on your money, then a dollar today is worth 10% more in one year, or $1.10. This is the future value. Likewise, a dollar a year from now is worth $0.90 today. This is the present value. A dollar earning 10% interest every year for two years has a future value of $1.21 not $1.20. The extra penny is interest on the interest from the first year (10% of the ten cents earned in year one is one penny). This is compound interest, and has been called the eighth wonder of the world.

You have a project that you think will make $10,000 dollars in one year. To accomplish this project, you will need $9000. If you are confident in your numbers, you are willing to borrow money and pay a 10% interest rate. At the end of the project, you need to pay back the $9000 plus $900 interest, and you can put the remaining $100 in your pocket.

Having $100 in your pocket doesn't do anyone any good. It just loses value as time moves on. If you can't find another project of your own that needs these resources, you can put your money in a bank savings account. They will pool your money with others and then loan it to someone else.

The formulas to calculate the time value of money are not difficult. If you can't do them in your head, you can find many financial calculators on the internet.

FV= PV (1 + i )^N
PV = FV / (1+i)^N

• FV = Future Value
• PV = Present Value
• i = the interest rate per period
• n= the number of compounding periods
• (The ^N means to the power of.. 5^2=25 3^3=27)

What is the future value of $1000 in 5 years if the interest rate is 5%?
• FV= PV ( 1 + i ) ^N
• FV= $ 1000 ( 1+ .05 ) ^5
• FV= $ 1000 (1.2762815)
• FV= $1276.28

How much do I need now to have $1000 in 5 years if the interest rate is 5%?
• PV = FV / (1+i)^N

The copyright of the article Time Value of Money in Small Business Managers is owned by . Permission to republish Time Value of Money in print or online must be granted by the author in writing.