Hello, The relevance of time value for money in financial decision making. A finance manager is required to decide on investment, financing, and dividends keeping in mind the objectives of the company. Decisions in the form of the purchase of assets or purchase of funds i.e. investment/financing decisions affect cash flow over different time periods.
Cash outflows will occur at one point of time and flow at some other time, hence, they are not comparable due to the change in the value of the rupee. They can be made comparable by introducing interest factors. In the theory of finance, the interest factor is one of the important and exclusive concepts, known as the time value of money.
The time value of money means that the value of one rupee received today is different from the amount received in the future. The preference for money now as compared to the future is known as the priority of time. The concept applies to both individuals and business houses.
What is the reason for the priority of money?
- Preference for current consumption: Most of the individuals and companies that have a preference for current consumption may be due to the urge to require.
- Risk: There is uncertainty about the receipt of money in the future.
- Investment Opportunities: Most individuals and companies have a preference for current funds due to the benefit of investment opportunities to earn additional cash flow.
Importance of Time Value for Money:
The concept of the time value of money helps to arrive at comparable values of different rupee amount arising at different points in time to equivalent values at a particular time, present, or future. Cash flows generated at different points in time can be made comparable using any of the following:
- By combining present money at a future date, that is, by finding the value of current money.
- By finding the future money to the present date i.e. the present value (PV) of future money.
Read the article below!
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Business management expert and Leadership Consultant and Business Coach, who writes her blog, Jay’s Trends, focused on helping small business owners understand trends in Business management. Other posts by Jayprakash Prajapati»