What Is the Time Value of Money (TVM)?

The time value of money (TVM) is the concept that a sum of money is worth
more now than the same sum will be at a future date due to its earnings
potential in the interim. The time value of money is a core principle of finance.
A sum of money in the hand has greater value than the same sum to be paid
in the future. The time value of money is also referred to as the present
discounted value.

Time Value of Money Formula

The most fundamental formula for the time value of money takes into account the following:
the future value of money, the present value of money, the interest rate, the number of
compounding periods per year, and the number of years.

Based on these variables, the formula for TVM is:

��=��(1+��)�×�where:��=Future value of money��=Present val
ue of money�=Interest rate�=Number of compounding periods per year�=N
umber of yearsFV=PV(1+ni)n×twhere:FV=Future value of moneyPV=Present va
lue of moneyi=Interest raten=Number of compounding periods per yeart=Numb
er of years
Keep in mind, though that the TVM formula may change slightly depending on the situation. For
example, in the case of annuity or perpetuity payments, the generalized formula has additional or
fewer factors.

 
The time value of money doesn't take into account any capital losses that you may incur or any
negative interest rates that may apply. In these cases, you may be able to use negative growth
rates to calculate the time value of money

Examples of Time Value of Money

Here's a hypothetical example to show how the time value of money works. Let's assume a sum
of $10,000 is invested for one year at 10% interest compounded annually. The future value of
that money is:

FV=$10,000×(1+10%1)1×1=$11,000FV=$10,000×(1+110%)1×1=$11,000

The formula can also be rearranged to find the value of the future sum in present-day dollars. For
example, the present-day dollar amount compounded annually at 7% interest that would be worth
$5,000 one year from today is:
PV=[$5,000(1+7%1)]1×1=$4,673PV=[(1+17%)$5,000]1×1=$4,673