In these times of low inflation, it’s easy to forget or at least underestimate the impact of time on the value of money.
$1 today is worth $1. That is easy to understand. However, $1 last year was worth more than $1 today, and $1 next year will be worth less than $1 today.
One may believe that with inflation under 2% per annum, surely the impact of time on money is minor. But who knows of a business that has borrowed money at a 2% interest rate? Anyone? I certainly don’t. Most of the businesses I know are paying between 5 and 12%. And I am even not talking about the individuals or businesses that draw finance with a credit card and pay around 20%!
So money does have a time value and businesses need to take it into consideration when calculating future cash flows.
The general formula to calculate today’s value of a sum of money (or cash flow) that will be received in the future is:
Present value = Future value / (1 + Interest Rate) Time Read more