Continuing from my June 1st post, this is a principle everyone, not just finance or accounting folks should know about and apply. Yes, it involves everyone.
TVM simply means cash in hand today is worth more than cash tomorrow. why? Because cash in the future will come under the influence of factors like inflation and uncertainty which will affect its purchasing power.
For instance, you live in a flat in Lagos, your rent is N1,000,000 per annum, paid two years in advance. your landlord, informs you he needs cash and is willing to accept rent payment in advance for N900,000 for two years per annum if you paid now. You have two choices, pay N2m in full next year, or Pay N1.8m now. Which option will you choose?
Why is the time value of money important?
Whether you are managing your own finances or determining your investing strategy, One critical factor is Opportunity cost.
Opportunity cost
Opportunity cost, also known as implicit cost, compares the value of money today versus a future financial payment. In other words, the money you have today can be invested and increase in value over time.
On the other hand, if you wait for a future payment, that money will not have the same amount of time to accrue interest as the money you receive and invest today. Today’s cash provides immediate purchasing power, so put that money to good use.
There are 3 major uses of time value of money .
* It is used to understand the depreciation in the value of the currency by virtue of inflation.
* It is essential to make financial decisions involving acquisition of assets or procurement of funds.
* Financial managers will take a decision about where to invest based on the time value of money and the goal involved i.e. value maximization or wealth maximization.
In this new month, understand the value of your time and your money as it can help you make good future financial decisions. Remember, Time is Money, and Money used well, produces good Value.