Glossary - Time Value of Money
The Time Value of Money (TVM) is the concept that a sum of money has greater value now than at a future date due to its earning capacity. This principle holds that any amount of money is worth more the sooner it is received, because of its potential to be invested and earn interest or generate returns over time. TVM is a fundamental concept in finance that impacts decisions on investment, savings, loans, and many other financial instruments.
Also known as
- Present Value Principle
- Discounted Value
Use cases examples
- Loan Agreement: The interest rate applied represents the lender's application of the Time Value of Money, compensating for the opportunity cost of lending the principal sum over the term of the loan.
- Investment Proposal: The proposed investment's projected returns are discounted back to their present value using a discount rate, illustrating the Time Value of Money and providing a basis for comparing the investment's worth to current alternatives.
Considerations for investors
- Investors like venture capital firms and family offices should use TVM to assess the present value of an investment's future returns, helping to determine its viability and potential profitability.
- It's crucial for investors to consider the impact of inflation and the chosen discount rate on the Time Value of Money calculations, as these factors significantly influence investment decisions and the assessment of risk and return.
Considerations for founders
- Founders should understand how the Time Value of Money affects the valuation of future cash flows from their business operations, investments, or financing activities.
- When negotiating investments, founders must be mindful of how the TVM is used to calculate the present value of future earnings, impacts investment offers, and ultimately affects the equity they retain in their company.
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