# What is Time Value of Money?

The “time value of money” simply means: what a sum of money which is due in the future is worth today. A good illustration of this point is to compare the value of a dollar which is paid today versus the value of a dollar which is due to be paid ten years from now. We know, almost instinctively, that we would rather have the dollar in our pocket today than the promise of a dollar ten years from now. The dollar in your pocket today is certainly worth much more. It can be used to buy a house, pay off debt or send your children to college. A dollar in hand today is always worth more than a dollar promised at some future time.

## What is the Time Value of Money Formula?

The time value of money is clearly defined as the theory that a specific amount of money which is available in the present is worth more than it would be in the future as a result of its earning potential. Money has the ability to increase its value due to its ability to earn interest. This suggests that the sooner money is received the more its value can be increased. This theory has been established and validated across several credible fields of study including mathematics and economics. It is widely used among those in the financial industry and applied to many common banking & finance formulas.

“This principle allows for the valuation of a likely stream of income in the future, in such a way that annual incomes are discounted and then added together, thus providing a lump-sum “present value” of the entire income stream; all of the standard calculations for time value of money derive from the most basic algebraic expression for the present value of a future sum, “discounted” to the present by an amount equal to the time value of money.”

— Wikipedia

## The Time Value of Money is Commonly Applied in:

• Consumer Finance