Strategic Finance

Strategic Finance

Brief Definition of Time Value of Money

The time value of money refers to the fact that the worth of a unit of money differs in different time periods. That is, the worth of an amount of money we receive today is higher than it's worth when we receive it in future periods. In other words, the sum of money received today is more valuable as compared to it is in future. Conversely, the present worth of dollar received today is higher than a dollar received in future. As a dollar received associates more value if received today, rationale investors do prefer current receipt than future receipts. The time value of money is also referred to as the time preference of money (Jain, 2007). Thus, the time value of money adjusts for the fact that dollars to be paid out or received in the potential periods are not equals to those paid or received today.

Significance of Understanding Time Value of Money for Financial Managers

Effective financial management incorporates the need of understanding the time value of money. In fact, every organization is involved with money and thereby they must have some understanding of the time value of money. Bankers, security analysts, financial officers, companies, and individuals are all involved in frequent utilization of time value of money. Though some people fear that the working knowledge of this concept is perhaps too hard to master, but the availability of information like financial calculations, interest tables, and excel programs like Excel makes the subject readily reachable (Moyer et al, 2012).

The concept of time value of money is integral to all parts of business operations. A company doesn't only want to determine the actual value of an investment today; it desires to determine the net worth of an investment. In order to determine the actual value of investment today, it is essential for businesses to understand and apply time value of money. As far as financial managers are concern, they are not only concerned about the financial decision making of just the cash flows' sizes but also with their time periods. Cash outflows as well as cash inflows resulting from the company's financing and investing activities will typically occur over various timings, and it is the respective time period of cash flows that is virtually significant for financial managers. This is mainly due to the fact that cash flows' timing impacts on their value and eventually the firm's value (Bierman & Smidt, 2003). Thus, time value of money is one of the most significant concepts for financial managers and is tremendously relevant to financial decisions of the company.

The time value of money represents the fact that money received instantly holds a higher value as compared to an equivalent amount to be received at some future time period. Understanding of this concept is highly important for financial managers due to three major reasons: opportunities of reinvestment, uncertainties, and inflation. Companies reinvest money they received today in order to receive further ...