Time Value of Money

The time value of money is a core financial principle stating that money available today is worth more than the identical sum in the future because today's money can be invested to earn returns. A dollar today can be invested at a given interest rate to grow into more than a dollar tomorrow. This concept underpins virtually all of finance, from loan pricing and bond valuation to retirement planning and business investment decisions.

Two key calculations illustrate this concept. Present value answers the question of what a future sum is worth today by discounting it at an appropriate rate. Future value calculates what today's money will grow to over time at a given return rate. For example, $10,000 invested today at 7% annual return grows to approximately $19,672 in 10 years. Conversely, $19,672 to be received in 10 years has a present value of $10,000 when discounted at 7%.

The time value of money explains why starting to save for retirement early is so powerful, why lenders charge interest on loans, why businesses discount future cash flows to evaluate projects, and why inflation erodes purchasing power over time. It is the mathematical foundation for net present value analysis, internal rate of return, annuity calculations, and bond pricing.