Time Value of Money (TVM) – greater benefit of receiving money now rather than later. This is the basis of paying or receiving interest, be it bank deposit or debt. Hence, a naira received today is always more valuable than a naira received in the future and a naira received in the future is always less valuable than a naira received today.
The meaning and implications of the three key words: time, value and money are:
Time:– the system of those sequential relations that any event has to any other, as past, present, or future; indefinite and continuous duration regarded as that in which events succeed one another.
Duration regarded as belonging to the present life as distinct from the life to come or from eternity; finite duration.
Value:- the desirability of a thing, often in respect of some property such as usefulness or exchangeability; worth, merit, or importance;
Amount, especially a material or monetary, considered to be a fair exchange in return for a thing; reasonable or equivalent return; satisfaction: value for money
The moral principles and beliefs or accepted standards of a person or social group: a person with old-fashioned values.
Money:- any circulating medium of exchange, including coins, paper money, and demand deposits stamped by public authority and issued as a medium of exchange and measure of value, measure of wealth, or means of payment, as checks on demand deposit or cowries.
The typical driving forces are inflation, exchange rate and interest.
- Inflation (when more money buys less goods, i.e., money is worth less relative to the goods and services that it can purchase). Consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange.
- The exchange rate is the ratio or price at which a unit of the currency of one country can be exchanged for that of another country. Exchange rate fluctuates over time and this fluctuation affects the value of money.
- Everyone knows that money deposited in a savings/deposit bank account will earn interest. The rate of return (on simple or compound interest basis) affects value of money. Because of this universal fact, we would prefer to receive money today (and invest it to yield interest) rather than the same amount in the future.
Consequently time-value-of-money matters when negotiating contracts and associated payment. It is also central to many capital budgeting decisions (expected return on investment) running. It therefore plays a large role in project cash-flow planning together with determining whether a project is profitable or not. Hence, when client fails to pay contractor/service provider as at and when due, it places significant constrains on the delivery efficiency and the overall survival of the service organization.
Written by: George Kpesu – Finance Co-ordinator, FISAS