Time value of money is something that every individual must know. The concepts of the time value of money act as the vital foundations for the business sector. As per the statistical records by IBEF, in 2019 FPI investments in country-based equities touched Rs. 101,122 crores.
IBEF also records that Indian companies were able to raise approximately 2.5 billion USD with the support of 17 IPOS. So, this proves that the Indian economy was affected positively as the investors understood the time value of money.
An Overview Time value of money
As far as the time value of money is concerned, a person having a specific amount of money currently has more importance than a similar amount of he/she can possess in the future. Investors take the time value of money concepts seriously to make business decisions that can help them in the future.
Here you can know the leading parameters of the Time Value of Money and the examples by which you can easily understand the concept.
Time Value of Money: Crucial Parameters
There are three main parameters on which the Time Value of Money depends. In a vast country like India, having an unstable economy, the investors have to keep these parameters in mind when investing.
Risk is the most crucial parameter that major investors have to keep in mind. If an investor has a certain amount of money now, he/she can invest it in a random sector. However, one must always calculate the chances of risk.
Following the concept of the time value of money, investors seek ways to get the best values of ROI. It is known as opportunity cost. Most investors tend to invest money in a specific sector early to get interested. So, the value of money can increase with the due course of time.
Since inflation is a common occurrence in India, the time value for a specific amount of money is more than it can be in the future. This is the only reason why most people in the country are investors.
Reasons why Time Value of Money is important
The time value of money is important because it is prominently connected with financial management.
Growth in Business
Investors, having money in hand, can invest and experience business growth in due course of time. Moreover, investments that ensure regular return can be the best for an inverter as he/she can use it based on their needs.
If you are an investor, always try to invest some money and get a regular return. Once you make a separate sum by saving some amount from the returns, invest an amount for the second time. It will help you to get more interest.
If you are into business, the time value of money will help you to manage finances in such a way that you can get good profits. All you need to do is properly follow the time value concept.
Any business whatsoever can carry a certain amount of debt. The concepts of the time value of money can help you to keep track of the debts in your business at any point in time. Since the time value of money is an abstract concept, both entrepreneurs and investors avoid studying it in detail. However, it can support one to properly manage finances at any point in time.
Examples to understand the Time and Value of Money
Here are the examples that can help you understand the time and value of money.
DDM (Dividend Discount Model)
The DDM model helps a company executive to predict stock prices based on the present market rate. Then the future value is also calculated, taking into account the present rate of cash flow.
Now, if the value of DDM is more than the current value of trade, automatically, the stocks will be of the lower value. As a result, you can see how the current worth of money is vital.
EMI Calculators for Loans
The loan providing company gets the monetary benefits each time it offers the loan. Here, you can understand the concept of the time value of money easily. Every loan has a specific interest rate. No matter if it is fixed or floating in nature, the current money helps the loan providing company to enjoy the profit for a prolonged period. This is the only reason why banks and NBFCs sanction loans with longer tenures easily.
Similarly, if the loan is of short tenure, the interest rate remains high.
Compound interest on money
The compound interest on money can be another excellent example to understand the time value of money. In the case of compound interest, the rate of returns might fall in the future. So, investors always concentrate more on the money that is on hand.
Other Concepts related to the time value of money
Here are two other concepts related to the time value of money that can be easily understandable.
Money doubling concept
Money doubling stands on the Rule of 72 and is a complicated process to understand. Simply put, you can consider that a sum of Rs 10,000, when invested at an 8% interest rate, will take a tenure of 9 years to double. In such a scenario, you have to consider whether the sum of Rs. 10,000 has more worth now or Rs. 20,000 nine years later.
In the case of single-time payment for the same figures mentioned in the point above, the net proceeds will be Rs. 14,641. Now, it is up to you, considering Rs 10000 or Rs. 14641, almost a decade later.
In the case of business, entrepreneurs can mostly use Rs 10000 as an investment to expand their business. On the other hand, investors would most likely seek monthly returns than a single return on the same investment.
The time value of money is a concept that most people are unaware of it. However, if you are planning to be a regular investor or an entrepreneur, you need to know about it as it can help you a lot with making better decisions.
A clear concept of time value for money can help you take monetary decisions wisely while minimising the chances of incurring a loss. Always try to be in touch with a financial expert!
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Q. Can I invest a huge amount of money and get guaranteed returns?
Ans: Yes, you can invest a huge amount of money and get guaranteed returns on it. However, you should be aware of the ultimate value that you will get as a return and consider it's worth.
Q. Is it better to invest money in such a plan that gives regular returns?
Ans. It depends totally on the investor where he wants to invest. However, you should be aware of the fact that a plan with regular returns gives a lower ROI than the plan with the one-time return.