Time Value of Money
“In five years, the cost of that smartphone will have gone up. Your money will buy less.
And more importantly — you’ve lost the chance, the opportunity to grow that money over time (opportunity cost).”
Let’s say you have £1,000 in your pocket right now.
Now pause for a moment and think — What could you do with it?
You could buy the latest smartphone.
You could save it in the bank and earn interest.
Or you could invest it in a small side hustle — maybe help a friend start a coffee cart and watch your £1,000 grow.
Now imagine you didn’t have that £1,000 today — someone offered you the same amount five years later.
Would you still feel it’s worth the same?
Of course NOT!
Because in five years, the cost of that smartphone will have gone up. Your money will buy less.
And more importantly — you’ve lost the chance, the opportunity to grow that money over time (opportunity cost).
This, dear readers, is the Time Value of Money (TVM) — a core concept in financial management which means that money has more value now rather than in future.
🧠 Why Does It Matter in Investment Appraisal?
When a company evaluates whether or not to invest in a new factory, a marketing campaign, or even a tech system or is appraising investment decisions, it’s not just about how much cash it will bring in, It’s about when that cash comes in.
Let’s say a project gives you:
£100,000 cash in 1st Year
£100,000 cash in 2nd Year
£100,000 cash in 3rd Year
If we ignore the time value of money, we’d say, “Wow! That’s £300,000 — let’s go for it!”
But finance doesn’t work that way.
Money today is more valuable than the same amount in the future, because of:
Inflation reduces the purchasing power
There is an opportunity cost of lost returns
And there is a risk of uncertainty over time
So, to properly assess this project, we convert those future cash flows using a rate (like the cost of capital) to get the cash flows in today’s terms.
🆚 Why Not Just Use Simple Methods?
You may have read my previous articles on:
Payback Period: “How quickly can we get our money back?”
Return on Capital Employed (ROCE): “What’s the average return over time?”
These methods are easy to apply, yes — but they’re flawed.
Why?
Because they ignore the timing of cash flows.
They assume £100,000 in Year 1 is as good as £100,000 in Year 3 — and that’s simply not true, that’s why we assess the financial feasibility of the projects using techniques which consider the time value of money (discounted cash flow techniques) like Net Preset Value, Internal Rate of Return and Discounted payback period to properly assess the projects.
