Introduction
There are various economic terms with which we are familiar. Economic value is the measurement of benefits that can be enumerated from people’s preferences. Financial management contains the deliberate planning, assembling, administrating, and restraining of financial undertakings in an organization or an institute. Though the method of retaining financial accounts is termed “Accounting”.
There are two well-acquainted terms called present value and future value in accountancy. From the term “present value” we can easily define it means today’s value of a one-time cash amount that is to be obtained behind schedule and given at an identified discount rate. Contrarily, future value referred to the increasing value of today’s sum at an identified rate of interest, and the sum of today’s value is determined at a specified future data given.
Compounding: The technique by which the future value of money is enumerated from the present value of money is termed compounding. Compounding means the rising value of an asset for the interest earned on both a principal and conglomerated interest. The calculation of compounding is given below:
Compound interest = P[(1+i) n-1], where P is principal, I is the rate of interest, and n is the number of compounding periods.
Present Value vs. Future Value
Present value states that the amount of money today is more profitable than the same amount of money down the road. Conversely, Future value is A value of a current asset at an identified date in the future. The markdown value of the future sum of money, as well as inflation, is taken into consideration in the calculation of the present value. Whereas, inflation is not being taken into consideration in the calculation of future value. Present value allows the investors to make their judgments (accept or invest or reject the proposal). Whereas with the help of future value, investors can take a calculated guess on the maount of money they will have in hand based on the Interest Rate. Discounted rate and interest rate both are taken into the consideration of present value. Whereas future value requires interest rate (simple / compound) only. The method of obtaining present value is called discounted whereas the method of obtaining the future value is known as capitalization. In the case of the present value, the future value is itemized. In the case of future value, present value is already identified. Present value is very much important to the investors as it allows the investors to analyze their profit. Whereas, the future value is lesser significant than the present value.
Difference Between Present Value and Future Value in Tabular Form
Parameters of comparison | Present Value | Future Value |
Definition | Present value states that the amount of money today is more profitable than the same amount of money down the road. | Future value is A value of a current asset at an identified date in the future. |
Inflation | The markdown value of the future sum of money, as well as inflation, is taken into consideration in the calculation of the present value. | Inflation is not being taken into consideration in the calculation of future value. |
Notable Feature | Present value allows the investors to make their judgments (accept or invest or reject the proposal). | future value allows the investors to anticipate the amount of money that will be gained predicated on the interest rate. |
Interest rate and Discounted rate | Discounted rate and interest rate both are taken into the consideration of present value | future value requires interest rate (simple / compound) only. |
Special term | The method of obtaining present value is called discounted | the method of obtaining the future value is known as capitalization. |
Identification | In the case of the present value, the future value is itemized. | In the case of future value, present value is already identified. |
Importance | Present value is very much important to the investors as it allows the investors to analyze their profit. | Future value is lesser significant than the present value. |
What is Present Value?
The present value defines that the amount of money today is advantageous more than the same amount in upcoming days. This can be conceptualized through the word present. It highlights that if you do not spend money from today in a consistent way, then it could lose value down the word. Future cash flow is a process of brushing off the cash that you estimate to receive in the future. The amount of the discount rate is conversely proportional to the amount of present value Here, the enumeration process lies in presuming the rate of return that could be earned through the funds over the period. The Present value is the amount of money today that is more beneficial than the exact amount of money in the future. It indicates that if you are receiving $3000 today is more worthy than receiving $3000 after five years from now.
Inflation and Purchasing Power
Inflation is an economic term that declares a general proliferation in the prices of goods and services. Inflation rises the prices of goods and services from now on which would diminish the purchasing power of your money. If you do not get aware of spending money today, then it will cause a great loss in the future by some implicit annual rate. So, we can demonstrate that inflation or a rate of interest are corresponding terms to the present value.
The formula of Present Value (PV) and the calculation:
Present Value = FV/ (1+r)
Where:
FV = Future value
r = Rate of interest
n= Number of periods
Implementation of the Formula
You can expect of receiving $80,000 twelve years from now, estimating an annual rate of 8%, you can enumerate the value of that sum today with the help of the above formula.
PV = $80,000 / (1+0.08)12
= $6,172.84
This means the PV of your investment is $6,172.84
Generally, you could find many online calculators to calculate PV on various platforms like
Importance of Present Value
Present value is very important as it allows the investors to choose to check out the dissimilarities of the value over time. For a paradigm, if an investor wants to compare two or more categories of investments, then he can avail of the best one which gives him the best returns by comparing the present values. Morally, the future financial advantages of current assets could be easily evaluated with the help of PV. Present value calculation is major in areas such as financial decision-making, financial risk management, and investment analysis.
The discount rate is used in evaluating the present value which is often termed as investment rate of return. The discount rate of return plays a critical role in calculating the PV as it’s that rate of return that you are expecting if and only if you had invested some amount of money from today for some time. The risk-free rate of return is that type of return that contains no risk on the specified investment. The risk-free rate can be enumerated by subtracting the current inflation rate from the relent of the treasury bond resembling the duration of the investment. Generally, a risk-free rate of return policy is used as the discount rate which is known as the “hurdle rate”. The discount rate increments the future value in nominal or absolute terms. For a paradigm, net present value, bond yields, and pension obligations all are depended upon the discount rate of present value. So, it will be more beneficial to you if you learn the process of using a financial calculator. It will help you in judging whether you should concede that kind of offer as a cash refund or not.
What is Annuity?
An annuity is a financial expenditure that gives rise to systematic payments for a fixed period. In contemporary times, an annuity is most often acquired through an insurance company or a company that gives financial services. When you pick up an annuity, a lump sum of money is taken and invested by the insurance company. In consideration of this, the investor will be provided with an agreed sum of money at a methodical interim over some time. The computation of both present value and future value estimates a systematic annuity.
Present Value in an Annuity
The contemporaneous value of all the income that will be initiated by that investment in the future is called the present value in an annuity Briefly, it’s an amount of money that we need to lay out today to bring about a particular income henceforward.
For example, to achieve a $2,000 annuity payment for 12 years with interest rates at 8%, you'd need to invest $6,710.08 today.
What is Future Value?
A value of a current asset at an identified date in the future can be termed as future value. This value is based on an estimated financial growth. Future value sparks the light upon the profit that is generated by various investments. Knowing the basic concepts of future value will help the investors to make financial decisions well. Usually, it means that you could be able to know the profitable amount of your future made by today’s investments, through the calculation of future value. Though inflation can negatively affect the future value of the asset by corroding its value.
Dictating the future value can be demanding because of its market unpredictability. Anticipating the future value can be complex as it is depended upon the types of assets. Besides this, the calculation of future value is formulated on the audacity of a stable growth rate. If you have sunk your money into a savings account with a guaranteed interest rate, then the computation of future value will be easy and accurate. There are two approaches to evaluating the future value of an asset: Future value using simple interest and another is future value using compound interest. To get acquainted with the fundamental concept of Future value, simple and compound interest rates are the most significant examples.
Types:
- Future value using simple interest: It signifies that the interest rate relies on the initial investment. In this case, the formula of future value is: FV = I * (1+ (R*T))
Where:
I = investment amount
R= Interest rate
T= Number of years
For an instance, suppose a $2,000 investment occurred for ten years in a savings account with 8% simple interest paid annually. In this condition, the future value of the $2,000 inceptive investment is $3.600 (applying to the above formula).
Future Value Using Compound Interest
Here, the interest rate relies upon each period’s accumulative account balance. The calculation of future value using compound interest can be worked out through the formula mentioned below:
FV = I * (1+R)
Where:
I = Investment amount
R = Interest rate
T = Number of years
For example, suppose a $2,000 investment occurred for ten years in a savings account with an 8% compounding interest rate paid annually. In this condition, the future value will be $4,320.
Future Value of an Annuity
In the future value of an annuity, You have to make congruous investments over a set of periods to get the entire amount of money as a result. The total amount of money you will acquire in the future is depended on the calculation of how much you are investing now. If you are investing $1000 monthly with interest rates at 8%, after 10 years the future value will be $19,990.05.
Main Differences Between Present Value and Future Value
- Present value states that the amount of money today is more profitable than the same amount of money down the road. Conversely, Future value is A value of a current asset at an identified date in the future.
- The markdown value of the future sum of money, as well as inflation, is taken into consideration in the calculation of the present value. Whereas, inflation is not being taken into consideration in the calculation of future value.
- Present value allows the investors to make their judgments (accept or invest or reject the proposal). Whereas future value allows the investors to anticipate the amount of money that will be gained predicated on the interest rate.
- Discounted rate and interest rate both are taken into the consideration of present value whereas future value requires interest rate (simple / compound) only.
- The method of obtaining present value is called discounted whereas the method of obtaining the future value is known as capitalization.
- In the case of the present value, the future value is itemized. In the case of future value, present value is already identified.
- Present value is very much important to the investors as it allows the investors to analyze their profit. Whereas, the future value is lesser significant than the present value.
Conclusion
Howover, we have discussed several contrasts between Present Value and Future Value. In conclusion, we can say that this content will be effective for you for a better understanding of the dissimilarities between the Present Value and Future Value. For further information, tell us by commenting down below.