Present value (PV)
The more commonly known calculation is for net present value, which involves bundling all future expected cash flows in with inflation, in order to calculate the value of that future earning, today.
Future value (FV)
Future value involves a similar process, yet it is moving the money forward in time to calculate a value at a specific point in the future. I.e. if you know you have to pay off a lump sum loan of £10,000 on 1st December 2022, then how much do you need to put in a bank account with a fixed interest rate today, in order to meet that payment in full?
The time value of money
Both of these terms helps us to understand the time value of money, which can help us to make smart financial decisions throughout out lives.
The time value of money (read: inflation) means that money today is worth more than the same money in the future.
To move money forward in time we use a process called compounding. This involves multiplication.
Compounding involves multiplying the value of a cash flow by a number greater than one, therefore compounding always increases the value of a cash flow.
To move money backward in time, we use a process called discounting. This involves division.
Discounting involves dividing the value of a cash flow by a number greater than one, therefore discounting always reduces the value of a cash flow.
It doesn’t matter whether the cash flows are positive or negative, discounting and compounding are only about which way the money is moving.