What is the concept of "time value of money"?

The concept of "time value of money" is based on the principle that a dollar today is worth more than a dollar in the future. This is primarily due to the potential earning capacity of money. When you have a dollar today, you can invest it to earn interest or generate returns over time. Conversely, a dollar you receive in the future could have less purchasing power than a dollar today because inflation can erode its value, and there are also opportunities lost by not having that dollar invested.

Understanding this principle is crucial for making informed financial decisions, as it underpins various financial concepts, including discounting future cash flows and evaluating investment opportunities. By acknowledging that the value of money changes over time, individuals and businesses can better assess the worth of future cash flows relative to current cash flows, ultimately guiding them in budgeting, investing, and financial planning.