Microsoft Office Tutorials and References
In Depth Information
Chapter 11: Borrowing and Investing Formulas
Time value of money
The concept of Time Value of Money, or TVM, simply means that money has a different value
depending on what time it is. That is, not the time of day, but the time relative to right now (or
some other defined time). If I give you \$1,000 today, it’s worth precisely \$1,000. However, if I
give you \$1,000 in a year, that money will be worth \$1,000 when I give it to you, but it’s worth
something different today.
If you had the \$1,000 today, you could put it in a savings account, invest it in stocks and bonds,
or go on a wild shopping spree. You would have control over the money, and you could put it to
work for you. Because you’re not going to get the money for a year, it’s worth less to you now. In
fact, you may be willing to take a lesser amount if you got paid today.
These are all practical implementations of the concept of TVM:
h Banks charge interest on loans, and pay interest on deposits.
h Lotteries pay out less when you take the lump sum option.
h Vendors give a discount when you pay earlier than the normal terms.
Cash in and cash out
All financial formulas are based on cash flows — cash that is flowing out (payments) and cash
that is flowing in (receipts). Even those financial transactions that don’t seem to be dealing with
cash flows, really are. If you buy a car on credit, you get a car, and the lender gets a promise.
From a financial perspective, the bank is giving you cash to buy a car (positive cash flow to you).
In the future, you will pay back that money (negative cash flow to you). The fact that the money
was used to buy a car doesn’t change the underlying financial transaction. Always think in terms
of cash in or out.
The first decision you make when constructing a financial formula is: Who is asking the question?
Because you must designate the cash flows as either positive or negative, you need to determine
where the cash will be flowing from:
If you buy a house and calculate your mortgage payments, the cash flows from your
perspective are:
h When you borrow the money for the house, it’s a positive cash flow.
h When you make mortgage payments, it’s a negative cash flow.
If the bank is doing the calculation, the cash flows are exactly opposite.
In Excel’s financial functions, positive cash flows are shown as positive values, and negative cash
flows are shown as negative values.
When a formula returns a result that you know is wrong, the first place to look is at the
signs in front of the cash flow numbers.

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