As we know, the Time Value of Money tells us that money today is worth more than the same amount in the future, but how do we quantify that? Enter Present Value (PV) and Future Value (FV), two essential financial concepts that help businesses and individuals make smart financial decisions. Although they are closely related, PV and FV serve different purposes and are used in different financial scenarios so in the final part of the KangaROI Triolgy of Value blogs, we’ll break down their key differences.
Refresher: What are PV and FV?
ℹ - you can read more about Present Value (PV) and Future Value (FV) in the first two blogs, but to summarise:
📉 Present Value (PV) calculates how much a future sum is worth today, using a discount rate to adjust for risk and inflation. It accounts for the fact that money loses value over time due to inflation, risk, and opportunity costs.
📈 Future Value (FV) estimates how much money will grow over time, considering interest and compounding. It is crucial for estimating the potential growth of investments and savings.
So now that we know what they are, let’s take a look at the main differences between PV and FV.
Direction of Calculation
While both PV and FV measure the value of money over time, they do so in opposite directions. Here’s how they differ:
🗓️⏪ PV moves backward in time as it calculates how much a future sum is worth today by discounting it.
🗓️⏩ FV moves forward in time as it calculates how much today’s money will grow by applying interest.
Different rates applied
PV and FV may both apply “rates”, but what this means is another key difference between the two:
🏷️PV uses a discount rate as it is adjusting future cash flows for inflation, risk, and opportunity cost.
🏦 FV uses an interest rate as it is measuring growth over time.
Purpose
📆 PV helps investors and businesses decide whether an investment is worthwhile today as it is used to compare different financial options by determining their value in present terms.
🗓️⏩ FV helps individuals and businesses estimate the future growth of savings, investments, or assets as it’s used for goal-setting and long-term planning.
The Role of Inflation and Risk
✅ PV accounts for inflation and risk by applying a discount rate, reducing the value of future money.
❌ FV does not consider risk nor inflation as it assumes consistent growth at the specified interest rate.
Examples
Let’s imagine that we expect to receive $1,000 in 3 years, and we want to determine both:
its Present Value today (i.e. how much that $1,000 is worth today)
its Future Value if invested today (i.e. how much $1,000 today will be worth in 3 years)
Calculating PV
If the discount rate is 5% per year, as we know:
PV = FV / [ 1 + r / n ] ^ ( n * t )
where:
PV = present value
FV = future value
r = discount rate
t = the number of years
n = the number of compounding periods per year
= $1,000.00 / [ 1 + ( 5% / 12 ) ] ^ [ 12 * 3 ]
= $860.98 (Present Value)
we can see that $1,000 in 3 years is worth $864 today when discounted at 5%.
Calculating FV
If we invest $1,000 today at 5% interest per year, as we know:
FV = PV * [ 1 + ( r / n ) ] ^ ( n * t )
where:
PV = present value
FV = future value
r = interest rate
(ℹ note: the PV calculation above uses a discount rate, but FV uses an interest rate instead)
t = the number of years
n = the number of compounding periods per year
$1,000 * [ 1 + ( 5% / 12 ) ] ^ [ 12 * 3 ]
= $1,161.47 (Future Value)
So, $1,000 today grows to $1,161.47 in 3 years when earning 5% annually.
Summary
Both Present Value and Future Value are essential financial tools and they underpin the calculations that KangaROI performs when calculating Net Present Value, but they serve different purposes as PV helps us understand what future money is worth today, allowing for smarter investment decisions, while FV helps us estimate how today’s money will grow, making it useful for financial planning.
