What is the time value of money?

The time value of money tells us that receiving cash today is more valuable than receiving cash in the future. The reason is that the cash received today can be invested immediately and will begin growing in value. For instance, if a company receives $1,000 today and it is invested at 8% per year, the company will have $1,080 after 365 days.

A time value of money of 8% per year also tells us that receiving $1,080 one year from now is comparable to receiving $1,000 today. With a time value of money of 8% per year, accountants will state that receiving $1,080 in one year has a present value of $1,000.

In accounting, a time value of money of 8% means that a company performing services today in exchange for cash of $1,080 in one year has earned $1,000 of service revenues today. The $80 difference will become interest income as the company waits 365 days for the money.

The time value of money is important in accounting because of the cost principle and the revenue recognition principle. However, materiality and cost/benefit allow the accountants to ignore the time value of money for its routine accounts receivable and accounts payable having credit terms of 30 or 60 days.