When it comes to Finance management, accounting, and banking, it is entirely necessary for an individual to understand the terminologies that are used so as to ensure they do not get lost along the way. This field is characterised by the use of certain terms to define different activities that revolve around its operation. In this paper, some of the keywords used are discussed and differentiated to help in understanding them much better.
To start with are simple interest and compound interest, terms that are commonly used in banking. Simple interest is based on a loan's principal amount. It is calculated by doing a multiplication of the principal amount “by the interest rate and the number of periods” associated with a loan. On the other side, compound interest is based on the principal amount itself plus the accumulated interest (Surbhi, 2015). It is calculated by doing a multiplication of “the principal amount by one” and adding the yearly interest rate which is “raised to the number of compound periods minus one.”
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Another set of terminologies is the future value and present value (PV). PV refers to the value of money today. It implies that if one has $50 today, the current value of that amount is $50. If in any case this sum of money is kept somewhere, say at home, it loses its value creating an opportunity cost due to saving money other than investing it. On the other hand, future value refers to the benefit gained from investing and creating interest (Aldridge, 2016). If the same $50 is saved in a bank with compound interest, it is bound to increase in value over time. This means that the $50 has increased in value thereby having a future value higher than its present value.
The time value of money is a concept that brings into account the relevant worth of money in the future due to financial decisions made. It is evaluated by considering the opportunity cost. It should be put into consideration that the cost of receiving money in the future is capable of being greater than the loss of its value due to inflation (Time value of money, 2013). Again, it should be considered that by not having the money now is inclusive of loss of additional income that one could earn in the form of interest had they received the cash earlier on.
The statement ‘a dollar today is worth more than a dollar tomorrow’ is a real sentiment given the loss in value of a dollar over time. For instance, if a person has $50 today and they keep it for a year in their house, the value it has today is not the same value it will have a year later. It will have gained in value, and an item that one could have bought at that amount will no longer be purchasable as it will have increased in value. This means that the individual will have to find more capital to purchase it. The dollar will have depreciated as it will not be able to buy the same good it can purchase today.
It is, therefore, crucial to understanding the implications of these terms in relevance to finances and banking. Knowing what each of them implies and their application in day to day life is of quite a great essence. With this understanding, one is then legible to engage in any activities that are in line with banking, finance, and accounting.
References
Aldridge, D. (2016). Future value vs present value. Small Business . Retrieved from http://smallbusiness.chron.com/future-value-vs-present-value-77714.html.
Surbhi, S. (2015). Difference between Simple Interest and Compound Interest. Retrieved from http://keydifferences.com/difference-between-simple-interest-and-compound-interest.html.
Time value of money (2013). Accounting-Simplified . Retrieved from http://accounting-simplified.com/management/investment-appraisal/time-value-of-money.html.
