FV (Future Value) is a type of formula in the subject of finance. It calculates the value of cash flow at a later date than originally received. The idea of the concept is that the amount today doesn’t hold the same value as it would in the future, which is based on the time value of money.
The concept of the “time value of money” is that the amount prior is worth more than the same amount that you’ll receive in the future.
For instance, if someone offers you $100 today or $100 five years from now, it’s better to receive it earlier rather than later. You determine the opportunity cost of not investing or saving this money by using the future value formula.
If an individual wants to see the amount they will receive one year from now in comparison to receiving $100 today, he or she would use the future value formula.
Future Value – Example
Here’s an example:
If John invests $1000 for five years with a 10% interest rate compounded annually, the future value of his investment would come out to $1610.51.
- Future Value = $1,000 x [(1 + 0.1)5]
- Future Value = $1,000 x 1.61051
- Future Value = $1,610.51
It’s good to note that simple interest is based on current, present value. Compounded interest means that an amount significantly increases every year.
In addition, the future value formula looks at the coming effects of compounding. If you earn .5% per month, that’s not the same as earning 6% per year. That’s assuming of course that the monthly earnings are being reinvested.
As time goes by, the earnings you receive next month will make money from the previous months. If an individual earns $40 in interest in a single month, the month after that will earn interest on the original balance plus $40 extra from the month prior.
Calculating the Future Value
There are two ways to calculate the future value:
- An asset with simple annual interest, you calculate the FV as –
Original Investment X (1+(interest rate*number of years))
2. An asset that has compounding interest on an annual basis, you calculate the FV as –
Original Investment X ((1+interest rate)^number of years))
For example, what if you invest $1000 for 5 years with a simple annual interest rate of 10%? Then the FV would be $1500.
Moreover, if you invest $1000 over a span of 5 years with an interest rate of 10%, compounded annually, $1610.51 would be the future value of the investment.
Use of Future Value
Many areas regarding the subject of finance use this formula. Other formulas include the FV formula quite often.
For example, the sum of an FV of a deposit consists of an annuity in the form of regular deposits. Industries such as the banking, investments, and corporate finance industry all use the FV formula to a certain degree.
Even though there are benefits of calculating FV, it’s important to note that the FV doesn’t include inflation adjustments, interest rate fluctuation, or fluctuating currency values.
Keep in mind that these things have the power to affect the real value of money or future assets.