What does the term "time value of money" refer to?

The term "time value of money" captures the principle that a dollar today is worth more than a dollar in the future. This concept is grounded in the idea that money available now can be invested to generate a return, meaning it can grow over time through interest or other investment vehicles.

When assessing financial decisions, future cash flows must be discounted back to their present value to make accurate comparisons and assess profitability. The ability to earn interest or invest funds today makes current money more valuable than the same amount received later. Thus, when determining investment opportunities or the value of cash flows, one must account for this time factor, underscoring the fundamental principle that receiving money sooner provides greater financial advantage than receiving it later.

Understanding this principle is crucial for various financial analyses, including capital budgeting, loan amortization, and evaluating the profitability of investments.