Share capital (UK English) or capital stock (US English)[1] refers to the portion of a company's equity that has

been obtained (or will be obtained) by trading stock to a shareholder for cash or an equivalent item of capital value. For example, a company can issue shares in exchange for computer servers, instead of purchasing the servers with cash. The term has several meanings. In its narrow, classical sense, still commonly used in accounting, share capital comprises the nominal values of all shares issued (that is, the sum of their "par values"). In a wider sense, if the shares have no par value or the allocation price of shares is greater than their par value, the shares are said to be at a premium (called share premium, additional paid-in capital or paid-in capital in excess of par); in that case, the share capital can be said to be the sum of the aforementioned "nominal" share capital and the premium. In the modern law of shares, the "par value" concept has diminished in importance, and share capital can simply be defined as the sum of capital (cash or other assets) the company has received from investors for its shares. Besides its meaning in accounting, described above, "share capital" may also be used to describe the number and types of shares that compose a company's share structure. For an example of the different meanings: a company might have an "outstanding share capital" of 500,000 shares (the "structure" usage); it has received for them a total of 2 million dollars, which in the balance sheet is the "share capital" (the accounting usage). The legal aspects of share capital are mostly dealt with in a jurisdiction's corporate law system. An example of such an issue is that when a company allocates new shares, it must do so in a way that does not inequitably dilute existing shareholders.

Contents

1 Types of share capital 2 See also 3 References 4 External links

Types of share capital

Authorised share capital is also referred to, at times, as registered capital. It is the total of the share capital which a limited company is allowed (authorised) to issue. It presents the upper boundary for the actually issued share capital. o Shares authorised = Shares issued + Shares unissued Issued share capital is the total of the share capital issued (allocated) to shareholders. This may be less or equal to the authorised capital. o Shares outstanding are those issued shares which are not treasury shares. These are all the shares held by the investors in the company.[2] o Treasury shares are those issued shares which are held by the issuing company itself, the usual result of a buyback.

Shares issued = Shares outstanding + Treasury shares

Issued capital can be subdivided in another way, examining whether it has been paid for by investors:

Subscribed capital is the portion of the issued capital, which has been subscribed by all the investors including the public. This may be less than the issued share capital as there may be capital for which no applications have been received yet ("unsubscribed capital"). Called up share capital is the total amount of issued capital for which the shareholders are required to pay. This may be less than the subscribed capital as the company may ask shareholders to pay by instalments. Paid up share capital is the amount of share capital paid by the shareholders. This may be less than the called up capital as payments may be in instalments ("calls-in-arrears").

Meaning of Share Capital: Share capital denotes the amount of capital raised by the issue of shares, by a company. It is collected through the issue of shares and remains with the company till its liquidation. Share capital is owned capital of the company, since it is the money of the shareholder and the shareholder are the owners of the company. The total share capital is divided into small parts and each part is called a share. Share is the smallest part of the total capital of a company. Features of Share Capital:

Owned capital: Share capital is owned capital of the company. It is actually the money of the shareholders and since the shareholders are the owner of the company, so share capital is the owned capital. Remains with the company: It remains with the company till its liquidation. Dependable sources: Share capital is the most dependable source of finance for the joint stock companies. Raises creditworthiness: It raised the credit worthiness of the company. Substantial funds: It provides substantial funds to the company. Available for: Share capital is easily available for expansion and diversification of business activities. Amendment: The amount of share capital can be raised by amending the capital clause of the Memorandum of Association. No charge: Share capital does not create any charge on the assets of the company.

Opportunity to participate: Share capital give its shareholders an opportunity to participate in the company's management with normal rights of shareholders. Benefit of bonus shares: It gives it shareholders the benefit of bonus shares. Benefit of limited liability: Share capital also gives its shareholders the befit of limited liability as the liability of its shareholders is limited up to the face value of each share. Meaningful participation: Share capital enables its shareholders to have a meaningful participation in the expansion of corporate sector.

Types of Share Capital:

Authorized capital: It is the maximum amount of capital which a company can collect or raise by selling it's shares to the general public. Authorized capital is known as nominal capital or registered capital. For example: A company wants to sell 100 shares of Rs. 10/- each, so the total amount collected by the company is Rs. 1000/- i.e. 100 shares x 10 each = 1000 The capital with which a company is registered is known as its authorized capital.

Issued capital: It is that part of the authorized capital which is actually issued to the general public. For example: A company has issued 80 shares of Rs. 10/- each so the issued capital is Rs. 800/Unissued capital: It is that part of the authorized capital which is not being issued to the general public.That is, company has not issued 20 shares of Rs. 10/- each, so the unissued capital is Rs. 200/-. Subscribed capital: It is that part of the issued capital which is actually subscribed by the general public. That is company has issued 80 shares out of which 70 shares are being bought by the general public, so the subscribed capital is Rs. 700/-. That is 70 shares of Rs. 10/- each. Unsubscribed capital: It is that part of the issued capital which is not subscribed by the general public. That is, if the the company has issued 80 shares out of which 70 are bought by the general public and 10 are not being bought by them, so the unsubscribed capital is 10 x Rs. 10 = Rs. 100. That is 10 shares of Rs. 10 each. Called up capital: It is that part of the subscribed capital which is actually called up by the company. For instance, if a company has asked its shareholders to pay Rs. 5/- per share so on 70 shares, they have to pay 70 shares x Rs. 5 each = Rs. 350/-. This is the called up capital.

Uncalled up capital: It is that part of the subscribed capital which is not being called up by the company. It may be called up as and when the company need funds. That is out of Rs. 10/- per share, Rs. 5/- per share is being called up by the company and Rs. 2 is being uncalled up and Rs. 3 is kept as reserve, that is yet to be called. Reserve capital: Reserve capital is that part of the uncalled capital which is reserved to be called up only at the time of winding up or liquidation of the company. It cannot be called during the life time of a company. It is to be used only for meeting extra- ordinary situation such as liquidation of the company. The purpose of reserve capital is to meet the interests of the creditors at the time of winding up of the company. Paid up capital: It is that part of the called up capital which is actually paid up by the shareholders. For example, out of 70 shares which were subscribed for 60 shareholders have paid up their call money, that is 60 x Rs. 5 = Rs. 300/- is called as the paid up capital of the company. Unpaid up capital: It is that part of the called up capital which is not being paid by the shareholders. For example: out of 70 shareholders, 60 shareholders have paid up their call money and 10 shareholders have not paid their call money, so 10 x Rs. 5 = Rs. 50/- is called as unpaid up capital. Unpaid up capital is also known as Calls in Arrears.

A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower. An arrangement in which a lender gives money or

property to a borrower, and the borrower agrees to return the property or repay the money, usually along with interest, at some future point(s) in time. Usually, there is a predetermined time for repaying a loan, and generally the lender has to bear the risk that the borrower may not repay a loan (though modern capital markets have developed many ways of managing this risk). Written or oral agreement for a temporary transfer of a property (usually cash) from its owner (the lender) to a borrower who promises to return it according to the terms of the agreement, usually with interest for its use. If the loan is repayable on the demand of the lender, it is called a demand loan. If repayable in equal monthly payments, it is an installment loan. If repayable in lump sum on the loan's maturity (expiration) date, it is a time loan. Banks further classify their loans into other categories such as consumer, commercial, and industrial loans, construction and mortgage loans, and secured and unsecured loans. A written promise to repay the loan is called a promissory note. Read more: http://www.businessdictionary.com/definition/loan.html#ixzz1wqCqxiWp

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In a loan, the borrower initially receives or borrows an amount of money, called the principal, from the lender, and is obligated to pay back or repay an equal amount of money to the lender at a later time. Typically, the money is paid back in regular installments, or partial repayments; in an annuity, each installment is the same amount. The loan is generally provided at a cost, referred to as interest on the debt, which provides an incentive for the lender to engage in the loan. In a legal loan, each of these obligations and restrictions is enforced by contract, which can also place the borrower under additional restrictions known as loan covenants. Although this article focuses on monetary loans, in practice any material object might be lent. Acting as a provider of loans is one of the principal tasks for financial institutions. For other institutions, issuing of debt contracts such as bonds is a typical source of funding.

Contents

1 Types of loans o 1.1 Secured o 1.2 Unsecured o 1.3 Demand o 1.4 Subsidized 2 Target markets o 2.1 Personal or commercial 3 Loan payment 4 Abuses in lending 5 United States taxes 6 Income from discharge of indebtedness 7 See also 8 References

Types of loans
Secured See also: Loan guarantee

A secured loan is a loan in which the borrower pledges some asset (e.g. a car or property) as collateral. A mortgage loan is a very common type of debt instrument, used by many individuals to purchase housing. In this arrangement, the money is used to purchase the property. The financial institution, however, is given security a lien on the title to the house until the mortgage is

paid off in full. If the borrower defaults on the loan, the bank would have the legal right to repossess the house and sell it, to recover sums owing to it. In some instances, a loan taken out to purchase a new or used car may be secured by the car, in much the same way as a mortgage is secured by housing. The duration of the loan period is considerably shorter often corresponding to the useful life of the car. There are two types of auto loans, direct and indirect. A direct auto loan is where a bank gives the loan directly to a consumer. An indirect auto loan is where a car dealership acts as an intermediary between the bank or financial institution and the consumer.
Unsecured

Unsecured loans are monetary loans that are not secured against the borrower's assets. These may be available from financial institutions under many different guises or marketing packages:

credit card debt personal loans bank overdrafts credit facilities or lines of credit corporate bonds (may be secured or unsecured)

The interest rates applicable to these different forms may vary depending on the lender and the borrower. These may or may not be regulated by law. In the United Kingdom, when applied to individuals, these may come under the Consumer Credit Act 1974. Interest rates on unsecured loans are nearly always higher than for secured loans, because an unsecured lender's options for recourse against the borrower in the event of default are severely limited. An unsecured lender must sue the borrower, obtain a money judgment for breach of contract, and then pursue execution of the judgment against the borrower's unencumbered assets (that is, the ones not already pledged to secured lenders). In insolvency proceedings, secured lenders traditionally have priority over unsecured lenders when a court divides up the borrower's assets. Thus, a higher interest rate reflects the additional risk that in the event of insolvency, the debt may be uncollectible.
Demand

Demand loans are short term loans [1] that are atypical in that they do not have fixed dates for repayment and carry a floating interest rate which varies according to the prime rate. They can be "called" for repayment by the lending institution at any time. Demand loans may be unsecured or secured.
Subsidized

A subsidized loan is a loan on which the interest is reduced by an explicit or hidden subsidy. In the context of college loans in the United States, it refers to a loan on which no interest is

accrued while a student remains enrolled in education.[2] Otherwise, it may refer to a loan on which an artificially low rate of interest (or none at all) is charged to the borrower. An unsubsidized loan is a loan that gains interest at a market rate from the date of disbursement.

Target markets
Personal or commercial See also: Credit_(finance)#Consumer_credit

Loans can also be subcategorized according to whether the debtor is an individual person (consumer) or a business. Common personal loans include mortgage loans, car loans, home equity lines of credit, credit cards, installment loans and payday loans. The credit score of the borrower is a major component in and underwriting and interest rates (APR) of these loans. The monthly payments of personal loans can be decreased by selecting longer payment terms, but overall interest paid increases as well. For car loans in the U.S., the average term was about 60 months in 2009.[3] Loans to businesses are similar to the above, but also include commercial mortgages and corporate bonds. Underwriting is not based upon credit score but rather credit rating.

Loan payment
The most typical loan payment type is the fully amortizing payment in which each monthly rate has the same value over time.[4] The fixed monthly payment P for a loan of L for n months and a monthly interest rate c is: [5]

Abuses in lending
Predatory lending is one form of abuse in the granting of loans. It usually involves granting a loan in order to put the borrower in a position that one can gain advantage over him or her. Where the moneylender is not authorized, they could be considered a loan shark. Usury is a different form of abuse, where the lender charges excessive interest. In different time periods and cultures the acceptable interest rate has varied, from no interest at all to unlimited interest rates. Credit card companies in some countries have been accused by consumer organisations of lending at usurious interest rates and making money out of frivolous "extra charges".[6]

Abuses can also take place in the form of the customer abusing the lender by not repaying the loan or with an intent to defraud the lender. An investment instrument, other than an insurance policy or fixed annuity, issued by a corporation, government, or other organization which offers evidence of debt or equity. The official definition, from the Securities Exchange Act of 1934, is: "Any note, stock, treasury stock, bond, debenture, certificate of interest or participation in any profit-sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit, for a security, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or in general, any instrument commonly known as a 'security'; or any certificate of interest or participation in, temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing; but shall not include currency or any note, draft, bill of exchange, or banker's acceptance which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited." 2. Property which is pledged as collateral for a loan. Akin to promissory notes, debentures are instruments for raising long term debt capital. Debentures holders are the creditors of the company. The obligation of the company towards its debenture holders is similar to that of a borrower who promises to pay interest and capital at specified times. Features Trustee When a debenture issue is sold to the investing public, a trustee is appointed through a deed. The trustee is usually a bank or an insurance company or a reputable firm of attorneys. Entrusted with the role of protecting the interest of debenture holders, the trustee is responsible to ensure that the borrowing firm fulfils its contractual obligations. Security Debentures are typically secured by a charge on the immovable properties, both present and future, of the company by way of an equitable mortgage, which is effected by deposit of the title deeds relating to mortgaged assets in favour of the trustees. Debentures not protected by any security are called unsecured or naked debentures. Redemption Debentures are generally redeemable-perpetual debentures are very rare. The redemption takes place in a pre specified manner. Typically, it occurs between the 5th year and the 9th year. Companies are now required to create a debenture redemption reserve to facilitate timely redemption. A major requirement is that the company should create a Debenture Redemption Reserve equivalent to 50 per cent of the amount of debenture issue before debenture redemption commences.

Interest The interest payment on debentures is a fixed obligation, irrespective of the financial situation of the issuing firm. Typically payable semi-annually, it is a tax-deductible expense. Right Debentures for Working Capital Public limited companies can issue "rights" debentures to their share-holders with the object of augmenting the long-term resources of the company for working capital requirements. The key guidelines applicable to such debentures are as follows

The amount of the debenture issue should not exceed (a) 20 percent of the gross current assets, loans and advances minus the long-term funds presently available for financing working capital, or (b) 20 per cent of the paid-up share capital, including preference capital and free reserves, whichever is the lower of the two. The debt: equity ratio, including the proposed debenture issue, should not exceed 1:1. The debentures shall first be offered to the existing Indian resident shareholders of the company on a pro rata basis.

Definition of 'Debenture'
A type of debt instrument that is not secured by physical asset or collateral. Debentures are backed only by the general creditworthiness and reputation of the issuer. Both corporations and governments frequently issue this type of bond in order to secure capital. Like other types of bonds, debentures are documented in an indenture.

Investopedia explains 'Debenture'

Debentures have no collateral. Bond buyers generally purchase debentures based on the belief that the bond issuer is unlikely to default on the repayment. An example of a government debenture would be any government-issued Treasury bond (T-bond) or Treasury bill (T-bill). T-bonds and T-bills are generally considered risk free because governments, at worst, can print off more money or raise taxes to pay these type of debts.

A debenture is a document that either creates a debt or acknowledges it, and it is a debt without collateral. In corporate finance, the term is used for a medium- to long-term debt instrument used

by large companies to borrow money. In some countries the term is used interchangeably with bond, loan stock or note. A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital.[1] Senior debentures get paid before subordinate debentures, and there are varying rates of risk and payoff for these categories. Debentures are generally freely transferable by the debenture holder. Debenture holders have no rights to vote in the company's general meetings of shareholders, but they may have separate meetings or votes e.g. on changes to the rights attached to the debentures. The interest paid to them is a charge against profit in the company's financial statements.

Contents

1 Attributes 2 Security in different jurisdictions 3 Convertibility 4 See also 5 References

Attributes

A movable property. Issued by the company in the form of a certificate of indebtedness. It generally specifies the date of redemption, repayment of principal and interest on specified dates. May or may not create a charge on the assets of the company.[2] Corporations often issue bonds of around $1000, while government bonds are more likely to be $5000.

Debentures gave rise to the idea of the rich "clipping their coupons," which means that a bondholder will present their "coupon" to the bank and receive a payment each quarter (or in whatever period is specified in the agreement). There are also other features that minimize risk, such as a "sinking fund," which means that the debtor must pay some of the value of the bond after a specified period of time. This decreases risk for the creditors, as a hedge against inflation, bankruptcy, or other risk factors. A sinking fund makes the bond less risky, and therefore gives it a smaller "coupon" (or interest payment). There are also options for "convertibility," which means a creditor may turn their bonds into equity in the company if it does well. Companies also reserve the right to call their bonds, which mean they can call it sooner than the maturity date. Often there is a clause in the contract that allows this; for example, if a bond issuer wishes to rebuy a 30 year bond at the 25th year, they must pay a premium. If a bond is called, it means that less interest is paid out.

Failure to pay a bond effectively means bankruptcy. Bondholders who have not received their interest can throw an offending company into bankruptcy, or seize its assets if that is stipulated in the contract.

Security in different jurisdictions

In the United States, debenture refers specifically to an unsecured corporate bond,[3] i.e. a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bond's maturity. Where security is provided for loan stocks or bonds in the US, they are termed 'mortgage bonds'. However, in the United Kingdom a debenture is usually secured.[4] In Canada, a debenture refers to a secured loan instrument where security is generally over the debtor's credit, but security is not pledged to specific assets. Like other secured debts, the debenture gives the debtor priority status over unsecured creditors in a bankruptcy; however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures[citation needed]. In Asia, if repayment is secured by a charge over land, the loan document is called a mortgage; where repayment is secured by a charge against other assets of the company, the document is called a debenture; and where no security is involved, the document is called a note or 'unsecured deposit note'.[5]

Convertibility
There are two types of debentures: 1. Convertible debentures, which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time. "Convertibility" is a feature that corporations may add to the bonds they issue to make them more attractive to buyers. In other words, it is a special feature that a corporate bond may carry. As a result of the advantage a buyer gets from the ability to convert, convertible bonds typically have lower interest rates than non-convertible corporate bonds. 2. Non-convertible debentures, which are simply regular debentures, cannot be converted into equity shares of the liable company. They are debentures without the convertibility feature attached to them. As a result, they usually carry higher interest rates than their convertible counterparts. 3. What are debentures? 4. Debentures are creditor ship securities representing long-term indebtedness of a company. A debenture is an instrument executed by the company under its common seal acknowledging indebtedness to some person or persons to secure the sum advanced. It is, thus, a security issued by a company against the debt. A public limited company is allowed to raise debt or loan through debentures after getting certificate of

commencement of business if permitted by its Memorandum of Association. Companies Act has not defined the term debenture. 5. Debentures, like shares, are equal parts of loan raised by a company. Debentures are usually secured by the company by a fixed or floating debentures at periodical intervals, generally six months and the company agrees to pay the principal amount at the expiry of the stipulated period according to their terms of issue. Like shares, they are issued to the public at part, at a premium or at a discount. Debenture-holders are creditors of the company. They have no voting rights but their claims rank prior to preference shareholders and equity shareholders. Their exact rights depend upon the nature of debentures they hold. 6. Debentures can be of following types: 7. Redeemable and Irredeemable Debentures Redeemable debentures are those which can be redeemed or paid back at the end of a specified period mentioned on the debentures or within a specified period at the option of the company by giving notice to the debenture holders or by installments as per terms of issue. Irredeemable debentures are those which are repayable at any time by the company during its existence. No date of redemption is specified. the debenture holders cannot claim their redemption. However, they are due for redemption if the company fails to pay interest on such debentures or on winding up of the company. They are also called perpetual debentures. 8. Secured and Unsecured Debentures Secured or mortgaged debentures carry either a fixed charge on the particular asset of the company or floating charge on all the assets of the company. Unsecured debentures, on the other hand, have no such charge on the assets of the company. They are also known as simple or naked debentures. 9. Registered and Bearer Debentures Registered debentures are registered with the company. Name, address and particulars of holdings of every debenture holders are recorded on the debenture certificate and in the books of the company. At the time of transfer, a regular transfer deed duly stamped and properly executed is required. Interest is paid only to the registered debenture holders. Bearers debentures on the other hand, are transferred by more delivery without any notice to the company. Company keeps no record for such debentures. Debentures-coupons are attached with the debentures-certificate and interest can be claimed by the coupon-holder. 10. Convertible and Non-convertible Debentures Convertible debentures are those which can be converted by the holders of such debentures into equity shares or preference shares, cannot be converted into shares. Now, a company can also issue partially convertible debentures under which only a part of the debenture amount can be converted into equity shares. 11. A deferred credit could mean money received in advance of it being earned, such as deferred revenue, unearned revenue, or customer advances. A deferred credit could also result from complicated transactions where a credit amount arises, but the amount is not revenue. 12. A deferred credit is reported as a liability on the balance sheet. Depending on the specifics, the deferred credit might be a current liability or a noncurrent liability. In the past, it was common to see a noncurrent liability section with the heading Deferred Credits.

deferred credit

Definition
Prepayment received from customers or tenants, and carried forward as a liability until the associated goods, services, or benefits are delivered. Also called deferred liability or deferred revenu

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Income items received by a business, but not yet reported as income; also called deferred revenue and deferred income. Read more: http://www.answers.com/topic/deferred-credit#ixzz1wqETpM1m Income that is received by a business but not immediately reported as income. Typically, this is done on income that is not fully earned and, consequently, has yet to be matched with a related expense. Such items include consulting fees, subscription fees and any other revenue stream that is intricately tied to future promises. For example, a book club might defer income from a twoyear membership plan until all the costs of procurement and shipping are assessed. Also known as deferred revenue or deferred income. Investopedia Says: Deferred credit is used largely for bookkeeping purposes and as a means to even out, or "smooth" financial records and give a more accurate picture of business activities. Using the previous example of a book club, if all membership or subscriptions fees just happened to come in during the first quarter and all products were shipped out in the second, the quarter-to-quarter income statement would obviously be skewed.

Read more: http://www.answers.com/topic/deferred-credit#ixzz1wqEWtViE ncome that is received by a business but not immediately reported as income. Typically, this is done on income that is not fully earned and, consequently, has yet to be matched with a related expense. Such items include consulting fees, subscription fees and any other revenue stream that is intricately tied to future promises. For example, a book club might defer income from a twoyear membership plan until all the costs of procurement and shipping are assessed. Also known

as deferred revenue or deferred income.

Investopedia explains 'Deferred Credit'

Deferred credit is used largely for bookkeeping purposes and as a means to even out, or "smooth" financial records and give a more accurate picture of business activities. Using the previous example of a book club, if all membership or subscriptions fees just happened to come in during the first quarter and all products were shipped out in the second, the quarter-to-quarter income statement would obviously be skewed.
deferred credit is, in most cases, a customer advance. This is a situation where a customer pays you before you have provided it with an offsetting amount of services or merchandise. Since you have not yet earned the corresponding amount of revenue, you should instead record the payment as a current liability. Once you have provided services or shipped merchandise, you can debit the liability account to eliminate the liability, and credit the revenue account to recognize revenue. Thus, the recognition of the credit is no longer deferred.

A deferred credit can also be classified as a long-term liability if it will take more than one year to provide services or merchandise to the customer (as may be the case under a multi-year subscription service). If you were unable to provide the services or merchandise for which the customer advance was paid, the correct transaction (subject to the terms of the contract) would be to pay the customer back, which results in a debit to the liability account and a credit to the cash account. Different companies and organizations use a variety of accounting practices and methods so that they can keep accurate records and to make sure that income, revenue and expenses are reported when they should be. One of the methods that some companies use is called deferred credit. Deferred credit is a concept that organizations use as a method of recording and reporting income and revenue. With deferred credit a company will take on a job and receive up-front payment for the job but they will not report the income or revenue received as income until the project is completed. One of the primary reasons for reporting income in this manner is to make sure that accounting records are kept in balance. It would throw the records off if the money was reported as income and that job had not been completed. Another reason for this method of accounting is because certain jobs or projects will not utilize all of the funds collected for a particular project or job, in which case the unearned income needs to be returned back to the client or customer. If the income had been reported in advance prior to completion another journal entry would have to be made to account for the income or revenue that was returned to the client. When it comes to income received the relationship it has with revenue is the fact that it is earned. Two type of transactions which have to been identified as separate is when income is received and not earned versus the amount of a payment made on an invoice received. The invoice payment is money that has been earned for a job completed and the advance revenue is income received but the organization has not earned it yet. If revenue is received and the full amount is not used the unused portion is returned to the client and the used portion is reported as income at that point in time. During the time that the deferred

credit is on the books as unearned income it is considered to be and reported as a liability but once the income is earned, which is after a project or service is completed the revenue is reported on the accounting books as earned income. Keeping the accounting books and records in order is a matter of great concern and the method used should remain consistent throughout the accounting process. The working capital requirement is the minimum amount of resources that a company requires to effectively cover the usual costs and expenses necessary to operate the business. Since the capital needs of each company will be a little different, there is no ideal working capital requirement that is universally applicable to all businesses, or even to companies engaged in the same industry. However, new companies can develop an idea of what type of working capital requirement they will need to operate at given levels by researching the cost and expenses associated with other corporations engaged in similar operations. The basic formula for determining working capital involves only two factors. First, it is necessary to define the current liquid assets in the possession of the company. This may be somewhat different from general assets, since the focus is on those resources that can be converted into cash quickly and easily. Liquid assets may be such resources as the outstanding current Accounts Receivable balance, property that is not directly used in the operation of the business, and balances in various operating accounts. Along with defining the liquid assets of the company, determining the working capital requirement will also allow for the current liabilities of the corporation. This will include both short-term liabilities, such as the usual and general monthly operating expenses, as well as any long-term debt. By deducting the liabilities from the liquid assets, it is possible to determine the current working capital requirement. o know working capital requirement is very important for operating business without any risk. Because less or over working capital than exact working capital requirement is harmful for the progress of any business. In simple words, working capital requirement means exact amount of cash or other liquid asset to operate the business. If you have required money in the pocket of business, you need not worry for paying expenses, paying for raw material and other creditors. Now come to the point "how to calculate working capital requirement?" It is totally based on the nature of business. Requirement of working capital may differ in different type of business. I often compare working capital as petrol in your car. If you have to drive your car in local area, you need less petrol but if you want to travel highway for long, you need more petrol. Like this, if your business credit deal is more, then you require more capital, because one side you are buying credit and other side selling on credit. But it is not true that all debtors will convert in cash. One the other side you have to pay your full dues. So, you need big amount of working capital requirement. Minimum double of credit purchase amount. But, if you calculate average collection period and if it is less than average payment period, then you can keep less cash in your pocket. Simple formula of working capital requirement

WCR = [Accounts Receivable + Inventory + Prepaid Expenses] - [Accounts Payable + Accruals] You must study following points before calculating working capital requirement 1. The average time Raw materials are in stock 2. Average time to produce goods or service 3. Average time finished goods in stock 4. Credit Terms from suppliers 5. Average credit terms offered to customers 6. Estimated sales next month 7. Net Profit Margin The amount of working capital a company determines it must maintain in order to continue to meet its costs and expenses. The working capital requirement will be different for each company, depending upon many factors such as how frequently the company receives earnings and how high their expenses are. Read more: http://www.investorwords.com/6960/working_capital_requirement.html#ixzz1wqHXtmvk here are four main financial requirements of a business, namely, working capital, fixed assets, marketing costs and a contingency fund. Financial management for a business involves managing all of these in an efficient manner. Working capital is the amount of money a company has to carry on with its daily operations. To determine working capital requirement, lets first of all learn how to calculate working capital. Working Capital Calculation A company has two kinds of assets namely fixed assets such as property and machinery and current assets. The current assets of a company are those which will be used up within a single fiscal year. They include cash in hand, cash at bank, accounts receivable, pre-paid expenses, inventory and short term investments. Current liabilities are those which have to be settled in cash within the current fiscal year. They include all the accounts payable pertaining to goods and services including short term loans payable within one year. Working capital is the difference between the current assets and the current liability. The mathematical formula for this is: Working Capital = Current Assets - Current Liabilities Working Capital Requirements The net working capital requirement will vary from company to company. And within the company itself it may vary from month to month. It depends on two factors namely, how much earnings a company has and what is the frequency of receiving those earnings. Secondly, what are the expenses that a company has and how frequently these payments have to be settled. For determining how to calculate working capital for a new investment, the business managers

have to make forecasts of the earnings i.e. accounts receivable and inventory as well as the expenses i.e. accounts payable. After the projections have been made, you have to compare the actual earning and expenses with the projections. Next, add the increase in accounts receivable and the increase in inventory and subtract the accounts payable from this amount. The figure you then get will reflect the probable change in working capital which can be used for the new investment. Change in working capital is also determined through the inflow and outflow of funds. So these two things should also be taken into consideration while calculating the working capital requirements. The mathematical formula for this is: Working Capital Required = (Increase in accounts receivable + Increase in inventory + Cash inflows i.e. cash in bank, bank loan, other current assets) - (Increase in accounts payable + Cash outflows i.e. prepaid expenses, payment to suppliers, other current liabilities) Working Capital Management Working capital management is very important to ensure that the company has enough funds to carry on with its day-to-day operations smoothly. A business should not have a very long Cash Conversion Cycle. A cash conversion cycle measures the time period for which a firm will be deprived of funds if it increases its investments as a part of its business growth strategies. For this the company has to take certain measures such as reduce the credit period of the customers, negotiate with the suppliers and increase its own credit period with them, maintaining the right level of inventory which reduces the raw material costs and proper cash management which ensues that cash holding costs are reduced. If these measures are followed, the working capital requirement automatically comes down. There are a few other things to consider. If the current liabilities of a company are more than the current assets, it represents a working capital deficiency and may sometimes lead to business debt. A deficit working capital has a negative impact on the company's image as it depicts that the company is facing problems in liquidity and is not able to pay for its short term costs. In such a scenario, the investors may back out on making any kind of investments in the company. Thus, financial planning including working capital planning is very essential to run a business efficiently. By Aastha Dogra

The working capital needs of an enterprise are influenced by numerous factors. These are : (i) Nature of business (ii) Size of the enterprise (iii) Seasonality of operations (iv) Production policy (v) Market conditions

(vi) Technology and manufacturing policy (vii) Price level changes. (i) Nature of Business: The requirement of working capital of an enterprise depends upon the nature of business. A trading concern like a garments show-room, a service concern like an electricity undertaking or a transport corporation have a short operating cycle. Their requirement for working capital is small. A manufacturing concern like cotton textiles or woolen factory will have a long operating cycle specially if they are selling their goods on credit. Hotels and restaurants have minimum requirement of working capital 10 to 20% whereas trading and construction industries have highest working capital requirement 80 to 90%. (ii) Size of the Enterprise: An enterprise working on a high level of activity has a higher level of working capital requirement and vice-versa. An increase in production from time to time will tend to increase the need of working capital. (iii) Seasonally of Operations: Those firms which have marked seasonality in their operations have fluctuating working capital requirements. A firm manufacturing refrigerators will have maximum sales during summer seasons and minimum sales during winter seasons thus affecting its working capital. Such firms have a need of higher working capital during summers and lower in winter season. Firms also experience cyclical fluctuations in the demand of their product and services. During upward swing in the economy, sales will increase and hence, debtors too. Under boom, the firms generally do substantial borrowing to increase their productive capacity. Whereas a decline in the economy results in low level of sales, inventories, debtors etc. Rather, firms try to reduce their short-term borrowings. (iv) Production Policy: A firm having the product of seasonal nature may follow a policy of steady production in order to dampen the fluctuations in working capital requirements. A manufacturer of referigerator will not intensify the production activity during the peak business rather he will follow a steady production throughout the year. Such a production will help firms utilise its resources to its fullest extent. Such a policy will mean accumulation of inventories during off season and their quick disposal during the peak season. (v) Market Conditions: When competitive conditions are prevailing in the market, a larger inventory of finished goods in needed as customers mayn't be inclined to wait. Further, a liberal credit policy may be offered to

the customer by the competitors. Both the conditions demand higher level of working capital, more investment in finished goods and debtors as well. A higher collection period will also imply tie-up of larger funds in book debts. Similarly, delayed payments, if not checked in time, may increase the working capital requirements much to the detrimental of the entrepreneur. (vi) Technology and Manufacturing Policy: The manufacturing cycle comprises of the purchase and use of raw-materials and the production of finished goods. Longer the manufacturing cycle, larger will be the working capital requirements. The manufacturing cycle of a computer may range in months whereas that of a toothpaste may be a few hours. Thus, if there are alternative technologies of manufacturing a product, the technological process with the shortest manufacturing cycle should be chosen. Nonmanufacturing firms, service enterprises like P & T department, and financial enterprises like .banks don't have a manufacturing cycle. (vii) Price Level Changes: An increase in price level will require a firm to maintain a higher amount of working capital. Some companies may not be affected by rising prices while others may be badly hit by it. Rising prices have different effects for different companies. The time value of money is the value of money figuring in a given amount of interest earned over a given amount of time. The time value of money is the central concept in finance theory. For example, $100 of today's money invested for one year and earning 5% interest will be worth $105 after one year. Therefore, $100 paid now or $105 paid exactly one year from now both have the same value to the recipient who assumes 5% interest; using time value of money terminology, $100 invested for one year at 5% interest has a future value of $105.[1] This notion dates at least to Martn de Azpilcueta (14911586) of the School of Salamanca. The method also allows the valuation of a likely stream of income in the future, in such a way that the annual incomes are discounted and then added together, thus providing a lump-sum "present value" of the entire income stream. All of the standard calculations for time value of money derive from the most basic algebraic expression for the present value of a future sum, "discounted" to the present by an amount equal to the time value of money. For example, a sum of FV to be received in one year is discounted (at the rate of interest r) to give a sum of PV at present: PV = FV rPV = FV/(1+r). Some standard calculations based on the time value of money are:
Present value The current worth of a future sum of money or stream of cash flows given a specified rate of return. Future cash flows are discounted at the discount rate, and the higher the discount rate, the lower the present value of the future cash flows. Determining the appropriate discount rate is the key to properly valuing future cash flows, whether they be earnings or obligations.[2]

Present value of an annuity An annuity is a series of equal payments or receipts that occur at evenly spaced intervals. Leases and rental payments are examples. The payments or receipts occur at the end of each period for an ordinary annuity while they occur at the beginning of each period for an annuity due.[3] Present value of a perpetuity is an infinite and constant stream of identical cash flows.[4] Future value is the value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today.[5] Future value of an annuity (FVA) is the future value of a stream of payments (annuity), assuming the payments are invested at a given rate of interest.

Contents

1 Calculations 2 Formula o 2.1 Present value of a future sum o 2.2 Present value of an annuity for n payment periods o 2.3 Present value of a growing annuity o 2.4 Present value of a perpetuity o 2.5 Present value of a growing perpetuity o 2.6 Future value of a present sum o 2.7 Future value of an annuity o 2.8 Future value of a growing annuity 3 Derivations o 3.1 Annuity derivation o 3.2 Perpetuity derivation 4 Examples o 4.1 Example 1: Present value o 4.2 Example 2: Present value of an annuity solving for the payment amount o 4.3 Example 3: Solving for the period needed to double money o 4.4 Example 4: What return is needed to double money? o 4.5 Example 5: Calculate the value of a regular savings deposit in the future. o 4.6 Example 6: Price/earnings (P/E) ratio 5 Continuous compounding o 5.1 Examples 6 Differential equations 7 See also 8 References 9 External links

Calculations

There are several basic equations that represent the equalities listed above. The solutions may be found using (in most cases) the formulas, a financial calculator or a spreadsheet. The formulas are programmed into most financial calculators and several spreadsheet functions (such as PV, FV, RATE, NPER, and PMT).[6] For any of the equations below, the formula may also be rearranged to determine one of the other unknowns. In the case of the standard annuity formula, however, there is no closed-form algebraic solution for the interest rate (although financial calculators and spreadsheet programs can readily determine solutions through rapid trial and error algorithms). These equations are frequently combined for particular uses. For example, bonds can be readily priced using these equations. A typical coupon bond is composed of two types of payments: a stream of coupon payments similar to an annuity, and a lump-sum return of capital at the end of the bond's maturity - that is, a future payment. The two formulas can be combined to determine the present value of the bond. An important note is that the interest rate i is the interest rate for the relevant period. For an annuity that makes one payment per year, i will be the annual interest rate. For an income or payment stream with a different payment schedule, the interest rate must be converted into the relevant periodic interest rate. For example, a monthly rate for a mortgage with monthly payments requires that the interest rate be divided by 12 (see the example below). See compound interest for details on converting between different periodic interest rates. The rate of return in the calculations can be either the variable solved for, or a predefined variable that measures a discount rate, interest, inflation, rate of return, cost of equity, cost of debt or any number of other analogous concepts. The choice of the appropriate rate is critical to the exercise, and the use of an incorrect discount rate will make the results meaningless. For calculations involving annuities, you must decide whether the payments are made at the end of each period (known as an ordinary annuity), or at the beginning of each period (known as an annuity due). If you are using a financial calculator or a spreadsheet, you can usually set it for either calculation. The following formulas are for an ordinary annuity. If you want the answer for the Present Value of an annuity due simply multiply the PV of an ordinary annuity by (1 + i).

Formula
Present value of a future sum

The present value formula is the core formula for the time value of money; each of the other formulae is derived from this formula. For example, the annuity formula is the sum of a series of present value calculations. The present value (PV) formula has four variables, each of which can be solved for:

1. 2. 3. 4.

PV is the value at time=0 FV is the value at time=n i is the discount rate, or the interest rate at which the amount will be compounded each period n is the number of periods (not necessarily an integer)

The cumulative present value of future cash flows can be calculated by summing the contributions of FVt, the value of cash flow at time t

Note that this series can be summed for a given value of n, or when n is .[7] This is a very general formula, which leads to several important special cases given below.
Present value of an annuity for n payment periods

In this case the cash flow values remain the same throughout the n periods. The present value of an annuity (PVA) formula has four variables, each of which can be solved for:

1. 2. 3. 4.

PV(A) is the value of the annuity at time=0 A is the value of the individual payments in each compounding period i equals the interest rate that would be compounded for each period of time n is the number of payment periods.

To get the PV of an annuity due, multiply the above equation by (1 + i).

Present value of a growing annuity

In this case each cash flow grows by a factor of (1+g). Similar to the formula for an annuity, the present value of a growing annuity (PVGA) uses the same variables with the addition of g as the rate of growth of the annuity (A is the annuity payment in the first period). This is a calculation that is rarely provided for on financial calculators. Where i g :

To get the PV of a growing annuity due, multiply the above equation by (1 + i). Where i = g :

Present value of a perpetuity

When n , the PV of a perpetuity (a perpetual annuity) formula becomes simple division.

Present value of a growing perpetuity

When the perpetual annuity payment grows at a fixed rate (g) the value is theoretically determined according to the following formula. In practice, there are few securities with precise characteristics, and the application of this valuation approach is subject to various qualifications and modifications. Most importantly, it is rare to find a growing perpetual annuity with fixed rates of growth and true perpetual cash flow generation. Despite these qualifications, the general approach may be used in valuations of real estate, equities, and other assets.

This is the well known Gordon Growth model used for stock valuation.
Future value of a present sum

The future value (FV) formula is similar and uses the same variables.

Future value of an annuity

The future value of an annuity (FVA) formula has four variables, each of which can be solved for:

1. FV(A) is the value of the annuity at time = n 2. A is the value of the individual payments in each compounding period 3. i is the interest rate that would be compounded for each period of time

4. n is the number of payment periods Future value of a growing annuity

The future value of a growing annuity (FVA) formula has five variables, each of which can be solved for: Where i g :

Where i = g :

1. 2. 3. 4. 5.

FV(A) is the value of the annuity at time = n A is the value of initial payment paid at time 1 i is the interest rate that would be compounded for each period of time g is the growing rate that would be compounded for each period of time n is the number of payment periods

Derivations
Annuity derivation

The formula for the present value of a regular stream of future payments (an annuity) is derived from a sum of the formula for future value of a single future payment, as below, where C is the payment amount and n the period. A single payment C at future time m has the following future value at future time n:

Summing over all payments from time 1 to time n, then reversing the order of terms and substituting k = n - m:

Note that this is a geometric series, with the initial value being a = C, the multiplicative factor being 1 + i, with n terms. Applying the formula for geometric series, we get

The present value of the annuity (PVA) is obtained by simply dividing by

Another simple and intuitive way to derive the future value of an annuity is to consider an endowment, whose interest is paid as the annuity, and whose principal remains constant. The principal of this hypothetical endowment can be computed as that whose interest equals the annuity payment amount:

+ goal

Note that no money enters or leaves the combined system of endowment principal + accumulated annuity payments, and thus the future value of this system can be computed simply via the future value formula:

Initially, before any payments, the present value of the system is just the endowment principal ( ). At the end, the future value is the endowment principal (which is the same) plus the future value of the total annuity payments ( the equation: ). Plugging this back into

Perpetuity derivation

Without showing the formal derivation here, the perpetuity formula is derived from the annuity formula. Specifically, the term:

can be seen to approach the value of 1 as n grows larger. At infinity, it is equal to 1, leaving the only term remaining.

as

Examples
Example 1: Present value

One hundred euros to be paid 1 year from now, where the expected rate of return is 5% per year, is worth in today's money:

So the present value of 100 one year from now at 5% is 95.24.

Example 2: Present value of an annuity solving for the payment amount

Consider a 10 year mortgage where the principal amount P is $200,000 and the annual interest rate is 6%. The number of monthly payments is

and the monthly interest rate is

The annuity formula for (A/P) calculates the monthly payment:

This is considering an interest rate compounding monthly. If the interest were only to compound yearly at 6%, the monthly payment would be significantly different.

Example 3: Solving for the period needed to double money

Consider a deposit of $100 placed at 10% (annual). How many years are needed for the value of the deposit to double to $200? Using the algrebraic identity that if:

then

The present value formula can be rearranged such that:

(years)

This same method can be used to determine the length of time needed to increase a deposit to any particular sum, as long as the interest rate is known. For the period of time needed to double an investment, the Rule of 72 is a useful shortcut that gives a reasonable approximation of the period needed.
Example 4: What return is needed to double money?

Similarly, the present value formula can be rearranged to determine what rate of return is needed to accumulate a given amount from an investment. For example, $100 is invested today and $200 return is expected in five years; what rate of return (interest rate) does this represent? The present value formula restated in terms of the interest rate is:

see also Rule of 72 Example 5: Calculate the value of a regular savings deposit in the future.

To calculate the future value of a stream of savings deposit in the future requires two steps, or, alternatively, combining the two steps into one large formula. First, calculate the present value of a stream of deposits of $1,000 every year for 20 years earning 7% interest:

This does not sound like very much, but remember - this is future money discounted back to its value today; it is understandably lower. To calculate the future value (at the end of the twentyyear period):

These steps can be combined into a single formula:

Example 6: Price/earnings (P/E) ratio

It is often mentioned that perpetuities, or securities with an indefinitely long maturity, are rare or unrealistic, and particularly those with a growing payment. In fact, many types of assets have characteristics that are similar to perpetuities. Examples might include income-oriented real estate, preferred shares, and even most forms of publicly-traded stocks. Frequently, the terminology may be slightly different, but are based on the fundamentals of time value of money calculations. The application of this methodology is subject to various qualifications or modifications, such as the Gordon growth model. For example, stocks are commonly noted as trading at a certain P/E ratio. The P/E ratio is easily recognized as a variation on the perpetuity or growing perpetuity formulae - save that the P/E ratio is usually cited as the inverse of the "rate" in the perpetuity formula. If we substitute for the time being: the price of the stock for the present value; the earnings per share of the stock for the cash annuity; and, the discount rate of the stock for the interest rate, we can see that:

And in fact, the P/E ratio is analogous to the inverse of the interest rate (or discount rate).

Of course, stocks may have increasing earnings. The formulation above does not allow for growth in earnings, but to incorporate growth, the formula can be restated as follows:

If we wish to determine the implied rate of growth (if we are given the discount rate), we may solve for g:

Continuous compounding
Rates are sometimes converted into the continuous compound interest rate equivalent because the continuous equivalent is more convenient (for example, more easily differentiated). Each of the formul above may be restated in their continuous equivalents. For example, the present value at time 0 of a future payment at time t can be restated in the following way, where e is the base of the natural logarithm and r is the continuously compounded rate:

This can be generalized to discount rates that vary over time: instead of a constant discount rate r, one uses a function of time r(t). In that case the discount factor, and thus the present value, of a cash flow at time T is given by the integral of the continuously compounded rate r(t):

Indeed, a key reason for using continuous compounding is to simplify the analysis of varying discount rates and to allow one to use the tools of calculus. Further, for interest accrued and capitalized overnight (hence compounded daily), continuous compounding is a close approximation for the actual daily compounding. More sophisticated analysis includes the use of differential equations, as detailed below.
Examples

Using continuous compounding yields the following formulas for various instruments:
Annuity

Perpetuity

Growing annuity

Growing perpetuity

Annuity with continuous payments

Differential equations
Ordinary and partial differential equations (ODEs and PDEs) equations involving derivatives and one (respectively, multiple) variables are ubiquitous in more advanced treatments of financial mathematics. While time value of money can be understood without using the framework of differential equations, the added sophistication sheds additional light on time value, and provides a simple introduction before considering more complicated and less familiar situations. This exposition follows (Carr & Flesaker 2006, pp. 67). The fundamental change that the differential equation perspective brings is that, rather than computing a number (the present value now), one computes a function (the present value now or at any point in future). This function may then be analyzed how does its value change over time or compared with other functions. Formally, the statement that "value decreases over time" is given by defining the linear differential operator as:

This states that values decreases () over time (t) at the discount rate (r(t)). Applied to a function it yields:

For an instrument whose payment stream is described by f(t), the value V(t) satisfies the inhomogeneous first-order ODE ("inhomogeneous" is because one has f rather than 0,

and "first-order" is because one has first derivatives but no higher derivatives) this encodes the fact that when any cash flow occurs, the value of the instrument changes by the value of the cash flow (if you receive a $10 coupon, the remaining value decreases by exactly $10). The standard technique tool in the analysis of ODEs is the use of Green's functions, from which other solutions can be built. In terms of time value of money, the Green's function (for the time value ODE) is the value of a bond paying $1 at a single point in time u the value of any other stream of cash flows can then be obtained by taking combinations of this basic cash flow. In mathematical terms, this instantaneous cash flow is modeled as a delta function

The Green's function for the value at time t of a $1 cash flow at time u is

where H is the Heaviside step function the notation " " is to emphasize that u is a parameter (fixed in any instance the time when the cash flow will occur), while t is a variable (time). In other words, future cash flows are exponentially discounted (exp) by the sum (integral, ) of the future discount rates ( for future, r(v) for discount rates), while past cash flows are worth 0 ( ), because they have already occurred. Note that the value at the moment of a cash flow is not well-defined there is a discontinuity at that point, and one can use a convention (assume cash flows have already occurred, or not already occurred), or simply not define the value at that point. In case the discount rate is constant, this simplifies to

where

is "time remaining until cash flow". for no

Thus for a stream of cash flows f(u) ending by time T (which can be set to time horizon) the value at time t, cash flows:

is given by combining the values of these individual

This formalizes time value of money to future values of cash flows with varying discount rates, and is the basis of many formulas in financial mathematics, such as the BlackScholes formula with varying interest rates.

Introduction
Time Value of Money (TVM) is an important concept in financial management. It can be used to compare investment alternatives and to solve problems involving loans, mortgages, leases, savings, and annuities. TVM is based on the concept that a dollar that you have today is worth more than the promise or expectation that you will receive a dollar in the future. Money that you hold today is worth more because you can invest it and earn interest. After all, you should receive some compensation for foregoing spending. For instance, you can invest your dollar for one year at a 6% annual interest rate and accumulate $1.06 at the end of the year. You can say that the future value of the dollar is $1.06 given a 6% interest rate and a one-year period. It follows that the present value of the $1.06 you expect to receive in one year is only $1. A key concept of TVM is that a single sum of money or a series of equal, evenly-spaced payments or receipts promised in the future can be converted to an equivalent value today. Conversely, you can determine the value to which a single sum or a series of future payments will grow to at some future date. You can calculate the fifth value if you are given any four of: Interest Rate, Number of Periods, Payments, Present Value, and Future Value. Each of these factors is very briefly defined in the right-hand column below. The left column has references to more detailed explanations, formulas, and examples.

Interest

Simple Compound

Interest is a charge for borrowing money, usually stated as a percentage of the amount borrowed over a specific period of time. Simple interest is computed only on the original amount borrowed. It is the return on that principal for one time period. In contrast, compound interest is calculated each period on the original amount borrowed plus all unpaid interest accumulated to date. Compound interest is always assumed in TVM problems.

Number of Periods

Periods are evenly-spaced intervals of time. They are intentionally not stated in years since each interval must correspond to a compounding period for a single amount or a payment period for an annuity.

Payments

Payments are a series of equal, evenly-spaced cash flows. In TVM applications, payments must represent all outflows (negative amount) or all inflows (positive amount).

Present Value

Single Amount Annuity

Present Value is an amount today that is equivalent to a future payment, or series of payments, that has been discounted by an appropriate interest rate. The future amount can be a single sum that will be received at the end of the last period, as a series of equally-spaced payments (an annuity), or both. Since money has time value, the present value of a promised future amount is worth less the longer you have to wait to receive it.

Future Value

Single Amount Annuity

Future Value is the amount of money that an investment with a fixed, compounded interest rate will grow to by some future date. The investment can be a single sum deposited at the beginning of the first period, a series of equally-spaced payments (an annuity), or both. Since money has time value, we naturally expect the future value to be greater than the present value. The difference between the two depends on the number of compounding periods involved and the going interest rate.

Loan Amortization

A method for repaying a loan in equal installments. Part of each payment goes toward interest and any remainder is used to reduce the principal. As the balance of the loan is gradually reduced, a progressively larger portion

of each payment goes toward reducing principal.

Cash Flow Diagram

A cash flow diagram is a picture of a financial problem that shows all cash inflows and outflows along a time line. It can help you to visualize a problem and to determine if it can be solved by TVM methods.

The time value of money serves as the foundation for all other notions in finance. It impacts business finance, consumer finance, and government finance. Time value of money results from the concept of interest. This overview covers an introduction to simple interest and compound interest, illustrates the use of time value of money tables, shows a matrix approach to solving time value of money problems, and introduces the concepts of intrayear compounding, annuities due, and perpetuities. A simple introduction to working time value of money problems on a financial calculator is included as well as additional resources to help understand time value of money. Time Value of Money A fundamental idea in finance that money that one has now is worth more than money one will receive in the future. Because money can earn interest or be invested, it is worth more to an economic actor if it is available immediately. This concept applies to many contracts; for example, a trade in which payment is delayed will often require compensation for the time value of money. This concept may be thought of as a financial application of the saying, "A bird in the hand is worth two in the bush." Farlex Financial Dictionary. 2012 Farlex, Inc. All Rights Reserved

time value of money The concept that holds that a specific sum of money is more valuable the sooner it is received. Time value of money is dependent not only on the time interval being considered but also the rate of discount used in calculating current or future values. Wall Street Words: An A to Z Guide to Investment Terms for Today's Investor by David L. Scott. Copyright 2003 by Houghton Mifflin Company. Published by Houghton Mifflin Company. All rights reserved.

Time value of money. The time value of money is money's potential to grow in value over time. Because of this potential, money that's available in the present is considered more valuable than the same amount in the future.

For example, if you were given $100 today and invested it at an annual rate of only 1%, it could be worth $101 at the end of one year, which is more than you'd have if you received $100 at that point. In addition, because of money's potential to increase in value over time, you can use the time value of money to calculate how much you need to invest now to meet a certain future goal. Many financial websites and personal investment handbooks help you calculate these amounts based on different interest rates. Inflation has the reverse effect on the time value of money. Because of the constant decline in the purchasing power of money, an uninvested dollar is worth more in the present than the same uninvested dollar will be in the future. Dictionary of Financial Terms. Copyright 2008 Lightbulb Press, Inc. All Rights Reserved.

Time Value of Money What Does Time Value of Money Mean? The idea that money available today is worth more than the same amount of money in the future, based on its earnings potential. This principle asserts that money can earn interest and grow, and so any amount of money is worth more the sooner a person has it so that that person can put it to use now rather than later. Also referred to as present discounted value. Investopedia explains Time Value of Money Everyone knows that money deposited in a savings account will earn interest. Because of this, the sooner it starts earning interest, the better. For example, assuming a 5% interest rate, a $100 investment today will be worth $105 in one year ($100 multiplied by 1.05). Conversely, $100 received one year from now is worth only $95.24 today ($100 divided by 1.05), assuming a 5% interest rate. Related Terms: Discount Rate Future Value Net Present ValueNPV Present Value Present Value Interest FactorPVIF