Wouldn’t it be convenient to know how much the sum of money you invest today at a specific interest would be worth in the future?
In other words, wouldn’t it give you peace of mind to know the time value of the money invested today?
It would. As time passes, money losses value, therefore valuation of financial assets is that important function of financial management that measures the time value of money.
Knowing the present value should help you decide between investment and hire purchase options. Or decide among any other transactions that involve a delay in payment.
Definitions of key terms are necessary for the proper understanding of the valuation of financial assets:
- What is a financial asset?
A financial asset is an asset that can easily be converted to cash in a short period of time. A financial asset is a liquid asset.
The value of a financial asset is associated with its ownership claim or contractual rights.
This value indicates the inherent risk and the impact of the forces of supply and demand on it.
Examples of financial assets are cash, bank deposits, stocks, mutual funds and bonds.
2. What is financial asset valuation?
Financial asset valuation is the process of determining the amount that a future cash flow from a financial asset, Is worth in terms of today’s money.
An accurate knowledge of a company’s financial assets is useful for determining a company’s net worth for investment and funding purposes.
3. What is the time value of money?
The time value of money concept states that the value of money (the purchasing power of money) changes over time.
The value of money is the amount of goods and services a given amount of money can purchase at a given time or over a period of time.
The value of money changes over time in response to changes in levels of interest rate and inflation.
The valuation of financial assets assesses the value of money based on market rate of interest and the associated degree of risk.
Therefore, simple financial tools which measure the impact of interest rates on future value of investments are used. They include;