Don't let anyone look down on you because you are young, but set an example for the believers in speech, in conduct, in love, in faith and in purity. ~I Timothy 4:12~

Wednesday, February 8, 2012

Biblical Business: The Time Value of Money

If you've ever taken a Finance or Accounting class then you've probably heard about the time value of money. The concept in itself may be simple enough, but do enough calculations and you'll start seeing how the relationship between time and money can be pretty overwhelming.

The bottom line is that a dollar today is worth more than a dollar tomorrow.

But why is that? 

Well first, I want you to ignore inflation. Just go to a perfect world where it doesn't exist. Are you there? Good, let's move on.

A dollar today and a dollar received a year from now are still a dollar. They can still buy you that same, one dollar candy bar (if you were to spend it). However, you would want to take the dollar today if given the choice. Not because you will have it sooner, but because you can invest it and earn interest on it over that year. So, if you wanted to buy that candy bar in a year you could 1) take the money now and keep it in your pocket and wait, 2) wait a year and then get the dollar, or 3) take the money now and let it set and earn interest until you want the candy bar. Obviously you'd want to go with option 3. This way you still get that candy bar and you would have a few extra cents (how many depends on the interest rate) to pocket as well.

Therefore, a dollar is worth more to you today than in the future, because you can invest it today and earn a return (interest) on it during that time.

Now that you understand the basic, underlying principle of the time value of money let's look at where the Bible talks about the time value of money. We'll be looking at the words of the Great Teacher, Jesus himself. This is where Jesus tells the Parable of the Bags of Gold in Matthew 25.


14 “Again, it will be like a man going on a journey, who called his servants and entrusted his wealth to them. 15 To one he gave five bags of gold, to another two bags, and to another one bag, each according to his ability. Then he went on his journey. 16 The man who had received five bags of gold went at once and put his money to work and gained five bags more. 17 So also, the one with two bags of gold gained two more. 18 But the man who had received one bag went off, dug a hole in the ground and hid his master’s money.
  
   24 “Then the man who had received one bag of gold came. ‘Master,’ he said, ‘I knew that you are a hard man, harvesting where you have not sown and gathering where you have not scattered seed. 25 So I was afraid and went out and hid your gold in the ground. See, here is what belongs to you.’
   26 “His master replied, ‘You wicked, lazy servant! So you knew that I harvest where I have not sown and gather where I have not scattered seed? 27 Well then, you should have put my money on deposit with the bankers, so that when I returned I would have received it back with interest.


So the first two servants doubled their money, which is equivalent to a return (or interest rate) of 100%. However, the third servant did nothing and only returned the exact amount. The master was very upset! He had seen the return of 100% on all his other investments but yet this one had a return of zero.

If the master would have given the bag of gold to another servant he would have an additional bag of gold from interest. So based on the time value of money the third servant essentially lost his master a bag of gold.

The master understood this and the time value of money. That is why he said "you should have put my money on deposit with the bankers, so that when I returned I would have received it back with interest."


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