Determining Future Values

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Similar to determining present value amounts, determining future values depends on the concept of time value of money. This concept states that if the same amount of money is available now and in the future, it is worth more at present due to the potential to earn more money. So, due to time value, the future value of an amount can become more valuable as a deposit earns interest and that interest earns interest in the form of compound interest.

If an interest rate is constant, the future growth of a deposit’s value can be determined, showing the business which investments would be more profitable. Calculating future value can aid in tracking the growth of investments, single deposits, and balances. This calculation can also be used to find the length of time or interests rates needed to reach a desired future value.

To determine a future value, four pieces of information are needed. The first is the present value of the amount of a single item or account being analyzed. The second is the future value of the amount, the end result of the present value amount. The third piece of information needed is the amount of time that interest will accumulate for an amount, typically broken into time periods such as months, quarters, semiannually, and annually. The final piece of information needed is the interest rate for the time period. Note that only three out of these four variables are necessary for calculating future values.

The interest rate could be annual, semiannual, quarterly, or monthly. Depending on how frequently interest is compounded, the sum totals may be different at the end of a period. With an interest rate set, smaller time periods are adjusted accordingly. For example, if an interest rate is set at 12% for a year, that would mean that each month would account for 1% of the interest rate for that year. When compounding interest on interest more frequently, smaller timeframes yield higher balances at the end of an accounting year.

When determining future value amounts, accounting software is able to make these calculations for you.

The Rule of 72 is used to determine when an amount of money will double, and the interest rate needed for that amount to double. This amount is determined by multiplying an investment rate per year, as a percentage, by the number of years an investment will last, which will equal 72. Ergo, by filling in one of the two numbers, the other can be determined. To find out how long it will take for an amount to double, divide 72 by the established annual interest rate. To find out the correct compounded interest rate, divide the time needed by 72.

If multiple amounts of future values need to be determined, this can be accomplished by calculating and adding the future values for each amount. Note that amounts must match in terms of time and interest rates. For example, two amounts need to be broken down into the same time period such as month, quarter, or year.

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