Question

Why is it important to prepare a financial budget?

Explain what is meant by the term "time value of money". For example, why might it be better to receive $8 today, over receiving a promise of $9 seven years from now?

How should one consider the time value of money when planning for retirement? Please share examples within your response.

Comment on least 2 posts.

Answer 1

A financial budget in budgeting means predicting the income and expenses of the business on a long-term and short-term basis.

Organizations prepare a financial budget to manage the cash flows in a better way. This budget gives the business better control and provides a more efficient planning mechanism to manage the inflows and outflows. To prepare a financial budget, it is important to prepare the operating budget first. With the help of the operating budget, the organization can predict the sales and production expenses. Therefore, the organizations prepares a financial budget only after planning the different financing activities in the operating budget.

The financial budget provides a blueprint for the business to move forward. It addresses not only the financial aspects of the business, but also checks the operational efficiency. The extra expenses are cut by emphasizing cost reduction and improving the market share. In terms of financial budgets, the organization is well prepared to meet the long-term and short-term expenses. A good financial budget helps in achieving the goals and objectives of the business in the shortest possible span of time.

TIME VALUE OF MONEY

Time value of money means of a unit of money is different in different time period. It is also referred to as time preference of money. The time value of money is the idea that there is greater benefit to receiving a sum of money now rather than an identical sum later.

Is accepting $8 today better or $9 seven years later

It is better to receive $8 dollars today because the present value of eight dollars today is $8. Also if we are ready to take $9 seven years from now then the present value of this $9 is equal to $6.40.

When we compare the PVs then Accepting $8 today is a better option.

This is possible to understand through time value only.

(Taking r=5%)

Present value =Future Value{1/(1+r)^n}

=9{1/(1+0.05)^7}

=$6.40

One should consider the time value of money while planning for retirement because it helps us to know how much we should save per year in order to fulfil our requirements for retirement. This can be better explained with the help of numerical example.

Suppose the retirement is 10years from now and the amount which we need for retirement is $10,000. It is compounded every year at the rate of 10%. Now through this example we can find out how much we should save each year in order to meet our retirement requirements that is $10,000

Here we will use the formula for Future Value of Annuity(FVA)

FVA=A[{(1+r)^n}-1]/r

where A is annuity

r is rate

n is no. of years

Now 10,000=A[{(1+0.1)^10}-1]/0.1

10,000=A(15.9374)

A=$627.45

Hence, we need to save $627.45 for 10years in order to meet our retirement needs.

In this way one can plan for retirement using Time Value of Money.