Why cash flows at different times are not comparable, and how they are made comparable

Why it matters. Financial decisions compare money paid or received at different times. ₹1,000 now is worth more than ₹1,000 after a year: we part with money now only for something more later, and that extra is interest, the time value of money. Money has time value because of the preference for present consumption, the opportunity to invest present cash, the uncertainty of the future (the most important reason) and inflation. Adding up cash flows of different years as if they were equal would overvalue distant benefits and lead to wrong investment, financing and dividend decisions.

How time is adjusted. Cash flows of different dates are brought to a common date at an interest (discount) rate:

1. Compounding (future value): interest earned becomes part of the principal at the end of each period, so a sum grows to P(1 + i)ⁿ after n periods; all flows are carried forward to a future date.
2. Discounting (present value): the exact opposite: a future sum is divided by (1 + i)ⁿ to find its value today, and all flows are brought back to the present. Capital budgeting uses this, through NPV, IRR and the profitability index.

Tables of compound and present-value factors (and annuity factors for equal annual amounts) make the adjustment simple.

Illustration. At 10%, ₹1,000 received after one year and ₹1,100 received after two years cannot be compared as they stand. Brought to today, they are worth 1,000 × 0.909 = ₹909 and 1,100 × 0.826 = ₹908.60: almost equal. Carried forward to the end of year 2 instead, ₹1,000 grows to ₹1,100. Only on a common date do the two sums become comparable.