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Key Differences

1. Compounding and discounting are methods used in time value of money to determine the future value of present money and present value of future money, respectively. 2. Compounding uses compound interest rates to calculate future value, while discounting uses discount rates to calculate present value. 3. The key difference is that compounding determines what amount will be received in the future if an amount is invested today, while discounting determines how much needs to be invested today to receive a specific future amount.

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50 views2 pages

Key Differences

1. Compounding and discounting are methods used in time value of money to determine the future value of present money and present value of future money, respectively. 2. Compounding uses compound interest rates to calculate future value, while discounting uses discount rates to calculate present value. 3. The key difference is that compounding determines what amount will be received in the future if an amount is invested today, while discounting determines how much needs to be invested today to receive a specific future amount.

Uploaded by

Wongani Msiska
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Key Differences

Know the Differences & Comparisons

Difference Between Compounding and


Discounting

Time Value of Money says that the worth of a


unit of money is going to be changed in future. Put simply, the value of one rupee today will be
decreased in future. The whole concept is about the present value and future value of money.
There are two methods used for ascertaining the worth of money at different points of time,
namely, compounding and discounting. Compounding method is used to know the future value
of present money. Conversely, discounting is a way to compute the present value of future
money.

Compounding is helpful to know the future values, of the cash flow, at the end of the particular period,
at a definite rate. Contrary to this, Discounting is used to determine the present value of the future cash
flow, at a certain interest rate. Here, in this article, we’ve described the differences between
compounding and discounting.

Comparison Chart

Basis for
Compounding Discounting
Comparison
The method used to determine the future The method used to determine the
Meaning value of present investment is known as present value of future cash flows is
Compounding. known as Discounting.
If we invest some money today, what What should be the amount we need
Concept will be the amount we get at a future to invest today, to get a specific
date. amount in future.
Basis for
Compounding Discounting
Comparison
Use of Compound interest rate. Discount rate
Known Present Value Future Value
Future Value Factor or Compounding Present Value Factor or Discounting
Factor
Factor Factor
Formula FV = PV (1 + r)^n PV = FV / (1 + r)^n

Key Differences Between Compounding and Discounting


The following are the major differences between compounding and discounting:

1. The method uses to know the future value of a present amount is known as
Compounding. The process of determining the present value of the amount to be received
in the future is known as Discounting.
2. Compounding uses compound interest rates while discount rates are used in Discounting.
3. Compounding of a present amount means what will we get tomorrow if we invest a
certain sum today. Discounting of future sum means, what should we need to invest today
to get the specified amount tomorrow.
4. The future value factor table is referred to calculate the future value in case of
compounding. Conversely, in discounting, present value can be computed with the help
of a Present value factor table.
5. In compounding, present value amount is already specified. On the other hand, the future
value is given in the case of discounting.

Conclusion

Compounding and Discounting are simply opposite to each other. Compounding converts the
present value into future value and discounting converts the future value into present value. So,
we can say that if we reverse compounding it will become discounting. Compounding Factor
table and Discounting Factor table is taken into consideration for the quick calculation of the
two. In the table, you will find the factors, concerning different rates and periods. The factor is
directly multiplied by the amount to arrive the present or future value.

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