SUBJECT: Financial Management 2

27/JANUARY/2020

“TIME VALUE OF MONEY IN PAKISTAN VS ISLAMIC &

CONVENTIONAL CONCEPT”

 WHAT IS TIME VALUE OF MONEY?

It is the idea that money that is
available at the present time is worth more than the same amount in the
future, due to its potential earning capacity.
FORMULA,
 FV = PV x [ 1 + (I/ N) ] (N*T)
Where,
FV is Future value of money,
PV is Present value of money,
I is the interest rate,
N is the number of compounding periods annually and
T is the number of years in the tenure.
 IMPORTANCE,
The time value of money (TVM) is
an important concept to investors because a dollar on hand today
is worth more than a dollar promised in the future. The dollar on hand
today can be used to invest and earn interest or capital gains.

In Pakistan the value of money changed drastically

the way Islamic banks operate should by now be well understood, I still come
across people who contend that there is no concept of the time value of money in
Islamic finance. Normally these are young people with no practical experience of
Islamic banking.

If you want to buy a car costing $10,000, and don’t have the money but are
otherwise creditworthy, a conventional bank may lend you the $10,000 so you can
buy the car today. In return, you agree to repay the bank, say, $12,500 in 60
months’ time. (This corresponds to simple interest at 5% for five years.)
If you approach an Islamic bank, they will of course refuse to undertake the above
loan transaction. However, assuming you are creditworthy, the Islamic bank will
agree to buy that car from the dealer (paying the dealer $10,000) and sell you the
car for $12,500 payable in 60 months’ time, while giving you immediate ownership
and possession of the car. The net cash flows for you, the bank, and the dealer,
both today and in 60 months’ time, are identical.

For accounting purposes, the conventional bank will, of course, record $500
interest income in each of the five years. (This column uses simple interest to
avoid clogging up the text with compound interest calculations.)

An Islamic bank accounting under International Finance Reporting Standards will

report the same figures as the conventional bank, since IFRS fundamentally
accounts for the economic substance of transactions

Reference:

https://www.mohammedamin.com/Islamic_finance/Time-value-of-m
oney-in-Islamic-finance.html