Compounding vs. Discounting — What's the Difference?

Exponential growth due to reinvestment of interest.

A method to account for the time value of money.

The growth process where interest earns its own interest.

Reducing the future value of money to today's terms.

Reinvestment of earnings to generate additional earnings over time.

Present value estimation of future amounts.

Increasing the value of an investment by reinvesting earnings.

Calculating what future cash flows are worth currently.

In the field of pharmacy, compounding (performed in compounding pharmacies) is preparation of a custom formulation of a medication to fit a unique need of a patient which cannot be met with commercially available products. This may be done for medical reasons, such as to be administered by a different route (ex: tablet to liquid), to avoid a non-active ingredient that the patient is allergic to, or to provide an exact dose that isn't commercially available.

The process of determining the present value of future money.

To combine so as to form a whole; mix

Discounting is a financial mechanism in which a debtor obtains the right to delay payments to a creditor, for a defined period of time, in exchange for a charge or fee. Essentially, the party that owes money in the present purchases the right to delay the payment until some future date.

To produce or create by combining two or more ingredients or parts; compose or make up

Present participle of discount

To settle (a debt, for example) by agreeing on an amount less than the claim; adjust.

To compute (interest) on the principal and accrued interest.

To add to or intensify so as to make worse

To make worse by being an additional or intensifying factor

To combine in or form a compound.

To come to terms; agree.

Consisting of two or more substances, ingredients, elements, or parts.

(Botany) Composed of more than one part

A combination of two or more elements or parts.

(Linguistics) A word that consists either of two or more elements that are independent words, such as loudspeaker, self-portrait, or high school, or of specially modified combining forms of words, such as Greek philosophia, from philo-, "loving," and sophia, "wisdom."

(Chemistry) A pure, macroscopically homogeneous substance consisting of atoms or ions of two or more different elements in definite proportions that cannot be separated by physical means. A compound usually has properties unlike those of its constituent elements.

Present participle of compound

An accumulation of compound interest.

The act of mixing or combining substances to make a compound, such as a medicine

The act of combining things.

The act of combining things to form a new whole

The accumulation of interest on principal and previously accrued interest.

Discounting helps businesses evaluate the present value of future cash flows, aiding in investment decisions and project evaluations.

Yes, Compounding can occur daily, monthly, quarterly, or annually. Daily compounding leads to higher returns compared to less frequent compounding.

Yes, Compounding benefits investors as it leads to interest earning its own interest, accelerating growth over time.

In Discounting, the discount rate represents the time value of money and factors like risk and inflation, determining the present value of future cash flows.

While the principle of Compounding is consistent, the frequency and rate can vary across investments, affecting overall returns.

The discount rate in Discounting is influenced by factors like inflation, interest rates, and risk associated with future cash flows.

Yes, Discounting always reduces future values to present terms, reflecting the time value of money.

A higher discount rate in Discounting reduces the present value more, which might be less favorable for assessing future revenues or returns.

While not termed "negative Compounding," decreasing returns due to losses can compound, leading to accelerated decreases in investment value.

When choosing a Compounding frequency, consider factors like the nature of the investment, expected returns, and financial goals.

Inflation erodes the purchasing power of future money. Discounting accounts for this, reducing future values to present-day terms.

Primarily, yes. Discounting is about translating future cash flows to their present value, accounting for the time value of money.

Compounding can lead to exponential growth over time, turning small investments into substantial sums, making it a powerful financial tool.

Yes, both can be used in financial planning. For instance, Compounding to project future wealth and Discounting to assess the present value of future expenses.

Banks use Compounding for savings and deposit accounts, where interest earned is reinvested, growing the principal amount.