An annuity, in financial and accounting terms, is a series of equal cash amounts occurring at equal time intervals — monthly rent, a semiannual bond coupon, or a fixed loan installment are all everyday examples. The concept underlies much of the time value of money math used throughout accounting and finance, since a great many real-world cash flow streams happen to take this regular, repeating shape.
Ordinary annuities versus annuities due
The timing of each payment within its interval matters for the math: an ordinary annuity pays at the end of each period, which describes most loan payments and bond coupons, while an annuity due pays at the beginning of each period, which describes most lease and rent payments. Because an annuity due's payments arrive sooner, its present value is always somewhat higher than an otherwise identical ordinary annuity's, and its future value compounds for one extra period.
Present and future value of an annuity
The present value of an annuity answers how much a series of future equal payments is worth today, discounted at some required rate of return; the future value of an annuity answers how much a series of equal deposits will grow to by some future date, given compound interest along the way. Both calculations rest on the same underlying annuity factor, adjusted for whether the cash flows occur at the start or end of each period.
Where annuities show up in accounting and finance
Bond valuation treats the coupon payments as an ordinary annuity and the final principal repayment as a separate single lump sum. Loan amortization schedules are built directly from annuity math, since a fixed monthly mortgage or auto loan payment is itself an ordinary annuity whose present value, discounted at the loan's interest rate, equals the amount originally borrowed. Lease accounting similarly relies on annuity-due calculations whenever rent is payable in advance, which is the market norm for most commercial and residential leases.
Annuities as retirement and insurance products
Outside pure accounting mechanics, “annuity” also names a specific type of insurance or retirement product, where an individual pays a lump sum or a series of premiums to an insurer in exchange for a promised stream of future payments, often for life. These commercial annuity products are built on exactly the same mathematics described above, with the insurer pricing the promised payment stream using annuity present-value formulas adjusted for mortality risk, interest rate assumptions, and its own profit margin.
A simple worked example
Depositing $1,000 at the end of each year for five years into an account earning 6% annually produces a future value of roughly $5,637, reflecting both the five deposits themselves and the compound interest earned on the earlier deposits before the series ends — a calculation that would differ only slightly, by one extra period of compounding, if the same deposits were instead made at the start of each year as an annuity due.
Why the timing distinction matters so much
The difference between payments occurring at the end versus the beginning of each period seems small, but it compounds meaningfully over a long annuity, since every payment under an annuity due earns one extra period of interest or discounting compared with the equivalent ordinary annuity payment. This is why loan amortization schedules, which are built on ordinary annuities, and lease payment schedules, which are frequently structured as annuities due because rent is conventionally paid in advance, cannot simply share the same present-value or future-value factor tables — a formula built for one timing convention will misstate the result if applied to the other without adjustment.