Compounding means earning money on the money already earned. It refers to the increase in the value of an asset due to interest earned on both- the principal amount as well as the accumulated interest.
This is also referred to as the Time Value of Money. It means that the value of a unit of money is more today than one year later, because of the presence of inflation, which reduces the value of money.
Thus, if money is invested, it earns a rate of return that increases its value through the compounding effect.
