Free Cash Flow explained

In simple terms, Free Cash Flow (FCF) refers to the amount of cash generated by the entity after accounting for reinvestment in non-current assets. 

FCF = Cash from Operations [-] Capital Expenditure

Wherein, Cash from Operations = Net Income [+] Non-Cash expense [+] Changes in Net Working Capital. This number can readily be referenced from Cash Flow statement presented by the entity.

Non-Cash expense includes P&L expenses which have not been actually spent in Cash, like - Depreciation, Amortization, Stock based compensation, impairment charges etc.

Working Capital is calculated primarily difference between current asset and current liabilities, like -  Accounts Receivable, Inventory, Accounts Payable, etc.. Change in Net Working capital may be positive or negative number and will need to be added or deducted accordingly

Lot of Equity research report also calculates Levered and Unlevered Free Cash flow. So it's very important to understand the difference between them

Unlevered Free Cash Flow, also called Free Cash Flow to Firm (FCFF)

Levered Free Cash Flow, also called Free Cash Flow to Equity (FCFE)

Main difference between FCF, FCFF and FCFE is with respect to how the interest and debt is treated. Here's quick formula to give an idea on interest / debt treatment.

Free Cash Flow: Includes interest expense, but NOT debt issuances or repayments

Unlevered Free Cash Flow: Excludes interest expense and ALL debt issuances and repayments

Levered Free Cash Flow: Includes interest expense, and mandatory debt repayments

Formula to calculate each:

FCF: Cash Flow from Operations [–] Capital Expenditure

Unlevered Free Cash Flow (or FCFF): Earnings before Interest & Taxes (EBIT) [-] Taxes [+] Non-Cash Adjustments (like Depreciation, amortiztion, stock compensation) [+] Changes in Net Working Capital [–] Capital Expenditure

Levered Free Cash Flow (or FCFE): Net Income [+] Non-Cash Adjustments [+] Changes in Net Working Capital [–] Capital Expenditure [–] Debt Repayments

Note - as we started FCFE from Net Income, tax impact on debt repayment should be adjusted to arrive at more accurate number.

Unlevered free cash flow or FCFF is mostly used while doing discounted cash flow analysis


Exempt Income - Understanding & reporting in ITR

Income tax terminology can get very confusing at times and one of the most confused term is distinction of 'Tax deduction' and 'Exemption'. The lack of understanding leads to lot of people failing to report in the Exempt income in the Income Tax Return (ITR) filing. 

Understanding difference between 'Tax deduction' and 'Exempt income'

Tax deduction refers to the amount of money that is allowed as deduction from your total taxable income. The final amount after 'tax deduction' from total income is referred as ‘taxable income’. Concept of 'Tax deductions' is to motivate individuals to save and invest, also allowing some necessary expenses. Examples of 'Tax deduction' are amount deposited in PPF, NPS, donation made to charities (section 80G), Medical insurance, etc.

'Exempt income' on other hand means income that are excluded for arriving at taxable income. Exempt income are of two types - fully exempt (like Agricultural income, PPF interest, etc) and partially exempt (income subject to certain limit, like House Rent Allowance, Leave Travel Allowance, etc). Remember Exemptions are always from the specific income head and not from the gross total income. For e.g., Exemptions allowed under salary head cannot be claimed from any other income head.

To summarize, Exempt income is tax free from the point it is earned, while tax deduction are the part of income which is excluded basis certain tax provision and excluded from computing taxable income.

Tax Deduction vs Exempt Income


Why disclosure of Exempt Income is important?

Disclosure of Exempt Income is often ignored by individuals while filing income tax return, thinking it does not get taxed anyway - what assesse forgets is, this non-reporting can put them in risky situation when the future enquiry about the source of income is raised by Income Tax officer. In absence of disclosure under Exempt Income, you cannot pin-point source and open the assessment for further enquiry.

Section 10 of Income tax Act deals with all the incomes which are exempt from computing income taxes. Some examples of Exempt Income:
  • Interest credited to Provident Fund - Fully exempt (Statutory PF, PPF). In case of Recognized PF, only to the extent interest does not exceed 9.5% (Learn more about PPF here)
  • Dividend income from domestic company (amount not exceeding Rs. 10 lakh)
  • Gift or Voucher or Coupon on ceremonial occasions or otherwise provided to the employee - (a) Gifts in cash or convertible into money (like gift cheque) are fully taxable (b) Gift in kind up to Rs.5,000 in aggregate per annum would be exempt, beyond which it would be taxable.
  • Any income generated from agriculture and related activities including rent from land/farmhouse used for agricultural purpose, further processing of the agricultural product, income from seeds or saplings, etc. [Section 10(1)]
  • Share of income received from the family income, being a part of a Hindu Undivided Family [Section 10(2)]
  • Any amount received as a part of a life insurance plan including policy bonus [Section 10(10D)]
  • Any withdrawals from the provident fund (for salaried employees) [Section 10(11)(12)]
  • Amount received as compensation from the government, in case of disasters [Section 10(10BC)]
  • Income generated from tax-free securities [Section 10(15)]
  • National Pension System -  Any payment from the National Pension System Trust to an assesse on closure of his account or on his opting out of the pension scheme referred to in section 80CCD, to the extent it does not exceed 60% of the total amount payable to him at the time of such closure or his opting out of the scheme.
Disclosure Of Exempted Income For Salary Allowances in ITR

Disclosure of this type of exempted income is required to be made under "Schedule S - Details of Income from Salary" when filing tax returns
  • House Rent Allowance (HRA)
  • Leave Travel Allowance (LTA)
  • Encashment of Leave
  • Pension
  • Gratuity
  • Voluntary Retirement Scheme
  • Perquisites
Disclosure Of Exempted Income For Non-Salary Allowances in ITR

The Income Tax Act also specifies specific types of non-salary income that are also exempt from tax. These incomes include dividends, agricultural income, interest on funds, capital gains etc. Disclosure of these types of income is required to be made by the taxpayer under "Schedule EI - Details of Exempt Income" when filing tax returns

Screenshot of Exempt Income input required in ITR2:

ITR 2 - Exempt Income

Long-term Capital Gain tax exemption

It's important to note, Budget 2018 proposed to remove Section 10 (38) of the Income Tax Act, 1961. As per this section, the long-term capital gains (LTCG) arising on sale of equity shares or units of an equity-oriented mutual fund on which Securities Transaction Tax (STT) is paid was exempt from taxation. This section was initially introduced through the Finance Act, 2004, with effect from AY 2005-06, based on the Kelkar Committee report to attract investments from Foreign Institutional Investors (FII).

The Budget 2018 introduced Section 112A by withdrawing Section 10(38). It proposed to impose tax on the LTCG of the following: Shares, Equity-oriented funds or Business trusts. 

The LTCG tax is applicable at a rate of 10% on gains over and above Rs 1 lakh a year, and there is no benefit of indexation. The provisions of this section will apply from the financial year (FY) 2018-19, i.e. AY 2019-20.

Note: Article is meant for basic understanding and general guidance. Check with your tax consultant before filing taxes. Article is written on 1st Jan 2021 basis the then prevailing tax rules.

What is Exchange Traded Fund (ETF) and Index Fund?

For major participants in stock market - passive investing is the most preferred way. When it comes to passive investing - two of the most preferred way is investing via Mutual Fund SIPs or ETF. In Mutual Fund, easiest way to take the most balance approach is via Index Fund. It becomes imperative to understand this passive approach little more before embarking on long term wealth creation journey. Let's just dive into the basics -

What are Index Fund?

In most simplified definition - Index Funds are mutual fund schemes that track an underlying index like Nifty or Sensex. Objective is to invest in the same stocks that builds the underlying index in the same proportion, to replicate the performance of the underlying index.

What are Exchange Traded Fund (ETF)?

ETF is like a closed ended fund, where funds are raised in the beginning and then the ETF creates a portfolio of stocks representing underlying index (Sensex, Nifty, etc). Once portfolio is made, no further  fresh applications or redemption requests are taken. However, the ETF mandatorily gets listed on the stock exchange so you can always buy and sell it like equity shares in the market and also hold it in your demat account. 

What are the advantages of investing via Index Fund or ETF?

  • Both ETF vs Index Funds allow diversification of risk as they follow the particular index, and not any particular company or sector or industry.
  • Both being passively managed, operating costs are lower

Index Fund vs ETF

So, now question is - what is better? ETF or Index Fund?

ETFs have the advantage of comparatively lower cost over index funds. However, index funds have more advantages in ease of transacting, buying and selling at will and no need to have a demat account. Ideally, cost is the biggest factor when investing in a passive fund but in India due to low awareness there is lesser liquidity in ETFs. Therefore, personally I prefer Index Fund as opposed to ETFs.

You can check the list of Index Fund at StockXplain site here

Sovereign Gold Bond (SGB) Explained

Sovereign Gold Bond SGB

What is Sovereign Gold Bond (SGB)?

SGBs are government securities (issued by Reserve Bank of India on behalf of Government of India) denominated in grams of gold. They are substitutes for holding physical gold. Investors have to pay the issue price and the bonds will be redeemed at time of maturity.

What is the advantage of SGB over actual physical gold?

  • Purity of Gold
  • The quantity of gold for which the investor pays is protected
  • Government pays nominal interest rate each year
  • There is no additional cost impact of ‘making charges’ which is charged, if bought in physical form
  • It reduces risk and cost of storage associated with keeping physical gold
  • The bonds are held in the books of the RBI or in dematerialize form eliminating risk of loss of physical certificate

Benefits of Sovereign Gold Bonds

What about risks associated with SGBs?

Only risk is of price of gold at time of redemption / maturity. Capital loss will be there, if actual gold price falls below the purchase price.

Can I apply for SGBs?

Any person resident in India as defined under Foreign Exchange Management Act, 1999 are eligible to invest in SGB. Eligible investors includes  individuals, HUFs, trusts, universities and charitable institutions. Also you can invest in joint holding as well as on behalf of the minor his/her guardian.

I was resident, but now I am no longer resident. What happens to SGB I bought?

You can continue to hold SGB till early redemption/maturity, which you bought when you were eligible.

How can I apply for the bonds?

You can fill in the application form provided by the issuing banks/SHCIL offices/designated Post Offices/agents. You can also download application form from the RBI’s website. Banks may also provide online application facility. Lastly, you can also apply via your stock broking account (would be listed under Bonds at time of issuance).

How much can I invest? Is there any minimum or maximum limit?

The Bonds are issued in denominations of 1 gram and in multiples thereof. Hence, minimum investment needs to be 1gm. Maximum limit is 4 kg for individuals, 4 kg for Hindu Undivided Family (HUF) and 20 kg for trusts and similar entities notified by the government from time to time per fiscal year (April – March). 

In case of joint holding, the limit applies to the first applicant. 

For purpose of annual ceiling – it will include all SGB subscribed under different tranches during initial issuance by Government and those purchased from the secondary market.

What is the rate of interest and how will the interest be paid?

The Bonds bear interest at the rate of 2.50 per cent (fixed rate) p.a. on the amount of initial investment, i.e. issue price. 

Interest will be credited semi-annually to the bank account of the investor and the last interest will be payable on maturity along with the principal.

Is allotment guaranteed?

Yes, If you meet the eligibility criteria, produces a valid identification document and transfer the application money on time, allotment is guaranteed.

You can apply online (digital application) to be eligible for Rs 50 per gram discount as compared the issue price

How is the gold price arrived at?

The nominal value of SGB is in Indian Rupees fixed on the basis of simple average of closing price of gold of 999 purity, published by the India Bullion and Jewelers Association Limited, for the last 3 business days of the week preceding the subscription period.

What is the duration of bonds? Can I exit before the maturity?

Bonds are issued with tenor of 8 years. Early redemption of the bond is allowed after fifth year from the date of issue on interest payment dates. The bond will be tradable on Exchanges, if held in demat form. It can also be transferred to any other eligible investor.

How will maturity price of Gold arrived at?

Similar to issuance procedure, maturity amount would be based on simple average of closing price of gold of 999 purity of previous 3 business days from the date of maturity, published by the India Bullion and Jewelers Association Limited.

Is it possible to gift the bonds?

The bond can be gifted/transferable to a relative/friend/anybody who fulfills the eligibility criteria. Transfer can be done by execution of an instrument of transfer which is available with the issuing agents.

Can I use bonds as collateral for loans?

Yes, bonds are eligible to be used as collateral for loans from banks, financial Institutions and Non-Banking Financial Companies (NBFC).

What are the tax implications on i) interest received and ii) capital gain?

Interest on the Bonds will be taxable

Long term capital gain is tax free, if redeemed at time of maturity. Redemption prior to maturity will make the long term capital gain taxable

Indexation benefit is available, for computation of Long term capital gain tax, if transferred before maturity

Note, no TDS is applicable on the bond. However, it is the responsibility of the respective bond holder to comply the taxation requirements.

Can I trade these bonds?

The bonds are tradable from a date to be notified by RBI. (It may be noted that only bonds held in de-mat form with depositories can be traded in stock exchanges) The bonds can also be sold and transferred as per provisions of Government Securities Act, 2006. Partial transfer of bonds is also possible.

How does It compare to Gold ETF and Physical Gold?

SGB, Gold ETF, Physical Gold comparison
I consider, it has better edge compared to Gold ETF, if held till maturity, as long term capital gain is tax free. 

Drop in your comment for any additional questions / views.

Public Provident Fund (PPF) Explained

The Public Provident Fund is a sound savings cum tax saving instrument in India. Started in 1968 by the National Saving Institute of the Ministry of Finance. It is a long term saving instruments with stable return and zero capital risk, bundled with tax savings feature giving extra edge.

Should you open a PPF account?

This is ideal for an individual who are risk averse. Having said that, I personally feel, everyone should have this as a part of their investment strategy. This can be used to allocate debt component of the portfolio. Obviously with the limits, which we will see further below.

Who can open a PPF account?

Any individual Indian citizen residing in India can open PPF account. Parent can open account in the name of minor children. While opening account for minor, one of the parent’s PAN is required. Remember, tax savings will continue to be at Rs 1,50,000 for both account put together i.e. of parent and minor child.

You cannot open Join account, it's for individual.

Non-residents are not permitted to operate PPF account but can continue the existing account till it matures. No further extension of 5 years is available, once it matures.

Hindu Undivided Family as known as HUF is no longer permitted to open PPF account (notification no GSR 291(E) dated May 13, 2005). In order to claim deduction u/s 80C, HUF can contribute to the PPF account of its members and claim tax deduction

Who can open PPF account?

Where you can open PPF account?

You can open PPF account in either Post Office or Bank.

Banks accepting the PPF accounts are - designated branches of State Bank of India and its subsidiaries, ICICI bank, Axis bank, HDFC bank and few others.

Amount of deposit

Minimum deposit in each financial year should be of Rs 500 and maximum can be Rs 1,50,000

Deposits can be made in multiple of Rs 50 and any number of times in a financial year. Earlier, a maximum of 12 deposits were only permitted in a financial year.

PPF Investment Limit

You can see the power of compounding very well in this instrument. For example, considering interest rate stay at 7.1% and you continue to invest annually to the maximum permissible investment of Rs. 1,50,000 at the beginning of the year – over 15 years, you will end up with sound corpus of Rs. 40.7 lakhs. You can see by Year 10, interest compounding is significant and interest earned is becoming higher compared to the amount deposited each year.

PPFReturn

(Tip - You can use excel built in function FV to do the quick calculation)

Interest Rate

Interest rate is fixed by the Finance Ministry every quarter. The current PPF interest rate is 7.1%. Though the interest is calculated every month, it gets credited to your account on 31st March every year. Also, the PPF interest is calculated on the minimum balance between the fifth and the last day of the month.

For example: You have a balance of Rs 1 lakh in your PPF account on 30th April. Now, let's imagine you deposit ₹10,000 in your PPF account on 3rd May and ₹5,000 on 30th May. Now, the interest on your fund for the month of May will be calculated on Rs 1.10 lakh and not Rs 1.15 lakh

Taxation

Investments up to Rs. 1.5 lakh is eligible for tax deductions under Section 80C

PPF falls under EEE Category, i.e. Exempt – Exempt – Exempt, which basically means

The amount you deposit is tax exempt [under Section 80 C]
The interest on deposit is tax exempt [under Section 10(15)]
Final maturity amount is also tax exempt

Note:

  • Always disclose Interest earned in PPF account as part of Exempt income in your tax returns
  • All the balance that accumulates over time is exempted from wealth tax computation

Inactive PPF account

For any reason, if you do not deposit minimum amount of Rs. 500 in any financial year, account gets inactive. However, to re-activate, you can pay the minimum amount of Rs. 500 for each financial year you have not deposited together with nominal penalty of Rs. 50 for each such financial year and get your account re-activated.

Lock in period & Premature closure

The minimum lock-in period of a Public Provident Fund is 15 complete financial years from the end of the year in which the account was opened . On maturity, you can withdraw your entire corpus. If you wish to continue for a longer period, you can continue to do so (with or without making additional contributions) by applying for the extensions in 5 year blocks. There is no limit on how many time you can extend after the initial lock-in period of 15 years.

PPF Lockin Premature closure

One can prematurely close the account after 5 years from the opening of account under specific circumstances

  • Treatment of life threatening disease of the account holder, his spouse or dependent children or parents, on production of supporting documents and medical reports confirming such disease from treating medical authority
  • Higher education of the account holder, or dependent children on production of documents and fee bills in confirmation of admission in a recognised institute of higher education in India or abroad
  • On change in residency status of the account holder on production of copy of passport and visa or income tax return

Premature closure of PPF accounts will lead to 1% lower interest than the rate at which interest is credited to the account

Loan against PPF account

An advantage of PPF accounts is that you can take a personal loan against the balance in your PPF account provided your PPF investment is not due for withdrawal. This loan can be availed between the third and the sixth financial year of opening the account. The loan amount is limited to 25% of the balance at the end of the second financial year prior to the year in which you applied for the loan. You are not required to pledge a collateral when taking a loan against your PPF account.

Under the new rules, the rates at which the account holder can borrow from his account has been reduced to 1% above the prevailing PPF interest rate, from 2% earlier. In case of death of the account holder, the nominee or legal heir shall be liable to pay interest on the loan availed by the account holder but not repaid before his death. Such amount of due interest shall be adjusted at the time of final closure of the account.


Summary of the salient features of PPF account:

  • Deposit any amount between Rs. 500/- (minimum) and Rs. 1,50,000/- (maximum) in a financial year
  • Current Rate of Interest Payable (Currently as on Oct 20, it is 7.1%)
  • Loan facility is available from 3rd financial year up to 6th financial year
  • One withdrawal is permissible every year from 7th financial year
  • Account matures on completion of 15 complete financial years from the end of the year in which the account was opened
  • After maturity, account can be extended for any number of a block of 5 years with further deposits
  • Account can be retained indefinitely without further deposits after maturity with the prevailing rate of interest
  • Deposit in PPF account is qualified for deduction under Sec 80C of Income Tax Act
  • Interest earned in PPF account is completely exempted from Income Tax under Sec 10(15) of Income tax Act
  • The amount in the PPF account is not subject to attachment under any order or decree of a court of law

Frequently Asked Questions

Q: Can you open 2 PPF account?

A: No, only one PPF account can be opened by an individual

Q: Can I close my PPF account early?

A: Under specific circumstances, you can withdraw after completion of 5 years. So for example, if you open an account in Jan 2020, you can begin making partial withdrawal starting FY 2025-26

Q: Can I extend PPF account for 4 years after maturity?

A: No, extensions can be done only in block of 5 years

Q: I deposited amount in my child’s name, can I claim benefit?

A: Yes, if your PAN is used to open the minor’s account, you can claim the benefit of deposit. However, overall deposit cannot exceed Rs. 1,50,000 and so the benefit.

Q: Can I transfer my PPF account?

A: Yes, you can transfer your PPF account from one branch to another

To conclude, it’s one of the most wonderful investment option for risk averse investor.

Resource: Historical PPF interest rates

Period Rate of Interest
1968-69 4.80%
1969-70 4.80%
1970-71 5.00%
1971-72 5.00%
1972-73 5.00%
1973-74 5.30%
1 Apr 1974 to 31 July 1974 5.80%
1 Aug 1974 to 31 Mar 1975 7.00%
1975-76 7.00%
1976-77 7.00%
1977-78 7.50%
1978-79 7.50%
1979-80 7.50%
1980-81 8.00%
1981-82 8.50%
1982-83 8.50%
1983-84 9.00%
1984-85 9.50%
1985-86 10.00%
1 Apr 1986 to 31 Mar 1999 12.00%
1 Apr 1999 to 14 Jan 2000 12.00%
15 Jan 2000 to 28 Feb 2001 11.00%
1 Mar 2001 to 28 Feb 2002 9.50%
1 Mar 2002 to 28 Feb 2003 9.00%
1 Mar 2003 to 30 Nov 2011 8.00%
1 Dec 2011 to 31 Mar 2012 8.60%
1 Apr 2012 to 31 Mar 2013 8.80%
1 Apr 2013 to 31 Mar 2016 8.70%
1 Apr 2016 to 30 Sep 2016 8.10%
1 Oct 2016 to 31 Mar 2017 8.00%
1 Apr 2017 to 30 Jun 2017 7.90%
1 Jul 2017 to 31 Dec 2017 7.80%
1 Jan 2018 to 31 Sep 2018 7.60%
1 Oct 2018 to 30 Jun 2019 8.00%
1 Jul 2019 to 31 Mar 2020 7.90%
1 Apr 2020 to 31 Dec 2020 7.10%
1 Jan 2021 to 31 Mar 2021 7.10%

What is Repo and Reverse Repo Rate?

If you are tuned to stock market or general economic news, you would have heard this term come up every time there is central bank’s credit policy meet. Here’s an attempt to explain what does this rate mean? and how does it affect you?

What is Repo Rate?

We all put our money in bank or borrow from bank at particular interest rate. Similarly, rate at which central bank (in case of India – Reserve Bank of India aka RBI) lends money to commercial banks in the event of any shortfall of funds is called Repo rate. 

Why is it important?

This is very important tool for authorities to control inflation. In case of inflation, the central bank increase repo rate as this acts as disincentive for commercial banks to borrow from the central bank. Which effectively reduced the money supply in the economy and thus helps in arresting inflation. 

Let’s just summarize above explanation

  • Repo Rate serves as control mechanisim for the central bank for increasing / decreasing liquidity in the economy
  • Change in Repo Rate impacts the cost of borrowing for commercial banks
  • It is a key tool used by the central bank to fight inflation and achieve price stability in the economy
  • Repo rate changes can lead to changes in interest rates from deposits and interest rate applicable to loans

What is Reverse Repo Rate?

This is exactly opposite of Repo Rate. This signifies the rate at which the central bank (RBI) borrows money from the commercial banks. 

An increase in reverse Repo Rate will decrease money supply in the economy and vice-versa. Increased Reverse Repo Rate will incentivise the commercial bank to park their funds with central bank and vice-versa.

RBI Repo Rate explained


Both this rate forms part of central bank’s monetary policy instruments which helps in controlling the money supply in the country and thereby controlling the inflation.

Calculator: Return on SIP investment

Most suggested route in personal finance world to achieve long term financial goal is via making regular investment or popularly known as Systematic Investment Plan or SIP.

Now, this brings important questions

  • How much you can expect to save, if you invest an X amount for Y period at expected rate of Z%?

  • How much return will differ, if I save at the beginning of the month or at the end of the month?

  • What is the absolute return %?

  • What is the effective annualized return? etc.

To answer this basic questions, I have made small Excel spreadsheet, feel free to download from here and play around.

Excel Calculator - SIP Return

Drop in a comment for any feedback.