What is Equity Delivery?

Buying stocks is more straightforward, especially after transitioning to electronic and digital channels. However, few things have remained the same, such as how and when stocks get delivered. It is also valid for a few trading parts, such as intraday trading and equity delivery. Today, we learn what equity delivery is and why you must know about this.

Equity Delivery Meaning

In the Indian stock market, when an investor buys or sells, their stakes are not settled immediately or on the same day. The transactions follow a T+2 settlement cycle. Thus, if a buyer purchases a stock on Monday, those shares would be delivered to their DEMAT account on Wednesday.

When the stocks get delivered to their DEMAT account, the account holder can sell or hold them as per his convenience. This is called equity delivery. In this case, the person holding the shares is the owner of the stocks. 

Delivery-based trading is one of the many ways one can trade in the Indian stock market. In delivery-based trading, one can hold the shares for as long as they desire after they have been delivered to the investor’s account. The investor has complete ownership of what stocks to buy and how long to wait for an excellent opportunity to sell, taking home a good profit. 

This is the different from other stock trading types, such as intraday trading, wherein one can buy and sell stocks within the same trading day. 

What is the T+2 Settlement framework?

In the Indian stock market, share transactions do not get delivered at the very instance when they are bought or sold on the same day. These transactions must follow a settlement cycle known as the T+2 cycle. Generally, as per theT+2 settlement cycle; transactions must be completed in the timeline of T+2 days that is, Trading Day + 2 Working Days.

Consider an investor has purchased many stocks on Monday; these stocks are not sent directly to their DEMAT account. This transaction will take T+2 Days, Monday, and two more Working days, which means by Wednesday. In the T+2 settlement phase, the investor can not sell their stock before delivery or make a short position, as the investor has still not received the shares and hence does not own them. Once the shares are delivered to their account, they can hold them for as long as possible and sell them according to their wish. This is the T+2 cycle framework in equity delivery.

Does Equity Delivery Have Any Costs?

When investors buy a stock of any company, they purchase it through a brokerage firm or a broker on a website or any digital application. When you trade on a stock or make a transaction, some part as commissions or brokerage is deducted. 

Advantages of equity delivery:

In the process of equity deliveries, investors get many benefits: 

  • It gives you time to decide on your investments: Equity delivery provides investors with the time for as long as they plan to hold them. Consider you have purchased shares of ABC company, and the time they are delivered to your DEMAT account, it can be held for as long as the investor wants.
  • Passive money: If an investor has some shares or stocks for an extended period, they can earn an income in the form of dividends. Generally, the concept is to hold the position that will be profitable since the price would rise one day, and along with this, investors can earn passive income in the form of dividends.
  • Capital appreciation: The idea of capital appreciation is nothing new and challenging to understand; when an investor earns profits over a duration of time, getting the difference between the buying price and selling price of the stock they hold is known as capital appreciation.

More such benefits of delivery based trading:

  • Many banks and financial institutions give loans in place on your shares. So, when you face any difficult situation financially, you can please your shares and take on a loan.
  • Also, if a company makes a hefty profit, it may announce bonus shares. Let’s assume a company declares a 1:1 bonus; that would mean you can get one share free for every share you hold of the company.

Disadvantages of equity delivery trading:

A few demerits or some common cons of delivery trading:

  • Upfront liquidity required: Unlike leverage trading, where the trader does not have to pay the entire cost of trades, delivery trading needs you to pay the total amount upfront. Investors who have less liquidity and wish to trade with heavy volumes usually opt for margin trading over delivery trading. Also, it can mandate you to miss out on profit-making chances if you do not want or cannot pay a large capital upfront.
  • High brokerage charges: Many stockbrokers charge high brokerages even for delivery trading. This increases the cost of transaction and lowers the profits that investors make by selling the stocks. 
  • Blocking funds: One of the significant delivery trading demerits is blocking funds to buy stocks in delivery trading. As in this case, investors need to pay the entire costs of the stocks upfront, which in a way, would block that specific amount in the shares bought. And investors get the funds back only when they sell the shares.
  • High transaction charges: High transaction charges like the STT also add to delivery trading demerits. The securities transaction tax or STT is a direct tax by the Securities and Exchange Board of India or SEBI on the purchase and sale of equities. It is a massive cost for equity delivery investors as the charges are as high as 0.01% on purchase and sale. 

Conclusion:

An investor when taking delivery of his shares in their DEMAT account can hold shares for as long as he wishes, unlike in intraday trading where he has to square off his position by the end of the day. The shares are delivered to the investor’s DEMAT account after the settlement cycle of T+2 days. 

While taking equity delivery, one must also know the various charges one has to bear, apart from the upfront investment amount. Several charges are applicable when an investor buys into shares through equity delivery, including service tax, stamp duty, costs of the depository participant, among others.

How to Select Stocks for Swing Trading?

Intro and Overview

Swing Trading is a trading method that focuses on taking smaller profits in short-term trends while eliminating losses faster. The benefits may be modest, but they can add up to significant yearly returns when compounded over time. Swing Trading positions are often kept for a few days to a few weeks, although they can be held longer. Swing trading is a style of trading that combines fundamental and technical analysis to profit from large market movements while minimizing downtime.

It focuses on benefiting from price action patterns that frequently change over short periods. Swing traders aim to profit on price swings in the stock market. Positions are generally kept for one to six days, although some may be extended for several weeks if the transaction is lucrative. Swing traders use a range of technical indicators to detect patterns, trend direction, and probable short-term trend shifts to uncover trading opportunities.

Five Strategies for Swing Trading Stocks

All of these strategies may be used in your future transactions to help you spot swing trading opportunities in the markets you care about. We’ve put together a list of five swing trade tactics that you may use to spot trading opportunities and manage your deals from beginning to end.

To find suitable trade entry opportunities, use these swing trading tactics to the equities you’re most interested in.

Fibonacci retracements: The Fibonacci retracement pattern may be used by traders to identify support and resistance levels on stock charts, as well as possible reversal levels. Within a trend, stocks frequently retrace a specific percentage before reversing and charting horizontal lines at the standard Fibonacci ratios, which suggest possible reversal levels. Even though it does not follow the Fibonacci pattern, traders frequently check at the 50% level since stocks tend to revert after retracing half of the previous rise.

Support and resistance triggers: Support and resistance lines, which are the pillars of technical analysis, may be used to create a winning stock swing trading strategy. A support level on the chart is a price level or region below the current market price when purchasing pressure is strong enough to overcome selling pressure. Consequently, a price decrease is halted, and the price begins to rise once more. A stock swing trader would try to place a buy trade with a stop loss below the support line on the rebound off the support line. 

Support is the opposite of resistance. It refers to a price level or area above the current market price when selling pressure may outnumber purchase desire, causing the price to reverse its upward trend. In this example, a swing trader may open a sell position on the rebound off the resistance level, with a stop loss placed above the resistance line. When it comes to implementing support and resistance into your swing trading method, it’s important to note that when price breaches a support or resistance level, the support or resistance level switches roles – what was previously supported becomes resistance and vice versa. 

Channel trading: To use this swing trading method, you must first choose a stock showing a definite trend and trading within a channel. When the price rebounds down off the top line drawn around a negative trend on a stock chart, you should consider establishing a sell position. It’s vital to trade with the trend when utilizing channels to swing-trade stocks, so in this case, when the price is in a downtrend, you’d only look for sell positions unless the price breaks out of the channel, rising higher and suggesting a reversal and the start of an uptrend. Here’s where you can learn more about breakout stocks.

10- and 20-day SMA: Simple moving averages are another of the most common swing trading tactics (SMAs).SMAs smooth out price data by establishing an average price that is continually changing and can be taken across a range of periods or lengths. A 5-day SMA, for example, calculates a new average each day by adding the daily closing prices for the previous five days and dividing by 5. Each average is linked to the next to form a smooth line that aids in the reduction of ‘noise’ on a stock chart. From one minute to weekly, any chart interval can utilize the length (5 in this example). SMAs with shorter periods react to price fluctuations more quickly than those with longer spans.

MACD crossover: One of the most common swing trading indicators used to detect trend direction and reversals is the MACD crossover swing trading technique, which gives a straightforward approach to finding chances to swing-trade equities. It consists of two moving averages – the MACD line and the signal line – and when they cross, buy and sell signals are created.

A bullish trend is signaled when the MACD line crosses above the signal line, and you should consider initiating a buy transaction. A negative trend is expected if the MACD line crosses below the signal line, indicating a sell transaction. A stock swing trader would wait for the two lines to cross again before entering the market, before abandoning the transaction, signaling a trade in the other direction. The MACD oscillates around a zero line, and trading signals are created when it crosses above (buy signal) or below it (sell signal).

How to Swing Trade Stocks

Now that we’ve gone through the most common swing trading tactics, take the steps below to establish an account and begin swing trading stocks.

  • Open a live trading account. To begin swing trading stocks, open a live trading account.
  • You may establish a demo account to practice the above-mentioned swing trading methods in a risk-free environment. 
  • Technical analysis may be used to research markets: You can notice trend reversals and other price indications utilizing tools to educate your swing trading attempts. 
  • To swing trade, pick an asset: Decide whatever asset and time range you want to swing trade once you’ve done your homework. Also, depending on your swing trading signal, select your entry and exit plan. 
  • Conditions for risk management are used: To reduce risk, include a stop loss and take profit order. These risk management tools aid in the consistency and relevance of your transactions concerning your trading plan.
  • Monitor your position: While your deal is open, keep an eye on it. Keep an eye out for gapping and slippage, as well as shifts in market mood. Learn everything there is to know about gap trading.
  • Exit the market: Close the trade according to your swing trading method if your stop loss has not quit the transaction.

Finding Stocks to Swing Trade

When swing trading stocks, picking the correct assets is critical since poor market selection can significantly flaw your trading approach. Use these pointers to improve your market selecting efforts. 

Use chart patterns to your advantage: Use our pattern recognition scanner to detect reversal patterns such as a double or triple top chart pattern. Discover the most basic chart patterns and their implications in our essay on stock chart patterns. 

Keep an eye on the economic calendar. Keep an eye on the economic calendar, which may help you figure out how healthy a country’s economy is, as well as future trading possibilities and hazards. 

Take into account earning calendars: Swing trading techniques will benefit from using earnings calendars for accounting for unexpected market changes.

 What Does a Swing Trader Do daily? 

Swing trading is a style of trading that combines fundamental and technical analysis to capture significant market movements while minimizing downtime. The advantages of this trading style include more effective capital allocation and greater profits, while the disadvantages include higher commissions and more volatility. For the ordinary retail trader, swing trading may be challenging. Professional traders have more significant expertise, leverage, information, and cheaper commissions; nevertheless, the instruments they can trade, the risk they can take on, and the amount of cash they have limit them.

Large institutions trade in volumes that make it challenging to trade equities fast. Retail traders that are well-informed can take advantage of these factors to benefit regularly in the market. Here’s an example of a solid daily swing trading routine and method, as well as how you may replicate it in your trade.

How to Find Stocks to Swing Trade?

So you’ve heard about swing trading but aren’t sure where to start. The first step in developing a good swing trading strategy is to learn how to identify stock swing trading. Swing traders select equities with a high potential for future performance, allowing them to take a more significant share of the market. But how do they accomplish this? Let’s take a look.

Swing trading allows you to profit from market movement over a short period, such as days or weeks. It, like day trading, provides traders with profit possibilities when the market moves in their favor. Your trading approach will be built on the foundation of learning to choose good stocks. And, much like day trading, you’d want to select equities with plenty of liquidity and the potential for high price and volume swings.

Let’s look at how to identify stocks to swing trade with that in mind.

Swing Trading Stock Selection Rules By Thumb 

Every swing trader swears by a set of broad guidelines. Of course, you may create and implement your plan, but having one or two of them in your arsenal is a good start.

  • Market direction: Traders follow a rule that states that if a stock gains value in the present market, it will continue to climb if market characteristics stay intact. You may identify the best-performing stocks in various methods, including reading corporate news, pursuing the top stocks on the market, or monitoring stock indexes.
  • Direction bias: Swing traders look for possible buy or sell indications to find opportunities. They use a combination of fundamental and technical research to discover sectors and companies that have outperformed indices for the majority of the trading time. They scan through equities to find those that reflect volatility with volume and store their hopes there, known as screening stocks.
  • Liquidity: Swing traders use liquidity as a critical metric. A stock’s daily traded volume is a gauge of market demand. The frequency with which a stock trades on the market is liquidity. Swing trading is possible with a stock with a large daily trading volume. Stocks with a high trading volume have a lower risk profile.
    • Performance: It compares a stock’s performance to that of other equities in the same sector. The idea is to find the strongest stocks in a sector that have outperformed sector indices.
  • Frequent trading pattern: Swing traders seek equities with a market pattern that repeats itself. They believe that a consistent pattern is more dependable. Experienced traders will wait for the stock to break out of its trading range before entering, and they may make multiple tiny profits by trading in the direction of the trend. 
    • Clear uptrend: Some swing traders favor equities with less volatility. They avoid stocks that are subject to sharp pullbacks and frenetic selling. Instead, they would focus on equities with minor price fluctuations and no gaps in the price line.
  • Correlation and volatility: Even if they appear beneficial, most swing traders will avoid equities that move against the market trend. The idea is that unstable equities should be avoided in favor of those that move in lockstep with key crucial market indexes. Understanding why a stock is acting the way it is can be found by looking at its previous performance.

Volatility is another crucial factor that measures how much the stock price will change if the goal and stops are appropriate and whether the risk parameters are acceptable for the trader’s duration in the trade.

Conclusion

Swing trading can provide better returns than the market averages, but you’ll need a solid technique and the ability to adapt to fluctuations. After we’ve covered how to swing trade stocks, it’s important to remember that swing trading is riskier than day trading because the holding time is longer. As a result, you’ll need a solid technique to recognize trading possibilities as well as any warning signals. 

When choosing stocks for swing trading, traders should remember that the tactics outlined in this article aren’t the only options. Every trader needs to develop a strategy that works for him. Whether you want to swing trade or not, knowing how to locate stocks can help you succeed in the stock market. You may use this knowledge to develop profitable trading methods and better understand stock price movement.

Cost Inflation Index (CII) – Meaning, Calculation & Examples

The current scenario

As always, our world economy has never ceased to be dynamic and is always subject to constant changes. This variation is evident from the fall in the purchasing power of money because of the existing rise in the prices of goods and other services. The principle of a decrease in the value of money, which increases a person’s lifestyle expenses, is known as inflation.

What is the Cost Inflation Index?

The Cost Inflation Index or CII is a method used to calculate an approximate yearly increment in an asset’s price due to inflation. The central government sets the index level and displays it on the official central gazette for measuring inflation. This index is updated each year by the government according to the procedure mentioned under Section 48 of the Income Tax Act, 1961.

Why do we need CII?

A Cost Inflation Index table is prepared to calculate the long-term capital gains from the transfer or sale of any capital asset. Capital gains are nothing but the profit realised after the sale or transfer of any capital asset, including property, stocks, land, shares, patents, trademarks, etc.

While maintaining accounts, generally, a long-term capital asset is held at its cost price in books. So, despite the price risings of assets, the capital assets do not get re-valued.

Hence, during the event of the sale of an asset, the profits or gains realised from these assets remain elevated due to a higher sale price in contrast to the original purchase price. A person also tends to pay a higher income tax on the gains from these assets.

With the use of the Cost Inflation Index in case of capital gains, for the long term, the purchase price of an asset is iterated according to its sale price, resulting in a lower profit and thus lower tax amount to be paid to the government.

The Central Board of Direct Taxes (CBDT) in February 2018 brought in the new Cost Inflation Index numbers for the term from 2017-18 onwards. In this update, there was a move from the old base year of 1981 onto 2001, with 100 fixed as its CII. The indices for the upcoming years also got updated sequentially.

This update in the base year was brought into effect to solve the problems posed to taxpayers in calculating total tax payable for gains through capital assets purchased on or before 1981.

So, CII is used to measure the inflation-adjusted cost price of an asset. The inflation-adjusted price is then implemented to get the long-term capital gains or losses. The CII is used to find the inflation-adjusted price of an asset such as building, land, gold, house, jewellery, stocks, mutual funds, etc. Although, it cannot be applied to equity shares and equity mutual funds whose capital gains are taxable at a rate of 10 percent without the indexation benefit.

When filing income tax returns (ITR), this CII number can significantly help you index the long-term capital gains you have to pay the taxes.

The Central Board of Direct Taxes or the CBDT updated the cost inflation index or the CII for FY 2021-22 as 317 through a notification on date June 15, 2021. For the past year, i.e., FY 2020-21, CII was updated as 301. 

As per the recent update, CII for FY 2021-22 came into effect from April 1, 2022, and will apply to the assessment year 2022-23 and consequently to upcoming assessment years.

Instances When Indexation Benefit is Not applicable

According to our above discussion, a Taxpayer cannot get the benefit of indexation for long term capital gains in case of transfer of the following assets:

  • Equity shares of a company where STT has been given on the transactions related to the buying and, or transfer.
  • Parts of an equity-based fund where STT has been paid off in the transfer of its units
  • Parts of a company’s trust where STT has been paid off in the transfer of its units
  • Bonds and, or debentures other than for capital indexed bonds issued by the Government of India and sovereign gold bond (SGB) issued by the RBI
  • Non-Resident Indians (NRIs) cannot claim any indexation benefits in terms of stocks or bonds/debentures of any Indian company acquired by their foreign currency.

Cost Inflation Index Chart:

Below is the updated cost inflation index chart for the last ten financial years.

Financial Year Cost Inflation Index
 2001 – 02 (Base Year) 100
2002 – 03 105
2003 – 04 109
2004 – 05 113
2005 – 06 117
2006 – 07 122
2007 – 08 129
2008 – 09 137
2009 – 10 148
2010 – 11 167
2011 – 12 184
2012 – 13 200
2013 – 14 220
2014 – 15 240
2015 – 16 254
2016 – 17 264
2017 – 18 272
2018 – 19 280
2019 – 20

2020 – 21

2021 – 22

289

301

317

 

What do you mean by the Base Year in CII?

The base year is the foremost year in the index whose value is fixed at 100. The indexation of years after the base year is done according to the base year to track their increase in the inflation levels. In case of any capital asset bought before the base year of the cost inflation index, taxpayers may assume the purchase price as higher than the actual cost or Fair Market Value (FMV) on the 1st day of the base year. Indexation benefit applies to the purchase price of such calculated purchases. FMV is found based on the valuation report of a certain registered valuer.

Why was the base year for the Cost Inflation Index changed to 2001 from 1981?

In the early days, 1981-82 was set as the base year. However, taxpayers faced many problems to value their properties purchased before April 1, 1981. Tax authorities in India also found it complex to depend on the then valuation reports. So, the Government finally decided to change the base year to 2001 to rapidly and effectively valuations. Thus, for a capital asset purchased before April 1, 2001, taxpayers can now use higher of the actual cost or FMV as of April 1, 2001, as its purchase price and get the benefit of indexation.

How is Indexation really applicable on Long Term Capital Assets?

Indexation is applicable for the cost of asset acquisition to adjust the price of assets according to inflation. Long-term capital assets are recorded at cost price on paper. Despite increasing inflation, these assets are set at the cost price, and their value remains constant. During the sale of such assets, the profit amount remains high as the higher selling price is compared to the purchase price. This means a higher income tax as well. The cost inflation index is used at the long-term capital assets, meaning its purchase price increases, reducing the realised profits, meaning lesser taxes to benefit the taxpayers. The cost inflation index benefit is made applicable to the long-term capital assets, because of which purchasing price increases, resulting in fewer profits and lower taxes.

Following formula is made use of to find indexed cost of asset acquisition:

Indexed cost of asset acquisition = The CII for the year of sale or transfer* (Cost of asset acquisition)/ CII for the first year for the holding period of asset or year 2001-02,  considering the later one.

Following formula is made to find the indexed cost of asset improvement:

Indexed cost of asset improvement = CII for year of sale or transfer*( Cost of asset improvement)/ CII for the year during which the asset got the improvement.

How can the benefits of Indexation be used to reduce Tax Liabilities on Long Term Capital Gains for Taxpayers?

To understand this topic in detail, we consider an actual case for the FY 2019-2020, in which The Central Board of Direct Taxes or CBDT had fixed the Cost Inflation Index for FY 2019-20 at 289, updating it from 280, which was the CII in FY 2018-19. As we understood, CII is used to determine the inflation-adjusted cost of asset acquisition to calculate Long Term Capital Gains on assets appreciating. The indexation process can help reduce the tax burden for the same.

Taxpayers can pull down their total sum of tax liabilities on their realised long-term capital gains from the transfer of assets like debt mutual fund properties, real estate, etc. Estimating the entire amount invested according to the cost inflation index asset bought and sold years. This can also be done with the help of a cost inflation index calculator online.

Now, let us consider, a taxpayer realises capital gains from either transfer or sale of, say, a land will attract applicable taxes on capital gains, whether long or short term. If the holding period of this land is less than 24 months, then the profits or gains realised from such a transfer or sale of this asset will be considered a short-term capital gain, and this is not applicable for Indexation. But, if the person has held the asset for more than 24 months during the transfer or sale, they are taxed at a rate of 20%, with the Cost Inflation Index being applicable.

When the Cost Inflation Index is used to gain on the property, the sum of the profit is voluntarily deducted. So, the amount on which taxes would be applicable also gets reduced, thus minimising a person’s tax liabilities on Long Term Capital Gains.

Reducing one’s tax liabilities is one of the primary reasons for the increase in the demand and issuing of bond or debt funds and the Fixed Maturity Plans (FMP). The utilisation of the Cost Inflation Index on Long Term Capital Gains can help taxpayers save after all tax dues on long-term gains, which they can then use to invest in the various financial products. In this way, the taxpayers can have surplus savings and propel their wealth by investing the surplus sum, building their wealth and the nation.

Who updates the Cost Inflation Index?

The Central Government notifies the cost inflation index by updating the value in their official publication. 

Roughly calculated as, Cost Inflation Index = 75%* the average rise in the Consumer Price Index (urban) for the most recent year. 

The Consumer Price Index here accounts for the current price of a range of goods and services that represent the economy with the cost of the same range of goods and services in the past year to find the increase in prices.

Things to remember about Cost Inflation Index:

While finding out the indexed cost of asset acquisition, there are a few critical points one should keep in mind:

  • If the asset is received at an individual’s will, the Cost Inflation Index will be considered for the year when it was received. The asset’s actual purchase year should be ignored in the current case.
  • The improvement cost experienced before April 1st, 2001 is not applicable for indexation.
  • The benefit of indexation is not applicable for debentures or bonds, apart from those issued by the RBI bonds, including the sovereign gold bonds or the specialised capital indexation bonds.

Funds Flow Statement – Meaning, Analysis & Uses

The Funds Flow Statement attempts to match the source of in-flow and the resulting outflow of funds in a specific accounting duration and helps analyze how the flow affects the firm’s working capital. 

It is an essential tool that helps analyze the funds used. With the use of the fund flow statement, lenders or investors can validate the fund flowing through any firm in the coming future. 

The fund flow statement indicates the motion of funds and their several applications and sources. It is also called the Application of Funds and Source Statement.

Generally, fund flow statements are created after the fund flow analysis. It caters to the firm’s financial parameter that assists in controlling its finances and forming a better plan to utilize its funds.

What is Funds Flow Statement Analysis?

Funds Flow Statement analysis or fund flow analysis is the difference in the various components of a balance sheet. While evaluating a fund flow statement, it is also necessary to know all the aspects of a balance sheet.

  • Assets

When there’s an increase in the asset side of a balance sheet, it suggests that the company has purchased assets by investing funds. These assets will, in turn, generate an inflow of funds. 

Following are some components :

  • Fixed assets

  • Short-term loans

  • Long-term loans

  • Inventory

  • Cash and cash equivalents

  • Receivables

  • Present investments

And, if the assets show a decline, it reflects that the company has laid off some of its assets to generate fund inflow.

  • Liabilities

In the Funds Flow Statement, an increase in liability indicates that the organization has funds inflow to be paid in the future. Some components are:

  • Lenders

  • Customers

  • Vendors

  • Employees

  • Shareholders

A decline in liabilities means that the current dues have been satisfied.

How are Funds Flow Statements Prepared?

A Funds Flow Statement is prepared in the following three ways:

Statements having differences in working capital

According to the working capital calculation: Working capital = Current assets – Current liabilities

The above statement emphasizes the implications that change the working capital. Here are some reasons for a change in the company’s working capital.

  • If the firm only keeps investing in fixed assets or long-term business prospects without creating long-term funds, the working capital can reduce drastically.
  • If the company uses most of its profit as an expense in paying off dividends to its shareholders and not for building any assets.
  • Working capital can also change after over-lending.
  • Also, not planning for long-term funds, if the firm requires to pay back long-term obligations or to preferred stockholders in case of unforeseen circumstances, it lacks working capital requirements.

Statement showing funds from operations

In this step, the statement carries solely the funds flow from operating activities. The current year’s profit and loss are found, considering the depreciation or accounting for the loss on the sale of fixed assets. Following this, the previous year’s profit or loss is deducted from the latest calculations to derive the value of funds from operations.

Statement depicting the flow of funds

This is the last step to determine the flow of funds. Thus, the answers to the previous calculations will be considered to understand the use of funds. 

Example for funds flow statement:

Companies have longer-term funds in non-current assets, such as patents, various investments in different companies, plants and types of machinery, intellectual property rights, equipment, buildings, etc. Thus, non-current assets are formulated in a given year whose monetary valuation is not thoroughly utilized in the accounting and financial year. 

This factor gives rise to two situations:

  • When long-term funds finance non-current assets: The fund flow statement will show these assets realized from the long-term funds. These changes can be known when the company uses only long-term funds to finance non-current assets. It is considered a standard organizational behavior that improves using the funds appropriately.
  • When short-term funds finance non-current assets: The changes in the fund flow statement report the usage of short-term funds. This is an unwanted event, as it indicates risky use of short-term funds on long-term investment. Moreover, the company will likely be cash-strapped for its short-term requirements and financial dues since the long-term investments cannot be liquidated.

So, the fund flow analysis highlights the modifications and applications of working capital; it can be long or short-term funds or their usage and can indicate its financial well-being. It is widely used to know the effect of the difference in a fund’s position and its uses in the short period between two balance sheets through its proper understanding.

Who should use the Funds flow Statement?

Capital lenders want to understand the company’s financial standing before putting money in it. The funds flow statement is a significant scope of interest as it utilizes funds instead of focusing only on the operating profits or losses mentioned in a company’s financial statements. The best example of this is banks that use the funds’ flow statement to verify the overdraft status of the company and other cash credit inflow facilities.

Uses of a Funds Flow Statement:

A statement of funds flow of any business is a crucial financial tool to spectate and regulate working capital. Below are a few uses of Funds Flow Statement that financial analysts and funds managers opt for.

  • Analytical impedance in financial operations

Although all financial statements report the resources and their utilization, they do not reflect the reasons for any changes in the balance sheet. The statement, thus, provides an analytical view of the variations between current assets and current liabilities. Moreover, it explains how the variations occur in the first place in the funds of a concerned company. Even when the company has earned a profit, it might face a cash shortage in a few cases. This statement gives a clear picture of the gains made in such situations.

  • Helps form effective dividend policy

Sometimes a firm has enough available profits to be distributed as a dividend to its shareholders but finds it difficult to do it due to insufficient liquidity. A Funds Flow Statement then helps identify liquidity errors and helps plan an effective dividend policy.

  • Assists as a financial guide

This statement also acts as a financial guide for any company. It brings out the financial arrears that a specific company could face in its future. The management can then plan an appropriate strategy to safeguard the company from significant future losses.

  • It helps determine a company’s creditworthiness.

Institutions lending capital often evaluate this statement for a chain of years to analyze a prospective company’s creditworthiness before approving a loan. Hence, it also displays the firm’s competence in fund management.

Reading a fund flow statement:

Case 1: Increase in working capital

This situation kicks in when current assets increase the capital of a business. It can be stated as increased receivables or other assets or a decrease in current liabilities, leading to this situation. It shows that the company can now utilize the funds to align with its working capital needs, pay dividends, pay off some of its outstanding short-term obligations, etc., from a long-term standpoint. It is financially strong and a good prospect for its capital investors.

Case 2: Decrease in working capital:

This is when a company has minor long-term sources and more fund application points. Such a company needs to raise a loan to match its needs. Investors look to invest in the working capital needs of such a profitable company. The company that gets such working capital funding can reduce the stress of funds required for its working capital and use it to create long-term assets. 

Due to this, the fund flow statement has many advantages. Other than pinpointing a company’s health, it also depicts the working capital reductions to create funds that can be utilized for long-term commitments and how different assets can drastically change the source of funds by using it judiciously. 

Proper understanding of the company’s funds flow statement, and investor feedback is critical, as it depicts changes in sources of capital and fund usage for different purposes. Therefore, the excess/deficit in a firm’s current liabilities and assets is effectively shown only in the funds flow statement and not the P&L Statement or Balance Sheet.

Benefits of a Fund Flow Statement:

From our above discussion, we can easily list down the benefits of a fund flow statement as:

  • It helps fund managers show the firm’s working capital and liquidity stress, though its P&L or income statement may prove profitable. 
  • It serves the fund managers in knowing the financial stability of a company and its operational losses.
  • It assists the fund managers in assessing the fund flow and risk level when inappropriate usage of short-term funds to finance long-term assets occurs. Generally, this is the gray area not reflected in either the company’s balance sheet or P&L statement.

Limitations in Funds Flow Statement

Some Funds Flow Statement problems have limitations to its use.

  • This statement cannot depict the financial factors represented in a balance sheet or an income statement. It only factors in on the movement of funds during a specific duration and does not quantify other essential items.
  • The statement does not add any new financial value to a company’s financial standing. It only re-arranges the present information to look out for issues with fund management.
  • Due to the ever longing nature, this statement can not finalize the present-day financial standing of a company with accuracy.
  • Working capital plays a vital role in business and finance. However, the cash movement is essential for the company’s financial future. Thus, the flow of funds does not conclude as an effective indicator for that purpose.

Nonetheless, even with its limitations, this statement helps a financial analyst evaluate the financial statements and give inferences to use funds effectively. Thus, all small or big firms must be aware of their fund movements to make improved financial decisions.

What Is NIFTY? How It Is Calculated?

NIFTY is the Indian stock market index created and christened by the National Stock Exchange on April 22, 1996. It is a conjunction of two different words: the National Stock Exchange and Fifty. 

The NIFTY 50 is a benchmark-based index. It is also one of the major indices of the NSE. It consists of the top 50 companies’ equity stocks out of the total 1600 stocks traded in the stock exchange. The stocks range through over 12 sections of the Indian economy: information technology, consumer goods, financial services, entertainment, media, banks, metals, cement, automobiles, pharmaceuticals, telecommunications, fertilisers and pesticides, energy, and other services.

NIFTY is one of the two major national stock indices. The other one is SENSEX, an index of the Bombay Stock Exchange (BSE). NIFTY is promoted by NSE Indices, previously known as India Index Services and Products (IISL). It is a wholly-owned subsidiary of the National Stock Exchange Strategic Investment Corporation Limited, now NSE India Ltd. NIFTY 50, its flagship product, follows the direction and trends of the blue-chip businesses listed on the exchange. These blue-chip companies are the most liquid, biggest listed Indian securities. 

The NSE consists of several indices: the NIFTY 50, NIFTY Bank, NIFTY IT, and the NIFTY Next 50. NSE is also a pioneer of Futures and Options (F&O), a segment that deals in derivatives (financial contracts deriving their value from underlying stocks) through this segment.

What are the Eligibility Criteria for NIFTY Index Listing?

The eligibility criteria that have been formulated for a company to get listed on the NIFTY Index are as follows:

  1. The company must be domiciled in India and registered on the NSE.
  2. Stocks traded must have high liquidity, calculated using the average impact cost. The impact cost is the expenses related to the security transaction, charged with the index weight, and assessed through its market capitalization. It must be 0.50% or less for six months, while 90% of its value is derived from a portfolio of ₹10 crores.
  3. The company must have had its trading frequency at 100% capacity during the previous six months.
  4. The company must contain an average free-float market capitalization of around 1.5 times greater than the minor stock in the Index.
  5. Stocks with Differential Voting Rights (DVR) are also eligible to be listed on the Index.

The NIFTY Index is reassembled every six months and tracks the performance of each stock over this period. Based on how a stock performs, and whether the company and the stock meet all the eligibility criteria given above, it could be retained or eliminated. In the cases of adding or removing stocks, the concerned companies are notified via a publication four weeks before the rejigging.

Other than the processes mentioned above, stock can be rejigged when a company goes through any major corporate decisions, including mergers, spin-offs, suspensions, or a mandatory delisting.

NIFTY, via its exchange, is instructed to carry out a quarterly screening of companies to verify their compliance to the portfolio diversification regulations for Index-related Funds and ETFs as per SEBI guidelines, notified on 10th January 2019.

A brief background and the top companies listed under NIFTY

NSE Indices formerly had a publicity and licensing agreement with Standard & Poor for jointly branding the equity indices up to 2013. On April 22, 1996, the NIFTY 50 Index was launched, and is still the major stock index of NIFTY.

NIFTY 50 has turned out to be the country’s most significant financial product entity, with a range of exchange-traded funds both onshore and offshore, and also exchange-traded fund Options at NSE. Futures and options available at the SGX NIFTY 50 abroad are the most actively traded contract globally, volume-wise. 

The NIFTY 50 index consists of 12 sectors as per the latest April 2021 reports of the Indian economy and fund managers, with investments in the Indian markets.

The NIFTY 50 Index constitution is as follows: 39.47% weightage to the financial services, 15.31% to the Energy Sector, 13.01% to the IT Sector, 12.38% to the consumer goods sector, 6.11% to the Automobiles sector, and 0% of the total to the agricultural industry

 

Company Name               Ticker/Symbol     Sector

Adani Ports ADANIPORTS Infrastructure
Asian Paints ASIANPAINT Consumer Goods
Axis Bank AXISBANK Banking
Bajaj Auto BAJAJ-AUTO Automobile
Bajaj Finance BAJFINANCE Financial Services
Bajaj Finserv BAJAJFINSV Financial Services
Bharti Airtel BHARTIARTL Telecommunication
Bharat Petroleum BPCL Energy – Oil & Gas
Britannia Industries BRITANNIA Consumer Goods
Cipla CIPLA Pharmaceuticals
Coal India COALINDIA Metals
Divi’s Laboratories DIVISLAB Pharmaceuticals
Dr. Reddy’s Laboratories DRREDDY Pharmaceuticals
Eicher Motors EICHERMOT Automobile
Grasim Industries GRASIM Cement
HCL Technologies HCLTECH Information Technology
HDFC HDFC Financial Services
HDFC Bank HDFCBANK Banking
HDFC Life HDFCLIFE Financial Services
Hero MotoCorp HEROMOTOCO Automobile
Hindalco Industries HINDALCO Metals
Hindustan Unilever HINDUNILVR Consumer Goods
ICICI Bank ICICIBANK Banking
IndusInd Bank INDUSINDBK Banking
Infosys INFY Information Technology
Indian Oil Corporation IOC Energy – Oil & Gas
ITC Limited ITC Consumer Goods
JSW Steel JSWSTEEL Metals
Kotak Mahindra Bank KOTAKBANK Banking
Larsen & Toubro LT Construction
Mahindra & Mahindra M&M Automobile
Maruti Suzuki MARUTI Automobile
Nestlé India NESTLEIND Consumer Goods
NTPC NTPC Energy – Power
Oil and Natural Gas

 Corporation

ONGC Energy – Oil & Gas
Power Grid Corporation

 of India

POWERGRID Energy – Power
Reliance Industries RELIANCE Energy – Oil & Gas
State Bank of India SBIN Banking
SBI Life Insurance Company SBILIFE Financial Services
Shree Cements SHREECEM Cement
Sun Pharmaceutical SUNPHARMA Pharmaceuticals
Tata Motors TATAMOTORS Automobile
Tata Steel TATASTEEL Metals
Tata Consultancy Services TCS Information Technology
Tata Consumer Products TATACONSUM Consumer Goods
Tech Mahindra TECHM Information Technology
Titan Company TITAN Consumer Durables
UltraTech Cement ULTRACEMCO Cement
United Phosphorus Limited UPL Chemicals
Wipro WIPRO Information Technology

How is NIFTY for the Share Market Calculated?

A team of experts at the NSE Indices Ltd. operates the NIFTY share index. It has created the Index Advisory Committee that utilises its expertise and guides solutions to large-scale problems related to the equity indices.

The NIFTY 50 Index and its various products are calculated depending on the number of tradable shares, also known as the free float, included and their market cap weighed in. This methodology, which displays the average market value of stocks available in the index in a specific set period, forms the basis of the process of finding out the stocks’ average market value. This fixed period is known as the base period. For the NIFTY 50 Index, the period starts from November 3, 1995, wherein the base value of this stock index is set at 1000 points, and the base capital is at ₹ 2.06 trillion.

An index like the NIFTY 50 helps in choosing a stock, as selecting a company from an ocean of shares can be pretty tricky. So that is where the stock index becomes usable. It demonstrates the general standing of the overall market. It can be used to assess the value of any stock over a duration to calculate how it has performed. These instances of favorability of a stock index make picking stocks simpler by marking the way how the market moves.

The stock index assesses the stock market’s overall direction. And as we know, we have two major stock indices — the NIFTY, which is the NSE’s index, and Sensex, which is the BSE’s index.

The formula to calculate the price listed in the index is mentioned below:

Index valuation = Current market value / (Base Market Capital * 1000)

The method followed in making this calculation also includes the changes in corporate decisions, which consist of rights issues, stock splits, etc.

As discussed, the NIFTY share market index is a benchmark standard against which all other equity stock markets in India are compared and measured. Thus, NSE carries out frequent index inspections to ensure that it stays stable and continues as the gold standard in the Indian stock market.

Broad-based indices like the NIFTY and the Sensex are also used as a standard benchmark for the Mutual Funds industry to measure their performance comparatively. The NIFTY is much broader than the two indices, thus giving the Indian financial market a more comprehensive measure. Also, NIFTY ranked the highest closing numbers on October 17, 2019, with auto, banking, metal, and energy sectors providing the leading highs.

What are Multibagger Stocks?

Multibaggers stocks are those stocks that give an investor very high returns. Thus a 10x multibagger is stock that has increased by 10 times. Most successful investors have a number of multibaggers in their portfolio.  

What Characteristics Should a Company Possess to Generate Multibagger Shares?

Top Quality Management

Companies with qualified and experienced management produce multibagger stocks. Sticking to a strategy and knowing when to be flexible enough to change it 

High Growth in Revenue, Net Profit, and EPS

A company that gives multibagger returns has impeccable financial performance. These include high growth in sales at the same time maintaining or improving their operating margin and steady profit growth. 

These firms often have a low debt-to-equity ratio, showing superior financial management abilities. 

Strong Future Outlook:

You can also see a strong future outlook from the future demand for the company’s product and its ability to innovate on the product continuously.

Major Key performance Indicators of Multibagger stocks

You can research many important KPIs to identify multibagger stocks. We have listed them below for your reference.

KPI Description
Debt-free or Low Debt Keep the company’s debt within appropriate limits: There are no set amounts of debt, since it varies from business to industry. Generally, a debt-free company is a good indicator.
Revenue Growth Strong growth in revenue above the industry average is crucial. We research and compare the revenue performance with the industry.
Net Profit Net profit can be lower during the investment phase of the company. Therefore, we need forecasts keeping in mind the historical investment the company has made.
Earnings Per Share Earnings per share (EPS) are the strongest indicator of a company’s earnings growth. EPS is the portion of a company’s profit allocated to each share. You can determine it by dividing the company’s net profit by the number of shares outstanding.

A good firm is not always a good stock. For example, Wipro is regarded as one of the greatest firms in the IT industry. But it has only provided a CAGR of 0.4 percent over the previous 20 years. 

Why Invest in Multiblogger Stocks?

Returns that not only outperform inflation but create wealth

Inflation reduces the purchasing power of money over time. Investing in general stocks may help you defeat inflation, since they can produce long-term profits. However, investing in multibagger stocks can give 100x more returns than a standard Blue chip stock investment, thus helping wealth creation.

Abnormal growth of capital 

Investing in multibagger shares can significantly increase the value of your money more than a regular equity stock or even mutual funds. Multibagger stocks multiply your capital 50x to 100x in a short period. 

What is the Risk Associated with Multibagger Shares?

When it comes to multibagger stock investments, value traps are becoming common. Products made by a corporation may seem to be a successful investment choice in the short term, but they will result in losses in the long run. Investors anticipate that the values of such shares will skyrocket in the future, which doesn’t happen since the asset has no inherent value.

Before investing in multibagger stocks, investors should thoroughly examine a company’s financial statements as well as the current health of the stock market. 

Below are the common risks which an investor needs to avoid:

  • Lower levels of liquidity

A lack of knowledge and a fast money mindset may sometimes lead to investors carrying liquidity risks. These prospects are seldom larger inequities whose prices markets have identified.

  • Uncertainty about the rewards

There is a reduced likelihood of bigger payouts from all probable multibagger equities and a higher possibility of markets failing to find the predicted price of the selected scripts.

  • Myths related to Multibagger stocks

There is a common misconception that low-priced/penny stocks may offer significant profits in the future, but high-priced stocks cannot. Several instances can help better describe this myth.

Page Industries grew from Rs. 1000 in 2010 to Rs. 29,500 in 2021, becoming a multibagger (2000 percent return). On the other hand, Suzlon has lost more than 70% of its value in the previous nine years. The stock price has fallen from Rs. 19 in 2011 to Rs. 5.1 in 2021.

Before investing one’s hard-earned money in stocks with high hopes of a multifold increase in share price, one should always become well-versed in the company’s fundamentals. The investor must also have the patience and confidence to hang on to the equities until the market discovers the hidden value. 

Finally, diversification is crucial. Putting all of one’s money in a single company projected to generate high returns might lead to unsystematic or unpredictable risk.

Patience is the Key to Riding the Multibagger Wave

The most critical part of investing in a prospective multibagger stock is one’s patience and capacity to retain it through good and bad times since the firm itself takes several years to establish itself as the industry leader. It is often more tricky to hold a prospective multibagger than to recognize it.

Liquidity Ratio – Meaning, Types, Formulas & Examples

Liquidity ratios are an indicator that helps to understand the company’s capacity to honour the existing debt commitments without any external assistance. The liquidity ratio is a crucial accounting technique to assess a borrower’s current loan repayment capabilities. Simply put, this ratio represents whether an individual or business can pay off short-term debts without the aid of outside funds.

Liquidity is the capacity to turn assets into cash rapidly and inexpensively. Liquidity ratios are most beneficial when utilised in a comparative context. We can classify this into Internal and external studies. 

  • An internal study of liquidity ratios uses the past historical internal data of the company with that of the current period, while the accounting procedures remain the same. 

Analysts may monitor changes in the firm by comparing historical periods to present operations. A higher liquidity ratio highlights that the company is more liquid and is better positioned to cover and service its existing loan commitments.

  • The external analysis compares a company’s liquidity ratio with other companies or even industry players. 

This evaluation helps to compare the data of existing companies with its peer competitors and incorporate a higher standard in liquidity management. 

Liquidity ratio analysis will be different for one industry compared to others. Since the ratio requirement will differ for various industries, you cannot compare it with other sectors. 

Liquidity ratio analysis also has drawbacks compared with companies of different sizes. The turnover, market cap, and liquidity strategy will be different. A startup company will have a different liquidity strategy than a well-established MNC.

Key Points

  • Liquidity is the ease with which an asset or security may be purchased or sold on the market and converted to cash.
  • Liquidity risk is classified into two types: funding liquidity risk and market liquidity risk.
  • A corporate treasurer’s primary worry is funding or cash flow liquidity risk, which examines whether the company can fulfil its obligations.
  • Asset illiquidity, or the inability to readily exit a position, is a market or asset liquidity risk.

Different Types of Liquidity Ratio and their Formula

  • Current Ratio 

The current ratio denotes a company’s ability to meet its current commitments by using its existing assets. Cash, shares, receivables, prepaid expenditures, marketable securities, deposits, and so forth are examples of current assets. Current obligations also include short-term loans, payroll liabilities, unpaid costs, creditors, various other payables, etc.

Current ratio = Current assets/Current liabilities

Example:

Current assets of ABC Ltd is 250 crores, and the current liabilities is 150 Crores.

Then, the current ratio will be 250/150 = 2:1

  • Quick Ratio

The quick ratio (or acid test ratio) assesses a company’s capacity to satisfy short-term commitments using its most liquid assets, eliminating inventories from current assets. It is also called the acid-test ratio.

Quick ratio = (Marketable securities + available cash and/or equivalent of cash + accounts receivable)/Current liabilities

Example:

Financials extract of XYZ Limited:

Particulars Amount in Cr
Cash and Cash equivalent Rs. 65
Liquid Investments Rs. 15
Inventory Rs. 35
Debtors Rs. 45
Daily Operational Expenses Rs. 2
Total Current Assets Rs. 160
Total Current Liabilities Rs. 60
Quick Ratio Rs. 115/Rs.60 = 1.91

 

  • Cash Ratio

The cash or equivalent ratio compares a company’s most liquid assets to its total current debt, such as cash and cash equivalents. Because money is the most liquid asset, this ratio reveals how fast and to what extent a corporation can repay its existing liabilities using readily accessible assets.

Cash ratio = Cash and equivalent/Current liabilities

Example: 

Cash ratio calculation from above data of XYZ Limited

Rs. 65/Rs. 60 = 1.08

  • Absolute Liquidity Ratio 

The absolute liquidity ratio compares marketable securities, cash, and cash equivalents to current obligations. Companies should aim for an absolute liquidity ratio of 0.5 or higher.

Absolute liquidity ratio = [Cash and equivalent + marketable securities]/ Current liabilities 

Example:

Absolute ratio calculation from above data of XYZ limited:

 = (Rs. 65 + Rs. 15 ) / Rs. 60 = 1.33

  • Basic Defence Ratio

The basic defence ratio is an accounting indicator that evaluates how many days a corporation can operate on cash costs alone without outside financial assistance. 

Basic defence ratio = Current assets/Daily operational expenses 

Example:

Basic defence ratio calculation from above data of XYZ limited:

= Rs. 160/2 = 80

  • Basic Liquidity Ratio 

Unlike the other ratios mentioned above, the basic liquidity ratio has nothing to do with the company’s financial status. Instead, it concerns an individual. 

A person’s financial ratio specifies a time frame for how long a family can fund its needs using liquid assets. It is preferable to have at least three months of cash on hand.

Basic liquidity ratio = Monetary assets/Monthly expenses

The Importance of Liquidity Ratios

  • Ability to cover the debts

Water rates are vital for investors and lenders to judge whether and to what degree a firm can satisfy its short-term commitments. A rating of 1 is better than a rating of less than 1, but it is still not satisfactory. High-interest rates, such as 2% or 3%, are favourable to lenders and investors. 

If the rate is high enough, the company will pay off its short-term commitments. A grade of less than one indicates that the firm is incurring excessive operational expenditures and experiencing a cash deficit.

  • Identify creditworthiness

Lenders consider the amount of money when considering whether or not to lend to a company. They want to ensure that the company they are funding can repay them. Any indications of financial insecurity might hinder a corporation from obtaining a loan.

  • Determine investment feasibility

For investors, stock ratings will determine if the firm is financially solid and worth investing in. Compelling financial issues will place constraints on the rest of the company. The company must pay off its short-term loans by a specific date.

There is a balance in terms of available income between a company that can reliably fulfil its obligations and an unjust cash allocation. The deployment of capital funds should be in the most efficient manner possible to increase the profit of the shareholder company.

Which Is Better: Solvency Ratios or Liquidity Ratios?

In contrast to liquidity ratios, solvency ratios assess a company’s capacity to meet its financial and long-term total obligations. Solvency refers to an enterprise’s total ability to pay creditors and maintain operations. At the same time, liquidity is mainly concerned with short-term financial and current accounts. 

When a company’s total assets exceed total liabilities, it is solvent. When its existing assets are more than current liabilities, it is a liquid company. While solvency is not directly related to liquidity, liquidity ratios are a good starting point for determining a company’s solvency.

You can calculate a company’s solvency ratio by dividing its net income and depreciation by its short- and long-term obligations. This ratio demonstrates if a company’s net income can fulfil its total commitments. A corporation with a greater solvency ratio is typically a better investment. 

What if a Company’s Ratios Are Not Liquid?

In this case, even robust businesses may face a liquidity crisis. It will be impossible to meet short-term commitments such as credit repayment and payment to employees or suppliers. 

The worldwide credit crunch of 2007–09 was one example of a recent extraordinarily severe liquidity crisis. During this crisis, many corporations could not provide short-term financing for their urgent needs. 

Mutual Fund Liquidity Ratio

A mutual fund’s cash and cash ratio equals the current assets. In other words, if a mutual fund has a large amount of cash that has not been invested in securities, the ratio is greater. However, the ratio is lower if all or almost all of its liquidity has been invested. 

A high ratio is an unusual signal since it indicates that investments with high returns are complex for the Mutual Fund. Hence, higher cash stocks are held. Mutual funds disclose cash ratios once a month. 

What Is the Importance of Calculating Liquidity Ratios?

The organisation may wish to calculate and analyse its liquidity ratios for several reasons. A major reason is to ensure that creditors, bankers, shareholders, and other stakeholders do not anticipate a cheap rate due to a bad liquidity ratio.

  • The board of directors will also look at these percentages when evaluating executive performance.
  • Banks, creditors, and investors primarily review these ratios in their research. You want to know what is best for your company before giving loans or investing in a new fund.

When the percentages are excessively low, these stakeholders generally have strong opinions and are not interested in the entity. That is why a business must ensure that the ratio appears good from time to time.

Why Are There So Many Different Liquidity Ratios?

The liquidity ratio is to assess the company’s capacity of servicing and repayment of its existing loans. The cash ratio considers cash on hand divided by CL. However, the quick ratio includes cash equivalents (such as money market holdings), marketable securities, and accounts receivable. All current assets are taken into consideration for calculating the current ratio.

Which Asset Can Be Classified as the Most Liquid Asset?

Cash is the world’s most liquid asset. A bigger cash holding suggests that a corporation has a higher liquidity ratio. That indicates the organisation is prepared to satisfy any short-term financial obligation without the assistance of outside funds.

Exceptional Factors

Even strong businesses might have a liquidity crisis if conditions make it impossible to satisfy short-term commitments such as loan repayment and employee pay. The global credit crunch of 2007–09 is the finest illustration of such a wide-reaching liquidity disaster in recent memory. Commercial paper, which is short-term debt issued by major corporations to fund current assets and pay off current creditors, played a key part in the financial crisis.

There was a near-total freeze in the 2 trillion commercial paper market in the United States. This move made it very difficult for even the most solvent firms to acquire short-term funding at the time. This aspect hastened the downfall of prominent organisations such as Lehman Brothers and General Motors (GM).

On the other hand, a company-specific liquidity crisis may be remedied simply with a cash injection unless the financial sector is under a credit constraint (as long as the company is solvent). This solution is because the corporation may pledge certain assets to obtain cash through the liquidity crisis. A technically insolvent firm may not choose this path since a liquidity crisis would aggravate its financial predicament and drive it into bankruptcy.

Examples of Liquidity Ratios

Given below are the various liquidity ratios of two different companies. Let us analyse which company has better liquidity.

Tractors Ltd. Cars Ltd
Current ratio – 3.0

Quick ratio – 2

Debt-to-Equity ratio – 3.33

Debt-to-Asset ratio – 0.67

Current ratio – 0.4

Quick ratio – 0.20

Debt-to-Equity ratio – 0.25

Debt-to-Asset ratio – 0.13

These ratios allow us to make numerous inferences regarding the financial health of these two firms.

Tractors Ltd has a very high level of liquidity. According to its current ratio, it has 3 in current assets for every 1 in current liabilities. Even after eliminating inventory, its fast ratio indicates acceptable liquidity, with two assets converted quickly to cash for every 1 in current obligations.

However, financial leverage looks to be highly substantial based on its solvency measures. Debt outweighs equity by more than three times, and debt has funded two-thirds of assets. Consequently, the debt-to-tangible-assets ratio of —0.91 indicates that borrowing has supported more than 90% of tangible assets (plant, equipment, and inventory, for example). 

Therefore, Tractors Ltd has a healthy liquidity position but a dangerously high level of debt.

Cars Ltd finds itself in a new situation. With just 0.40 of current assets available to pay every 1 of existing obligations, the company’s current ratio of 0.4 shows an insufficient level of liquidity. The quick ratio reflects an even more catastrophic liquidity situation with just 0.20 of liquid assets for the daily obligation.

On the other hand, financial leverage looks reasonable, with debt accounting for just 25% of equity and debt financing only 13% of assets. Overall, Cars Ltd is in a problematic liquidity condition, although it is well-capitalised.

Conclusion

Here are the key takeaways from this article:

  • You may need to include several additional Liquidity Ratios in your ratios study depending on the sectors and other areas in which your firm operates.
  • It may be necessary to relate your ratio with expectations, industry research, and/or rivals to make it speakable. Aside from looking at cash flow, you must also consider additional non-financial elements.
  • In contrast, you may efficiently address a company-specific liquidity crisis with a capital injection unless the banking system is experiencing credit constraints.

What Is Short-Term Capital Gains Tax on Sale of Shares?

We are all aware that salary, rental, and company income are all taxed. Similarly, income/loss from selling equity shares is classified as ‘Capital Gains.’

So what is a capital gain? 

Any profit derived from the sale of a capital asset is referred to as a capital gain. The profit earned comes under the category of income. As a result, a tax must be paid on the income earned. The tax is known as capital gains tax, and it may be either long-term or short-term.

This categorisation is based on the length of time the shares have been held. The holding period is the length of time that an investment is held from the date of purchase to the date of sale or transfer.

Income is further categorised under the heading ‘Capital Gains’ into two types:

  • Long term capital gains (LTCG)

  • Short term capital gains (STCG)

 

Note: India’s capital gains tax is not required under the Income Tax Act if the person inherits the shares and there is no sale.

Computation of Tax on STCG on Shares:

If an equity share listed on a stock exchange is sold within a year after the acquisition, the seller may realise a short-term capital gain (STCG) or suffer a short-term capital loss (STCL). When the selling price is more than the purchase price, the seller makes a short-term capital gain profit. 

STCG = (Sale price) – minus (Purchase price) – minus (expenses incurred on sale)

Things to Remember:

  • You have to pay short-term tax on shares at 15%, irrespective of your tax slab rate. Even if you are a senior citizen and have a higher slab rate, you must pay 15% on your STCG.
  • If a stock exchange-traded equity share is sold within 12 months of purchase, the seller may realise a long-term capital gain (LTCG) or incur a long-term capital loss (LTCL) (LTCL).
  • Before the introduction of Budget 2018, long-term capital gains on the sale of equity shares or equity-oriented units of mutual funds were tax-free, i.e., no tax was payable on gains on the sale of long-term equity investments.
  • This exemption was removed from the 2018 Financial Budget. If the seller makes a profit on the sale of equity shares or mutual funds above Rs. 1 lakh, it will be subjected to 10% long-term capital gain taxes (plus any cess if applicable). The seller will not benefit from indexation effective from April 1, 2018. 

What about the Taxes on selling shares at a Loss?

Short-term Capital Loss 

  • Any short-term capital loss from equity share sales may offset any short- or long-term capital gain from any capital asset sale. If the loss is not set off, it may be carried forward for eight years and offset against any short- or long-term capital gains made during the same period.
  • A taxpayer can only carry forward the losses provided he has filed his income-tax return before the due date. Thus, even if your total income for the year is less than the minimum taxable income, you must file an income tax return to carry forward these losses.

Long-term Capital loss

  • Long-term capital loss from equity shares was deemed a dead loss until Budget 2018 — it could not be modified or carried forward. It’s because long-term capital gains from listed equity shares are excluded. Similarly, they were not permitted to put aside or take forward their losses.
  • Following the amendment of the Budget 2018 to tax such profits of more than Rs 1 lakh at 10%, the government has also stated that any losses originating from such listed equities, shares, mutual funds, and so on will be carried forward.
Capital Loss on Sale of Shares Holding Period Applicable Taxes Carry forward provision
Short Term Capital Loss Less than 12 Months Set off against both STCG & LTCG Available up to 8 years
Long Term Capital Loss More than 12 Months Set off not allowed Not applicable

What is Securities Transaction Tax (STT)?

STT is levied on all equity shares traded or purchased on a stock exchange. The tax mentioned above applies solely to shares traded at a stock exchange. STT applies to any sale or buys on a stock market. As a result, the tax considerations outlined above only apply to shares on which STT is paid.

Capital Gain on Sales of Non-STT Paid Shares:

Capital Gain on Sale of Shares for Non-STT paid shares Holding Period Applicable Taxes
Short Term Capital Gains Less than 12 Months As per Slab Rates
Long Term Capital Gains More than 12 Months 20% Tax

Exemptions and deductions under short-term capital gain tax on shares:

Sale of Unlisted Shares:

The Central Board of Direct Taxes (CBDT) department has given its opinion for sales of shares not listed on any stock exchange and does not have any official data related to trading. To minimize disputes/litigation and maintain a unified approach, income deriving from the transfer of unlisted shares will be taxed under the head ‘Capital Gain,’ regardless of the holding period (as per the CBDT circular Folio No.225/12/2016/ITA.1I dated May 2, 2016).

What if you are in the Business of Selling Shares?

If you have extensive share trading activity (for example, if you are a day trader with a lot of action or routinely trade in Futures and Options), your income is usually classed as business income. In this scenario, you must submit an ITR-3, and your revenue from share trading is reported under ‘income from business and profession.’

Certain taxpayers classify earnings or losses from stock sales as “income from a company,” while others classify them as “capital gains.” It has been hotly debated whether your profits/losses from selling shares should be classified as company income or capital gains.

What if selling shares is considered my regular business?

When you classify the sale of shares as business revenue, you may deduct the costs of earning that money. In such circumstances, the earnings are added to your total income for the fiscal year and, as a result, taxed at slab rates.

  • Taxpayers get letters from the tax department and spend a significant amount of time and effort explaining why they picked a specific tax treatment for the sale of shares.
  • If the taxpayer chooses to regard his listed shares as stock-in-trade, the income will be handled as business income. Regardless of the length of time, a listed share has been held. The AO must accept the taxpayer’s preferred position.
  • If the taxpayer considers the income as capital gains, the AO will not contest it. This applies to listed shares held for longer than a year. However, this position, once adopted by a taxpayer in a given assessment year, is relevant in the following assessment years. The taxpayer cannot change their mind in the next years.
  • Taxpayers are now given the option of how they wish to approach such income. They must, however, continue to use the same procedure in consecutive years unless there is a significant change in the facts of the case. It should be noted that the option is limited to listed shares or securities.

Tips to Reduce the Burden of Short Term Capital Gain Tax on Shares

With proper tax planning, you can reduce your Short term capital gain tax on shares. 

Some essential tips are as follows – 

  1. Make use of Basic Exemption Limit: You can also open a Demat account in your spouse’s name and trade shares. If your spouse is not earning, you can benefit from the basic exemption limit. If your spouse is a senior citizen, you can reduce your burden even more since senior citizens have higher exemption limits. Refer to the latest tax slab rates applicable for the year here.
  2. Setting-off losses can help reduce your current year tax: Short-term capital Losses incurred in share sale can be offset against short-term capital gains. This helps reduce your tax burden. Hence, it’s essential to maintain your transaction records properly to account for the losses also.
  3. Carry Forward your losses to save future tax: Unutilised short-term capital Losses can also be carried forward and set off against the future short-term capital gains. You need to calculate the losses and disclose them in the current ITR filing to avail this benefit in the next year. Thus, it’s essential to file your ITR with the help of a tax practitioner, to carry forward these losses to the following year.

Some examples for the Calculation of Short Term Capital Gains Tax on Stocks

Example 1: Mr Janak is a paid worker. In December 2020, he acquired 100 equity shares of X Ltd. from the Bombay Stock Exchange for Rs. 1,400 per share. These shares were sold on the BSE in August 2021 for Rs. 2,000 per share (a securities transaction tax of 2% was paid at the time of sale). In this scenario, what is the nature of the capital gain?

Answers:

  • Shares were acquired in December of 2020 and sold in August of 2021, implying that they were sold after holding them for less than a year, and so the gain will be a short-term capital gain. 
  • Section 111A applies to STCG originating from the transfer of equity shares, units of equity-oriented mutual funds, or units of business trusts via a recognised stock exchange on or after 1-10-2004 if the transaction is subject to the securities transaction tax.
  • Section 111A applies to STCG originating from the transfer of equity shares, units of equity-oriented mutual funds, or units of business trusts via a recognised stock exchange on or after 1-10-2004 if the transaction is subject to the securities transaction tax.
  • If the prerequisites of section 111A are met, the STCG is referred to as STCG covered by Section 111A. Such gain is taxed at a rate of 15% (plus relevant surcharges and cess).
  • In this situation, shares were sold after possessing them for less than 12 months via a recognised stock exchange, and the transaction was subject to STT. Hence, the STCG can be classified as STCG covered by Section 111A. Such STCG will be taxed at a rate of 15%. (plus surcharge and cess as applicable).
Example 2: Mr Poddar is a salaried worker. He acquired 100 equity shares of ABC ltd. in December 2020 for USD 70 per share. These shares were sold in August 2021 at $85 per share. Since the shares were traded in a recognised  international financial centre, there was no STT on the share transfer. 

Answers:

  • Section 111A applies to STCG resulting from the transfer of equity shares through a recognised stock exchange where the transaction is subject to the securities transaction tax.
  • STCG subject to taxation under Section 111A is taxed at a rate of 15% (plus relevant surcharges and cess).
  • However, beginning with the Assessment Year 2018-19, the benefit of a 15% concessional tax rate will be available even if the STT is not paid, provided that the transaction is conducted on a recognised stock exchange located in any International Financial Service Centre and the consideration is paid or payable in foreign currency.
  • Mr Poddar sold shares of ABC Ltd. listed on a recognised stock exchange in an International Financial Services Centre in the stated instance (IFSC). Furthermore, payment is made in foreign currency.
  • Shares were acquired in December 2020 and sold in August 2021. This indicates that they were sold after less than a year of ownership. As a result, the gain will be a short-term capital gain.
  • The shares were sold at the International Financial Services entre (IFSC Stock Exchange), and the payment was made in Foreign currency, i.e., USD. 
  • As a result, even though the transaction of sale was not subject to STT, the STCG might be referred to as STCG covered by section 111A.
  • Such STCG will be taxed at a rate of 15% (plus surcharge and cess as applicable).

Redemption of Debentures – Meaning, Types & Methods

Debentures are a type of debt instrument. As a result, when their term finishes, debenture holders get their principal amount returned. The process of repaying the company’s debt is known as debenture redemption.

When debentures are redeemed, the debenture obligation is discharged. To put it another way, the quantity of investment required for debenture redemption is high. Thus, economic businesses make enough provision from profits and accumulate money to reclaim debentures.

Once the redemption of debentures gets completed, the company will remove or reduce the value of debentures from its liability.

Normally, a debenture certificate will have all the terms of redemption. The redemption approach can be as follows:

  • Redemption can be done at par or at a premium
  • The terms will provide the number of debentures to be redeemed at a specific period
  • The company’s debenture prospectus will have all terms and conditions of redemption at the time of issuance of debentures.

What are debentures and the different types of debentures?

The term “debenture” is derived from the Latin word “debere,” which means “to borrow.”

A debenture is a written document that acknowledges a debt and bears the company’s common seal. It includes a deal for repayment of principal after a certain term, at intervals, or the company’s discretion, as well as interest payment at a fixed rate due typically half-annually or yearly on fixed dates.

Types of debentures summarized in the table below:

ViewPoint Type 1 Type 2
Security Secured Debentures Unsecured Debentures
Tenure Redeemable Debentures Non-Redeemable Debentures
Mode of Redemption Convertible Debentures Non-Convertible Debentures
Coupon Rate Zero-Coupon Debentures Specific Rate debentures
Registration Registered Debentures Unregistered Debentures

Difference between Equity Shares and Debentures

Features Shares Debentures
Ownership in Company Yes, Gives Ownership Acknowledgment of Debt by Company
Returns on Investment Dividends and capital appreciation Payment of Interest
Repayment by Company Not redeemed or returned Redemption available
Voting Rights Yes, voting rights are available Not available
Risk of investment High Risk Low Risk
Convertibility Cannot be converted to other instruments Can be converted to shares if the debenture is convertible debentures

Methods of Redemption of Debentures

A company may issue a variety of debentures, which are classified as follows:

  • One-time Payment

The business redeems the debentures by making a lump sum payment to the debenture holders at the maturity/expiry date specified in the terms specified during issuance.

If the debentures are not redeemed at a discount or premium, a lump sum payment equal to the total of the principal values of all debentures is paid out on the predetermined or maturity date specified in the debenture agreement. The issuing business may choose to repay the debenture value before it matures. Companies are better placed to simplify debenture payments since they know when they must pay them.

In the case of a lump sum or one-time payment, debenture holders need to be careful about the liquidity and solvency conditions of the company since redeeming an entire debenture amount can be done only if the company is well-capitalized and has comfortable liquidity positions.

Hence, the investors need to invest in such debentures only if the company has a good track record on such redemptions.

  • Installment payment

Under this procedure, debentures are often redeemed in installments on specific dates throughout the period the debentures are in place. Divide the whole amount of debenture debt by the whole number of years. It should be mentioned that the legitimate reclaimable debentures are verified by the source of drawing the necessary number of lots from the debentures due for payment.

It’s like repaying a loan in installments where we pay the principal amount along with interest. By the end of the debenture period, the entire debenture would be paid off along with interest. Similarly, the interest amount would also get reduced as the principal amount is paid off.

  • Buying from the open market

When a company acquires its debentures for the intention of canceling them, the act of acquiring and canceling the debentures constitutes debenture redemption by purchase in an open market.

If a company’s units are listed on a controlled exchange, it may also buy debentures on the open market. It will spare them the trouble of having to deal with administrative paperwork. 

This type of redemption helps the company to maintain its liquidity since the company can go for redemption when the liquidity is high and cut its final redemption value and vice versa. Also, if the debentures are available at a discounted price, the company gains from such purchases.

Example:

Company XYZ issues debentures of Rs. 20 crore for 5 years and gets listed in the market. The company purchases Rs. 10 cr value of debenture after 2 years from the market when they have sufficient liquidity and thereby reduce their redemption liability.

  • By converting into fresh shares or debentures

In case of convertible debentures a company may redeem its debentures by exchanging them into shares or new debentures. If debenture holders believe the offer is advantageous, they may exercise their entitlement to convert their debentures into equity or a new category of debentures. These additional shares or debentures may be issued at face value, a discount, or a premium.

The businesses should bear in mind that the DRR account must be created in any financial institution in India that is approved by the Reserve Bank of India.

  • Call and Put Option:

Some companies issue debentures with the option of call and put during redemption. The call option gives companies the right to purchase their debenture before or on the due date at a specific price. The put option provides the debenture holders the right to sell the debenture back to the company at an agreed price on or before the maturity period.

What Is Debenture Redemption Reserve?

According to the requirements of the Companies Act of 1956, the firm is required to put aside a percentage of its income each year and transfer it to the Debenture Redemption Reserve for the redemption of debentures until the debentures are redeemed.

According to Section 117C of the Companies Act of 1956 (as amended in 2000):

(a) Where a firm issued debentures after the commencement of this Act, it must establish a Debenture Redemption Reserve for the repayment of such debentures, to which a sufficient sum shall be credited each year until such debentures are redeemed.

(b) The sum allocated to the Debenture Redemption Reserve must not be used by the corporation for any purpose other than debenture redemption.

SEBI’s Regulations

The Securities and Exchange Board of India (SEBI) has established rules for debenture redemption:

1) Every firm must establish a Debenture Redemption Reserve if it issues a debenture that is redeemable after more than 18 months from the date of issuance.

2) Only non-convertible debentures and non-convertible portions of partially convertible debentures are required to establish a Debenture Redemption Reserve.

3) Before beginning the redemption of debentures, a firm must establish a Debenture Redemption Reserve equal to at least 50% of the debenture issuance amount.

4) Withdrawal from the Debenture Redemption Reserve is permitted only once the corporation has decreased 10% of the debenture debt.

The Debenture Redemption Reserve account is shown under “Reserves and Surpluses” on the liability side of the Balance sheet. When debentures are redeemed, the appropriate amount of Debenture Redemption Reserve is moved to General Reserve.

Understand with an example:

Assume a business issued 10 Crores in debentures on January 10, 2021, with a maturity date of December 31, 2025. In this situation, a 1 Crore (10% x 10 Crore) debenture redemption reserve must be established before the debenture’s maturity date.

Companies who fail to establish such reserves within 12 months of an issue of the debentures will be obliged to pay debenture holders 2 percent interest in penalties. Companies, however, are not required to immediately fill the reserve account with a hefty deposit. Instead, they do have the option of replenishing the account by a sufficient amount each year to meet the 10% threshold.

Companies must also reserve or deposit at a minimum of 15% of the number of their debentures set to maturity on March 31 of the following year by April 30 of each year. These monies, which may be placed in a scheduled bank or deposited in corporate or government bonds, must be used to repay interest or principal payments on debentures expiring during the fiscal year that can be used for any other purpose.

Creation of Debenture Redemption Reserve

When the firm agrees to create the Debenture Redemption Reserve Account, the value specified by the Debenture Redemption Reserve tables is deposited into the account and deducted from the profit and loss account. This demonstrates the company’s desire to put aside an amount of cash to develop a fund for repaying debentures. The business should immediately buy outside capital. 

If the debentures are acquired during the interest period, the price includes interest if they are purchased “cum-interest,” but if they are purchased “ex-interest,” the interest until the date of purchase is due to the seller in addition. To offset the impact, the amount of interest accumulated up to the date of purchase, if paid, is charged to the Interest Account, whereby the interest for the whole term will be credited. As a consequence, the account balance would be equal to the interest earned throughout the time wherein the debentures were kept by the company.

Debenture Redemption Reserve Requirement for Different Types of Company

Sr No Debentures issued company DRR Requirement
1 For both public and privately issued debentures, the Reserve Bank of India regulates All India Financial Institutions (AIFIs) and Banking Companies. Not Applicable
2 Other Financial Institutions (FIs) within the meaning of clause (72) of section 2 of the Companies Act, 2013 DRR needs to be created
 

3

 

For listed companies

 

A)  All listed NBFCs (registered with RBI under section 45-IA of the RBI Act, 1934) and listed HFCs (Housing Finance Companies registered with National Housing Bank) for both public as well as privately placed debentures

 

B) Other listed companies for both public as well as privately placed debentures

 

 

 

 No DRR Required

 

 

 

No DRR Required

 

4

 

For Unlisted Company

A)   All unlisted NBFCs (registered with RBI under section 45-IA of the RBI (Amendment) Act, 1997) and unlisted HFCs (Housing Finance Companies registered with National Housing Bank) for privately placed debentures

 

B)  Other unlisted companies

 

 

 

No DRR Required

 

 

 

DRR Shall be 10% of the value of outstanding debentures issued

Investment of Debenture Redemption Reserve (DRR) 

  • The cash placed or invested above should not be used for any purpose other than the redemption of debentures due during the above-mentioned year. Provided, however, that the amount being deposited or invested, as the case may be, must never at any time fall below 15% of the number of debentures expiring on March 31st of that year.
  • In the event of partially convertible debentures, DRR must be generated in respect of the non-convertible component of the debenture issued in line with this sub-rule. The sum credited to DRR must not be used by the business for any purpose other than the redemption of debentures.
  • It must be noted that allocation to DRR might be made at any moment before redemption. Investments in the above-mentioned securities can be made before the 30th of April for debentures maturing that year; however, for the sake of simplicity and ease, it is preferable to make the allocation and investment rapidly after the debentures are allotted, assuming that the company has sufficient profits.
  • Also, in certain situations, the date of allocation may be absent; in such cases, allocation and investments should be completed on the first day of the fiscal year for which ledger accounts are to be created.

Who Oversees the Debenture Redemption and Safeguards the investors?

A debenture trustee works to safeguard the debenture investors and enforces the debenture trust deed. A debenture trustee ensures that the debentures were turned or redeemed in line with the requirements and circumstances under which they were issued to debenture holders.

A debenture trustee is a trustee of a deed of trust to ensure a body corporate’s issuance of debentures. The entity acting as debenture trustee must be either a scheduled bank engaged in commercial business, a major public bank, an insurance company, or a corporate body. To function as a debenture trustee, the firm must be registered with SEBI.

Different Types of Preference Shares: A Complete Overview

Companies release preference shares or preferred stocks to raise capital. They are also known as preference share capital. If any company is facing losses or is winding up, the last payments are made to the preference shareholders before the equity shareholders.

Preference shares enable shareholders to receive the dividends announced by the company. Preferred stocks shareholders always receive dividends before equity shareholders. If a company pays out a dividend to its investors, the preferred shareholders receive the first payout.

Features of Different Types of Preferred Stocks

The unique characteristics of preference shares have turned ordinary investors into expert investors even during bad phases of economic growth. Some features of preference shares are explained below:

  • Preferred Shares can be converted into a common share

It is easy to convert preference shares into common stock. A shareholder willing to change its holding position can get it converted to a predetermined number of preference shares. In some types of preference shares, investors are provided with a specific date to convert their shares. In other types, shareholders might require permission from the company’s board.

  • Payouts of Dividend

Shareholders with preference shares receive dividend payouts, while other shareholders might receive it later. Sometimes, the other shareholders do not receive the payout.

  • Dividend Preference

Regarding dividends, preference shareholders receive dividends before equity or other shareholders.

  • Voting Rights

Preference shareholders have the right to vote in case of any extraordinary events. But this is occasional. With preference shares, shareholders do not have voting rights in matters of the company’s management. 

  • Preference Offered in Assets

In the case of the company’s liquidation, the preferred shareholders are prioritised over non-preferential shareholders on its assets.

What are the Different Types of Preference Shares?

The varied types of preference shares have been enumerated below:

  • Cumulative Preference Shares

  • This is the most preferred equity. Here, if the dividends are not paid, it is considered in arrears and prioritised over other dividend payments. 
  • If a company cannot pay dividends to its shareholders, the cumulative dividends can be paid in later years as arrears.
  • Per the law preference, shareholders must receive dividends before any common shareholders.
  • Non-Cumulative Preference Shares

  • Unlike the cumulative preferred shareholders, the non-cumulative shareholders are not compensated for the unpaid dividends.
  • For instance, if a company fails to make a dividend payment even after an announcement, they are under no obligation to pay the dividends.
  • Redeemable Preference Shares

  • Redeemable shares are issued by a company to redeem them later. 
  • The company opts for a buyback in near future.
  • Irredeemable Preference Shares

  • This type of share can only be redeemed if the company shuts down its operations or faces liquidation.
  • Adjustable-Rate Preference Shares

  • In this category, there is no provision of the fixed rate.
  •  The dividend payment amount depends upon the existing specified rates in the market at all times.
  • Callable Preference Shares

  • Callable preferred shares are of a hybrid security.
  • The issuing company here has the right to redeem the shares at a specified date and at a price specified by the corporation at the time of issuance.
  • This preferred equity does not appeal much to its investors because of its characteristics.
  • Convertible Preference Shares

  • Convertible preferred shares can be converted to common equity at a specified price and time.
  • This is the most versatile as well as appealing form of preferred stocks as it has diversified risk exposure.
  • Non-Convertible Preference Shares

  • Those preferred stocks that are not convertible are non-convertible preference stocks.
  • This type of preferred equity cannot be converted into common equity.
  • Participating Preference Stocks

  • If the preferred stocks are of participating nature, they have the chance to earn higher than the stated rate of the fixed dividend. 
  • The dividends on the participating preference shares are higher if the company receives more than its benchmark earnings.
  • Non-Participating Preference Shares

  • The dividends made to the non-participating preferred shareholders cannot be made from surplus profit.
  • It has a fixed dividend rate.

Why Should Shareholders Prefer Preference Shares?

Preferred Shareholders enjoy the following benefits:

  1. In the form of dividends, they get regular income.
  2. Compared to bonds, preference shares have a higher potential for returns.
  3. The lower amount of risk compared to common shares.
  4. As per the Indian tax laws, the dividend income on preferred shares is tax-free up to Rs. 10,00,000.

Difference Between Preference Shares and Equity Shares

Some of the significant differences between preference shares and equity shares are explained below:

S.No Category Preference Shares Equity Shares
Voting Rights In case of an extraordinary situation. Otherwise does not have any voting rights. Common equity has got voting rights.
Payments Preferred equity holders receive dividends, both cumulative and non-cumulative. Common shareholders are not entitled to fixed dividends. They may or may not receive dividends.
Volatility Preferred shares have got steady price movements. Common shares react actively to the developments of the market.

Similarity Between Preferred Stocks and Equity Stocks

Preference stocks are classified as equity. It is similar to the general equity offered by a company. Preference shares are paid dividends from the profit after the tax, whereas preference shares have a fixed dividend rate.

Difference Between Preference Shares and Bond

The differences between preference shares and bonds have been discussed below:

S.No Category Preference Shares Bond
Classification Preference shares as equity. Bonds have been classified as debt.
Dividend Payments The dividend amounts are fixed but not guaranteed.  The interest on the bonds must be made as per schedule.
Tradability Preference shares are more of liquid nature as they trade on the stock exchange. Bonds are over-the-market securities that have a negligible presence on the exchange.

Conditions to Redeem Preferred Stocks

The condition to redeem preference shares are:

  • Permission is granted only to redeem fully-paid up preference shares.
  • The redemption of the preferred stocks is allowed only from the profits available for the distribution of the shareholders.
  • The proceeds of the equity or preference shares are issued solely for the redemption of preference shares.
  • If the company wishes to redeem preference shares from the fresh proceeds of any newly-issued preference shares, at least 75% of the shareholders need to give consent, along with the tribunal’s approval, to carry out the activity.
  • After receiving the existing shareholders’ consent and the necessary approvals, the shareholders who opposed the new preferred shares will immediately get their respective shares.
  • Moreover, preference shares issued to redeem old preference shares cannot be added to the company’s existing share capital.

Conclusion

In previous years, several reputed companies, such as IL&FS Transportation networks, Tata Capital, and many more, have issued preference shares under private placement. The dividend rates of these preferred stocks are lucrative and tax-free, up to Rs. 10 lakh.

Preference shares have their risks and potential. Investors must study the company’s performance and growth potential. It would be wise to analyse its fundamentals and management before investing in preference shares. Yes, it is too much work. With TradeSmart, you will get instant ratings with all the company details listed on the stock exchange.

Hence, open a Demat Account with TradeSmart today, and invest in the best profitable companies.

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