Sunday, November 22, 2009

Term Vs Endowment Plans

- Chellamuthu Kuppusamy

In response to the previous post "Jeevan Anand - Unique insurance plan" Vinod has commented:

"My experience on this:

Policy is good.

Since this is mainly life insurance, the cover to premium required ratio did not fit me well.

Since I was looking at life cover that could substitute my income (to a good extent) so financially my family is not in the woods to pay up all the emi's and liabilities. The premium required was too high. For those who can afford the premium this policy is great.
I have now decided to go for term policy for covering life and with the rest of money invest wisely (as much as possible ;) )

Best regards,
Follow up communication:

Hi Vinod,
I am glad you said this. That is precisely how one should view insurance. But in India insurance is not considered as an instrument for life cover alone. People tend to ask, “What do I get back after paying my premium?” A reply that their family is protected against the financial loss due to an unlikely ecent of their sudden demise does not suffice.

That’s why penetration of term insurance plans are very very low in our country. Data reviels that only 26 per cent are insured in India. That too the average sum assured per policy is just over Rs 90,000. This is never going to be sufficient.

As you said, premium to sum assured ratio is high in India, because we rarely have term insurance policies. Invariably every policy holder expects a maturity value. This leave the insurers with no choice but to promote emdowment plans.

For instance, in one of LIC’s term assurance plans Anmol Jeevan – I, I would have to pay just Rs. 2,762 per year for a life cover of Rs 10 lakhs. In Amulya Jeevan, I would pay just Rs 5,850 per year for a life cover of Rs 25 lakhs.

Whereas as in Jeevan Saral (an Endowment plan), I would only get a coverage of Rs 1.25 lakhs for an annual premium of Rs 6,000.

But as everybody says, endowment plans gives back a maturity benefit which is not the case with term assurance plans. That does not matter if you are a streetsmart investor.

Friday, October 16, 2009

The bottom line is . . .

- Chellamuthu Kuppusamy

What do you think is the objective of companies across the globe? Is it customer service, employee satisfaction, social responsibility? May be yes - may be no. Yes, because they are the means to achieve the primary objective and no, because they are the objectives on their own. Well, what could be the primary objective, if not only objective?

Let me borrow a line from Wikipedia to answer this question: “Businesses are formed to earn profit that will increase the wealth of its owners and grow the business itself” Every action and transaction (and of course inaction) has a financial implication. Ultimately everything boils down and sums up to greenback.

Balance sheet and Operating Margin are believed to be the touchstones – perhaps millstones if not managed properly - of any organization. Trial balance, inventory turnover, top line, bottom line, ROI, sequential growth etc are some of the commonly used terms in our daily life. The extent to which these buzzwords are fathomed is subject to debate. Therefore, we make a small attempt here to give a brief introduction to those terms and Financial Accounting concepts.

Firstly, every transaction and activity that has a financial implication is recorded. Such transactions are entered in two accounts at a time. This practice, known as ‘Double-entry bookkeeping system’, requires a debit entry in one of the accounts and a corresponding credit entry in another account.

For instance, an employee buys raw material with cash. This transaction needs to be recorded in two accounts, namely, cash and raw material accounts. In the cash account you make credit entry and a debit entry in the raw material accounts. This sounds good, but how do we determine what to debit and credit? How do we ensure we don’t debit an account that should indeed be credited? This is where golden rules of accounting come in handy.

Golden Rules of accounting:
  • 'Personal Account': Debit the Receiver & Credit the Giver
  • 'Real Account': Debit what comes in, Credit what goes out
  • 'Nominal Account': Debit all expenses / losses, credit all Incomes / Gains
Personal accounts are accounts maintained for individuals and organization with whom the company does business with

Real accounts are for real things that can either be seen, felt and touched – an exception being goodwill. In other words these represent assets.

Nominal account represents expenses, losses, incomes and gains.

In our case, cash as well as raw material accounts are real accounts. When the company buys raw material by paying cash, cash goes out and raw material comes in and hence they are credited and debited respectively.

As all transactions are equally recorded on debit and credit sides, sum of all debit sides values and credit side values of all the account put together would be equal at any given point in time. Such an exercise is known as Trial Balance which serves as a tool to detect errors, which can result in the totals not being equal.

With accounting entries are maintained for each and every transaction, they are used to arrive at the Final Accounts which comprises of P&L (Profit and Loss) account and Balance sheet at the end of the accounting period, which is normally a quarter.

Balance sheet is a snapshot of company’s assets and liabilities at the end of the period. P&L, on the other hand, is the summary of profit or loss the company has made for the entire period. You might have read items sounding like ‘assets stand at Rs 2,000 crore on 31-03-2009 and profit for the FY 08-09 was Rs 120 crores’. First one reflects balance sheet position on a given day and the latter draws reference from P&L statement for entire financial year.

While preparing Final Accounts at the end of accounting period, all account values should either be transferred to the balance sheet or to the P&L statement. Account that represent assets (such as inventories, investments, receivables etc) and liabilities (such as payables, owner’s equity, earning & surplus - liability from company’s point of view to its owners/share holder) – are transferred to balance sheet.

All others accounts, which can be classified under expenses, losses, incomes and gains, are transferred to P&L statement. Sales volume or revenue or gross profit comes at the top. Expenses, interest and tax are deducted from this to arrive at the net profit or earnings. Revenue, which appears on the top, is referred as top-line and the net profit, which appears at the bottom, is referred as bottom-line.

Lesser the expenses more the profitability or the ability to convert top-line into bottom-line is. Operating Margin is the ratio of the bottom-line (normally it is the operating income excluding other incomes/expenses and tax) to the top-line. A company reporting 30 % OPM saves Rs 30 as a profit by doing business for Rs 100 after meeting an expense of Rs 70.

Operating margin directly affects the profit. After all, it is the bottom-line that finally matters in business.

Wednesday, July 08, 2009

(Book) Prabhakaran - The Story of his struggle for Eelam

He is - perhaps was - a designated terrorist for some and an uncompromising freedom fighter for some. For the rest he was somewhere in between. Yes, I am talking about V. Prabhakaran, leader of the LTTE.

The story of his prolonged resistance and fierce confrontation with the Sri Lanka armed forces, nonetheless, ought to be studied, rather historically. Similarly, Indian involvement in the ethinic conflict and its consequences warrant a special mention.

I have made a sincere attempt to view these things objectively and retrospectively through the book 'Prabhakaran - The Story of his struggle for Eelam', in English. Though this is the English version of his biography 'Prabhakaran - A life' (பிரபாகரன் - ஒரு வாழ்க்கை) authored by me in Tamil, English version contains more information relevant to non-Tamil speaking people in India and international community.

It can be bought online and read as a Kindle book.

Monday, March 02, 2009

The economy will be in shambles throughout 2009!!

This is what Warren Buffet had to say in his annual letter to shareholders.

Our decrease in net worth during 2008 was $11.5 billion, which reduced the per-share book value of both our Class A and Class B stock by 9.6%. Over the last 44 years (that is, since present management took over) book value has grown from $19 to $70,530, a rate of 20.3% compounded annually.

The table on the preceding page, recording both the 44-year performance of Berkshire’s book value and the S&P 500 index, shows that 2008 was the worst year for each. The period was devastating as well for corporate and municipal bonds, real estate and commodities. By yearend, investors of all stripes were bloodied and confused, much as if they were small birds that had strayed into a badminton game.

As the year progressed, a series of life-threatening problems within many of the world’s great financial institutions was unveiled. This led to a dysfunctional credit market that in important respects soon turned non-functional. The watchword throughout the country became the creed I saw on restaurant walls when I was young: “In God we trust; all others pay cash.”

By the fourth quarter, the credit crisis, coupled with tumbling home and stock prices, had produced a paralyzing fear that engulfed the country. A freefall in business activity ensued, accelerating at a pace that I have never before witnessed. The U.S. – and much of the world – became trapped in a vicious negative-feedback cycle. Fear led to business contraction, and that in turn led to even greater fear.

This debilitating spiral has spurred our government to take massive action. In poker terms, the Treasury and the Fed have gone “all in.” Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome aftereffects. Their precise nature is anyone’s guess, though one likely consequence is an onslaught of inflation.

Moreover, major industries have become dependent on Federal assistance, and they will be followed by cities and states bearing mind-boggling requests. Weaning these entities from the public teat will be a political challenge. They won’t leave willingly.

Whatever the downsides may be, strong and immediate action by government was essential last year if the financial system was to avoid a total breakdown. Had that occurred, the consequences for every area of our economy would have been cataclysmic. Like it or not, the inhabitants of Wall Street, Main Street and the various Side Streets of America were all in the same boat.

Amid this bad news, however, never forget that our country has faced far worse travails in the past. In the 20th Century alone, we dealt with two great wars (one of which we initially appeared to be losing); a dozen or so panics and recessions; virulent inflation that led to a 211/2% prime rate in 1980; and the Great Depression of the 1930s, when unemployment ranged between 15% and 25% for many years. America has had no shortage of challenges.

Without fail, however, we’ve overcome them. In the face of those obstacles – and many others – the real standard of living for Americans improved nearly seven-fold during the 1900s, while the Dow Jones Industrials rose from 66 to 11,497. Compare the record of this period with the dozens of centuries during which humans secured only tiny gains, if any, in how they lived. Though the path has not been smooth, our economic system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it will continue to do so. America’s best days lie ahead.

Take a look again at the 44-year table on page 2. In 75% of those years, the S&P stocks recorded a gain. I would guess that a roughly similar percentage of years will be positive in the next 44. But neither Charlie Munger, my partner in running Berkshire, nor I can predict the winning and losing years in advance. (In our usual opinionated view, we don’t think anyone else can either.) We’re certain, for example, that the economy will be in shambles throughout 2009 – and, for that matter, probably well beyond – but that conclusion does not tell us whether the stock market will rise or fall.

In good years and bad, Charlie and I simply focus on four goals:
(1) maintaining Berkshire’s Gibraltar-like financial position, which features huge amounts of excess liquidity, near-term obligations that are modest, and dozens of sources of earnings and cash;
(2) widening the “moats” around our operating businesses that give them durable competitive advantages;
(3) acquiring and developing new and varied streams of earnings;
(4) expanding and nurturing the cadre of outstanding operating managers who, over the years, have delivered Berkshire exceptional results.