Is buying a car an investment or a liability?

March is the month when the last instalment of advance tax becomes due. Many professionals try to maximise their tax benefits by buying capital assets to avail of depreciation benefits. That is one reason for high demand for 2-wheelers and 4-wheelers in March.

For salaried employees, March is also the month when last minute investments are made by many to avail of tax benefits. Is March a good month to buy a car? In this month's guest post, Nishit explains when and how to go about buying a car to maximise benefits. 

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We talk about investing and preserving wealth.  Buying a car is a necessity for many of us. Is it an investment or a liability?

The value of a car keeps decreasing with every passing day. The minute it is driven out of the car showroom a 10% depreciation happens. So, how does one maximise a depreciating asset?

The trick is to go for the right car at the right time. If one is buying a car with a time horizon of 5-6 years, then which month of the year a car is bought is immaterial. December constitutes the best month for a discerning buyer because of low demand.

April is also a lean month for car sales. Why is this so? Most of the buyers who file income tax returns as professionals (they constitute a major chunk of the car buyers), buy a car in the month of March to avail of depreciation benefits.

The pent-up demand peaks in March thanks to this tax benefit, and also because people tend to wait for tax policy after the budget In February. One can, therefore, get good discounts in April.

Next, what one needs to evaluate is the likely usage. For example if you are going to drive around 750-1000 kilometres in a month, you are better off with a petrol car. This is because the running cost with a mileage of 12 km comes to around Rs 6 a kilometer, whereas for a Diesel variant of same car it will be around Rs 4. Diesel cars are priced at least Rs 1.50 lakhs more than petrol cars of same make. So, your breakeven point is 50000 kms and 5 years by which time you will probably change your car anyway. Also, the Rs 1.50 lakhs saved can be invested and the profits used to pay for the petrol bills.

Another option, especially with Maruti cars, is to go for the Duo option where one gets a CNG tank in addition to a Petrol tank. The cost per kilometer is very low - about Rs 1.50–2.

The next option is whether one pays the entire amount in cash or takes a loan for the car. A full cash payment often entitles one to a bigger discount from the car dealer.

Also, there are a certain car models which are very good but a bit slow moving. One can always get a higher rate of discount here. If one is going to keep the car for a longer time, the make of the car hardly matters as long as it does not break down often. However, one has to also keep in mind the likely resale value of the car.

So, that in a nutshell is how one can maximize the returns on buying a car. Buy at the right time, at the right price squeezing out maximum discounts from the dealer.

Postscript: I just now read that Tata Motors is offering a guarantee to buy back your Tata Indigo Manza car after 3 years and giving you 60% cash back. This scheme looks interesting in the sense that a sedan usually depreciates 50-60% after 3 years. You are being charged only 40% of the car value.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

How to read the Cash Flow Statement – Part 2

In last Tuesday’s post, I had covered the first part of the Cash Flow Statement – Cash Flow from Operating Activities. The next two parts will be discussed in this post.

Part 2: Cash Flow from Investing Activities 

To remain in business over the long haul, a company needs to grow. Without growth, a business will stagnate and eventually die or get acquired. But growth has a price. Cash has to be spent to buy land, machinery and related equipment, build factories and offices, acquire other companies, start subsidiaries or joint ventures, and make appropriate investments.

All of the above comes under Cash Flow from Investing Activities. You don’t have to be a genius to guess that this figure will be a (negative) one for most companies. Many mature companies, particularly those in the FMCG sector, don’t have much need for Capital Expenditure (i.e. spending cash on factories and equipment) because their rate of growth has slowed down.

Ideally, the depreciation amount in the Profit and Loss statement should be less than or equal to the amount of cash being spent in investing activities – because depreciation is meant to cover the notional loss due to wear and tear of the existing plant and machinery. If a company does not continuously spend on upgrading and modernising its facilities, it will not be able to compete with newer entrants who may have the latest technology and equipment.

The definition of Free Cash Flow is:

Cash Flow from Operating Activities – Capital Expenditure

This is a (negative) number for companies in their early growth stage, when cash generated from core operations may be insufficient to cover the cost of capital expenditure. But for well-established companies, positive Free Cash Flow is an indication of financial health. The more positive Free Cash Flow a company can generate, the easier it is for them to expand, acquire, pay dividend or buy back shares, and pay off loans.

Part 3: Cash Flow from Financing Activities 

What if a company has (negative) Free Cash Flow, or still worse, has (negative) Cash Flow from Operating Activities? Where will they get the cash to pay their suppliers, interest to banks for any loans taken, and for growing the business?

They can either resort to more borrowings, and/or issue more shares. If such companies are showing a net profit, then they are also expected to pay dividends to their shareholders. All inflows and outflows of cash due to loans, share issues, share buybacks, dividend payments come within Cash Flow from Financing Activities.

Financial prudence should dictate a company’s growth plans. As a thumb rule for selecting good stocks, about 60-70% of the Cash Flow from Investing Activities (Part 2) should be funded by positive Cash Flow from Operating Activities (Part 1); the balance 30-40% should come from Cash Flow from Financing Activities (Part 3).

Many companies forget the simple adage that one should cut one’s coat according to the cloth. They may even have positive Cash Flow from Operating Activities, but their ambitious growth plans require far more cash than they can afford. They resort to frequent borrowings and share issues in the hope of reaching the top quickly. One or two bad years can bring such companies down to their knees. Pantaloon and Suzlon come to mind.

(Note: The financial health of banks and financial institutions can’t be judged by analysing the Cash Flow Statement alone – because they need to borrow cash to give loans, and invariably have negative Cash Flow from Operating Activities. Price to Book Value and Return on Assets are better measures for such companies.)

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How to read the Cash Flow Statement – Part 1

Have you heard the statement: Cash is king? A business needs cash like a car needs fuel. If there is no regular generation of cash from the day-to-day operations, the business will need to resort to debt and share issues to survive. Seems logical that investors would first look at the Cash Flow Statement in an Annual Report – right?

Unfortunately, most investors in the stock market – even those who have been investing for many years - do not understand or know how to interpret the Cash Flow Statement. Just looking at the Balance Sheet, Profit and Loss statement and the Management Discussion and Analysis is not enough. The real state of a company’s finances is hidden in the Cash Flow Statement and the Notes on Accounts.

With another accounting year coming to a close on Mar 31, 2011, this is as good a time as any to learn the basics of the Cash Flow Statement:-

The Cash Flow Statement allows you to check the different sources of cash inflows into a company during a particular year vis-a-vis the prior year, how much cash was spent, and what it was spent on. Cash inflows are positive, cash outflows are (negative). The three parts of a Cash Flow Statement enable you to understand what a company’s management is doing with the cash at its disposal, by comparing the figures with those appearing in the Balance Sheet and Profit and Loss statement.

Part 1: Cash Flow from Operating Activities

The Net Profit before tax and exceptional items from the Profit and Loss statement is adjusted with depreciation, interest, provisions, profit/loss on investments, debtors, inventories, creditors to arrive at the cash generated from operations. Tax and exceptional items are then adjusted to arrive at the Net Cash from Operating Activities.

Though it may seem counter-intuitive to non-accountants (like me), depreciation is considered an inflow (it is an expenditure in the Profit and Loss statement, but the cash is not paid to any one and remains within the company); creditors/accounts payable is an inflow (because they haven’t been paid yet); debtors/accounts receivable is an outflow (because a ‘sale’ has been accounted in the Profit and Loss statement but the money hasn’t been received yet).

Net Cash Flow from Operating Activities should preferably be positive, and greater than the previous year’s if the net profit has gone up. Newly set-up companies, particularly those in high growth fields like Information Technology or Bio-technology, often have negative cash flows from operations in their initial years. They need to ramp up operations quickly to meet demand but may not be able to negotiate good payment terms from their clients.

Negative cash flows from operations of established companies, if over prolonged periods, indicate that there is something amiss with the business model, or the management has questionable integrity and is diverting cash to unlisted subsidiaries or to related parties.

Investors need to be particularly wary of companies that show good top-line and bottom-line growth year after year, and pay taxes and dividends but show negative cash flows from operations. Where is the cash to pay the taxes and dividends? It comes from regular borrowings and share issues. If such a situation continues for a few years, the debt burden will eventually sink the company. Many realty and high-flying infrastructure companies, and investor favourites like Bartronics, Cranes Software fall within this category.

(Note: The next two parts of the Cash Flow Statement will be covered in Thursday’s post – so please stay tuned.)

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