money never sleeps
Mother: Chinmay, I am thinking of taking a bank loan.
Me: May I know for what?
Mother: The new person who is taking care of our farm knows how to drive a tractor. So, I am thinking of buying a tractor.
Me: Hmm… and how many times in a year will we be using it?
Mother: I know we will not be using it regularly but we can rent it and/or it can be hired along with the driver. That way the new person will also be generating income and the tractor will also be generating income. According to you, both will be performing assets as you had mentioned last week.
Me: OMG! My genius mother, I really like and appreciate the way you are thinking.
Mother: (with a big bright smile) thank you… thank you
Me: Let us look at some critical numbers and analyse the same.
Mother: ok
Me: How much does a tractor cost?
Mother: around Rs 5 lacs (500,000)
Me: Even though I am not comfortable with the word ‘around’, let us take it as Rs 500,000
Mother: ok
Me: How much loan will be you taking?
Mother: I was told I can get up to 70%
Me: That will be Rs 350,000
Mother: yes
Me: Where will be the remaining 150,000 come from
Mother: I will invest Rs 50,000 from my savings and the remaining Rs 100,000 I will take from your father.
Me: Will you take it or borrow it?
Mother: It is all the same for me.
Me: (gave a weird look)
Mother: You know your father did not have any interest in buying the farm. I know how much I have struggled to convince him. Today, you know how much the land has appreciated…
Me: ok… ok… as we were analysing if it is worth buying a tractor so I asked.
Mother: whatever…
Me: (in my mind, women and their whatever) hmm… let us look at an example where you have borrowed $100,000 from a bank at 10% interest per annum (p.a)
Mother: ok
Me: If someone is going to ask you to lend that same Rs 100,000 for 5% p.a will you lend it?
Mother: defiantly no!
Me: what if they offer 10% p.a
Mother: no way, it is costing me 10%. So, why should I give it at 10% p.a?
Me: Correct. It is common sense that unfortunately is not very common when it comes to business finance.
Mother: what do you mean?
Me: Do you know how much is the interest on the tractor loan?
Mother: not sure
Me: ok, let us take it as 10% for easy calculation.
Mother: ok
Me: To get that Rs 350,000 loan from the bank at 10% p.a. you will have to give some kind of collateral or guarantee, sign on two dozen documents, and on top of that make sure to pay monthly interest/EMI irrespective of COVID pandemic – lockdown – and other external factors.
Mother: (in slow voice) yes
Me: now, for the Rs 50,000 from your savings and Rs 100,000 from Appa (father) do you think we should associate an interest amount in percentage? In other words, do you think they cost us?
Mother: it is my savings and your father’s money. I do not expect any interest and I am sure your father will not ask interest either. If he asks, then he can eat more mangoes in the next season!
Me: hmm… (in slow voice) common sense is not always common!
Mother: what did you say?
Me: nothing, if that Rs 50,000 of your money and Rs 100,000 of Appa’s money were deposited in a saving account how much return do you think it would generate?
Mother: around 4-5 %
Me: the same money if invested in mutual funds might generate 6-8%, in private equity 10-12%, in share market above 15%. Of course, every investment has a risk associated. And, higher the risk usually one should expect high returns, right?
Mother: makes sense.
Me: This means, that Rs 150,000 has the potential to generate a return anywhere between 5 – 15% depending on how much risk you want to take?
Mother: yes
Me: do you think investing in a tractor has some risk involved?
Remember, you will not only be investing money but have to manage the driver, maintain the tractor, get people to hire it which will involve your time to coordinate, and collecting money, and so on.
Mother: hmm… it depends… kind of yes
Me: for that risk, how much percentage of return should we aim for?
Mother: I guess it should be more than 15%
Me: uff… great!
I usually suggest at least we should aim to generate 20% simply because whether it is business or farming we do not work Monday-Friday, 9am-5pm. We work Monday-Monday, 7am – 11pm, and on top of that, we compromise on our family time, personal time, health. So, for the risk and moreover, for our efforts, we should aim for at least 20%.
Mother: hmm… agree.
Me: 20% of Rs 150,000 is Rs 30,000
and 10% of Rs 350,000 is Rs 35,000.
Total is Rs 65,000 (30k + 35k)
Mother: ok
Me: 65,000 is 13% of Rs 500,000
This means average interest on 500,000 is 13% (65,000/500,000 X 100)
Mother: ok
Me: This means, the investment on that tractor (asset) should generate a return that is at least equal to 13%
Mother: ok
Me: Do you think the tractor can generate Rs 65,000?
Mother: I think it will.
Me: really? Do you think it can generate Rs 65,000 after paying towards fuel, maintenance, salary, insurance, and other related expenses?
Mother: not sure
Me: Will the tractor be used 24 X 7?
Mother: definitely not
Me: So, your tractor (asset) cannot generate income (perform) all throughout the year? But do you think the bank loan (liabilities) perform throughout the year?
Can you tell the banker not to charge interest on days when the tractor is not used and at night when it will be in the shed?
Mother: certainly not.
Me: What if the new person quits? Then who is going to drive that tractor? What if there is another lockdown? What if the tractor breaks down?
I am not trying to be pessimistic, all I am trying to understand is will the tractor generate a return that justifies our investment and effort?
Mother: not sure
Me: I am not saying you should not take a loan. I would be more than happy to support you but I would like to know do we have plan-b, plan-c if things do not go according to plan???
Me: Ma, moral of the story – money never sleeps!
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If you are a business owner then please remember, the assets in your company cannot perform 365 days in a year but your liabilities will perform all throughout the year.
And every asset has a corresponding liability (please take some time to think on this point)
The incomes that your assets can generate are periodic but expenses are continuous and ongoing!
Many business owners have sleepless nights is simply because money never sleeps!
Sweet dreams 😉