The Challenges of Interpreting Internal Rate of Return (IRR)

The Internal Rate of Return (IRR) is one of the most universal return concepts, and rightly so because of its effectiveness in interpreting returns from an investment. However, it is also one of the most difficult concepts to wrap your head around. In my personal opinion, the difficulty arises primarily due to the understanding of the fundamental underpinnings of the definition. It is not my intention to turn this discussion into a technical one; since the objective is to demystify, I will break it down for simpler understanding.

Firstly, the IRR is better understood when used to compare returns from two or more investments. The decision rule is rather simple – the higher the IRR, the better. The confusion arises when investors look at the IRR in isolation i.e. an investment yields a 20% IRR so what does that mean? The answer is a complicated one and often leads to more questions.

Secondly, the IRR is a multi-period return measure. What this means is that when investors would like to compare investments that span different time periods, IRR becomes the best tool for this purpose. For instance, investment A returns 20% in X years whereas investment B returns 25% in Y years. The question as to which investment performs better is best answered by the IRR.

Thirdly, the IRR works best when investments have conventional cash flows patterns i.e. a negative cash flow followed by multiple positive cash flows. Any variations herein are bound to be detrimental to the IRR calculation. For instance, you buy a stock (negative cash flow) and receive dividends (positive cash flow) during the holding period. The IRR works well in this scenario. However, if you short a stock (positive cash flow) and buy another one (negative cash flow) with the proceeds and finally square of the transaction (positive or negative cash flow) later on, the IRR may not necessarily yield desired results.

Lastly, due to its very definition, in some instances an investment may have no IRR at all or at least one that can be determined! Obviously, in such instances, the IRR is of no use and creates confusion in the mind of the investor. Therefore, the challenges in interpreting IRR arise when investors use the IRR for purposes other than those mentioned above.

Although this list is by no means exhaustive, it captures the salient features of the IRR. Hope this piece has helped simplify the concept and gives you confidence to seamlessly compare investments using IRR.

Vinay Basavaraj

Vinay boasts of a decade of experience working in both large and small organizations. His roles have ranged from sales to operations and even a stint in academia. He currently manages affairs in capital markets in Capital Float.

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6 things school owners must know before taking a School loan

Lack of adequate finance should not be a constraint when it concerns improving or a running education institution. There are several options in the financial market for school loans that can be procured to upgrade campus infrastructure, buy new equipment for your labs/classrooms, add new facilities for students and staff or any other productive purpose.

How to get loan for school” is no more a concern for prospective borrowers. The availability of multiple alternatives, however, makes it necessary for the borrowers to be aware of certain factors before they settle upon a particular source of funds. Let us look into six of these.

1. Does the loan require collateral?

Loans for private schools may be secured or unsecured. Many banks still ask borrowers for collateral to be pledged as security. While the low interest rate of such school loans may be alluring, the idea of hypothecating a valuable asset to the lender feels distressing. Fortunately, schools that cannot afford secured loans can get collateral-free finance from digitally enabled NBFCs, also known as FinTech companies. A FinTech lender usually does not require collateral, and issues loans based on the borrowers’ creditworthiness.

2. Is there a limit on the minimum loan amount to be taken?

Inflation rates warrant that nothing worth investing is cheap. However, why take a big loan that will entail much interest? FinTech companies keep an adequate range on the issuable loan amount to accommodate the needs of all institutions that want to apply for school loans. There are no rules requiring schools to apply for a large ‘minimum’ amount if they need merely 5-10 lakhs for the planned purpose.

3. What will be the tenure of the loan?

No institution would like to be debt-ridden for long. Payment of total interest is also high on long-term school loans. This is why it is advisable to check the tenure before accepting the funding from any lender. A FinTech company can be very accommodating and can provide a loan that can be paid back in only one year. A loan for educational institutions may also be stretched to three years.

4. What is the interest rate, processing fee and other charges on the loan?

While taking loans for private schools in India, check the interest rate and additional charges upfront. Banks and traditional NBFCs often have low interest, but their processing fee, documentation charges, legal fee, commission and a bunch of other charges may add up to a significant amount. At times, this is also necessary to cover their paper-centric loan approval process. Conversely, FinTechs that have a succinct digital application process charge a processing fee of up to 2.5%.

5. Are there any pre-closure charges?

Whether you are applying for a loan for construction of school building or to buy new equipment for teaching, your earnings may make it possible to pay off the outstanding balance earlier than its tenure. Such an eventuality is usually met with pre-closure penalties. It is advisable to check the rate of this fee before paying off a lump sum. As compared to banks, most FinTech companies have no or low prepayment charges on their loans.

6. How will the loan be repaid?

Along with the repayment charge, it is also good to check the repayment options for school loans. EMIs are the only way to pay off the debts availed from a majority of the traditional lenders. In comparison, FinTechs have flexible repayment options that can be adjusted as per the borrower’s preferences.

Capital Float is a leading FinTech lender for educational institutions in India. Visit https://www.capitalfloat.com/school-finance to know more about our school loans.

Oct 24, 2018

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Bharat QR vs POS Machine: Which One Is Better?

FinTech is disrupting the very fundamentals of money management the world over, and India is no exception. With the Prime Minister’s focus, especially, on making India “digital”, a number of programs and schemes have been launched. In fact, many of the schemes have taken a cue from the private sector and have upped the innovation game to deliver a comfortable and convenient money management experience. From the point of sale (POS) machines to merchant cash advance to e-wallets, we are seeing a plethora of FinTech products and services change the way we pay. And this phenomenon is occurring across industries, whether it is the fast moving e-commerce sector or the heavy-duty manufacturing sector.

Consumers are at the receiving end of these changes and need to fast adapt to the new payment means. First it was a revolution of the plastic money, with cash bring replaced by credit and debit cards. This demanded the use of other paraphernalia, such as the point of sale devices at the checkout counters. Now, with niche FinTech innovators such as Paytm and MobiKwik, even the point of sale devices are not required. It is just scan and pay. The government has taken this ease of payment a step further by bringing to light the Bharat QR payment method.

What is Bharat QR 

Bharat QR is a payment process driven by a Quick Response Code or QR code. A user who has the Bharat QR-enabled bank application on his or her mobile phone can make a payment quickly, easily and safely. The best part is that scanning the machine-readable optical grid translates the bank account information without your having to swipe or hand over a card, making it extremely convenient! This is because the QR grid stores the person’s bank information. This is similar to using a Paytm or a FreeCharge or a MobiKwik e-wallet, the advantage being that in Bharat QR, payments are linked directly to your bank account rather than to a separate e-wallet. There is thus no hassle of transferring money to your Paytm wallet or MobiKwik wallet. Alternatively, the user can also access Bharat QR through the Bharat Interface for Money or BHIM universal app, which is a UPI developed by the National Payments Corporation of India (NCPI).

Currently, Bharat QR is available on the mobile applications of 15 nationalised and private banks, namely – Axis Bank, Bank of Baroda, Bank of India, Citi Union Bank, DCB Bank, Karur Vysya Bank, HDFC Bank, ICICI Bank, IDBI Bank, Punjab National Bank, RBL Bank, State Bank of India, Union Bank of India, Vijaya Bank and Yes Bank. It is also linked to VISA, MasterCard, American Express and RuPay cards. Its scale is expected to increase in the coming days.

A look at Point of Sale

Bharat QR is thus a leap ahead of the Point of Sale payment mechanisms, which were the mainstream payment devices used at most commercial and consumer locations such as shops and restaurants. The Point of Sale or POS terminal is a computerised replacement for a cash register that can process credit and debit cards. A customer swipes their card in the machine and enters the PIN number to verify and complete the transaction. The POS is installed at the merchant location, mostly by the bank that they associated with. Not only does the merchant bear the cost of the device and the installation, but they are also compelled to pay the issuer bank a merchant discount rate (MDR). This is a percentage of the transaction value. In a bid to boost cash transactions, the RBI had rationalised the Merchant Discount Rate (MDR) for debit cards. Accordingly, a cap has been introduced for debit card point of sale payments, capped at 0.75% for transaction values up to Rs 2000 and at 1% for transaction values above Rs 2000. However, it continues to be an expense for the merchant, and is often passed on to the customer by increasing the selling price of the product or service. Often, buyers may not even realise that they are being charged extra for the MDR.

Other payment instruments: e-wallets

The first leg of replacing the point of sale was the onslaught of e-wallets such as Paytm and FreeCharge. Although they operate on the same principle as that of scanning a QR code, they are somewhat restrictive because they require both the transferor and the receiver to have the same e-wallet installed on their smartphones. The need was thus felt for a faster and easier money transfer mode, which caused the Bharat QR to come to the fore, thanks to the design and development by NCPI.

Advantages of Bharat QR

The Bharat QR is a step towards financial freedom by means of cashless transactions. It relieves one from the hassle of swiping at the point of sale or of facing detection troubles with one’s plastic money at the point of sale. Because there is no requirement of a physical use of a card, the risk of data theft or security issues through tampered or cyber-compromised point of sale devices is also minimised. Costs are reduced from both the consumer and merchant viewpoints, since the need for expensive point of sale devices and their MDR charges is eliminated. A significant advantage of Bharat QR is its ease of operation; i.e., the buyer and seller need not download the same payment application to make the payment happen, unlike Paytm. This is because the Bharat QR is directly linked to a single bank account. It poses a logistical relief, since businessmen now need not shuffle between different wallets and track their credits and debits – a tedious task. Moreover, the money transfer happens instantly because Bharat QR uses an IMPS service. Bharat QR truly has the potential to create a FinTech revolution.

It is clear that Bharat QR paves a convenient way ahead for paying and receiving funds. It is a great idea to get started on this universal tool. As a merchant, you must register with your banks to get authorised to receive payments through Bharat QR. Link your bank account to the BHIM app and generate your unique Bharat QR Code, take a print of your QR code and stick it onto your payment counter to get started.

Oct 24, 2018

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Why Fintech Lenders are the Best Option to Avail Business Finance

Many start-ups are launched, propelled by a brilliant idea, but often face tough times due to inadequate funds. The first impulse is to turn to banks, which, however, usually refuse requests for a loan for business without security. They also ask for plenty of documents to corroborate the need for the grant and the purpose that it will be used for.

A parallel source of finance for small businesses come in the form of non-banking financial companies (NBFCs). Traditional NBFCs offer loans on terms similar to banks, but they do not hold a banking license. In addition, unlike banks, they cannot accept deposits from public. Other than loans and credit facilities, they can offer retirement planning schemes, money market instruments and underwriting activities.

While small and medium enterprises (SMEs) have been turning to banks and NBFCs to get loans, the long-drawn process from application submission to disbursal of funds is still a deterrent for many. After the financial crisis of 2008, there was an even greater need for reliable sources of business finance. Interestingly, the digital technology that gave rise to online banking and e-commerce was also progressing at a fast pace in the same period. This helped to create a new segment of NBFCs in the form of financial technology, known as FinTech companies.

With the aid of complex analytic tools, FinTech companies evaluate credit risk by using an array of customer data, including their digital footprint on social media, e-commerce platforms, smartphone usage and geo-location.

How are business loans by FinTech lenders more convenient than traditional loans for borrowers?

Conventional NBFCs do not usually have a human-centric approach to lending. The lengthy and cumbersome process of applying for business finance that requires piles of physical documents tires out borrowers. Young entrepreneurs who are eager to expand their operations and are confident about returns on their investment cannot afford to wait for long. Also, delays in work can also harm their long-term business interests. They need an alternative source of funds that can cater to their needs more actively.

What draws the digitally perceptive entrepreneurs to a FinTech company is its ability to offer quick loans at competitive rates of interest. Such companies have a holistic approach towards risk assessment and do not ask for heaps of paper-based documents before they start considering an approval for the loan. The basic files needed to check the creditworthiness of the borrower can be uploaded on the encrypted portals of FinTechs.

The advanced machine learning algorithms that these lending platforms employ read through information such as the net earnings of a business, the educational and professional qualification of its owners, the location from which the business operates and the returns on investment that it drew in the past one year. In comparison to this, a traditional NBFC loan is issued to companies that have been in business for at least 3 to 4 years.

Summarily, the prime reasons for which business borrowers prefer FinTech platforms are:

Simplified application process – Instead of visiting a branch in person, they can apply for the business loans from anywhere and at anytime. As the process is digital, all they need is a reliable Internet connection and the soft copies of minimal documents.

Swift funding – Unlike conventional NBFC loans, the funds from a FinTech corporation do not take long to be approved and disbursed.

No prepayment penalties – To make up for their loss on interest due to early pay-off on the loan, banks as well as most NBFCs charge a percentage of the loan amount as penalty. This is not the case with new-age technology based lending organisations. If a borrower can afford to make complete payment on the loan earlier than its stipulated tenure, there are no extra charges.

No hidden charges – You may on occasions have felt surprised when a bank or NBFC told you that there would be a payment protection “insurance premium” charged on your business loan. In the traditional lending sector, such charges are normal. The lending institutions claim that these help in protecting the monthly loan instalments in case sudden sickness or an accident prevents you from making payments on the loan. FinTech organisations do not include such clauses in their agreements. The funds are granted for business expenses in the short term and are approved based on the ability of the borrower to pay back.

The ability of FinTech firms to trawl the online portals and gather data relevant to the borrower’s paying capacity helps in affording more growth opportunities to start-ups. Many SMEs in India have reasonably strong business models, but they still cannot manage to get funds from banks and traditional NBFCs. This shift towards technology-backed alternatives has been favourable for promising ventures.

At the same time, the conventional lending institutions should also understand that FinTech companies are not a threat to their existence. Both these sectors can collaborate with each other in areas such as customer acquisition, product innovation, analytics, sales enablement and cyber security.

The access to innovation through digital peer-to-peer lenders allows NBFCs and banks to create competitive advantages for their own business.

Customer-centric innovation triggered by FinTechs is here to stay. The possibility of getting a loan for business without security or collateral is real. Open architecture-based wealth management tools, Big Data and online financial advice will continue to help entrepreneurs.

As a digital-age lender in this domain, Capital Float uses proprietary algorithms to inspect large amounts of data and evaluate a potential business borrower’s creditworthiness. We offer timely business finance without collateral to SMEs, start-ups, and freelancers to help them bear the expenses that are crucial for their stability and growth in the business world. Our process of judging the payment capacity of businesses is automated, fast and flexible, while also being diligent. If you need loans in less than a week and do not have a very long history in your industry, do not let any refusal from traditional NBFCs discourage you. Visit www.capitalfloat.com to find the business loan best suitable to you.

Oct 24, 2018