Month: June 2020

The database is an organized collection of structured data to make it easily accessible, manageable and update. In simple words, you can say, a database in a place where the data is stored. The best analogy is the library. The library contains a huge collection of books of different genres, here the library is database and books are the data.

In layman terms, consider your school registry. All the details of the students are entered in a single file. You get the details regarding the students in this file. This is called a Database where you can access the information of any student.

Facts about Database:

• Databases have evolved dramatically since their inception in the early 1960s.
• Some Navigational databases such as the Hierarchical database and the Network database were the original systems used to store and manipulate data. Although these early systems were actually inflexible
• In the early 1980s, Relational databases became very popular, which was followed by object-oriented databases later on.
• More recently, NoSQL databases came up as a response to the growth of the internet and the need for faster speed and processing of unstructured data.
• Today, we have cloud databases and self-driving databases that are creating a new ground when it comes to how data is collected, stored, managed, and utilized.

Database Components

The major components of the Database are:

1. Hardware

This consists of a set of physical electronic devices such as I/O devices, storage devices and many more. It also provides an interface between computers and real-world systems.

2. Software

This is the set of programs that are used to control and manage the overall Database. It also includes the DBMS software itself. The Operating System, the network software being used to share the data among the users, the application programs used to access data in the DBMS.

3. Data

Database Management System collects, stores, processes, and accesses data. The Database holds both the actual or operational data and the metadata.

4. Procedure

These are the rules and instructions on how to use the Database in order to design and run the DBMS, to guide the users that operate and manage it.

5. Database Access Language

It is used to access the data to and from the database. In order to enter new data, updating, or retrieving requires data from databases. You can write a set of appropriate commands in the database access language, submit these to the DBMS, which then processes the data and generates it, displays a set of results into a user-readable form.

Advantage of database

• Reduced data redundancy.
• Also, there is reduced updating errors and increased consistency.
• Easier data integrity from application programs.
• Improved data access to users through the use of host and query languages.
• Data security is also improved.
• Reduced data entry, storage, and retrieval costs.

Disadvantage of database

• Complexity: Databases are complex hardware and software systems.
• Cost: It requires significant upfront and ongoing financial resources.
• Security: Most leading companies need to know that their Database systems can securely store data, including sensitive employee and customer information.
• Compatibility: There is a risk that a DBMS might not be compatible with a company’s operational requirements.

Types of Database

There are a few types that are very important and popular.

• Relational Database
• Object-Oriented Database
• Distributed Database
• NoSQL Database
• Graph Database
• Cloud Database
• Centralization Database
• Operational Database

Data management is a very lexically challenged discipline. A major part of that lexical challenge is the terms data, information, and knowledge. These three terms are often misused, abused, and used interchangeably to the point that their real meaning is often unclear. These three terms must be formally defined and consistently used to begin resolving the lexical challenge and creating a formal data management profession.

Data

Data are the individual facts that are out of context, have no meaning, and are difficult to understand. They are often referred to as raw data. The term data is plural, equivalent to facts, while datum is singular, equivalent to a fact. Although some people continue to use the term data as singular, a comprehensive, denotative definition of data in the singular form, beginning with Data is not available. Most definitions of data in the singular are really definitions of a data resource.

Data could be considered an irregular noun, like deer or sheep, where the meaning is in the context. Data could be used to represent an individual fact the same as datum, and data could be used to represent a set of facts. However, the data management discipline has enough lexical challenge without treating data as an irregular noun. Therefore, datum is singular and data is plural.

Data in context are individual facts that have meaning and can be readily understood. They are the raw facts wrapped with meaning, but they are not yet information. Datum in context is a single fact wrapped with meaning.

Information

Information is a set of data in context with relevance to one or more people at a point in time or for a period of time. Information is more than data in context it must have relevance and a time frame. Information is considered to be singular.

Knowledge

Knowledge is cognizance, cognition, the fact or condition of knowing something with familiarity gained through experience or association. It’s the acquaintance with or the understanding of something, the fact or condition of being aware of something, or apprehending truth or fact. Knowledge is information that has been retained with an understanding about the significance of that information. Knowledge includes something gained by experience, study, familiarity, association, awareness, and/or comprehension.

Knowledge can be either tacit or explicit. Tacit knowledge, also known as implicit knowledge, is the knowledge that a person retains in their mind. It’s relatively hard to transfer to others and to disseminate widely.  Explicit knowledge, also known as formal knowledge, is knowledge that has been codified and stored in various media, such as books, magazines, tapes, presentations, and so on, and is held for mankind, such as in a reference library or on the web. It is readily transferable to other media and capable of being readily disseminated.

Organizational knowledge is information that is of significance to the organization, is combined with experience and understanding, and is retained by the organization. It’s information in context with respect to understanding what is relevant and significant to a business issue or business topic what is meaningful to the business. It’s analysis, reflection, and synthesis about what information means to the business and how that information can be used. It’s a rational interpretation of information that leads to business intelligence.

Knowledge management is the management of an environment where people generate tacit knowledge, render it into explicit knowledge, and feed it back to the organization. The cycle forms a base for more tacit knowledge, which keeps the cycle going in an intelligent learning organization. It’s an emerging set of policies, organizational structures, procedures, applications, and technology aimed toward increased innovation and improved decisions. It’s an integrated approach to identifying, sharing, and evaluating the organization’s information. It’s a culture for learning where people are encouraged to share information and best practices to solve business problems.

Some people have misperceptions of information. One misperception is that information is the same as data in context. Whenever raw data are wrapped with meaning, those data become information. However, if information is considered to be data in context, then the question becomes what are the terms for information that is relevant and timely and information that is not relevant and timely?

The answer might lead to relevant information and non-relevant information. However, only relevant information leads to knowledge and non-relevant information does not lead to knowledge.  Therefore, raw data are wrapped with meaning to become data in context, which can become either relevant or non-relevant information. Only relevant information can become knowledge.

Another misperception is that information is any summary data or derived data. That misperception is not valid because whether data are primitive or derived, they are still data.  They have not yet become relevant or timely and, therefore, are not yet information.

If data in context are not relevant or timely, then they are not information. However, data may not be relevant or timely to one person, but could be relevant and timely to another person. Therefore, the definition of information can be expanded.  Specific information is a set of data in context that is relevant and timely to one or more people at a point in time or for a period of time. General information is a set of data in context that could be relevant to one or more people at a point in time or for a period of time.

Now that these terms are defined, the data-information-knowledge cycle can be defined. The data-information-knowledge cycle is the cycle from data, to data in context, to relevant information (specific or general), to knowledge, and back to data when that information or knowledge is stored, as shown in the diagram below.

Many people want to belabor the issue, but when information and knowledge are stored, they become part of the organization’s data resource and are managed according to formal data resource management concepts, principles, and techniques. Whether those data were once raw data, specific or general information, or knowledge makes no difference. Everything stored is part of the organization’s data resource, is considered data, and is formally managed as data.

When specific information and general information are stored, they become part of the data resource, they are treated as data, and are managed like any other data. Those data will only become information again when they become relevant and timely. The same is true for knowledge.  Stored knowledge becomes data and is managed like any other data. Those data will only become knowledge again when they are extracted as information, combined with experience, and retained.

A book on the shelf, a document on a server, raw data, a stored form or document, a stored report, and so on, are all considered data and managed as part of the organization’s data resource.  The storage of information or knowledge is still data to other people, and may or may not become information or knowledge to those people.

Looking at the situation the other way around, all information and knowledge were data at one time, whether or not they were stored in the organization’s data resource. By becoming relevant and timely, those data became information. By being combined with business experience and retained, that information becomes knowledge.

Based on these definitions, there is no information resource, because timeliness and relevancy cannot be managed or stored. There can be information resources (plural) which is the set of resources used to produce information from data and present that information to the business.  Knowledge resource is the tacit and implicit knowledge within an organization or available to the organization, and most of that knowledge is stored in the human resource.

Information overload is a misused term that is part of the lexical challenge because it is unclear. Information assimilation overload occurs when information is coming too fast for a person to absorb and understand. A certain amount of time is needed for information to be assimilated, and the delivery needs to match that assimilation rate.

Disparate information is any information that is disparate with respect to the recipient. It could result from information acquired from different sources that are organized differently, or it could result from information created from disparate data that provide conflicting information, or it could be conflicting information.

Information paranoia is the fear of not knowing everything that is relevant or could be relevant at some point in time. It’s a situation where a person is obsessed with gaining information for information’s sake.

Non-information is a set of data in context that is not relevant or timely to the recipient. Data overload is a deluge of data or data in context coming at a recipient, but is not relevant and timely. It’s a deluge of non-information that is not wanted by the recipient.

Data management professionals must establish proper terms that are comprehensively and denotatively defined, and must use them properly. The development and proper use of basic terms is one step toward resolving the lexical challenge in data resource management and creating a formal data management profession.

Capital gearing ratio is a useful tool to analyze the capital structure of a company and is computed by dividing the common stockholders’ equity by fixed interest or dividend bearing funds.

Analyzing capital structure means measuring the relationship between the funds provided by common stockholders and the funds provided by those who receive a periodic interest or dividend at a fixed rate.

A company is said to be low geared if the larger portion of the capital is composed of common stockholders’ equity. On the other hand, the company is said to be highly geared if the larger portion of the capital is composed of fixed interest/dividend bearing funds.

formula:

Capital gearing ratio = (Common Stockholder^’ s equity)/(Fixed cost cost bearing funds)

In the above formula, the numerator consists of common stockholders’ equity that is equal to total stockholders’ equity less preferred stock and the denominator consists of fixed interest or dividend bearing funds that usually include long term loans, bonds, debentures and preferred stock etc.

Gearing (%) = (longterm Liabilities)/(Capital employed)

Notes:

Long-term liabilities include loans due more than one year + preference shares + mortgages

Capital employed = Share capital + retained earnings + long-term liabilities

How can the gearing ratio be evaluated?

• A business with a gearing ratio of more than 50% is traditionally said to be “highly geared”.
• A business with gearing of less than 25% is traditionally described as having “low gearing”
• Something between 25% – 50% would be considered normal for a well-established business which is happy to finance its activities using debt.

It is important to remember that financing a business through long-term debt is not necessarily a bad thing! Long-term debt is normally cheap, and it reduces the amount that shareholders have to invest in the business.

What is a sensible level of gearing? Much depends on the ability of the business to grow profits and generate positive cash flow to service the debt. A mature business which produces strong and reliable cash flows can handle a much higher level of gearing than a business where the cash flows are unpredictable and uncertain.

Another important point to remember is that the long-term capital structure of the business is very much in the control of the shareholders and management. Steps can be taken to change or manage the level of gearing for example:

Accounts payable turnover ratio (also known as creditors turnover ratio or creditors’ velocity) is computed by dividing the net credit purchases by average accounts payable. It measures the number of times, on average, the accounts payable are paid during a period.  Like receivables turnover ratio, it is expressed in times.

Formula:

Accounts payable turnover Ratio = Net credit purchases / Average accounts payable

In above formula, numerator includes only credit purchases. But if credit purchases are not known, the total net purchases should be used.

Average accounts payable are computed by adding opening and closing balances of accounts payable (including notes payable) and dividing by two. If opening balance of accounts payable is not given, the closing balance (including notes payable) should be used.

Analysis

Since the accounts payable turnover ratio indicates how quickly a company pays off its vendors, it is used by supplies and creditors to help decide whether or not to grant credit to a business. As with most liquidity ratios, a higher ratio is almost always more favorable than a lower ratio.

A higher ratio shows suppliers and creditors that the company pays its bills frequently and regularly. It also implies that new vendors will get paid back quickly. A high turnover ratio can be used to negotiate favorable credit terms in the future.

Interpretation of Accounts Payable Turnover Ratio

The accounts payable turnover ratio indicates to creditors the short-term liquidity and, to that extent, the creditworthiness of the company. A high ratio indicates prompt payment is being made to suppliers for purchases on credit. A high number may be due to suppliers demanding quick payments, or it may indicate that the company is seeking to take advantage of early payment discounts or actively working to improve its credit rating.

A low ratio indicates slow payment to suppliers for purchases on credit. This may be due to favorable credit terms, or it may signal cash flow problems and hence, a worsening financial condition. While a decreasing ratio could indicate a company in financial distress, that may not necessarily be the case. It might be that the company has successfully managed to negotiate better payment terms which allow it to make payments less frequently, without any penalty.

The accounts payable turnover ratio depends on the credit terms set by suppliers. For example, companies that enjoy favorable credit terms usually report a relatively lower ratio. Large companies with bargaining power are able to secure better credit terms, resulting in a lower accounts payable turnover ratio (source).

Although a high accounts payable turnover ratio is generally desirable to creditors as signaling creditworthiness, companies should usually take advantage of the credit terms extended by suppliers, as doing so will help the company maintain a comfortable cash flow position.

As with most financial metrics, a company’s turnover ratio is best examined relative to similar companies in its industry. For example, a company’s payables turnover ratio of two will be more concerning if virtually all of its competitors have a ratio of at least four.

The current ratio, also known as the working capital ratio, measures the capability of a business to meet its short-term obligations that are due within a year. The ratio considers the weight of total current assets versus total current liabilities. It indicates the financial health of a company and how it can maximize the liquidity of its current assets to settle debt and payables.  The Current Ratio formula (below) can be used to easily measure a company’s liquidity.

Current Ratio = Current Assets / Current Liabilities

What are Current Assets?

Current assets are resources that can quickly be converted into cash within a year’s time or less. They include the following:

• Cash: Legal tender bills, coins, undeposited checks from customers, checking and savings accounts, petty cash
• Cash equivalents: Corporate or government securities with 90 days or less maturity
• Marketable securities: Common stock, preferred stock, government and corporate bonds with a maturity date of 1 year or less
• Accounts receivable: Money owed to the company by customers and that is due within a year. This net value should be after deducting an allowance for doubtful accounts (bad credit)
• Notes receivable: Debt that is maturing within a year
• Other receivables: Insurance claims, employee cash advances, income tax refunds
• Inventory: Raw materials, work-in-process, finished goods, manufacturing/packaging supplies
• Office supplies: Office resources such as paper, pens, and equipment expected to be consumed within a year
• Prepaid expenses: Unexpired insurance premiums, advance payments on future purchases

 What are Current Liabilities?

Current liabilities are business obligations owed to suppliers and creditors, and other payments that are due within a year’s time. This includes:

• Notes payable: Interest and the principal portion of loans that will become due within one year
• Accounts payable or Trade payable: Credit resulting from the purchase of merchandise, raw materials, supplies, or usage of services and utilities
• Accrued expenses: Payroll taxes payable, income taxes payable, interest payable, and anything else that has been accrued for but an invoice is not received
• Deferred revenue: Revenue that the company has been paid for that will be earned in the future when the company satisfies revenue recognition requirements

 Why Use the Current Ratio Formula?

This current ratio is classed with several other financial metrics known as liquidity ratios. These ratios all assess the operations of a company in terms of how financially solid the company is in relation to its outstanding debt. Knowing the current ratio is vital in decision-making for investors, creditors, and suppliers of a company. The current ratio is an important tool in assessing the viability of their business interest.

The Debt Service Coverage Ratio (DSCR) measures the ability of a company to use its operating income to repay all its debt obligations, including repayment of principal and interest on both short-term and long-term debt. This ratio is often used when a company has any borrowings on its balance sheet such as bonds, loans, or lines of credit. It is also a commonly used ratio in a leveraged buyout transaction, to evaluate the debt capacity of the target company, along with other credit metrics such as total debt/EBITDA multiple, net debt/EBITDA multiple, interest coverage ratio, and fixed charge coverage ratio.

Debt Service coverage Ratio = EBITDA / (interest + Principle)

Debt Service coverage Ratio = (EBITDA-Capex) / (interest + Principle)

Where:

• EBITDA = Earnings Before Interest, Tax, Depreciation, and Amortization
• Principal = the total loan amount of short-term and long-term borrowings
• Interest = the interest payable on any borrowings
• Capex = Capital Expenditure

 Some companies might prefer to use the latter formula because capital expenditure is not expensed on the income statement but rather considered as an “investment”. Excluding CAPEX from EBITDA will give the company the actual amount of operating income available for debt repayment.

Interpretation of the Debt Service Coverage Ratio

A debt service coverage ratio of 1 or above indicates that a company is generating sufficient operating income to cover its annual debt and interest payments. As a general rule of thumb, an ideal ratio is 2 or higher. A ratio that high suggests that the company is capable of taking on more debt.

A ratio of less than 1 is not optimal because it reflects the company’s inability to service its current debt obligations with operating income alone. For example, a DSCR of 0.8 indicates that there is only enough operating income to cover 80% of the company’s debt payments.

Rather than just looking at an isolated number, it is better to consider a company’s debt service coverage ratio relative to the ratio of other companies in the same sector. If a company has a significantly higher DSCR than most of its competitors, that indicates superior debt management. A financial analyst may also want to look at a company’s ratio over time to see whether it is trending upward (improving) or downward (getting worse).

The Debtors Turnover Ratio also called as Receivables Turnover Ratio shows how quickly the credit sales are converted into the cash. This ratio measures the efficiency of a firm in managing and collecting the credit issued to the customers.

One important thing that needs to be taken care of is, generally the companies use total sales in the place of net sales, which gives an inflated turnover ratio. Thus, while calculating this ratio, only the net credit sales is to be taken into consideration.

Ideally, a company compares its debtors turnover ratio with the companies that have similar business operations and revenue and lie within the same industry The formula to compute Debtors Turnover Ratio is:

Debtors Turnover Ratio = Net Credit Sales/Average Account Receivable.

Where, Average Account Receivable includes trade debtors and bill receivables.

Higher the Debtors turnover ratio, better is the credit management of the firm.

Example: Suppose a firm has total sales of Rs 5,00,00 out of which the credit sales are Rs 2,50,000. The opening balance of account receivables is Rs 2,00,000 and the closing balance at the end of financial year is Rs 1,00,000. The debtors turnover ratio will be:

Debtors Turnover Ratio = 2,50,000/1,50,000 = 1.67 times

Credit sales = 2,50,000
Average Account Receivables = (2,00,000+1,00,000) /2 = 1,50,000

Interpretation of Accounts Receivable Turnover Ratio

The accounts receivable turnover ratio is an efficiency ratio and is an indicator of a company’s financial and operational performance. A high ratio is desirable, as it indicates that the company’s collection of accounts receivable is efficient. A high accounts receivable turnover also indicates that the company enjoys a high-quality customer base that is able to pay their debts quickly. Also, a high ratio can suggest that the company follows a conservative credit policy such as net-20-days or even a net-10-days policy.

On the other hand, a low accounts receivable turnover ratio suggests that the company’s collection process is poor. This can be due to the company extending credit terms to non-creditworthy customers who experience financial difficulties.

Additionally, a low ratio can indicate that the company is extending its credit policy for too long. This can sometimes be seen in earnings management where managers offer a very long credit policy to generate additional sales. Due to the time value of money principle, the longer a company takes to collect on its credit sales, the more money a company effectively loses, or the less valuable the company’s sales. Therefore, a low or declining accounts receivable turnover ratio is considered detrimental to a company.

It’s useful to compare a company’s ratio to that of its competitors or similar companies within its industry. Looking at a company’s ratio, relative to that of similar firms, will provide a more meaningful analysis of the company’s performance rather than just an abstract calculation. For example, a company with a ratio of four, not inherently a “high” number, will appear to be performing considerably better if the average ratio for its industry is two.

The Dividend Payout Ratio (DPR) is the amount of dividends paid to shareholders in relation to the total amount of net income the company generates. In other words, the dividend payout ratio measures the percentage of net income that is distributed to shareholders in the form of dividends.

Dividend payout Ratio = Dividends (or Dividends per Share) / Net income (income per Share)

Dividend Payout Ratio Formula

There are several formulas for calculating DPR:

1. DPR = Total dividends / Net income
2. DPR = 1 – Retention ratio (the retention ratio, which measures the percentage of net income that is kept by the company as retained earnings, is the opposite, or inverse, of the dividend payout ratio)
3. DPR = Dividends per share / Earnings per share

Interpretation of Dividend Payout Ratio

The dividend payout ratio helps investors determine which companies align best with their investment goals. When shareholders invest in a company, return on their investment comes from two sources: dividends and capital gains. The two sources of return are related as follows:

• A high DPR means that the company is reinvesting less money back into its business, while paying out relatively more of its earnings in the form of dividends. Such companies tend to attract income investors who prefer the assurance of a steady stream of income to a high potential for growth in share price.
• A low DPR means that the company is reinvesting more money back into expanding its business. By virtue of investing in business growth, the company will likely be able to generate higher levels of capital gains for investors in the future. Therefore, these types of companies tend to attract growth investors who are more interested in potential profits from a significant rise in share price, and less interested in dividend income.

The dividend payout ratio is not intended to assess whether a company is a “good” or “bad” investment. Rather, it is used to help investors identify what type of returns dividend income vs. capital gains – a company is more likely to offer the investor. Looking at a company’s historical DPR helps investors determine whether or not the company’s likely investment returns are a good match for the investor’s portfolio, risk tolerance, and investment goals. For example, looking at dividend payout ratios can help growth investors or value investors identify companies that may be a good fit for their overall investment strategy.

The DPR can also be used to gauge a company’s level of maturity, as follows:

• Younger, more rapidly growing companies are more likely to report a low DPR as they reinvest most of their earnings into the business for expansion and future growth.
• More mature, established companies, with a steadier but probably slower growth rate, are more likely to have a relatively high DPR as they do not feel the need to commit a high percentage of their earnings to business expansion. Blue chip stocks, such as Coca-Cola or General Motors, often have relatively higher dividend payout ratios.

Keep in mind that average DPRs may vary greatly from one industry to another. Many high-tech industries tend to distribute little to no returns in the form of dividends, while companies in the utility industry generally distribute a large portion of their earnings as dividends. Real estate investment trusts (REITs) are required by law to pay out a very high percentage of their earnings as dividends to investors.

Expense ratio (expense to sales ratio) is computed to show the relationship between an individual expense or group of expenses and sales. It is computed by dividing a particular expense or group of expenses by net sales.  Expense ratio is expressed in percentage.

Formula:

Expenses Ratio ( Particular expenses / Net Sales ) * 100

The numerator may be an individual expense or a group of expenses such as administrative expenses, sales expenses or cost of goods sold.

Significance and Interpretation:

Expense ratio shows what percentage of sales is an individual expense or a group of expenses. A lower ratio means more profitability and a higher ratio means less profitability.

Analyst must be careful while interpreting expense to sales ratio. Some expenses vary with the change in sales (i.e variable expenses). The ratio for such expenses normally does not change significantly as the sales volume increases or decreases. For fixed expenses (rent of building, fixed salaries etc.), the ratio changes significantly as the sales volume changes. The ratio is helpful in controlling and estimating future expenses.

In Mutual fund Industry

Annual Fund Operating Expenses, mostly known as the expense ratio, is the percentage of assets payable to the fund manager (i.e. AMC).

The asset manager, with the help of a team of analysts and other experts, allocate, manage (including the auditor and advisor fees) and advertise the fund to maximise returns and manage risks.

If the funds’ assets are small, then the expense ratio can be high. This is because the fund has to meet its expenses from a restricted or a smaller asset base.

Similarly, if the net assets of the fund are significant, then the expense percentage should ideally come down.
On 18 September 2018, SEBI brought about significant modifications by reducing TER of the mutual funds and changing the method of providing a commission to the distributors. Read more about it here

What are the Components of Expense Ratio?

The expense ratio includes numerous charges for smoothly running the mutual fund scheme. They recover this cost from the mutual fund investors on a day-to-day basis.
However, they disclose it to the investors once in every six months. Also, this will have a substantial impact on your take-home returns.
There are three major types of expenses as part of the expense ratio.

There are three major types of expenses as a part of the Expense Ratio. 

a. Management Fees

Mutual funds require the formulation of investment strategies before actually investing money in the underlying assets. Fund managers need to possess a high level of educational, relevant fund management experience, and professional credentials.

The management fee or investment advisory fee is compensation for these managers’ expertise. On average, this annual fee is about 0.50% to 1% of the funds’ assets.

b. Administrative Costs

The administrative costs are the expenses of running the fund. This would include keeping records, customer support, and service, information emails, and communications. They can vary greatly and are expressed as a percentage of fund assets.

c. 12-1b Distribution Fees

Many mutual funds collect the 12-1b distribution fee for advertising and promotional purposes. Usually, they charge their shareholders to market and promote the fund to the investors. These three fees combined are equal to the percentage of assets deducted from the fund.

Expense Ratio Limit By SEBI

All expenses of an AMC must be managed within limits specified under Regulation 52 of SEBI Mutual Fund Regulations. As per these regulations, the total expense ratio (TER) allowed is 2.5% for the first Rs.100 crore of average weekly total net assets, 2.25% for the next Rs.300 crore, 2% for the next Rs.300 crore and 1.75% for the rest of the AUM.
The limit for debt fund is 2.25%. On top of this, the Securities and Exchange Board of India allows all the mutual funds to charge 30 basis points more as an incentive to penetrate in smaller towns (B15 Cities). These cities also enjoy an additional 20 basis points as exit load charges.

How does Expense Ratio impact Fund Returns?

Expense ratios indicate how much the fund charges in terms of percentage annually to manage your investment portfolio. If you invest Rs.20,000 in a fund which has an expense ratio of 2%, then it means that you need to pay Rs.400 to the fund house to manage your money.

In simple words, if a fund earns returns equal to 15% and has TER of 2%, then you will make a return equal to 13%. The Net Asset Value (NAV) of a fund is reported after deducting all fees and expenses. Hence, it becomes essential to know how much are you paying to the fund house.

Expense Ratio Implications

Expense ratio indicates the percentage of sales to the total of individual expense or a group of costs. A lower rate means more profitability and a higher rate means lesser profitability. It becomes critical for schemes with comparatively more moderate yields.

Apart from that, you may use expense ratio to differentiate between actively managed and passively managed funds. In case of actively managed equity funds, the alpha generated by the fund manager is a compelling justification for the fee they charge. If you find a wide divergence between the returns of your fund and index funds, then you may think of making a switch.