There are many financial calculators available on the web. But, understanding a few basic financial calculators will help you manage your finances better.
Managing personal finance not only involves choosing the right investment vehicle as per an individual’s financial needs but also as an awareness about the common financial calculations. It is thus important to understand a few basic formulae given below.
1. Compound Interest
Many financial instruments offer a compounded interest scenario, which means they offer interest on your principal amount as well as on the accumulated interest. This means the longer your stay invested the greater is the final return thanks to the power of compounding. If Principal = P, Rate = R% per annum, Time = n years then the formula for compound interest compounded annually will be: Amount = P(1+r%/n)^nt – P
For example, if you invest Rs. 10,000 for 5 years at an interest rate of 10 percent and it is annually compounded, then the total amount after 5 years using the formula will equal to 10,000 (1+ 0.1) ^5 = 16,105. The interest earned would be Amount – Principal, which in this example would be 6,105.
2. Post Tax Return
Investments are made keeping returns in mind, but an essential component that often gets overlooked is the taxation. For example, people invest in Fixed Deposits looking at the rate of interest but the post-tax returns are subsequently lower depending on their tax bracket. The formula for calculation of post-tax return is interest rate – (interest rate*tax rate).
So, if an instrument offers 9% return and you are in the highest tax bracket of 30% your post tax returns would be 9-(9*30%) = 7.3%
If there is one factor that must be taken into account for all investments, it is inflation. Inflation measures the overall increase of the price of goods and services taking into account both wholesale price index and consumer price index. This means Rs. 5000 will not have the same purchasing value in 10 years. The formula to know the future equivalent value of any amount today is calculated as present amount * (1+inflation rate) ^ number of years. So, for Rs. 5,000 today at 5% inflation would be equal to 5000 * (1+5%) ^10 = Rs. 8144.
4. Purchasing Power
Inflation can also be used to determine the purchasing power of your money in the future. So, assuming 5% inflation, Rs. 10,000 today will be able to offer a purchasing power of 10,000 / (1+5%) ^10 = Rs. 6,139.
5. Compounded Annual Growth Rate (CAGR)
If you are confused between two investment options, CAGR can help you compare returns over a similar period of investment. Compounded Annual Growth Rate or CAGR can also be used for comparison of two entirely different asset classes. CAGR can be calculated using the formula ((FV/PV)^(1/n)) – 1 where FV is the maturity value, PV is the investing value and n being the number of years for investment.
6. Cost Inflation Index (CII)
If you have been investing in any capital assets, the cost of inflation index of CII will play a major role in your personal financial tax calculations. Cost of inflation index of CII is an index that measures the inflation rise and uses it as a tool to calculate long term capital gains tax for sale of any capital assets. The finance ministry releases CII for each financial year with the financial year 1981-82 as the base year with a cost inflation index of 100. CII is used in calculations of long term capital gains as follows.
Long term capital gains tax is calculated as Cost of sale or sale price – (indexed cost of acquisition – any indexed cost of improvement or maintenance). Where Indexed purchase price = Purchase price X (CII for year of sale/CII for year of purchase)
7. Loan EMI
Almost every one of us has borrowed some kind of loan and pay regular EMIs for the same. Calculation of Loan EMIs is usually left on the bank, NBFC or financial calculators. Loan EMI can easily be cross checked using the formula EMI= (A*R)*(1+R) ^N/ ((1+R) ^N)-1) where A is the loan amount, R is the interest rate and N is the duration of the loan.
Knowing these common financial calculations can ensure an easier selection of investments for a better financial future.