How to convert Trading income into a small business

[Shankar_M]

rather than lookig at it as starting a business to make loss so that you dont have to pay tax on trading income. think of it as using trading income to boost profits on a manufacturing business, where profit margins are paper thin.

also know that the machines were not bought with cash, so there is no question of opportunity cost. the machines were bought by pledging land.

so heres how the game is played:

you got land? pledge it for something capital intensive (doesnt mean you go buy a bentley) I mean something that generates cash flow… maybe in the maufacturing sector preferably (because I know ONLY this)… CNC machine, laser cutting machine, water jet cutting machine, plastic injection moulding machine, aluminium pressure die casting machine via a loan. look out for subsidies/PLI schemes (the one i went for was Tamil Nadu government’s NEEDS scheme for 1st gen entrepreneurs = 25% subsidy… i.e you can buy machines for 1Cr, but loan principal is only 75L). one more is the CGTMSE scheme where MSME’s can borrow upto 5Cr, collateral free!!!

now it’ll take 2 years to get the business to stand on its own 2 feet, in my case I had to support the business with 30L in the first 2 years, i.e. promoter’s capital…

manufacturing business are not known for the profits they generate, but are known for the tremendrous cash flows. in my case i was rotating 10-12 L every month + had access to around 30L (20% of turnover) as overdraft facility. i use my overdraft facility only on wednesday, thursday and friday (i trade ONLY NIFTY)… so every thursday i have the ability to deploy 30L which is not my cash (it is dangerous I know, but my loss will not be the burden of my lenders/creditors, if i take a big hit, i can still pay off people, thus my increased risk appetite)

[Shankar_M]

yes you cant be doing it if it is a pvt ltd company. but mine is a sole proprietorship. also you are right there are clauses in the T&C of some loans that you cant be using the loan for speculative stuff. but i saw no such thing in cash credit facility or over draft facility with bajaj finance flexi hybrid loan and ICICI overdraft account. so leagally i am in the clear (i think).

you see the spikey spikey pattern in my account value curve? it is beacsue of what i explained earlier… i get money into my zerodha account on wednesday… i take positions (WITH UPSIDE RISK ONLY) i.e. CE options contracts trading at Rs. 1-2…without hedge (i never take overnight downside risk NO MATTER HOW BULLISH THINGS SEEM)

on thursday’s i go all-in with company funds+personal funds+overdraft funds for intra-day…(i do ONLY far far far OTM options, i dont aim for anything beyond 0.2-0.5% on capital deployed).

after i am done on thursday, i place a withdrawal request and receive back the funds on friday and refill my overdraft account… so i pay interest ONLY for those 3 days.
overdraft interst @ 18% (plus the 1% annual maintenace cahrge) comes out to approx Rs. 55 per lakh rupees per day… so for any given expiry (include Rs. 9 + GST transaction charges on zerodha)…for 3 days i spend around Rs. 200 per lakh…

so assume 30 lakh on any given expiry… 10L my funds + 10L company running capital (both interest free) + 10L overdraft funds (Rs. 2000 cost of capital)…

BECAUSE i do this, it gives me an edge over my competitors. I dont need to make a profit in my manufacturing business. I under quote my competitors, to a point where I can just barely cover my fixed & variable expenses of running the business, i can pay my employees well above market rate (my shop floor employees - semi skilled- guys have a high turn around rate… i.e. they stay anywhere between 6 months to 2 years; but my core team has been with me for 7 years now).

I focus on generating larger and larger revenue (not profit), by Q4 FY 2024-25 i plan on doubling my current asset value by buying 2 more new machines valued at 1 Cr each (using the CGTMSE scheme, and removing my pledged assets completely outta the equation)… which will again repeat the cycle of depreciation and i expect it to more than double my turnover…

all this was done using a piece of land that we weren’t using and 30L initial investment in 2018 (yeah the pandemic was tough, if it wasnt for that, i would’ve already been sitting on 4Cr. worth of machinery). the business now has a book value of 1.2Cr… that is a 4x appreciation of my initail investment in 5 years… in my world, that is good enough…

i am 37 now, and hopefully by age 40 i’ll have a business generating good cash flow, with zero exposure of assets (no pledging family assets any more) and all invested amount (30L adjusted for inflation) recovered.

[Chetan_Nahata]

@Shankar_M Okay i understand your POV now

@Shankar_M

but mine is a sole proprietorship

@Jason_Castelino as a sole proprietorship there isn’t any tax benefit, right? Since the income of the proprietor and the firm is clubbed anyway…
and further wouldn’t this guy be violating any RBI/SEBI guidelines or norms? I’m not sure

@Shankar_M

10L company running capital

@Shankar_M I assume when u say “company” u mean your proprietorship right?

@Shankar_M

i am 37 now, and hopefully by age 40 I’ll have a business generating good cash flow, with zero exposure of assets (no pledging family assets any more) and all invested amount (30L adjusted for inflation) recovered.

That sounds good.
Further Hats off to u @Shankar_M to already having a full-on business and yet getting into trading the stress/time management and people management and after all this being able to give your family some time…
Guess I have a bunch of thing to take on note from u

[Shankar_M]

Yeah, ‘company cash’ is other people’s money, salary, bank due, creditor & sub contractor payments. things kinda fell into a this payment cycle where my customers pay me 60 days after delivery of goods, but I pay my creditors & sub contractors after 90 days (not a day early, not a day late) so I have their money for a full month…

The main purpose of the business is:

1. ability to mobilize large capital - it is very feasible to skim 0.2-0.3% on every Nifty expiry and do it consistently. we are talking collecting a combined premium of Rs. 3-4 for a pair of CE & PE strangle. Add Rs. 0.2-0.3 hedges for the margin benefit & do a little adjustment by moving 100-200 stikes depending on the afternoon move, yet always staying 300-400 points away from the spot and exiting at the first sign of trouble. 0.2-0.3% is peanuts, and doesnt justify you using your own money (the opportunity cost alone would make the risk you take meaningless). But when you have large sums of interest free money that belongs to other people for a short duration, it is worth it imo. of course, being a sole proprietorship, I am absolutely responsible for that money and in case i am not able to service my creditors/lenders the law has provisions to seize all my assets (not just the pledged ones)
2. The benefit of having depreciating assets (that give you notional loss on paper) but still generates revenue. which in turn provides access to large capital (either interest free or low cost of capital), creating a virtuous cycle of more depreciating assets & more access to capital.

I appreciate your compliment, but this is not a novel idea. generally old school entrepreneurs use something called “chits”… yes those same “chit funds” to rotate their spare capital. I am not very familiar with how it works (although many people have tried to explain it to me), i just know the system runs on a lot of “trust”. I’d rather take my chances with the markets.

All this was a result of desperation to survive the pandemic + Karthik Rangappa’s work on Varsity, I am forever indebted to that dude!

@Chetan_Nahata i would really appreciate it if you can discuss this in your circle and let me know if I am breaking the law in anyway. I wouldnt knowingly break the rules to make a few bucks, i did what i did because i didnt know what else to do… never engaged in unaccounted cash either, although there is plenty of opportunity to do so and is generally the norm in these kind of businesses.

[viswaram]

@Shankar_M

so now i have a profit of 10L from the business, and a 20L profit from trading. I pay 0 income tax.

Your income from your primary source is half of that of trading income. Ever thought about what will happen if all the other people in the manufacturing sector take up trading?

[Shankar_M]

that was just an example. in the p&l page of the IT filling, you can see total profits is around 24L out of which 12L was trading profits. so you could say that my machine shop was 2x more profitable (for that year FY 2022-23). competitors have similar machines, lenders give us loans @ the roughly the same interest rate, half of coimbatore runs the same valve components i do, with rates fixed by the customer, one has to figure out a way to get ahead of the pack, no?

but this year on, i intend to lower the profit from the machine shop much more. when me and my team talk about this stuff (i share the finances of the company with everyone who works there, including how profitable each month of trading was and how much i take home as drawings) we agreed that the game plan for FY 2024-25 was to go agressive with getting new customers (marketing) even though our capacity wouldnt allow it. all in the pursuit of increasing revenue. JUST BRING IN THE ORDERS. keep the most profitable components in-house and sub-contract everything else (at almost the same rate of machining my customer gives me, I literally show my ‘Purchase Order’ [PO] to the sub-contractor and tell him I am giving you the same rate as what the customer has given me) . negotiate for 60 day payments for us (from our customers) but 90 day payments for the sub-contractors (from us). giving us 30 days of intrest free funds

I just tell my team, to bring in the orders and excute them on-time without compromise on quality, in-house, sub-contract it doesnt matter. “give me revenue, i’ll give you profits” is the motto for this year.

but i get your point, and the thought has crossed my mind. I think the business I run is more risky than derivatives trading. alteast in the derivative segment ‘RISK’ can be quantified (for every position you take sensibull will spit out a ‘probability of profit’ number based on historical data).
last new year night, 2 of my shop floor employees got drunk, decided to go on a motorcycle without helmet and had an accident (they are both fine now). there is no way for you to quantify these kind of risks. but i guess wishful thinking and a little bit of megalomania are drivers that make you chase irrational things sometimes, like continuing to run a maufacturing business, in spite of making more money via trading while taking much less risk (imo)

take the case of “Kovai pazhamudir nilayam” which made ripples in the coimbatore’s entrepreneurial community. a 800Cr. stake sale to westbridge capital in june of last year. its a popular supermarket chain in coimbatore, chennai etc. a family run business that didnt see a profit for over 3 decades of operation. what kept them going? why? who would have the conviction to run a business for 30 years barely breaking-even year-on-year?

we just do these things, hoping for a big break sometime in the future… may be landing a big defence order, or a direct export order… who knows? if nothing works out… then get treatment for your megalomania, keep your head low, your liabilities even lower and live out the rest of your days… lol

[Anandrai]

Hi Shankar,
I have just read the whole thread and find it very informative. You can think of publishing this as a new thread under “Business Use case for Trading” as in current thread its fragmented.
Best of luck of your manufacturing enterprise and trading strategy.