FAQ for FD

What is Company Fixed Deposit?

Company Fixed Deposit is the deposit placed by investors with companies for a fixed term carrying a prescribed rate of interest.

Why is interest from Company Fixed Deposit higher than Banks?

Company Fixed Deposits have always offered interest which is 2-3% higher than Bank Deposit rate, because they have to pay higher interest to banks for borrowing money.

How is interest payments made?

Interest is paid on monthly/quarterly/half yearly/yearly basis or on maturity, and is sent either through cheque or through Electronic Clearing System basis.

Why is end-of-term lump sum payout better than regular interest payout?

The reason is compounding.

An example:

Suppose you opened two different FD accounts on January 1st for a 1-year term with the same bank for an amount of Rs.1,00,000 each. For the first FD you chose to receive interest along with the principal at the end of the term and for the second, you chose quarterly payout of interest. For simplicity sake lets assume the interest is calculated on a quarterly basis.

This is how the cash-flow for the two deposits would look like:

Tenure 1 Year Tenure 1 Year
Principal Rs. 1,00,000.00 Principal Rs. 1,00,000.00
Rate 10.00% p.a. Quarterly Comp Rate 10.00% p.a. Quarterly Comp
Option Compounded Option Quarterly Payout
Month Interest Account Bal Month Interest Account Bal
January 01 1,00,000.00 January 01 1,00,000.00
March 31 +2,500.00 1,02,500.00 March 31 +2,500.00 1,00,000.00
June 31 +2,562.50 1,02,062.50 June 31 +2,500.00 1,00,000.00
Sept 31 +2,626.56 1,07,689.06 Sept 31 +2,500.00 1,00,000.00
Dec 31 +2,692.23 1,10,381.30 Dec 31 +2,500.00 1,00,000.00
Total Payout 1,10,381.30 Total Payout 1,00,000.00
Interest Earned 10,381.30 Interest Earned 10,000.00
Effective Return 10.38% Effective Return 10.00%

How is interest calculated in Fixed Deposit

Noticed the difference? The total interest payout on the first FD was more than the interest payout of the second FD, where the interest was paid “out” every quarter. This is not a calculation error, but simple mathematics of compounding.

While the second FD paid out interest to you every quarter, the first FD accumulated the quarterly interest. The difference becomes apparent from the second quarter. In the second quarter, the second FD paid an interest of Rs.2,500 while the first FD generated an interest of Rs.2,562.50. The additional Rs.62.50 is the “interest earned on interest”. This need not be confusing; notice the account balances on the beginning of each quarter. The second FD maintains a fixed balance of Rs.1,00,000 i.e. your principal, while the first FD accumulates the interest paid during the previous quarter. While calculating the interest for the 2nd quarter, the first FD takes into account only your principal amount (since the interest of the 1st quarter is already paid to you), whereas the first FD calculates the same rate, but on the aggregate amount i.e. Rs.1,02,500. The Rs.62.50 difference is the interest on the additional Rs.2,500 in the account, a.k.a interest on interest. This is how compounding works.

When is TDS deducted on the interest from Company Fixed Deposits?

TDS is deducted if the interest on fixed deposit exceeds Rs.5000/- in a financial year.

Is there any scope of appreciation of principal?

No, at the end of deposit period, the principal is returned to the deposit holder.

How to choose a good company deposit scheme?

  • Ignore the unrated Company Deposit Schemes. Ignore deposit schemes of little known manufacturing companies. For NBFCs, RBI has made it mandatory to have an ‘A’ rating to be eligible to accept public deposits. One should go further and look at only AA or AAA schemes.
  • Within a given rating grade, choose the company with a better reputation.
  • Once you decide on a company, choose the schemes that have given a better return. Unless you need income regularly, you should prefer cumulative schemes to regular income options since the interest earned automatically gets reinvested at the same coupon rate, resulting in better yields. It also gives you a lump-sum amount at one go.
  • It is better to make shorter deposit of around 1 year to 3 years. This way, you can not only keep a watch on the company’s rating and servicing, but also have your money back in case of an emergency.
  • Check on the servicing standards of the company. You should not invest in companies that care little about investor services, like promptly sending interest warrants or the principal cheque.
  • Involve your Financial Planner / Investment Advisor for advice in all your transactions. Do not bypass and invest directly.
  • Check whether the company accepts outstation cheques and makes payment through at par cheques, especially if you do not live in the same city where the company is situated.

Which companies can accept deposits?

Companies registered under the Companies Act 1956, such as:

  • Manufacturing Companies.
  • Non-Banking Finance Companies.
  • Housing Finance Companies.
  • Financial Institutions.
  • Government Companies.

Upto what limits can a company accept deposit?

A Non-Banking Non-Finance Company (Manufacturing Company) can accept deposits subject to following limits.

  • Upto 10% of the aggregate of paid-up share capital and free reserves if the deposits are from shareholders or guaranteed by the directors.
  • Otherwise upto 25% of the aggregate of paid-up share capital and free reserves.

A Non-Banking Finance Company can accept deposits upto following limits:

  • An Equipment Leasing Company can accept four times of its net owned fund.
  • A Loan or Investment Company can accept deposit upto one and half time of its net owned funds.

What is the period of the deposit?

Company Fixed Deposits can be accepted by a Manufacturing Company having duration from 6 months to 3 years. Non-Banking Finance Companies can accept deposit from 1 year to 5 years period. A Housing Finance Company can accept deposit from 1 year to 7 years.

Companies where you should not invest

  • Companies that offer interest higher than 15%.
  • Companies that are not paying regular dividends to the shareholders.
  • Companies whose Balance Sheet shows losses.
  • Companies that are below investment grade (A) or less rating.

There is an old saying [“Don’t Put All Your Eggs In One Basket “.]
Company Deposits should be spread over a large number of companies. This will help you to diversify your risk among various companies/industries. Never put more than 10% of your total investible funds in one company