How does a Chit Fund work?
Simply put, the chit fund begins on a specified date and continues for the number of months equal to the number of subscribers. Members contribute their monthly instalments to the pot, and a reverse auction is conducted each month allowing members to bid for the Prize Money.
The subscriber willing to take the lowest sum with the lowest bid is declared the winner and receives the Prize Money for that month. The balance amount is distributed as a dividend among all members after deducting the Foreman’s Commission (5%). The process is repeated each month, thus allowing each member to win the Prize Money.
A Chit fund offers you the unique advantage of allowing you to borrow from your future savings.
Assume a chit fund scheme with 50 members that will run for 50 months, with each paying a monthly instalment of ₹10,000/- to create a ₹5,00,000/- pot. When the auction is announced, the member who bids the highest discount wins the Bid. (40% is the maximum discount anyone can bid as per Law).
- Number of members in the chit fund scheme – 50
- Duration – 50 months
- Monthly instalment payable by each member – Rs. 10000/-
- Total pot value – Rs. 500000/- (50 members x 10000)
In this example, let us assume the winning Bid offered a 35% discount.
- Discount offered by the winning Bid – 35%
- Amount of discount – Rs. 175000/- (35% of 500000)
- Amount received by the winner – Rs. 325000/- (500000 less 175000)
The balance amount is distributed equally among the members after deducting the Foreman’s commission.
- Foreman’s commission – 5-7% = Rs. 25000/-
- Total Dividend – Rs. 175000 less Rs. 25000 = Rs. 150000/-
- Dividend credited to each member’s account – 150000/50 = Rs. 3000/-
So in the following month, the member will have to pay only ₹7,000(₹10,000-₹3,000) instead of ₹10,000.
Chit terminology (explained with the help of the above example)
Instalment = Monthly Subscription =₹10,000
Period = Number of months = 50
Gross Chit Amount = Total of Instalments by all members = ₹5 lac (₹10,000x50)
Bid offer Amount = Amount willing to be foregone by the subscriber to win the prize Money = ₹1,75,000 (if we consider Bid = 35%).
Min Bid Amount = 5% (Foreman Commission),
Max Bid Amount = 30% (for 30 & 40 months Chit Fund) and 35% (for 50 months Chit Fund)
Net Amount (Prize Money) = Chit Amount minus Bid-Offer Amount (₹5,00,000 - ₹1,75,000 = ₹3,25,000)
Foreman Commission (FC) = 5% of the Gross Chit Amount (₹25,000)
Total Dividend = Bid offer Amount minus Foreman Commission (₹1,75000 - ₹25,000 = ₹1,50,000).
Dividend per Customer (Share of Discount) = Total Dividend/No of Subscribers (₹1,50,000/50 = ₹3,000)
Next Month Instalment = Gross Instalment minus Dividend (₹10,000-₹3,000 = ₹7,000)
Example of a Chit Table(statement) for the entire period
If someone waits to win the Prize Money at the end of the period
Total Amount Invested = ₹4,19,500
Total Amount Received = ₹4,72,000 (₹5 lakhs – (FC + 12% of FC as GST)
Profit = ₹52,500
Note:- The above calculation is only an illustration; the actual return is determined by the auction discount decided by the Chit Fund subscribers.