We are often asked this when offering a cash flow report to clients grappling with some of their biggest financial commitments. These could include buying a first home, saving for the education needs of children, planning retirement, during the divorce process, on changing career, passing on assets to future generations or coping with bereavement in later life.
Cash flow planning is a concept borrowed from business and every business owner or Finance Director will be familiar with the term. It involves looking at the assets and income of the company over a period and balancing these against current and future liabilities. It includes forecasts of future income and costs. It takes account of the objectives the business has to grow, to develop new products and services and to find efficiencies in delivering them. Investors like companies have a strong cash flows when the income is dependable and rising and where liabilities are predictable, and risks are managed.
These same principles can be applied to personal financial planning. The starting point is to identify personal goals. These may be just one or two specific immediate aims, but cash flow planning is most effective when all likely future needs are taken into account too. Just focusing on immediate needs may seem more practical, after all what is the point of worrying about retirement planning when the priority is to save for a first home? Why should I concern myself with care fees planning, when my priority is helping the next generation?
Focusing on one goal at a time can limit future options. For example, not joining an employer’s workplace pension plan in order to save for a deposit, means losing the money which your employer is obliged to pay. Giving money away too soon but then not having enough to fund a suitable care package could also be a costly mistake. A cash flow plan maps out all the current and likely future needs and goals of the family and enables you to prioritise to improve the chances of achieving more of them.
A cashflow plan can bring greater clarity to the question of suitable investment risk. Financial planners ask their clients about attitude to risk. Without specific goals in mind over a given timeframe, this is simply a measure of the individual’s psychological relationship with risk. It is the level of risk which, in an ideal world, you would want to take. But what if that level of risk is too high or too low to give you a realistic chance of achieving your objectives? Cash flow planning helps determine the return needed on investments and savings to meet the goals over a given period. It informs the investor how likely they may achieve their goals or whether they need to consider trade-offs, such as saving a little more, changing investment risk, altering the timeframe, buying a different house.
A cashflow plan can also identify the risks which may prevent or delay some goals being achieved. These include ill health, loss of employment, death of a loved one, investments falling in value, living costs rising, or changes in taxation. Many of these risks can be managed so that should misfortune strike, there is a plan B to cushion the impact. Planning for these risks does not make them more likely to happen, it just means you are more prepared.
As John Lennon famously said “Life is what happens to you while you’re making other plans,” so cashflow planning cannot forecast exactly what will happen in the future but it will show what is probable. To be effective, it needs to be updated regularly to take account of changing circumstances. Savings and investments can then be altered, income withdrawals reviewed, and insurance policies, wills and beneficiaries updated accordingly. Once a cashflow plan has been established as part of the financial decision-making process it is straightforward to update.
Does everyone need a cash flow plan before they invest? Not necessarily, but the analogy I would use is this. When going to the shops in your neighbourhood you do not need a map. If travelling further afield, to somewhere never visited before, few of us would venture out without a map and some pre planning. The future is somewhere you have never been before. Cashflow planning is the SatNav which guides and updates you on your journey. If there are delays on the way it can find another path. Combined with regulated advice it can help you arrive at your destination more smoothly.
Director of Public Policy, LEBC
Please remember, no news or research item is a recommendation or advice to buy. LEBC Group Ltd is not responsible for accuracy and may not share the author’s views.
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