We’ve talked a lot in the last couple of articles in this section about budgets, both in emotional terms and from a practical point of view, as well as looking at how budgets sit at the heart of financial planning.
It was Dickens who put it succinctly:
“Annual income twenty pounds; annual expenditure nineteen pounds, nineteen shillings and sixpence – result happiness. Annual income twenty pounds; annual expenditure twenty pounds, aught and six – result misery.”
Whilst this is not necessarily absolutely true today because some sort of debt or overdraft facility can be used and is often important in order to achieve short-term results for longer term benefit, the principle remains sound.
One element of cash flow planning is to have a strategy to deal with unexpected expenditure. This could be a reserve of cash held in a building society, or it could be a short-term to medium-term overdraft facility, and it is always worth acquiring some sort of overdraft facility when times are good to help out when times are not so good.
Cash flow does, of course, have a direct impact on your assets. If your cash flow is negative then money is going to have to come from somewhere else, either from existing savings or through the accumulation of debt, which has a direct impact on your capital or balance sheet, which obviously starts to deteriorate. Conversely, if cash flow is positive then money is almost certainly going into savings or investments, which has a positive impact on the balance sheet. In financial planning terms obviously what we look for is a positive cash flow with the surplus income being directed strategically into savings and investments and probably pension plans. It is this element of savings combined with the impact of compound returns and good asset management that is so important for delivering financial security and freedom in later life.
Of course, cash flow planning is not just about the here and now. We can easily carry out an exercise to work out cash flow in the current year but it is just as important, if not more so, to project cash flow forward into future years, looking forward to seeing the impact on liquid assets and cash over the longer term, and even over a life time. Whilst it may seem crazy trying to project your liquid balance sheet at age 99 when you are only 30, the point is that it helps to plan because you can see the impact of stopping work, taking out pensions, repaying mortgages, etc on liquid assets.
It is also a good exercise to look at options in your life and you can play around with “what if” situations - “what if I retire five years early?”, “what if I work four days a week but for ten years longer?” This is something you can build on an Excel spreadsheet, but there are a number of different software programmes available now for doing this in a more sophisticated way, such as Voyant and Mint. It is often worth looking at these and even investing in them to help your financial planning.
It can be comforting to know that on the assumptions you have made you will still have adequate cash at age 99. On the other hand, if it looks as though your capital is going to run out at age 66, then you can take steps now to rectify the situation