A process in managing expectations
There are three basic variables in financial planning: your objectives, the resources you have to commit to achieving them, and the risk you are prepared to take. The relationship between these three parameters can be brought together using cash flow forecasting and is the essence of a financial plan.
What is Cash Flow Forecasting?
Cash flow forecasting, or modelling, can be a key tool in the financial planning process an adviser uses to help clients, professionals and business owners better understand and visualise their future financial needs and requirements. No financial modelling tool can take the place of a skilled, competent professional adviser, but it can complement those skills and help clients achieve one of their most important aims – financial peace of mind. Using sophisticated financial software, an adviser is able to forecast a financial position year by year. This enables both adviser and client to combine and alter many different factors, such as expenditure, inflation, growth rates and tax rates, within a personal financial model, and then allows them to model the effect of different financial decisions.
The ability to use ‘what if’ scenarios shows us how hard your money has to work to achieve your objectives. The answer might be ‘too hard’ so this often prompts further discussion about capacity for loss and how realistic your expectations for investment returns are.
Most importantly, it visually helps to bring your money to life, helping to manage your expectations.
As well as investment and wealth strategies, cash flow forecasting can be used in specialist areas of advice:
Pensions & Divorce
Prior, during and at the end of the divorce process pensions specialists can compare the options of ‘off-setting’ and pension ‘sharing’, including comparing the after-tax cash flows arising from these options. It is common to find that one member of the couple has not handled the finances in the past so clear and concise forecasting really helps them get a feel for what an award will realistically provide in the future.
Financial Guardianship & Personal Injury Claims
These cases usually include some element of current and future medical and other support or care costs. Cash flow forecasting allows us to clearly demonstrate what these may look like and the suggested investment strategy required to help provide for these costs over the life of the client. For unsophisticated or first time investors this is invaluable.
The forecasting process can chart a client’s future cash flow position after the sale of their business and can help them establish their ability to achieve their lifestyle objectives by building a financial plan.
Elderly Care Planning
This process can help individuals and their families understand how they are going to fund the costs of care, either in their own home or in a residential care home. It takes into account providing the care not just now but, more importantly, well in to the future. For example, a client considering how to fund for a care home using a number of different options, including a Long Term Care annuity, can forecast the difference it would make compared to her current situation, i.e. had they not taken out the annuity.
Forecasting should not be used as the sole basis for making financial decisions, it should be used as part of the financial planning and review process, and in conjunction with other tools, such as attitude to risk questionnaires, asset allocation, and, of course, in conjunction with the adviser’s knowledge, experience and expertise. However, if you current financial adviser does not use cash flow forecasting as a standard practice with you then you need to question why not.
Craig T Gibson, Managing Director
AGL Wealth Management Ltd