If you’ve ever noted down the pros and cons of a situation when trying to make a decision, or transferred your problems and feelings onto paper at stressful points in your life, then you already understand the basic fundamentals of cashflow modelling.
Using an advanced, comprehensive software program, cashflow modelling has the ability to provide clear answers to the questions posed by people planning their own, or their business’, financial future. It brings those answers to life with the aid of graphs and solid strategies.
Most often, they’re not easy questions to answer either. Ben Hewitt, Senior Technical Planner at Alan Boswell Financial Planners in Norwich, is often faced with such broad enquiries as: ‘When can I retire?’, ‘How much do I need to be able to retire and never run out of money?’, ‘Can I gift a large sum of money to my children and still have enough to live off?’, ‘How much should I sell my business for?’ and ‘Can I afford to pass my business down a generation without affecting my lifestyle?’. After all, these are the kinds of questions we are all likely to have when retirement appears on the horizon.
Who is cashflow modelling for?
Cashflow modelling is essentially designed for people who are settled and have an end goal in mind. “For example, they may have children – who are perhaps in private education or at university, so costs are known – and they’re on their glide path to retirement. They’ll have an idea of when exactly they want to retire. They’re not sure how much money they’ll need, but they’ve got the earning capacity to make additional payments into their pensions if needs be,” Ben explains.
“What we don’t want is a lot of assumptions,” he adds. “Individuals in their 20s or 30s, for example, may not know if they’re going to have any children or how many. They may not know what path their career will take. They’re unlikely to know what they’ll be earning at the age of 50 etc. As a result, there are too many unknown costs to be guessed at.”
As an expert in cashflow modelling, Ben knows exactly when to employ the software to best effect. He recalls a client who knew little of how it worked. As he explains: “Some of the questions he had and things he was talking about – such as income being squeezed, expenditure rising, being asset-rich and cash-poor, and changes in personal circumstances – called for the program to be brought into play. It provided answers to his questions, brought them to life and got them down on paper. Now his family have peace of mind about the affordability of certain decisions.”
The process is exceptionally detailed because unlike other financial planning services, where pensions and investments are often considered in isolation, cashflow modelling provides a holistic view of the future. In other words, how your personal circumstances and finances fit in with your specific objectives for your life – and what changes or financial products might be required in order to achieve them.
“First we find out a bit about the clients. We discover what they want, what their goals are, where they’re heading and why. We want to understand how they operate,” says Ben. “Then it’s all about intensely gathering information.”
We discover what they want, what their goals are, where they’re heading and why
This can include such facts and figures as capital expenditure, net worth, assets, investments and income. They also learn where money is coming from and the tax rates that apply to it, such as inheritance or income tax.
“But it’s also a case of really thinking about what clients require,” adds Ben. “They may think they want £50,000 a year in retirement, but is it actually possible to spend that much when you’re 80? We tend to find that clients want to spend a lot in the first 15 or so years of retirement and then it tails off.
“This is where cashflow modelling comes into its own. We can factor in a gradual slowdown of work; different pensions coming in at different ages; expenditure rising and falling as retirement is enjoyed and then passing capital down to children over time. Many clients are worried about gifting heavily in the early years in case they require long-term care. All of this can be factored in.”
It’s worth bearing in mind that the quality of the answers is only ever going to be as good as the quality of the raw data provided. That’s why it’s important to provide your financial adviser with the most accurate and detailed information possible.
Inevitably, in any financial scenario there will be some unknowns. “You have to take a long-term view on things such as inflation, interest rates and property values,” Ben explains. “It’s not a case of saying, ‘Well, interest rates are currently at an average of one percent, so let’s stick one percent into the spreadsheet’. We have to look at interest rates over the last 20 or 30 years, and then take a conservative view, which must be approved by the client before we proceed.
“We’d much rather be cautious, in case a year like 2008 rolls around again and markets fall off the cliff.”
How cashflow modelling can help?
Life has a habit of throwing financial curveballs our way. Ben recalls when the CEO of a large firm, having had his business loan suddenly recalled, found himself in the situation where he had lost both his job and the shares he had hoped to sell on when he retired. Cashflow modelling was quickly brought to the rescue.
“The client was naturally very worried about how this had affected his plan leading up to retirement, so by going through various scenarios and playing around with some figures, cashflow modelling was able to show him that taking a £10,000pa job for eight years would solve the problem. No, he wouldn’t be able to buy a new car every three years, and he wouldn’t be able to leave as much money to his children as he’d hoped, but at least he didn’t have to worry. It changed his life.
Cashflow modelling was able to show him that taking a £10,000pa job for eight years would solve the problem
“After all, when you’re in a situation like that and there’s so much going through your mind, how do you focus on what’s important? Being able to visualise the future helps so much.”
The value of investments and any income from them can go down as well as up and you might not get back the original amount invested. The past is not a guide to the future.
Taxation depends on your individual circumstances. Tax laws can change.