Cash flow modelling sits at the heart of modern financial planning. It is something to which we are committed at Prest because we believe it plays an irreplaceable role in making it possible to have genuinely informed conversations about virtually all aspects of a client’s financial future.
At Prest we use a sophisticated software system to generate cash flow forecasts for clients. These demonstrate, among other things, the level of spending they can expect to be able to sustain over the course of a lifetime under a range of scenarios.
This information can then inform decisions ranging from investment strategy to how much a client can afford to give away in his or her lifetime.
Before a cash flow forecast can be produced we need to populate the system with accurate, comprehensive information about the client’s entire circumstances. This is where the financial planner’s knowledge, experience and common sense come into play, knowing which questions to ask to get the full picture.
Some of the information that goes into the system is absolute: current income and expenditure, existing pensions, property, financial assets, insurance policies and family members. Other items are more open to interpretation: valuation of business assets and possible inheritances, for instance.
Your future material needs and aspirations also have be factored in: everything from how often you plan to change your car to when you might intend to downsize, or the holiday property you hope to buy. Then there are a range of less predictable “known unknowns”: grandchildren who are as yet unborn and the possible cost of later life residential care being obvious examples.
A number of assumptions are then applied, including rates of inflation and possible investment returns. These can only ever be assumptions but, again, this is where the skills and experience of the financial planner come to the fore.
Output and outcomes
A lifelong cash flow forecast can now be generated, demonstrating numerically and graphically how your liquid assets and income could be expected to hold up under a range of scenarios. Different investment outcomes can be modelled, as can “what if” scenarios.
Many elements of financial planning are fun but “what if” scenarios can be particularly useful when contingency planning for the sorts of events nobody likes to talk about, and for ensuring that you and your family have the correct level of life and income protection insurance in case the worst happens.
At the other end of the scale cash flow modelling might demonstrate that you are likely have more than enough money to last a lifetime and that, potentially, you may wish to look at strategies to mitigate Inheritance Tax. With this in mind a lifetime cash flow forecast can also demonstrate how much you can potentially afford to give away and still maintain your lifestyle.
Investment strategy is another area where cash flow modelling can be hugely useful. In some cases it can demonstrate that clients can achieve their goals while taking less investment risk than they had anticipated while, for others, it may demonstrate that the greatest likely risk to their future wellbeing is inflation and that a little more investment risk may be necessary to provide the best chance of meeting their aspirations.
Cash flow modelling is, we would argue, vital for anyone planning to draw an income down from a defined contribution pension scheme. It is an essential element of any responsible defined benefit pension transfer advice process.
Of course, no matter how sophisticated the system, the output is based on assumptions and can never be 100 per cent accurate. Nonetheless, it takes a huge amount of the guesswork out of long-term financial planning and, when done properly, puts you, the client, firmly in the driving seat when considering your own future.
Please note that although Financial Conduct Authority regulates advice relating to the investments and financial products described above it does not regulate cash flow planning.
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