Cash flow planning is a way of mapping out your finances into the future. It’s sometimes referred to as cash flow financial forecasting or cash flow financial modelling.
In reality though, whatever name is applied, this is an exercise in modelling NOT forecasting.
What’s the difference?
Forecasting is an attempt to predict likely outcomes.
Modelling is different and is about looking at possible future scenarios.
Forecasting means trying to predict the unpredictable.
No-one knows what inflation will be, what returns will be on shares, future tax rates, interest rates, property prices or mortgage costs. If they will be divorced, what help their kids will need, whether they will be forced to retire early due to ill-health, how long they will live……none of these can be predicted with any certainty. There are too many moving parts.
Trying to forecast these aspects individually is difficult, but mixing them together is impossible.
Imagine your future finances required a seven but actually you get a double one – that wouldn’t be good.
But now imagine your financial plans are able to pre-empt the varying potential outcomes.
Modelling allows you to test your future financial assumptions against different scenarios helping you prioritise and prepare.
Cash flow financial planning is about using financial software to help model your finances from here today to consider different future points and to see what happens.
How does it work?
You start with where you are today – which can be analysed and summarised precisely.
You explore your goals and future targets, those things that are important to you and your family. For example you might want to aim for an early retirement or to pay off your mortgage by a certain age.
You then create a financial model using the software, making certain assumptions.
This gives you a picture of your financial pathway; a long-term income and expenditure pattern which shows how the financial picture moves over time.
You then start to address ‘what if’ questions.
You then adjust the cash flow model by changing the assumptions and see how this alters the picture and the future pathway.
What this does is create the best platform possible with a foundation on which to make informed financial decisions. If you can see the picture changing as you move the assumptions you can start to see where the risks are, where shortfalls might occur, what it will take to meet your goals, whether your investment objectives are realistic, whether they need to be revaluated or whether additional funding may be required, including how much money you may need for the rest of your life and so on.
Cash flow modelling provides a solid base for the decisions you make today about your financial future.
The software allows you to create scenarios, which means this becomes an exercise in planning for different scenarios.
This can produce useful information.
The cash flow modelling is not an end in itself, but a means to help support and plan the journey.
It will help you focus on what needs to be done, plan your future and be confident in the knowledge you’ve considered the variables.
Plus it is one you can regular review and update which allows you to continue to map your position as you progress through the years, making the process dynamic.
Working with a financial planner who has this software and the experience of this methodology is an invaluable exercise, one that looks at future pathways to inform today’s decisions.