Cashflow modelling- what it is and why it can help you to make decisions
One of my favourite parts of the financial advice process is doing cashflow modelling. I love the clarity it provides to people when I present them with a number of possible scenarios and what that looks like from a cashflow perspective.
So what is cashflow modelling?
Well, for most people, planning their budget around a particular goal is relatively easy. For example, if you want to save a deposit for a house, you can just put aside a certain amount each week knowing that in a certain number of weeks, you will have your deposit. But life doesn’t really work like that.
For most people, they might be saving for a deposit. At the same time though, they are considering having a baby, changing their work hours, looking at private school for their kids etc. Once you try to map all of these out, it gets a little too complex for the average person without the aid of software. This is where cashflow modelling comes in.
So how does cashflow modelling work?
As part of our financial planning process, we will seek to understand your earnings both before and after tax and what we call your ‘lifestyle expenses’. We want to understand what makes up these lifestyle expenses because these are constantly changing. For example, you may have day care costs now but in 2 years they may go up when you return to work an additional day or two. These costs might disappear once your child goes to school. By breaking it down we have more levers to pull.
Once we understand this information, we start modelling it out using our sophisticated software. This software allows us to come up with your ‘current’ lifestyle in a graph. Essentially, we plug in how much you earn, how much tax is coming out and then we map out your expenses and how they are going to change over the coming years. This software is so sophisticated it automatically addresses things like the fact that your employer pays superannuation, that some costs are tax deductible, that assets are growing in value and that there is inflation of costs.
At the end of this process, we can demonstrate what your incomings and outgoings are for the year to work out whether you are in a surplus or negative for cashflow. If you are in a negative, it automatically calculates the cost of borrowing money to sustain your lifestyle. It is illuminating to see it all laid out on a page, year by year, what your cashflow is going to look like. Up until this point, many people feel the pain of not having any money but struggle to understand where it is all going.
So how does it help me make decisions?
Once we have mapped out your current lifestyle, this is where the fun begins. We then proceed to list out a number of options based on your individual goals. For example, you may be wondering if you should pay down your home quicker or do renovations. We can map that out.
You may be wondering what it would be like if you had another child and had a couple more years off work, we can map that out.
You may want to take a year off work to travel the world. We can map that out.
There is no limit to how many scenarios we can map out. The benefit of this is you can see all of your life ideas on a page and make a more informed decision.
How has this helped people in the past?
I’m always amazed at how illuminating the cashflow modelling process can be. It’s usually not until I’ve gone through this exercise myself that I can fully understand a person’s financial situation. By laying out the figures on a page, you can see in black and white what different decisions will do to your financial situation.
I’ve had clients who were certain of their goals completely change their position after seeing their cashflow modelling. Why? Because it allows us to work out what is really important in life. Everything you do comes at a cost. For some clients, seeing what they have to give up to do those renovations or take that trip makes them feel like it’s not worth it. For others, the renovations are a priority and maybe they don’t want to have an additional baby.
The point is, you can’t do it all. By mapping out the cashflow situation of each option, you can work out how much you can do and work out from there which ones are the most important to you.
A financial planner will never be able to tell you what is important to you but we can paint out what life would look like if you go down those options. This helps you to make an informed decision to make sure you are living the life you want and not the life that is expected of you.
As always if you have any questions please do not hesitate to reach out.
This post is from our resident Financial Planner Ben Brett, check out his details in the About Us section.
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