Investments and savings are not the only focus of financial planning. The other aspects – cash flow and liability management – are also equally important. Particularly, in the current scenario, where improved lifestyles have led most households to indulge in discretionary spending. These include home and car loans, annual holiday, child’s education, taxes and so on.
This requires proper cash flow planning. To start with the basics, tracking your cash flow requires simple things like recording your deposits and withdrawals diligently. If you have cash inflow, it is a good sign as it means you are having more income than you spent. However, the reverse is bad news because it means you spend more than you earned. The net outflow has to be managed by funding it through borrowings in the short or long term.
Of course, funding for asset creation is also there. In case, you own a house and paying an equated monthly instalment for it while the total cost of the house will be much more, it is an asset which will only rise in value over time.
|MANAGE YOUR CASH FLOWS
- Know your source(s) of income and expenses; cash flow is the balance in hand
- Trim discretionary expenses wherever possible
- Maximise your surplus each month to save better for the future
- Keep a contingency fund to ensure you have enough in hand for unforeseen needs
- Do not borrow funds in excess, if you do not have capacity to service them
Cash inflows can be in the form of net salary, business income, interest received, dividend earned, maturing investments, proceeds from sale of assets, windfalls gains and so on.
On the other hand, money spent can be for essential or discretionary reasons. Essentials would be commitments towards utility bills, education, food, fuel, investments and so on. Loan dues not paid on time may lead to a penalty. Hence honouring commitments is very important as defaults can affect your credit rating.
Discretionary or lifestyle-related expenses like dining out, movies, club memberships, shopping will push up your outflow and make your things lopsided on a bad day. The best way to save money around the discretionary expenses is to develop a vigilant attitude toward cutting costs, no matter how small. Successful and intelligent investors are those who control tempting expenses.
On determining the inflow and outflow, taking into account the opening balance, you arrive at the net position. The net position may be surplus cash or deficit. In case it is surplus, you should invest the same in suitable avenues. In case of a deficit, borrow funds if extremely necessary. If you are already servicing a loan, it would be wise to get surplus cash in balance by either cutting back on expenditures or by increasing your income.
While investing in bank and / or company fixed deposits, bonds or debenture, opt for the regular income plan, where interest is paid to your on a quarterly or six-monthly basis. Similarly, you can invest in Post Office monthly income scheme (MIS), which offers interest payable on a monthly basis. If you invest in a mutual fund scheme, go for the dividend option. All these methods will ensure regular flow of money.
This gives dual advantage as you can use this interest income to meet emergency expenditure. Maintaining liquidity in your investment is very essential, that is, investing in liquid avenues is essential. Reason: You can never predict or time the need for cash. It can spring up at any time and for hefty sums. And at times of sudden need, you should be able to dispose of investments without much loss. So invest in instruments that are liquid. Real estate is an illiquid asset class, debt funds are liquid, just to illustrate.
You can also use an investment strategy known as laddering. This calls for establishing a pattern of rolling maturity dates for a portfolio of fixed-income investments. Your portfolio may include fixed deposits or National Savings Certificate (NSC). Then, instead of buying one NSC worth, say Rs 3 lakh for a six-year term, you buy twelve NSCs of Rs 25,000 each, each maturing in either a month or quarter. As each NSC nears its due date, you can reinvest the principal to extend the pattern. Same can be done with bank deposits.
It is very important to avoid a cash crunch at any time, as it may lead you into a debt trap. As you may decide to borrow to bridge the cash gap and in the process borrow more than you can repay. Specially, those who borrow to retire existing debt and keep piling on their liability. It is important to focus on your goals and the value each purchase brings to you. By avoiding lavish spending, you may attain your financial goals earlier.
You also need to manage your borrowings. In case of a home or vehicle loan or both, you may prepay a part of the liability at regular intervals, subject to cash availability. And give a breather to your pocket.
Eliminate expenditure on items not very essential by regularly reviewing your costs. Like you could two big holidays in a year than have four small ones and save on the traveling cost. Or, as traveling cost can be very high in the peak seasons, plan holidays in off season. Or, defer purchases that are not needed immediately.
Understanding your cash flow is an important step in financial planning. By knowing where your money is coming from and going to, you can take control of your finances. Monitoring cashflows at regular intervals is prudent for the same. Doing so will help you identify areas where you could improve your cash flow by cutting unnecessary costs. Similarly, without proper cashflow planning, one could easily get caught in a debt trap or fail to create wealth.
The writer is a freelancer