Topic 3 Cash Flow Management

Topic 3: Cash Flow Management Learning Objectives – (a) Identify opportunities and challenges related to a client’s cash inflows and outflows and make recommendations to assist the client in meeting their current needs and long-term financial goals. – (b) Communicate the need for liquid assets and emergency funds and recommend strategies for accumulating the appropriate levels of funds. – (c) Calculate savings required to meet financial goals and recommend how to incorporate planned savings into the cash flow plan.

Topic 3: Cash Flow Management Cash Flow Management is the process of monitoring and analyzing cash flows to ensure they are used effectively toward reaching goals Stages of Cash Flow Management – Cash Flow Analysis – Cash Flow Planning – Budgeting Emergency fund planning Debt management ratios Savings strategies

Topic 3: Cash Flow Analysis Gather data on income and expenses and organize it within the Statement of Cash Flow Analyze for strengths, weaknesses, opportunities, and threats (SWOT) – May reveal situations where resources are being used ineffectively or inefficiently – Makes clients more aware of saving and spending habits

Topic 3: Cash Flow Planning Attempts to determine the optimal use of net cash flows Net cash flow = income – expenses – Positive net cash flow May be allocated toward goals or used for consumption – Negative net cash flow Steps must be taken to increase income, decrease expenses, or both

Topic 3: Budgeting The tool that is used to allocate projected cash inflows toward savings and expenses Can be used to “create” positive net cash flow by seeking greater efficiency – Positive net cash flows can then be allocated toward achieving goals Creating the budget will require the client to think about which expenses are discretionary and which are nondiscretionary

Topic 3: Budgeting Advantages – Reveals inefficient uses of resources – Provides a way of measuring progress – Helps motivate the client Disadvantages – May lead to wrong decisions – May stifle creativity – May be boring and tedious Suggestions – Keep it flexible – Keep it short and simple – Begin with estimate of income – Use it to understand actual versus planned results (see example page 3.14)

Topic 3: Emergency Fund Planning Clients should have an adequate fund that can be drawn upon quickly if needed to cover major unexpected adverse events Typically 3 to 6 months of the client’s expenses depending on the client’s position and economic climate

Topic 3: Debt Management Ratios Consumer debt payments should not exceed 15% of take-home pay Monthly mortgage payments should not exceed 28% of gross income or one week’s take-home pay Monthly payments on all debt should not exceed 36% of monthly gross income

Topic 3: Cash Flow Management Analyzing strengths and weaknesses in the plan includes evaluating the client’s emergency funds and use of leverage If the client does not have adequate emergency funds and/or is over-burdened with debt, investment recommendations should not be made until these weaknesses have been dealt with.

Topic 3: Savings Strategies Savings should be planned as part of the budget and not considered a residual that will simply materialize if expenditures are controlled – Typically 5% to 10% of annual income – The actual savings rate needed to reach the individual client’s goals will be calculated within the plan Transfer a specific amount each month automatically from a checking account to a savings account

End of Topic 3