Cash flow forecasting is a critical component of personal financial planning as it allows you to gain a clear understanding of your current and future financial situation.

Cash flow forecasting is a projection of your assets, liabilities, expected income and expenses over a specific period (normally to age 95 or 100). A cash flow plan also makes assumptions on investment returns, taxes and costs/charges over the projected timeline. By creating and regularly reviewing a cash flow forecast, you are able to identify potential income shortfalls or surpluses, make adjustments accordingly, plan for tax mitigation strategies and manage investment risks.

The importance of cash flow forecasting in your personal financial plan can be highlighted in the following ways:

Identify and predict potential future problems

Forecasting future cash flow is the process of estimating how much money you will have coming in (from things like your salary or investments) and going out (for things like bills, groceries, and entertainment) in the future. This can be done by creating a budget and looking at past spending patterns. By doing this, you can get a better understanding of your current financial situation, and identify potential shortfalls or surpluses. For example, if you see that you have more bills coming up than usual, like an upcoming car repair or a vacation you’re planning, you can adjust your budget accordingly by cutting back on other expenses or finding ways to bring in more income. This can help you to prevent falling into debt or running out of money.

Informed decision making

Having a personalised cash flow forecast is like a map for your money. It helps you see where your money is coming from and where it’s going in the future. This way, you can make smart choices with your wealth.

For example, if you see that you’re going to have extra money in the future, you might think about buying a holiday home or creating a plan to gift to your children – a cash flow plan will allow you to compare each scenario and weigh up the outcomes in terms of ongoing affordability, taxes, required investment returns and total wealth at the end of the projected timeline.

A cash flow forecast helps you see the big picture, compare scenarios, and make more informed decisions.

Tax Mitigation

Tax mitigation is important to building wealth because it helps to keep more of the money that you earn. When you pay less in taxes, you have more money available to save, invest, and grow your wealth. 

Tax mitigation strategies can take many forms, such as taking advantage of allowances and investing in tax-advantaged accounts. By implementing these strategies, you can reduce your overall tax liability, which has a significant impact to build wealth. 

Managing Investment Risk

A cash flow forecast also allows you to understand and manage the risk associated with your investments by considering the investment’s expected return, volatility, and the correlation with other assets in your portfolio. 

A cash flow forecast can help you manage the risk you take in your underlying investments by providing a clear picture of your current and projected financial situation. By forecasting future cash flow, you can identify potential shortfalls and make adjustments to your spending or saving habits in order to avoid over-extending yourself financially.  

It allows you to assess your risk tolerance, and ensure you aren’t taking on more risk than you can handle. For example, you can assess the potential impact of a market downturn on your portfolio and determine if you have sufficient cash reserves to weather the storm. This enables you to make more informed investment decisions, ensuring you do not take on too much risk, and ultimately, reducing the risk of financial loss. 

Understanding your ‘Chance of Success’

Most cash flow forecasting tools can produce ‘Monte Carlo’ simulations. A Monte Carlo simulation is a statistical method that generates a large number of random outcomes (typically up to 1,000) based on probability distributions of key financial variables such as investment returns. 

This can be used to estimate the ‘Chance of Success’ of reaching your financial goals such as saving for retirement. The Chance of Success refers to the likelihood that a specific outcome will occur within a set of simulations. Typically it produces a probability of between 0% – 100% of the likelihood you will have sufficient liquid wealth at the end of the projected timeline.  

This can be useful if you are trying to balance multiple financial goals and need to make trade-offs between them. By understanding the Chance of Success for different scenarios, you can make more informed decisions and make adjustments as needed.

Conclusion

In conclusion, cash flow forecasting is a crucial element of personal financial planning. It enables you to gain a clear understanding of your current and future financial situation, make informed decisions about your finances and plan for tax mitigation strategies as well as manage investment risks.

A professional financial planner can assist in creating a cash flow forecast, interpreting the results, and providing guidance. With cash flow forecasting, you can have control of your finances and make decisions that align with your long-term goals. 

For further information on the benefits of cash flow forecasting, have a look at this video by clicking here.

If you would like to learn more about cash flow forecasting and how we may be able to help you. Please contact us here.

The Financial Conduct Authority does not regulate some aspects of Trust, Tax and Estate Planning 

The value of investments may go down as well as up and you may get back less than you invest. 

Past performance is not a reliable indicator of future performance.