When financial planning comes to mind, most of us don’t think about personal cash flow management. It’s actually a fundamentally important process where spending is broken down and analysed if used efficiently. Yet, it’s also often avoided or put off because it’s tedious and could even get depressing when we realise we have to cut down on expenditures!
In most cases, changing spending behaviour is difficult without sufficient motivation, emotional value, and discipline. This is where financial goal setting and prioritising goes hand in hand with cash flow management. Once you have identified your desired goals, it then comes down to prioritising as you might not have enough resources to reach all of them. Cash flow management will then help to ensure you allocate your incomes appropriately, and most importantly, maintaining a positive cash flow as without one, there is no way you can begin to achieve any of your financial goals.
To kick off your financial planning journey, it would be prudent to start with creating a monthly budget. To take it a step further, start recording your expenses for comparison against your budget. This shouldn’t be as challenging these days due to the availability of mobile apps. Ultimately, this effort will give you insights into your spending patterns, and the amount of flexible income at the end of the day. If you find a shortfall in allocating toward your financial goals, perhaps it’s time to scale back on some lifestyle choices and try to find areas where financial fat could be trimmed.
Give yourself a simple financial health check as you review your cash flow every few months. Some basic ratios to follow are: Liquidity Ratio, Savings Ratio and Debt Service Ratio.
Liquidity Ratio = Total Cash Reserves / Total Monthly Expenses
This monitors your emergency cash reserves to pay for monthly expenses in the event of unforeseen circumstances. Typically, a liquidity ratio between 3 to 6 is recommended, which means you’ll have a buffer of 3-6 months. However, in a bad economy, it may be sensible to double this ratio to 6 to 12 (buffer of 6-12 months) in the event of retrenchment or unemployment. Cash Reserves come from your savings accounts and assets that can be very quickly converted to cash such as money market funds.
Savings Ratio = Monthly Savings / Gross Monthly Income
This indicates if you are on track to meet your own financial goal allocations. As a rule of thumb, it’s recommended to aim for a ratio of 0.1-0.2, which means you are saving at least 10-20% of your monthly income on top of your EPF contributions. If this seems difficult, a common tip is to set aside savings first as a mandatory commitment instead of leaving it for the balances under flexible income.
Debt Service Ratio = All Debt Repayment / Net Monthly Income
This tells you how much of your income is taken up by debt service obligations, or if you can afford to handle more financial commitments. This is particularly useful as nowadays, it is so easy to sign up for instalment plans without considering the longer term impact it has on your cash flow. To be safe, you should ideally keep this ratio below 0.35 (35%).
Finally, to secure your progress towards achieving your financial goals, you mustn’t forget about managing as much risk as possible. At a minimum, you should have a personal hospitalisation plan in place as a backup and for additional medical treatment options. Without one, a major trip to the hospital could instantly wipe out your savings and you may even require financial support from other family members. Other major considerations are debt cancellation and income protection which will provide an additional safety net while you accumulate your wealth.
All in all, this article highlights the importance of cash flow management and why it’s a cornerstone in the financial planning process. It provides you with a spending structure to stay prepared and keeps you on track on your financial roadmap. It’s not easy to change spending behaviours and you could even consider engaging a licensed financial planner to help you explore what motivates you and keep you accountable. A planner may help develop financial planning strategies with you but remember, change always starts with yourself!
About the author
Jon Ti is a licensed financial planner who coaches families with their financial management and helps them focus on improving their long-term financial behaviour. He can be contacted at email@example.com