Your IndustryFeb 14 2023

What are the benefits of cash flow modelling?

  • Describe the significance of cash flow modelling
  • Explain the different types of cash flow modelling
  • Identify how to keep monitoring cash flow
  • Describe the significance of cash flow modelling
  • Explain the different types of cash flow modelling
  • Identify how to keep monitoring cash flow
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CPD
Approx.30min
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CPD
Approx.30min
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pfs-logo
cisi-logo
CPD
Approx.30min
What are the benefits of cash flow modelling?
(FT Money)

Deterministic vs stochastic modelling

  • If we are using a deterministic cash flow modelling system, then we know that we need to be stress-testing our results for stock market turbulence and crashes. 
  • With a stochastic modeller, the volatility in investments is already captured, but we need to be able to explain this to our clients. Our results will also be presented as a range and we need to ensure they understand the potential losses as well as gains.

Risk-based vs fund-based modelling

  • If we are using fund-based modelling, then we need to be sure that the current portfolio is representative of the portfolio we would expect our client to be in for the long-term, or enter a different asset allocation that is more representative. 
  • If we are using risk-based modelling, then the actual make-up of the portfolio matters less than the overall risk profile, which must be appropriate for the client for long-term investment. 

Real vs nominal outputs

  • We need to be sure of what we are looking at in our outputs. Real values will show a consistent level of purchasing power over the cash flow plan, but fund values will therefore look lower than if we are using nominal values.
  • With nominal values, we must check that our client understands how inflation will affect the purchasing power of their fund at different points in time.
  • For both forecasts, it is vital that we are using the appropriate expenses, either real or nominal, to match our portfolio values.  

The process: building a plan

Cash flow modelling is built on data, with the entire process built around understanding what goals might look like for your client, as well as showing them the path their finances may take.

As we all know, trash in leads to trash out, so we need a robust solution to collect accurate incomes and expenditures now, as well as in the future. 

We are therefore going to want to collect information on current levels of incomes and expenditures, including the day-to-day life costs and details of less frequent spending. Any anticipated changes to these income and expenditures also needs to be captured and modelled.

Once we have input current levels of incomes and expenditures, we also need to capture all of the clients’ investment, savings and debt products, including those not under advice. This gives us a clear view of the current situation. 

From here, we need to take the client on a goal setting journey, to include all of those essential and ‘dream of’ expenses we are hoping to achieve over our lifetime. This will include a view of what retirement might look like, and the level of expenditure we are expecting.

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