One very simple tool is a Financial Scorecard — the first step to effective financial planning. It captures total financial information in one page and comprises the four squares of
A. Income,
B. Expenses,
C. Assets and
D. Liabilities
A) The Income square has two subheadings of
Ø Income from active sources and
Ø Income from passive sources.
Active sources include employment salary, professional income and business income.
Passive sources include property rent, interest on deposits, dividends and capital gains from stocks and royalties. Deductions of taxation, pension contribution and any other source will provide the net monthly income.
B) The Expense square divides methodically expenses into various categories, like food, clothing and housing. These are followed by children, health and transportation related expenses. Appliances replacement costs and discretionary expenses are also added. EMIs for various loans will also be included in this square.
C) The Asset square divides assets into three parts —
Ø Liquidity,
Ø Safety and
Ø Yield enhancing
Some assets have to be liquid and readily available for contingencies, even if their returns are low. These will include short-term deposits and liquid funds. Some assets have to be in absolutely safe instruments that retain their value even in adverse circumstances and these include provident fund, government securities, contributory pension schemes, small saving schemes, real estate for own usage (primary residence) and safe fixed term deposits. The third part will be yield enhancing and will include stocks, equity funds, real estate for investment, long term bond funds, commodities, art, antiques and structured products. Only after liquidity and safety have been taken care of, should the remaining assets be utilised in return enhancing asset classes. This square facilitates asset allocation — the most effective part of financial planning.
D) The Liability square lists
Ø Short-term and
Ø Long-term loans
Short-term loans, generally with a tenor of less than three years, may include credit card loans, borrowings on life insurance policies, personal loans and accrued income taxes.
Long-term loans include the home loan principal yet to be repaid, loans for investment assets and personal assets like cars. This square renders an easy comparison of interest rates being paid on different loans. Loans like credit card loans may be carried at high interest rates and can be eliminated on a priority basis. It also provides vital information on the assets being financed by loans. For example, a home loan is financing an asset that can produce a rental cash flow and at the same time, show capital gains.
These four squares are interconnected and realising these connections can make financial planning more effective.
The difference between assets and liabilities is net worth, a popular measure of wealth and will be a good indicator of progress.
For example, if assets are giving good returns, it adds to passive income and bolsters the income square. This, in turn, increases savings, which can be utilised in productive assets. Contrastingly, a liability adding heavily to expenses could erode savings, thus decelerating the assets build up. Income and expense squares will show whether there is potential to save more or move expenses to an area which enhances lifestyle.
Armed with the four square scorecard, a planner has total financial information of client on a single page and knows the current picture.
This is an effective tool to judge progress — whether the client is approaching his/her goals or whether the current strategy requires modification.
