Cash flow management is the core of financial planning. It needs to addressed comprehensively, if the financial plan has to work.
Liquidity: The first principle in cash flow management is maintaining liquidity to the extent of approximately three months expenses. In certain cases, where the income flows are uneven, we may even suggest up to six months' salary or expenses as a liquidity margin. It is a good idea to keep this in the form of actual cash in the bank account, sweep-in deposits (which is near-cash) or in debt mutual funds. This is maintained to ensure there is no problem even in case of disone is changing jobs, has medical conditions due to which one is on loss of pay and so on. Then, the liquidity margin will come in handy. This will be especially useful for people who have monthly instalments to clear, like a house loan, which need to be paid over and above the regular expenses.
Additional provision: It is always better to have liquidity over and above that provided by regular income sources. Additional sources are those which could be liquidated when the need be, like in bank fixed deposits. Investments in stocks and mutual funds (equity or debt) could also come handy, as they can be liquidated as and when required. Investments in Public Provident Fund, Employees Provident Fund, National Savings Certificate are illiquid as they come with a mandated lock-in period.
Contingencies: You would like to provide for unforeseen times. Like, for your aged mother's health requirements. Contingency is for unknown situations or emergencies, for holidays or guests, insurance premiums, and so on, in a particular month. When such expenses come up together, they disrupt surplus available. It is a good idea to be prepared and invested for appropriate tenures.
Example: If holiday expenses are coming up in seven months, invest in a 180-day FMP and use the proceeds on maturity. If the amount is not available upfront for investment, you can accumulate it through a systematic investment plan (SIP) in a mutual fund scheme. Provisioning can also be done from maturing investments. For instance, investments maturing between now and the time required can be moved to a debt fund and be redeemed when required.
Handling investment inflows: Maturing investments need to be reinvested or put to use, as per your budget or upcoming expenses. It is important to have information regarding all the investments due to mature in the next one year. Plan for investing these amounts in the interim, after considering upcoming or sudden expenses. Ideally, chalk out which amounts are going to be invested, in what kind of products and how much need to be consumed. Sometimes, the amount expected to be received may be big, like a annual bonus. Since the actual amount may not be known, having a rough investment plan would be needed. There could be investments or money from insurance that we would have redeemed in a particular month. Such inflows also need to be considered for deployment.
Managing improved inflows: There are points when the monthly cash flows would improve. For instance, you may get an increment in six months of approximately eight per cent, then the increased cash needs to be deployed. Decide the investment avenue in advance. For instance, an SIP or recurring deposit is recommended for parking this fund. Sometime, it may be used to augment the liquidity to the required level, if it was dipped into due to sudden rise in expenditure. Once this is done, revert to investments in SIP or recurring deposit.
Cash outflows contingent on inflows: When planning, we sometimes suggest individuals incur an expense which is contingent on an inflow. For instance, a foreign holiday may be suggested only if they receive a bonus of a certain amount. Or, consider renovating your house only on receiving a raise or a bonus. Apart from easing the cash flows, it also brings discipline and commits cash inflows for cherished goals, especially not very important ones.
While planning your cash flow, it is necessary to choose the appropriate investment options based on the end-use of that money. When planning this, apart from the tenure, the choice of investment instrument would also be based on the returns, risk, liquidity requirements and tax liability. Appropriate choices, here, would help in improving the returns. And at the same time, provide for smooth management of your finances. Financial planning itself and cash flow management in particular, are easy to understand and mostly intuitive. Thinking through the whole thing and executing these over time is the key to success.
Just remember: God is in the details.
