What is cash flow modelling?
Lifetime cash flow modelling is designed essentially to help clients to become financially more organised. Learn more as you prepare to sit CII AF4, AF5, R02, R04 or R06 exams.
THIS ARTICLE IS RELEVANT TO EXAMINABLE TAX YEAR 2019/20.
A plan should produce a detailed summary of a client’s financial position and enable them to work towards achieving financial freedom. It can also help to plan:
- for the consequences of serious illness and death
- to minimise tax
- personal expenditure with cash inflows and future cashflows
- an investment strategy
The current cash flow statement is total income (earned and investment income) less expenditure (fixed and discretionary) for the current period collated all in one place.
By taking time to analyse inflows and outflows, a client can see where potential savings can be made and highlight any periods of high expenditure e.g. school fees.
The type of exam question on this topic that regularly comes up showed itself in one of the 2017 AF5 Financial Planning Process papers and one of the R06 Financial Planning Practice papers; this is the one from AF5:
Identify the main factors and assumptions that you should discuss with the clients when formulating a cash flow model.
Factors-type questions often appear in AF papers, and candidates need to ensure their answers relate back to the information in the fact-find. The model answer to part (a) of the question was:
- Target how much for each objective/future expenditure
- Term of investment/expected longevity/normal retirement date/mortgage repaid
- Budget/affordability/current expenditure/current income levels/inheritance
- Level of risk/ATR
- Capacity for loss
- Expected growth rate for investments
- Assumptions for charges/fees
- Inflation rates/earnings growth
- Use of tax-efficient wrappers/allowances/future tax rates
Part (b) of the question asked candidates to:
Explain briefly the risks of relying on cash flow modelling to help the clients meet their financial objectives.
The model answer for this part of the question was:
- Assumptions can be incorrect
- Provides estimates only/requires regular review
- Personal objectives/circumstances can change
- Cashflow model returns are linear
- Tax rules/rates may change/not all systems account for tax wrappers
- Market risk/systematic risk/political risk
- Does not consider liquidity of assets/investments/liquidity risk
Anyone studying for R06 and AF5 should ensure they are comfortable with this style of question on cash flow modelling.
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