Financial forecasting – sometimes known as cash flow forecasting – is an important part of Financial Planning.
Most people understand how vital it is for a business to produce forward-looking forecasts, including assessments of future, predicted, profit and loss accounts, balance sheets and cash flow statements. These forward-looking figures will often determine targets and budgets for a business.
This is exactly the same principle that we adopt in our financial planning work with individuals and families. A financial forecast is essentially a prediction (or assessment) of future income/expenditure.
Historically people have tended to ‘plan’ their finances through approximations and serious rounding exercises. A good example would be someone who wants to retire at a specific age and identifies they will need about £100,000 or £1 million or whatever. These rounded figures are often nothing more than a finger in the wind, a guestimate or stab at trying to find a number. They are not calculated in any meaningful way. They rarely take into account expenditure requirements (and fluctuations) and they are not scenario-tested. What does this mean? They are not looking at the impact of different future scenarios which may not be entirely predictable. A good example will be someone plotting their retirement income/expenditure who does not account for the financial impact of long term care costs being incurred.
Cash flow financial forecasting aims to take a different approach. As Financial Planners we have access to software which allows us to work with our clients to stress test long term income and expenditure patterns. By long term we mean taking multi-decade views. These long terms patterns can be tested against various different scenarios, for example, we can run one future forecast assuming a retirement age of 55, another at 65. We put all known factors into the forecast and can adjust for all sorts of variables, such as investment returns, inflation, savings amounts and expenditure patterns. These scenarios show variable results and will pinpoint future shortfalls, risks and threats.
It will help determine the right investment strategy, asset allocation, risks that need to be taken (or avoided) and quite possibly help with the tax structures.
Crucially it will also provide the clearest possible picture of how the financial plan needs to look overall – this often produces surprising and, on occasions, revealing results.
Our clients are always pleased to work with such an interesting model and we constantly receive great feedback on how effective this is in creating the clearest possible picture. It also regularly provides a high level of reassurance as many people find they are in a better position than they may have thought!
In Financial Planning terms, financial forecasting is a central plank in the decision-making process; plus, it is a component part of building a long-term, successful and efficient plan.