Managing Your Cash Flows

[Retirement Planning Series] Session 2: Managing Your Cash Flows
We are glad to have you with us for our 2nd Session on Retirement Planning - Managing Your Cash Flows

Alright so let's get started…

Managing your cash flows wisely is imperative in the journey of building your retirement corpus. You might have heard the saying ‘A penny saved is a penny earned'. It is therefore important to keep track of your income and expenses so that you do not deviate from your objective of saving enough for your future.

Managing cash flows is a challenge for many individuals. Even after earning a decent income, many individuals struggle to maintain positive cash flows. A key reason being their desire to own things that are clearly outside their means. It is therefore important to draw the line between what is affordable and what is not and keep personal finances under control. Remember, if you are not living within your means, you may possibly get into a debt trap. For that, you need to learn and distinguish between needs and desires so as to be able to comfortably manage your finances or cash flows better.

So, in this session of money simplified we will help you understand how to handle your money better so as to save and invest a decent amount for your golden years of retirement.

To begin with, here are 4 broad facets you should consider and the care you should take while managing your cash flows.

4 Facets You Should Consider
While Managing Your Cash Flows

  • Know Your Cash Inflows
  • Know Your Cash Outflows
  • Inclusions in Your Cash Flow or Budget Exercise
  • Rational Thinking and Proper Planning
Let's talk about each of them in detail…

1. Know Your Cash Inflows

i. If you are a salaried individual:

You should Consider your Net Take Home pay (i.e. net salary that you get in hand) as your income for the purpose of cash inflows and not the CTC (i.e. Cost to Company or gross salary) which is subject to statutory deduction and taxes. The reason for doing so is that you cannot use the money that you do not get in your hand.

Calculating Net Income from Your Salary
Gross Annual Salary 10,00,000
Statutory Deductions 1,00,000
Net Take Home 9,00,000
Monthly Take Home 75,000
(The figures in the above table are for illustration purpose only)

ii . If you have income from business and profession:

There may be some limitations in estimating your future income from business and profession as it may vary based on business conditions. In such cases you should find a way to get expected income from your business. While you do so, please ascertain whether it reflects a trend to give a clear picture. For example, taking an average of your past income may be helpful to judge the trend.

Calculating Income from your Business
Financial Year Net Income (Rs.)
2014-15 10,00,000
2013-14 9,00,000
2012-13 8,00,000
Total 27,00,000
Annual Average 9,00,000
Monthly Average 75,000
(The figures in the above table are for illustration purpose only)

(The figures in the above table are for illustration purpose only) In this example, we have assumed that over the past 3 years, the total income drawn from business (for personal use) is Rs 27 lakh. So it gives an annual average of Rs 9 lakh and monthly average of Rs 75,000. If conditions remain the same, the future income from business / profession may reflect a similar trend going forward.

iii. Windfall Gains / Bonus:

While calculating your cash inflows, you should not ignore such incomes as they can be utilised by you to meet some more needs. Windfall Gains / Bonus may be helpful in paying off a part of your debt, or fulfilling some key needs that may otherwise be expensive. You should prepare a list of commitments that can be fulfilled from such onetime inflows. For example, if you are on the verge of retirement, you should calculate the estimated gratuity that you would receive from your employer on retirement.

iv. Dividend and Interest income:

You may also be earning dividend and interest income by the virtue of the investments made in stocks, mutual funds, fixed deposits, small saving schemes, etc. So, you should account for such income as well while managing cash flows and see how they can be efficiently used. They may help you pay some of your monthly utility bills, or if you do not need them in the near future, you may club all such income to re-invest them at a rate higher than your savings bank account.

v. Rental Income:

If you have a property in which you do not reside, you can let-out the same to fetch a rental income. Rental income is an important source of earning for retired individuals and including such income while managing your cash flows may help you plan your finances better.

vi. Other Incomes:

If you have hobbies and interest, you should think of monetising them. If you are able to do so, then it may be used to improve your life style. Do not forget that such incomes may or may not be regular and should not be used to finance regular expenses. Nonetheless they can act as an extra stream of earning when you retire.

Now let's discuss the other side of managing cash flows i.e. Cash Outflows

2. Know Your Cash Outflows

You should be disciplined and systematic when it comes to managing your cash outflows. Spending carefully, while meeting your basic and important needs is the key to balance your cash flows. So, you need to live within your means. Here are things you should consider while handling cash outflows…

i. Prioritise your needs:

You may have various needs. The best is to prioritise needs. Moreover, you need to differentiate between needs and wants…
  • Your monthly groceries, your utility bills, travelling allowances, fees for children's education, EMIs, insurance premium etc., are your basic and compulsive expenses
  • Your clothing and lifestyle are your essentials
  • Dining at a 5 star hotel or buying an expensive gadget or the latest smartphone may be classified as a less important need. Similarly, buying a luxury car or that duplex in a posh location may be a mere desire or a want.

Thus it is important to classify your needs into ‘must have' and ‘good to have' and accordingly prioritise the same. The rest could be wants or desires.

ii. Compare your needs with income:

If you are falling short of meeting your needs, then postpone the ones that are less important to the next year.

Comparing your needs with your income
Estimated Yearly Income (Rs.) Estimated Yearly Expenses (Rs.)
Salary 12,00,000 Basic Needs 4,50,000
Dividend 40,000 Essentials 2,00,000
Interest 60,000 EMIs 4,20,000
    Regular Investments 2,00,000
    Less important needs 1,00,000
Total Income 13,00,000 Total Expenses 13,70,000
(The figures in the above table are for illustration purpose only)

(The figures in the above table are for illustration purpose only) If your comparison table shows a similar deficit, where your expenses are exceeding your income; then postponing some of your less important needs to subsequent years would be helpful. You would comfortably get closer to meeting your important needs. So don't overspend and try to economise.

iii. Know your spending habits:

You should ideally list your expenses to know your spending habits. This would help you to ascertain where you are overspending and do away with superfluous expenditure. If you want to go for discounted offers, don't over indulge in them and get swayed. In fact, you may end up buying more than you need. Pre-decide the frequency of dining out so that your expenses are within limit. While buying groceries check for loyalty discounts and other offers.

iv. Set a limit on your expenses:

This will help you in not going overboard under any expense head.

Setting Limit on Your Expenses
(In Rs.) Limit Monthly Annual
Income - 1,00,000 1,200,000
Basic 35% 35,000 4,20,000
Essentials 10% 10,000 1,20,000
EMIs 30% 30,000 3,60,000
Regular Investments 20% 20,000 2,40,000
Less Important 5% 5,000 60,000
(The figures in the above table are for illustration purpose only)

(The figures in the above table are for illustration purpose only) An exercise as depicted in the table here would be helpful to stay within your means. Setting a limit on each head of expense may help you keep your overall expenses under control, thus keeping your net cash flow positive.

v. Set a target for your monthly investments:

The way to create corpus for your golden years is to save and invest effectively. Hence provisions for investments should also be a part of your annual budget. You should inculcate a systematic investment approach and allocate a portion of your income to the same - say 20% of your annual income towards your savings and investments.

vi. Build up a contingency reserve:

A contingency fund helps manage any sudden outflows without hampering your regular planned expenses. You should always keep aside 1 to 2 years of your regular expenses or 6 to 12 months of your income as a contingency fund. This may help you take care of few months of expenses during times of crisis.

Apart from what we just talked about, here are some important aspects to take into consideration in your cash flow or budget exercise.

3. Inclusions in Your
Cash Flow or Budget Exercise
  1. Remember to track irregular cash outflows:
    This is something which many tend to miss out. Household maintenance, vehicle maintenance, donations, birthday /anniversary gifts or such other expenses tend to be missed out while planning cash flows. So, include them to be more realistic!

  2. Remember to discuss your Budget Exercise with your family:
    If you are spending as a family, you can also learn to save as a family. Keep your spouse and kids involved in the path of achieving your life goals, and also celebrate achievement of key goals with your family (but of course being within your means). Involving your family members will facilitate an integrated and well-co-ordinated approach.

  3. Track and review your cash flows:
    You should ideally do this at least once a month. Many people are under the impression that they are done once they plan expenses based on their income. But that may not be the case as you need to review your cash flows with the changing environment.

4. Rational Thinking and Proper Planning

  1. Remember, managing your cash flows prudently is means to an end
  2. Rational thinking is imperative to manage your cash inflows and outflows
  3. Prudent goal planning would help you to lead a peaceful retirement
  4. Adopt financial discipline while investing for your retirement and other financial goals
  5. If need be, take professional guidance to set your finances right

So to end our learning exercise today, we now invite you to test your learning by taking up this simple quiz (and win exciting prizes!)

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