Cashflow modelling - Essential or Superfluous?
Written by Niel Gavin on 17/05/2019

Over the years the financial services industry has come up with lots of “tools” designed to help a Financial Adviser do their job. 

If any of you remember the heady days of Friends Provident First Call, then you’ll remember fondly the “Rate Mate” which helped you all decide how much protection plans were going to cost your client there and then (subject to underwriting of course!) this was a tool that offered a limited ability to help you do your job. 

We have moved on quite a lot since the early 1990’s and there are plenty of tools swimming around the market that can potentially help an adviser do their job, tools for: 

DB Transfer Analysis

Annuity calculators

Pension switching comparisons

Cashflow modellers

Investment performance tools

Equity release calculators

CGT calculators

TER calculators 

To name but a handful….. 

But I want to look at one in particular and to tell you why I feel that it should be used and how it benefits your clients and you, the Cashflow Modeller

What is it? 

In simple terms a cashflow modeller is a budgeting tool, plain and simple. However it is much more than a tool to calculate how much disposable income your clients have each month to see if they can afford that term assurance that you want to recommend. 

It can do so much more if you use it right! It can show your clients just how their income and assets could behave in the future and help them understand if their plans for future income and capital expenditure have a chance of becoming reality. 

I am thinking here about Pension Drawdown and Income needs in general (maybe from an investment portfolio perhaps) 

When you look at a client that is approaching an age where they can and more importantly want to start drawing income from pensions or investments, you need, as their trusted adviser, to be able to demonstrate that what you are recommending is in fact the right solution. 

One of the most important things to look at here in my experience is cashflow! 

If you are recommending that your client commences Drawdown then they obviously have either a capital or income need or both. 

As their adviser you need to be able to show several things in this case, including that they will be able to meet their desired income requirement. 

Now if all they have is a PPP then you may argue that you don’t need to cashflow model as the Critical Yield A & B can show you if they can sustain an income target, right? How many clients have just that though? In fact almost every client will get a State Pension at some point (I know not everyone will but the % is pretty high) 

Allow me to show you my thinking here. 

Let us take a typical hypothetical client here, Mrs X

Mrs X has the following assets and is approaching her 60th birthday and considering her income options (she is thinking can she retire?): 

Paid-Up PPP                                       £500,000

ISAs                                                       £160,000

Premium Bonds                                £50,000

Buy to Let Property                        £225,000

AE Pension pot                                 £16,000

Savings account                                £9,000

Main residence                                £475,000 

She also works full time currently and has a small retained DB pension entitlement that will pay her £8,000 a year from age 66, which also is her State Pension Age (SPA). 

You know that she earns £45,000 a year and that she is actively accruing pension funds through her employer’s QWP (qualifying workplace pension) you also know her ATR and capacity for loss. 

In your discussions you know that she would like to have flexibility of income in retirement and that she could probably benefit from paying off the remaining Buy to Let mortgage of £100,000. 

In the brief summary above every single thing could influence your advice in some way. 

So you’re all set to review her existing pension plans and come up with a way to get her the £100,000 she wants and then a regular income, time to write your suitability report and get the ball rolling! 

BUT you haven’t carried out a Cashflow analysis have you? 

How can you give her advice without one? 

Never mind that the FCA say that for DB transfer cases Cashflow is all but mandatory as part of an analysis but let us consider what you are seeking to do here with this imaginary client. 

You are seeking to give “Best Advice” plain and simple for income and for it to be sustainable to meet her needs. 

How can you give best advice to a client in respect of income provision without modelling future potential cashflows? 

My answer would be that you simply can’t! 

In the hypothetical case above, never mind all the good stuff around ATR, Capacity for Loss etc, you should be analysing and showing your workings out (good old school stuff) on the various capital and income sources this client has access to and how this may affect your advice. 

Take our client above. 

Let’s assume that she wants £15,000 a year net income when she gets to 65 and that she is in fact going to receive a full State Pension at 66, already we have something that should affect her potential Drawdown, right?

Then there’s the ISA portfolio? Can that give the lump sum she needs? Will she draw income from it at some point?

What of her Buy to Let? What income does it generate and how long could it last?

What of her AE pension pot and the retained DB one? 

I won’t go on but hopefully you can see my point here…….? These things will affect the Drawdown advice that you will no doubt give and let’s be frank here, several of them can affect the longevity of a Drawdown pot, possibly making your potential advice more justifiable. 

Without doing a Cashflow Analysis here how can you possibly give good advice based upon this client’s personal circumstances? I believe that you cannot. 

Of course there are lots of assumptions used in any analysis, our whole industry lives on assumptions but here I am hoping that I can show the value of this particular way of doing business….. 

Cashflow modelling is essential in showing that you know your client, if you are arranging a future income stream you must be able to show that you have considered anything that could reasonably and realistically affect your advice and cashflow modelling is one of these key things, I believe that without it you cannot give good advice on drawdown. As the FCA have shown, they already consider it essential in DB transfers (where it is all about knowing your client and their future income benefits) and I would argue that Drawdown is another case where this approach is vital. 

I am not suggesting that advisers use this to satisfy some mandatory box-tick, rather I feel strongly that used correctly it can only serve to strengthen your advice and increase the relevance and value to your clients! Let us also not forget that in retirement annual reviews really are important and this forms part of showing your clients the real value of the ongoing fees charged. 

In summary, we at IFAC believe that giving good advice is obviously essential but will be profitable and frankly, not that that hard to do, provided that you maintain the view that you are there to do the best job that you can for your clients and the better the job you do, the longer that client will stay with you. 

Longevity here equals more income and better quality business. 

IFAC will be looking at the viability of providing a suitable Cashflow Modeller to our clients to help them support their advice process, so keep watching for more details on this subject but in the meantime with every Drawdown case you look at, consider the benefits Cashflow Modelling will offer to support your advice and help you do the best you can for your clients, we certainly will!

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