Why understanding your current financial status is crucial

Why Understanding Your Current Financial Status Is Crucial ?

One of the best ways to understand your current financial status is to prepare and analyse your cash flow statement on monthly and annual basis. A cash flow statement would tell you whether you have surplus cash after you pay your taxes and after accounting for your lifestyle expenses. Please note that you need to consider data for a Financial Year from April to March.

You can use the ‘50:30:20’ guideline to track your budget using your cash flow statement. As per this guideline, you must apportion 50% of your take home salary for your overall expenses, 30% towards savings, and 20% towards floating expenses. Your expenses must be 50% of your take home salary after you pay your taxes. Your expenses would include all your household expenses, rent, EMIs, utility bills, food, entertainment, education, and fuel. You should be saving at least 30% of your take home salary. You should invest this savings for achieving your long-term goals. These would include higher education of your children, their marriage, and your retirement plans. The last 20% of your take home salary should be apportioned for your floating expenses. This would be useful for your short-term goals such as cars, foreign vacation, and Smartphone. It would also be useful in terms of building an emergency fund for contingencies.

Let’s see the cash flow example of Rahul and Ritu. Rahul works as a Marketing Manager at Yes Bank and draws Rs. 100,000 per month. His wife Ritu, a Copywriter at Lowe Lintas, draws Rs. 75,000 per month. Following is their cash flow statement for the Financial Year 2016-17: For 2016/17

Salary

Ritu (Rs)(Monthly) Rahul Grand Total (Rs) Annually (Monthly) (RS) Inflows 75,000 100,000 2,100,000

Interest on FDs

1,666

3,334

60,000

Rent

-

-

-

76,666 Outflows 30,000

103,334

2,160,000

30,000

720,000

Household expenses

21,500

26,500

576,000

Insurance Premium & SIPs

10,000

10,000

240,000

Vacation

5,000

5,000

120,000

Other investments

-

-

-

Taxes

3,400

9,000

148,800

Total outflows Surplus/(Deficit)

69,900 6,766

80,500 22,834

1,804,800 355,200

Total Inflows EMI

The cash flow statement of Rahul and Ritu clearly shows that their main income sources comprise salary and interest of FDs. Salary in the above table is gross salary and the first two columns show monthly numbers with the last one showing annual numbers. Their outflows comprise EMI, household expenses, insurance premium and monthly SIPs, vacations, and taxes. Thus, after deducting total outflows from the total inflows, Rahul and Ritu have a joint annual surplus of Rs. 355,200. Now, Rahul and Ritu know that they can invest this annual surplus towards achieving their goals. Thus, understanding your financial position through a cash flow statement is very crucial for determining your savings surplus available for achieving your financial objectives.

Let’s now see if Rahul and Ritu’s cash flow management falls under the ‘50:30:20’ guideline. Total expenses (EMI + Household expenses) are 66.42% of the total take home salary, which is calculated after paying taxes. The guideline clearly states that expenses must be maximum 50% of the take home salary. Thus, Rahul and Ritu can do better in this department. They are saving 30.50% of their salary towards monthly SIP and insurance premium (including the cash flow surplus), which is close to 30% suggested by the guideline. Thus, they are doing well in this area. However, their floating expenses (Savings for vacation) are 6.14% of their take home salary, which is well below the suggested guideline of 20%. Thus, they are clearly not saving enough for their short-term goals. Analysis of their cash flow statement will now help them understand that their total expenses percentage of take home is at least 16-17% more than the maximum prescribed limit. Thus, they could allocate the excess share towards their floating expenses, which would help them cater to their short-term objectives much more effectively.

Thus, understanding your cash flow statement helps you make all the necessary adjustments to your inflows and outflows to get as close as possible to the ‘50:30:20’ guideline. For more information on financial planning and investment, write us at investmentz@acm.co.in or give a missed call at 08010968308