Care to be taken with cashflow in these times
Managing your cashflow has become critical since this Covid-19 crisis emerged. Most have lost or have reduced income. To meet this historic challenge, the Government of Bermuda has legislated emergency financial assistance for those unemployed after the business stoppage.
On May 8, the House of Assembly approved voluntary withdrawals of up to $12,000 from private pension plans. Before requesting an early distribution from your pension scheme, or continuing expenditures as usual with any financial support received, it is time to look at your spending patterns and habits.
Zero-based budgeting is a good discipline. Scrutinise each item for whether it is critical. Some items can be reduced, others postponed. Much of daily spending can be habitual or add-ons at the checkout counter.
If already faced with debt or mortgage payments, it may be that a moratorium could be arranged or a restructuring of the debt altogether.
A good benchmark is that debt payments should not be more than one third of gross income, preferably less. This is known as the debt-to-income ratio. For example, income of $5,000 a month should have monthly debt payments of $1,500 or less.
For an overview of cashflow, construct an income statement that captures all income and all expenses. The difference is your net cashflow. If it is negative, changes are in order. Extra funding may come from savings or by receiving emergency funding.
The balances of savings accounts and pensions will be reported on a balance sheet, which “balances” assets and liabilities. A balance sheet lists the total existing value of the monies, investments and pensions, along with amounts to be received, as well as houses, boats, cars or other valuables that are known as assets.
The balance sheet also lists the total balance owed on loans, mortgages or other financial commitments. These are the liabilities. The difference is net worth, or equity for companies.
A debt ratio of assets divided by debt indicates whether debt is at sustainable levels. It should be in the range of 0.6 to 0.7 — ie, $500,000 assets/$350,000 debt = 0.70 debt ratio.
More than that can be troublesome. This is one of the reasons to be careful about drawing from pensions, as it will dwindle the asset side of the equation. There are promotions encouraging pension withdrawals to put the funds in another account or to invest in something less secure.
There are so many unknowns about when and how business will resume, and what will be the income or revenue received. Plan for more than today. It is difficult to get an accurate idea of how long any shortfalls will need to be funded or what they may be. In this case, it is useful to make three cashflow forecasts or scenarios.
One scenario is the best case, where the lost revenue is minimal, if at all. The best case is based on known information and the spending cuts that need to be made. The worst case is where things go on for longer, which will necessitate more cutbacks and workouts. In the worst-case scenario, all the difficult choices can be considered in order to prepare accordingly.
The following format can be used and adapted for business use.
These scenarios will provide a planning picture. The amount of emergency funds needed will be estimated by the number of months in the various scenarios. A basic financial planning guideline is to have three months of spending in an emergency account when there are two incomes in the household. In a one-income household there should be a six-month emergency fund.
It is a good idea but difficult to achieve without planning for it. Put monies in a different account so it is not commingled with the normal operating account. If drawing down on it now, remember to replenish it when possible. In the other event, if things stay bad for longer, major rethinking of expenses and, possibly, housing will be in order.
Bulk-buying or house-sharing could address the two large expenditures. Another idea is to look at other means to raise income by making something to sell or offering services that can be done independently. There are also boot sales and eMoo. Difficult times require difficult measures.
There are a number of services in Bermuda to assist people and businesses with cashflow forecasts. the Department of Financial Services has a form to assess financial status. The Bermuda Economic Development Corporation has a series of financial statements to complete for its support. Many of the pension services have templates to determine present and retirement cashflows. This points how important it is to think long term. Really long term.
Balance actions today with what will be needed in the future. Financial planners such as Senior Solutions Ltd can guide clients by quantifying cashflows and cash goals in the future. What can be funded through savings and investment approaches and what might need to be reined in? Those are the questions.
Check out savings patterns to cash goals to see if the goals can be met.
Patrice Horner is the Director of Senior Solutions Ltd, holds a Master of Business Administration degree in Finance and is a certified financial planner