Objective: Understand Cash Flow Forecast

Question 1

(a) Identify the main factors and assumptions that you would discuss with
Tom and Sally when formulating a cash flow model (10)

Answer 1

(a) Factors and assumptions when formulating a cash flow model:
 Expected future expenditure pattern
 Their plans for future gifting
 Their expected longevity/health
 Likely need for long-term care/ plans if long term care is required
 Their attitudes to risk
 Their capacity for loss
 Expected growth rates to be used in respect of investments
 Assumptions for fees/ charges
 Assumed inflation rates
 Use of tax efficient wrappers/ willingness to place assets in the lower taxpayer’s
name to make maximum use of tax allowances and exemptions

Question 2

(b) Explain the benefits of using a cash flow forecast in establishing a strategy
for meeting Tom and Sally’s financial objectives. (6)

Answer 2

Benefits of using a cash flow forecast:
 Allows the adviser to compare the income Tom and Sally are receiving with their
expected expenditure pattern
 The adviser can stress test different scenarios to understand the impact various
future events would have on their ability to cover their outgoings
 This helps to identify any potential shortfalls and then put in place plans to avoid
these occurring
 The cash flow forecast allows various assumptions to be made/ assumptions for
inflation/ growth
 These can be adjusted based on actual inflation figures/ growth achieved to ensure
the figures remain meaningful.
 The cash flow forecast can help the adviser determine a suitable asset allocation for
Tom and Sally’s investments

Question 3

(c) Explain the risks of relying solely on cash flow modelling to help them
meet their financial objectives. (7)

Answer 3

(c) Risks of relying on cash flow modelling:
 Assumptions can be incorrect
 Requires regular reviews
 Objectives and circumstances can change
 Cash flow returns are linear
 Tax rules/ rates are likely to change
 Does not allow for market risk/ systemic risk/ political risk
 Does not consider liquidity of investments

Question 4

) Outline six scenarios that should be discussed with Tom and Sally when
carrying out a stress test of their cash flow forecast. (7)

Answer 4

(d) Stress testing cash flow forecasts:
 Permanent loss of income source/ capital assets (e.g. market crash)
 Future returns are lower than forecast
 Income requirements are higher than forecast
 Large unplanned capital withdrawal
 Inflation higher than forecast
 Living longer than expected
 Adverse change in personal circumstances (e.g. death/ divorce