Cashflow is critical to the survival of a property portfolio. I’ve made that statement on many occasions…probably because it’s the most fundamental truth of investment.
Without capital coming in, how do you safely and sustainably acquire, and hang onto, a retirement fund that grows to provide sufficient wealth for you and your loved ones when you stop working? You don’t. Period.
Although some people balk at the idea of number crunching, finding the process of calculating their personal net worth too daunting to contemplate, developing a cashflow forecast doesn’t have to be a traumatic undertaking.
So let’s go through the very simple steps, and explore the critical elements you’ll want to attend to, when developing a cashflow forecast…
Doing the cashflow four step
Analysing figures is really about lateral thinking and common sense, and can be broken down into four basic actions…
- First, add up all of your current and anticipated income for the year.
- Second, add up all up all of your current and anticipated expenditure for the same period.
- Third, deduct the answer you derive in the second step from the first step. i.e. Take away your expenses tally from your income tally.
- Finally, what are you left with?
While it can be tricky calculating some of these items, given potential unexpected fluctuations in things like income tax rates, pay rises or decreases, or commissions and bonuses, it’s important to be as accurate and forward thinking as possible.
If it’s a positive outcome, yay you! That’s the goal when it comes to financial planning; particularly for property investors who need some type of cashflow buffer in place to reduce the risk exposure of a highly geared investment.
How big is your buffer?
Once you do your calculations, it might be that you have very little left to contribute to a cashflow buffer; a critical component of your portfolio intended for emergency use only.
If this is the case, it’s time to drill down further into other potential risks to your cashflow position, including reduced income or large, unforeseen expenses, such as emergency repairs to rental premises or extended vacancy periods.
Then it’s about considering alternative strategies, such as fixing a portion of your investment debt to reduce the chances of a sudden increase in your monthly mortgage repayments.
How do I predict the unpredictable?
One of the most complicated tasks you’ll have to attend to when producing a comprehensive cashflow forecast is attempting to work out any ebbs and flows in your future earnings.
The key is to be conservative, as it’s always better to underestimate your financial capacity and be pleasantly surprised with any surplus, rather than the reverse scenario! Don’t forget to account for all revenue sources, including rental income.
Consistency can also be difficult to achieve when it comes to forecasting future expenses.
Things like interest rates might currently be a little more predictable than we’ve seen in the past. But that’s not to say things like banks making independent rate rises on their loan products won’t have any impact on your cashflow.
A good rule of thumb when calculating your cashflow capacity is to work on an interest rate of around 7 per cent. Not only will you satisfy the bank’s risk assessment criteria, you’ll also have a very comfortable safeguard against future rate rises.
As for general living expenses, mortgage brokers generally base their projections on the going rate of inflation, which is ideally managed at around 2 to 3 per cent by monetary policy.
Ultimately, a cashflow forecast is really a bunch of simple mathematical equations…the kind of adding and subtracting you most likely learnt in primary school.
The critical aspect of this planning is that it gives you genuine clarity on your financial perspective and where it is you’re heading, which in turn will provide a confidence boost as you venture further along the property investment journey.
If in doubt, seek advice from an appropriately qualified accountant or financial planner. Better yet…give the team here at Trilogy Funding a call, and we can guide your way with our extensive industry experience.
Click here to connect with us now.
About the Author
Since 2008, David Thomas has built a business aimed at servicing the needs of property investors, owner occupiers and small business owners. David is recognised as one of the top 10 independent mortgage brokerages in the country, David and his team have settled almost billions of dollars worth of residential and investment loans over the last decade.
Known for his straightforward, relatable style, David believes by educating people about property funding; they fare better in the market. By sharing his expertise openly, some of the people he educates will likely become his clients. It's a win-win approach.
David Thomas is a credit representative (Representative Number 506153) of BLSSA Pty Ltd, ACN 117 651 760 (Australian Credit Licence 391237).