The Importance of Cash Management

An important part of any financial planning strategy is cash management and in this article, we will look at some of the ways that cash can be used within a financial plan.

Receipt of a Lump Sum

From time-to-time clients will receive a large cash lump sum which may occur, for example, when selling a business or a property, when taking pension tax free cash or when inheriting some money.

Although most banks are in a much stronger financial position than they were during the financial crisis, it is important to consider the financial strength of any financial institution and to take into account the limits of the Financial Services Compensation Scheme (FSCS) which currently stands at £85,000 per person per eligible account.

For large lump sums, it is worth noting that the FSCS will also protect temporary high cash balances of up to £1m for six months from when the amount was first deposited.

Having said that, for most clients who are in receipt of large cash balances we will typically suggest that the money is held with National Savings and Investments which is guaranteed by the Treasury. The money can be held for a period of time whilst we discuss the client's goals and objectives and update the financial planning strategy which may then involve investing a portion of the cash for the longer-term.

Emergency Cash

We recommend that all our clients hold an emergency cash balance which can be accessed in the event of any unforeseen emergency. For example, if the boiler breaks down or the roof springs a leak.

Most of our clients will hold between three and six months’ worth of expenditure in an emergency cash account which is typically a deposit account with immediate access. It is important that the balance is maintained so we would always suggest topping it up where necessary when we carry out our annual reviews.

Short-Term Goals

The next reason to hold cash is to meet any short-term goals. If you are looking to make a significant purchase in the next few years, it is important that the capital value of your cash is maintained and so you would want to separate this money from any longer-term investment.

The great thing about online banking is that different cash accounts can be set up online and then given a name linked to that particular goal. For example, we have clients who hold several cash accounts labelled, ‘holiday fund’, ‘cycling fund’, ‘school fees fund’ and even ‘eating out fund’.

Income Needs

It is important that we ensure that clients, especially those in retirement, have sufficient cash to meet their expenditure. For most clients drawing down from their accumulated capital, we will look to ensure that they hold around two years’ worth of income in cash which will sit alongside their longer term investments. When markets fall, we will look to use the cash to meet their immediate cash needs and when markets rise, we will use some of the gains to top up their cash balance. Generally speaking, this will enable us to avoid having to sell longer-term assets when markets are falling.

Liquidity

Liquidity just means how easy it is to convert assets to cash and this is something we highlight in our financial plans as being extremely important.

I have seen many prospective clients who, whilst on the face of it appear to have significant assets, when we drill down we find that many of those assets are relatively illiquid. For example, those with much of their wealth tied up in property, private equity or other esoteric investments.

Although they can often borrow against these assets, it can be expensive and quite time consuming so it is important that clients do have some liquidity to meet any unexpected cash needs.

When we consider longer-term investments, it is important that a significant proportion of assets are liquid, in other words they can be sold via an investment platform and the monies can be within a client’s bank account within five to seven days.

Conclusion

Financial plans are designed to meet a client’s financial goals over the long-term and, as such, it is important to put in place a coherent, long term investment strategy. However, it is also important not to neglect a shorter-term cash management strategy to ensure that clients can meet their expenditure needs and this should be factored into their financial plans.