Evaluating the Financial Position of Clients

1Why cash flow management matters

Cash flow is the starting point of personal finance: both the amount and timing of income and expenses matter. A salaried person with monthly income and monthly bills is well matched; irregular income with steady expenses creates short-term mismatches that must be met by costly debt, whose interest cuts savings further. A steady surplus (savings) is needed for difficult times. Poor cash flow management causes stress in the family, even health problems; good management gives control and confidence and keeps the household running smoothly.

Remember

• Mismatched timing → borrowing → interest → less saving.

2Preparing a household budget

List all income (regular items such as salary, and irregular ones such as investment income). Then classify expenses:

• mandatory (PF contributions, tax, loan repayments);
• essential living (groceries, education, rent and maintenance, transport, phone and internet, utilities);
• discretionary (entertainment, lifestyle), which can be cut if needed.

Income minus expenses gives savings. Note the difference between the monthly surplus in hand and savings: the surplus is after mandatory deductions such as PF and NPS contributions, which are added back (along with planned investments) to get savings.

Example The ABC family earns ₹1,37,000 a month (salaries ₹1,10,000 + investment income ₹27,000). Expenses total ₹1,12,000 (including PF ₹9,000, tax ₹12,000, loan ₹12,000) and investments ₹18,000, leaving ₹7,000 in hand. Savings = PF 9,000 + investments 18,000 + surplus 7,000 = ₹34,000; savings ratio = 34,000 ÷ 1,37,000 ≈ 24.8%. For a six-month emergency fund, monthly expenses to cover are regular expenses ₹79,000 + loan ₹12,000 = ₹91,000.

Remember

• Savings = surplus in hand + PF/NPS contributions + investments.

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3Cash management and the income and expenditure statement

Cash management checks that budgeted income and expenses are backed by actual cash. If ₹15,000 of a ₹50,000 salary is reimbursements not yet claimed, only ₹35,000 actually arrives, which may cause a crunch. Bunching expenses at the start of the month, or a delayed salary, can do the same. Keep a cash or bank buffer, or a separate fund for short-term mismatches (distinct from the emergency fund, which covers loss of income).

The income and expenditure statement shows actual income and expenses for a period (month or year), for comparison with the budget. It is on an accrual basis: salary for March received on 1 April counts in March; a credit card purchase counts when made, not when the bill is paid. It shows the surplus and where money is going.

Remember

• Income and expenditure statement: accrual basis, not cash basis.

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4Budgeting and forecasting

Income should be regular and stable. It is applied first to mandatory expenses, then essential living costs, then discretionary ones; the rest is savings. Saving should be a defined target, not ad hoc. Steps:

1. list and total regular, definite income;
2. deduct mandatory expenses → disposable income;
3. deduct essential living expenses;
4. deduct discretionary expenses → savings.

If savings are inadequate, focus on expenses (income can only grow so far): rationalise heavy loan repayments with a planner, and cut or postpone discretionary and some living expenses.

Forecasting projects future figures and underpins the budget. It involves predicting future conditions; needs a clear basis; is dynamic; rests on assumptions that must be checked and may change; may need expert input; and improves with experience. Compare forecasts with actuals and close the gaps.

Remember

• Income − mandatory = disposable income.

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5Monitoring budgets and raising savings

Monitoring means recording actual income and expenses and comparing them with the budget, continuously, then correcting it. If conveyance is budgeted at ₹4,000 but runs at ₹6,000, either raise the budget or change the mode of travel. Regular record keeping allows mid-month reviews.

The aim is a surplus large enough for the goals: saving ₹15,000 a month is not enough if goals need ₹30,000. To close a big gap step by step:

1. set a target to raise the savings rate (say by 10%);
2. once met, set the next target;
3. cut wasteful and discretionary spending;
4. direct lump sums straight to savings;
5. do not commit pay rises to new spending.

Remember

• Raise savings in steps; save windfalls and increments.

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6Personal balance sheet and net worth

A personal balance sheet lists assets and liabilities at a particular date. Assets: physical (property, car) and financial (equity, debt, mutual funds), plus cash, bank balances and advances. Liabilities: loans and dues, including short-term debts such as credit card balances. Net worth = assets − liabilities. (The workbook repeats here the distinctions between physical and financial assets from Chapter 1.)

Example Lakshmi has a house ₹18,12,000, car ₹3,25,000, mutual funds ₹8,40,000, PPF ₹3,20,000, shares ₹2,80,000 and cash ₹45,000: total assets ₹36,22,000. Liabilities: home loan ₹12,02,000 and card dues ₹5,000 = ₹12,07,000. Net worth = ₹24,15,000. Much of her wealth was bought with loans still outstanding, and little is in growth assets. Net worth matters more than total assets.

Remember

• Net worth, not total assets, measures financial position.

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7Creating a budget and savings plan

a) gather full details of income and expenses; b) check nothing is missed; c) base figures on past actuals or likely changes; d) allow for seasonal variations (vegetable prices, birthday months); e) include a contingency amount; f) build in the required savings for goals by limiting expenses; g) allocate savings first, ideally by automatic transfers to investments, as a fixed line in the budget.

Remember

• Pay yourself first: automate savings.

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8Contingency planning

Prepare for:

• death of an earning member: life insurance;
• healthcare costs: medical insurance;
• job loss: two incomes give some protection;
• loss or fall in income: an emergency fund, the first goal to save for, covering about six months' expenses (including EMIs), held in liquid assets. With high income security, hold about three months in liquid assets and the rest in somewhat less liquid, higher-return assets (laddering). Replenish it after use and review it annually or when expenses rise (for example a new EMI);
• separation: pre-nuptial agreements are used abroad, but their legality in India is not established.

Holding arrangements between spouses: spread assets and liabilities sensibly between partners (alternate first and joint holders); align holdings with whose income funded them; keep each partner's salary account separate (with the other as joint holder) for investments, with a separate joint account for household expenses, which helps expense, investment and tax records; and make partners joint owners and joint borrowers on home purchases.

Remember

• Emergency fund first: about six months' expenses in liquid assets.

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9Savings and expense ratios

Advisers use personal finance ratios, as analysts use company ratios, to snapshot a client's position and set a course of action.

Formula Savings ratio = Savings in the year ÷ Annual income

Example ₹60,000 saved from ₹6 lakh → 10%.

Savings include money put into deposits, funds, shares, PPF, NSC, property, gold and so on, and also employer contributions to PF or superannuation. Income includes salary or business income plus interest, dividends and rent.

Example Gross salary ₹10,000 (including employer PF ₹500); take-home ₹9,000 after employee PF ₹500; interest ₹200; expenses ₹7,000. Income = 10,000 + 200 = ₹10,200. Savings = 9,000 + 200 + 500 + 500 − 7,000 = ₹3,200. Savings ratio = 31.4%.

Formula Savings to income ratio = Total accumulated savings ÷ Annual income

Example Accumulated investments (PF, deposits, funds, PPF, NSC) ₹15 lakh against salary ₹12 lakh → 1.25.

This measures readiness for long-term goals such as retirement. Use current values net of related loans, and exclude the self-occupied home. It is low when young and should rise; a suitable level in the early 40s is at least 3 times annual income, so the savings rate must rise with income.

Formula Expense ratio = Annual recurring expenses ÷ Annual income = 1 − Savings ratio

Example ABC spends ₹5.4 lakh of ₹6 lakh → 90%.

Exclude one-off expenses (a one-time ₹50,000 medical bill), but include regular ones (₹30,000 a year of routine healthcare) and the annual equivalent of periodic ones (a ₹6 lakh holiday every three years = ₹2 lakh a year). Savings usually improve by cutting discretionary items. Low expense ratio and high savings ratio are desirable.

Remember

• Savings to income ≥ 3x by the early 40s.
• Exclude the home you live in from savings.

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10Total assets and liabilities

Total assets = current value of all physical and financial assets (shares, debentures, funds, property, gold, PF, superannuation). Conservatively, exclude personal jewellery, the family home and personal-use assets such as a car when estimating assets available for goals.

Liabilities: loans and credit from institutions or friends and relatives; long-term and secured (home and car loans) or short-term and unsecured (credit cards, personal loans), which are more expensive. They are a claim on future income and are best used for appreciating assets.

Remember

• Unsecured short-term debt is the most expensive.

11Leverage, net worth and solvency

Formula Leverage ratio = Total liabilities ÷ Total assets

Example Property ₹50 lakh, investments and bank ₹10 lakh, PF ₹5 lakh: assets ₹65 lakh. Home loan outstanding ₹10 lakh, card dues ₹2 lakh, loan from a friend ₹1 lakh: liabilities ₹13 lakh. Leverage = 20%; net worth = ₹52 lakh; solvency = 52 ÷ 65 = 80%.

Higher leverage means more risk; above 1 means assets do not cover liabilities. It is high just after a big debt-funded purchase and falls as the asset appreciates. Judge it against debt-servicing capacity, and do not combine risky investments with heavy borrowing.

Net worth = total assets − total liabilities; track it over time. Assets bought with loans still outstanding add little; debt used for appreciating assets is not bad.

Formula Solvency ratio = Net worth ÷ Total assets = 1 − Leverage ratio

Net worth must be positive; a higher solvency ratio means a stronger position.

Remember

• Leverage + solvency = 1.

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12Liquid assets and the liquidity ratio

Liquid assets can be turned into cash quickly without much loss: savings accounts, FDs maturing within six months, liquid funds and similar short-term assets. Not liquid for this purpose: real estate (slow to sell), closed-end fund units, and assets whose value swings (shares, open-end equity funds, and even open-end debt funds with market-linked returns). Liquidity has a cost (lower returns), so hold enough for needs and invest the rest for growth.

Formula Liquidity ratio = Liquid assets ÷ Monthly expenses (including loan repayments)

A ratio of 4 to 6 (months) is comfortable.

Example Monthly expenses ₹1.5 lakh. Liquid assets = savings account ₹7 lakh + short-term FDs ₹2 lakh + liquid funds ₹4 lakh = ₹13 lakh (excluding shares, long-term FDs, other open-end funds and closed-end funds). Ratio = 13 ÷ 1.5 ≈ 8.7.

Liquid assets to net worth should be low when goals are far off (too much in low-return assets hurts long-term goals) and higher when goals are near.

Remember

• Liquidity ratio 4–6 months; shares are not liquid assets here.

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13Financial assets ratio

Financial assets (shares, debentures, deposits, PPF, mutual funds) offer liquidity, flexibility, convenience and small, frequent investing; physical assets include gold, precious metals, diamonds and real estate.

Formula Financial assets ratio = Financial assets ÷ Total assets × 100

Example Shares ₹5 lakh, FDs ₹10 lakh, mutual funds ₹12 lakh (financial ₹27 lakh); land ₹9 lakh and gold ₹14 lakh (physical ₹23 lakh). Ratio = 27 ÷ 50 = 54%.

A higher share of financial assets is preferred, especially as goals approach and income or funds are needed.

Remember

• Financial assets ratio rises in importance near goals.

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14Debt to income ratio

Leverage shows debt in asset building; debt to income shows ability to service debt from income, and lenders use it to judge eligibility.

Formula Debt to income ratio = Monthly debt servicing (principal + interest) ÷ Monthly income

Example EMIs ₹60,000 on income ₹1.5 lakh → 40%.

Above 35–40% is excessive: it squeezes regular expenses and saving, makes emergency borrowing hard, and any income drop causes stress.

Calculate ratios periodically (say yearly), compare with past values to see trends and the effect of actions, and customise benchmarks to the individual.

Remember

• Debt to income above 35–40% is excessive.

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