Financial planning is one of the most important cornerstones of success – and it is something that we have been told day in and day out. Why and how, we would be discussing its nitty-gritty’s later. But for now, let’s get into three hypothetical situations.
Imagine a person, Mr X, gets his salary of AU$10,000 at the beginning of every month. He ends up exhausting all his salary by 20th of every month and lives off a credit of AU$5,000 for next 10 days. Next month, when he gets his AU$10,000 salary, he squares his AU$5,000 debt. So, his disposable income for the month stands at AU$5,000 – and with his expenses he would gobble it up in just 10 days, unless he does not go for severe austerity measures. And then he would have to borrow AU$10,000 for the remaining 20 days. When he gets his fourth salary, he would need to square a debt of AU$15,000 with the income of AU$10,000, making him insolvent.
Now, imagine a businessman, owning a mid-scale company. His cash flows stand at AU$100,000 a year. He takes a loan worth AU$1 million. The principal and interest payment over the loan stand at AU$50,000. Suddenly, there is an economic slowdown which truncates his cash flows by 60%. To get over the deficit of AU$10,000, he borrows again. Contrary to his expectation of a quick economic turnaround, he must service two loans now. He keeps ever greening the loans till the time he and his mid-scale company declare bankruptcy.
Now imagine a fundamentally strong corporation, say Z Ltd. The company has all its parameters working like clockwork. It has a working capital line from a bank worth AU$1 million with a rotation time of three months. The corporation wants to grow more. So, it uses the working capital money towards the capital expenditure, with returns expected in the long term, i.e., after years. After three months, it is able to pay this AU$1 million on the back of strong sales. But somewhere down the line, its revenues dip due to headwinds. The company is unable to pay back its working capital. In that scenario, the company will either have to enter the debt trap or default over the loan.
What is common in all the three examples above? These all involve bad financial planning. And bad financial planning spares no one – be it the largest of corporations, biggest of businessmen, and commonest of the common man.
In technical terms, financial planning is a process that helps us ascertain people or a company’s current money situation and long-term monetary goals, as well as the strategies to achieve those goals. In the simplest of the terms, financial planning helps individuals or companies control their income, expenses, and investments, and hence are instrumental in managing their money and achieve their goals. And it is something that matters on both – the macro and micro levels.
Now, let us focus on the financial planning for retail investors. At a time when increments in salary continue to be substantially lower than the inflation rate, financial planning has gained more and more prominence. Given the current scenario, people are becoming poorer every passing year. In 2020, the average global inflation stood at 3.18% while salaries of people went down by 3.9%. This means that the purchasing power of people across the globe came down by 7% in 2020. Since 2020 was the pandemic year, the wages contracted. In normal years, while average inflation has been over 3%, the wage growth has been way smaller. This, in simple terms, means that whatever you were able to buy in 2019 with a certain amount of money, it will not be possible in 2020 (as your purchasing power plummeted in the pandemic year). However, that happens only when you do not have a proper pool of savings to help you sustain the truncation in the purchasing power parity. Thus, as financial planning helps you beat the dreaded inflation, it has started to gain traction among the masses, which were hitherto unaware of it.
Also, no one has the capacity to keep on working forever. Given the vagaries of life, a person may fall sick, his body may give up or he may retire. In all these cases, the person’s salary disappears; however, the expenses stay intact or in some cases, ratchet up further. With ever-increasing medical costs, and the increased cost of living in general, people need to financially plan their future for exigencies and retirement.
So, to sum it up, when a person starts planning his or her future, he or she considers different goals – wealth creation, retirement planning, and children’s education and saving tax. Saving tax is equally important; the more you save in taxes, the fatter is your take-home pay. Further having a thorough understanding of ways and means of managing your finances is essential and acquiring the necessary knowledge to achieve the same is paramount.
Having said that, a person can financially try to secure himself in five different ways –
- Understand your current financial situation
- Noting down your financial goals
- Exploring different investment options
- Implementing the right plan
- Monitoring the plan.
Hope this helps you execute your financial planning like a boss. Happy planning!
Furquan Moharkan- A journalist and an author with a focus on banking and financial markets. He has also authored a book on banking. Before becoming a journalist, Furquan was an investment banker. Furquan Moharkan is the Financial Journalist with Kalkine Media and author of bestselling financial thriller ‘The Banker Who Crushed His Diamonds: The Yes Bank Story