“Direction is much more important than speed, many are going nowhere fast”
Every person has a dream which generally drives his actions and motivates him to work hard. It sets an objective in life—a reason to live and fulfil his dreams. Not all but most of the dreams are fulfilled by healthy finance. E.g. every typical person wants to have his own house, a car, and a luxurious life. Similarly, one can observe that everything today is driven by finance.
As said, finance serves as the lifeline of any business, individual etc. and this is one thing which is always in constraint. It is a limited resource and hence, wastage of this resource should be avoided. Rather, it should be used in an optimum manner and should be applied towards the pre-committed objectives.
Good financial planning can work as a life-saving operation and can open completely new sources of earning, a healthy investment portfolio with a good return and balanced risk.
Further, financial planning is for everybody, a person earning Rs 15,000 per month or a person earning millions as everybody has dreams according to their wish. Hence, if you are a earning your livelihood then you must do financial planning.
Let us understand the five modern ways of financial planning.
1. Establish a plan:
Planning is the most important part of anything. Planning sets the way towards your assigned objectives. The plan should not be theoretical or an essay of 1,000 words, but simple, realistic, and based upon your objectives.
A financial plan should have the following characteristics:
a) Where you are—your current net worth: If you want to go somewhere you must know where you are standing. Calculate your net worth which shall include all your assets (building, car, bike, gold, etc) minus the liabilities (bank loans, car loans, etc). Also, list down your sources of income like bank interest, salary, rental income, business income, etc.
This will help you understand how much you are earning exactly and how much you are really worth.
b) Prepare your income statement: Income statement means how much you are earning and how much do you spend. Include all your regular cash outflows, like car instalment, tuition fees, etc. Categorise the expenses in the following format:
- Mandatory: This shall include all the mandatory cash flows like children’s tuition fees, your bank loan instalments, medical premium, etc.
- Saving: This shall include in case you are availing certain savings like recurring deposits etc.
- Optional: This shall include which are not mandatory right now and can be deferred.
- Luxury: This shall include all the expenses which are a luxury in nature like buying gold, car, etc.
After preparing the income statement, check whether you have cash surplus or cash deficit. In case you have a surplus, the same must be reflected in your savings and if you have a deficit, then the same shall be fulfilled from borrowings.
In case you have a deficit, then you should analyse the reason behind it because having a regular deficit is not healthily for your finances. Also, if you are making luxury items and which is causing a deficit, then it is detrimental for your wealth.
However, if you are having deficit due to the purchase of any new asset that will result in an increase in net worth and future cash inflows, then it shall be beneficial in the longer run.
c) Set up your goals: The stage is to set up your objectives like what you want to achieve. E.g. you want to buy a home, or you want to increase your income, etc. Whatever is the objective, it must be specific. E.g. if you want to increase your income, then how much: 20 percent, 40 percent, 60 percent etc. It should be specific.
d) Analyse the existing assets: Once your objective is set, the next step is to see whether the same can be fulfilled from the existing resources.
E.g. if you want to increase your income and you own a flat, you can put that on rent to earn basic income. Or if you own gold, you can exchange the gold with a gold bond (government-approved) and earn six to eight percent additional return on the same.
e) The future assets and new income source: In case your existing resources are not sufficient, you have to concentrate on building new assets and new income. There can be many examples of this as well, like:
- If you have a skill like teaching or engineering, utilise the same and start consultancy work. After one year or two, you will see a regular stream of cash inflow.
- If you are running a business and have rented premises, you should plan to buy the same rather than wasting money on rent.
Nowadays, mortgage finance is very popular.
There can be various examples. However, you need to brainstorm and you can definitely hit the bullseye. The skills you have are your biggest assets and based upon that you can open many profit-earning businesses.
Further, in case you do not have any specific skills, learn new skills. Nowadays, the Government of India also supports programmes like Skill India. You can refer to the link below for details:
Pradhan Mantri Kaushal Vikas Yojana (PMKVY):
You can even start your business by registering a private company in India to have organised form of business so that your new earning source complies with all legal compliances.
2. Revenue and capital approach
This is one of the greatest approaches of all time to reduce unwanted expenditure and simultaneously build wealth. Under this approach, you should divide your expenditure into two categories:
• Revenue expenditure: Under this category, all your running expenditures are counted. Any expenditure whose utility is consumed within a year is called revenue expenditure. E.g. buying a mobile phone, electricity bill, telephone bill, house rent, interest payment, etc.
• Capital expenditure: Under this category, all the long-term expenditures are counted. Any expenditure whose impact is for more than one financial year is known as capital expenditure. In other words, when an asset comes into existence, it is known as capital expenditure. E.g. home construction, buying a car, etc.
Now as per the approach, one should increase the capital expenditure and incur only that revenue expenditure which is essential in sustaining the life balance. One should avoid unnecessarily luxurious expenses and incur more capital expenditure which is also towards the objective you have set for.
Let us understand this by way of an example. Buying an iPhone 7 is a luxury and will not reap you any additional cash flow. Instead, if you buy a cheaper smartphone and invest the remaining money in mutual funds, the same will reap you high yields and capital appreciation at the same time.
This is all about the personal judgement. If one only incurs mandatory expenses as listed above and invests the rest of the amount in building wealth (e.g. buying a house, or building a factory, etc.) then after five years he will hold a stronger position than the one who has spent money on non-value-added things.
3. Improved and logical tax planning
Whether you are a businessman, salaried employee, or whatever, you cannot ignore tax. Taxation plays a very important role in financial planning. A substantial portion of your income goes into taxation. Hence, one must plan taxes within legal parameters so that he ends up paying the minimum tax after availing every available tax benefit.
Further, make sure while planning the taxes, the income tax return filing should be proper in order to avoid any mistake.
4. Create a healthy portfolio of your savings
This is something perhaps people are scared of. Most of the people are not risk-takers and hence they fear to put their money in anything other than fixed deposits, which offer a poor return of seven to eight percent per annum.
However, one should set up his priorities and develop some limited risk-taking capabilities. That said, do not put all eggs in a single basket. On similar lines, one should maintain a portfolio of investment to curb risk and maintain high yields.
If you have Rs 1,00,000 to invest, you can invest some portion in fixed deposit, some portion in shares, some portion in mutual fund, etc. By doing this, you not only mitigate risk and but also maintain an average return of 20 to 25 percent.
Here are some mutual funds which offer nice returns with tax saving benefits:
- DSP Black Rock offers 16 to 20 percent with tax benefit under 80C.
- TATA equity P-E offers 40 to 43 percent return.
You can research on the same and you can invest as per your needs.
5. Protect your future—retirement benefits
This is something you should not ignore while doing financial planning.
However, if you are doing financial planning properly you will be able to build a wealth that will automatically sustain your future after retirement. However, in case you are not following the plan properly, then it is recommended to provide for your future after retirement.
Under this point, we would like to explain something that might help you or someone in need. This is for old people over the age of 60 having only house property but no regular income. They become dependent and hence mistreated.
To all those kinds of people, the Government of India came up with the reverse mortgage scheme in 2008. Under this scheme,
• Bank mortgages the property and in return pays monthly/quarterly/yearly fixed amount to the senior citizens for the next 20 years.
• The senior citizens did not need to pay it back till they are alive.
• After their death, the bank gives the option to the legal heir to repay the loan and claim the property. However, if the legal heir is not able to repay the amount, the bank sells the property to recover the loan.
This scheme is not very famous and banks also do not advertise the same. However, this knowledge might save someone from financial problems.