On the plus side of expenses

By Deepank Gupta
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Positive cash flow occurs when the cash generating in the household is more than the amount of money leaving the household

Different people focus on different financial outcomes but most people want to have some ongoing dividends and growing net worth to free them up from the worries about putting food on the table or being able to pay their bills once they in the dusk of their lives. Positive cash flow is important in ensuring sustained loan repayments for property loans in order to build the property portfolio.

The amount of cash a household or an individual generates and spends during a particular time frame is called ‘Cash Flow’.  In other words, it is a virtual movement of money in and out of a household. Cash flow is generally tracked during standard reporting period, such as a month, quarter, or year.

Cash flow statement provides a snapshot of where the cash is coming from and going to. It is also good indictor to manage ongoing financial situation in order to plan the payments may it be loan instalments or other expenses.

Following are some of the examples of routine household expenditures: Groceries, Home Maintenance, Utility Bills (Electricity / Gas / Water / Internet), Travel Expenses, Medical Expense, Insurances, Rent, School Fees etc.

One may have a surplus cash position at the end of the year or have a stronger asset base, the deficit in ongoing availability of cash in hand may lead to failure in fulfilling the ongoing household financial liabilities. In extreme cases, the tied-up wealth may force one to sell the property at lesser than the expected market price.

The basic idea is that one should have cash available to carry out expenses. Let’s say that your monthly income is $10,000 per month and your employer says that instead of paying you monthly they will pay double of your salary but only in the end of the year and in one go, then the question to assess is how you would manage your expense for the whole year. In this case your overall income would be doubled but it would not help to manage your ongoing expenses, unless you have alternative sources of income.

Daily household expenses cannot be managed without having a routine stream of influx of adequate cash; may it by loans or incomes. No wonder, cash is king in all cultures around the globe.

Positive cash flow occurs when the cash generating in the household from wages, interests, savings or any other earning is more than the amount of the cash leaving the household such as loans, household expenses, school fees, utility bills, insurance premiums, council rates etc. Similarly, negative cash flow is a situation when the outflow of cash is greater than your incoming cash.

Achieving positive cash flow is not a process which occurs by chance, one has to work towards it. One should analyse the expenses and incomes to ascertain the requirement of cash and consequently devise rules to boost the inflow, importantly, before the requirement to payout for the expenses.

Inflow of cash can be boosted by picking more hours at work or obtaining second job. ‘Dollar saved is equal to the dollar earned’. This term is a financial gospel.  When earnings cannot be increased to a level where the cash flow gets in green then savings by reducing the expenses help.

This goes beyond making coffee at home and skipping the fancy latte. The overall saving behaviour shall come in to play.

The overall plan shall consider measures such as loan consolidations, managing and reducing utility liabilities, reducing the number of credit cards, refinancing high interest rate loans, maintaining offset accounts, reducing entertainment costs etc. all contribute in reducing cash flow burden.

In terms of the property-based portfolio, the positive cash flow can be maintained by investing in properties providing rental income instead of land or acreage properties where the wealth creation is based on the appreciation at the time of the sale. However, in case of rental properties, assessment should be carried out to lay out the overheads in addition the loan repayments such as council rates, water service charge, wealth tax, maintenance, etc.

Rental properties are distinguished in two main categories: Residential Properties and Commercial properties. In residential properties the upfront and outward cash flow costs such as bank fees, deposits etc are less than the commercial properties. However, the investor would need to incur ongoing costs such as (Council Rates, Body Corporate Fees, Water Service charge etc.) In commercial properties all the outgoings are paid by the tenant unless agreed differently.

The table provides a snapshot of how the residential and commercial rental properties and their loans impact the cash flow. I like to add a disclaimer here that this is generalised information and one should seek more information by doing research or from financial advisors, banks or loan agents to make their informed decisions.

Structure of Loan can also effect the cash flow. The structure of loans should be design to attain the optimised cash flow outcomes. Factors such as interest rate, fees, loan term, and repayment cycle all play important part and should be considered while selecting the bank loans.

Interest Rate and Bank Fees

It is difficult to compare home loans that have different interest rates and fees. This is why one should always ask the banks or their credit providers to provide the ‘Comparison Interest Rate’. The comparison interest rate conveys the total cost of loans which includes interest rate plus most fees and charges. It provides overall outgoings in terms of bank expenses. The table below demonstrates that how taking an extra step to assess ‘Comparison Interest rate’ could assist in minimising the overall cost of the loans.

In the example above, home loan B will cost less than home loan A, even though home loan A has a lower interest rate.

Loan Type

Borrowing money on an interest only loan can help in reduced outflow of cash. Interest only loans have smaller repayments in contrast to principal and interest loans.

The table below compares the loan repayments for interest only loans and principal and interest loans. In this case the value of the property is considered as $600,000 loan at 4.0% interest:

From the table above, it is clear that interest only loan has significant lower repayments. But it is only for a short period. After the completion of the stipulated time frame, Australian banks, as an industry practice, rolls interest only loans to principal and interest loan. Therefore, consideration should be given on how the increased repayments will be sustained after the roll over.

The other drawback of interest only loans is that the loan obligation to the bank will not be reduced and the borrower’s equity in the property will rely heavily on the appreciation of the property.

Loan Term and Repayment Frequency

Positive cash flow can also be managed by selecting an appropriate and feasible repayment cycle. In Australia, all major banks generally offer monthly, fortnightly and monthly repayment options.

The table below identifies different loan repayment cycle for $600,000 loan at 4.0% interest for 30 years and 25 years’ loan on Principal and Interest Loan terms:

From the table above, it is clear that 30-year loan with fortnightly repayment cycle offers advantageous repayments in managing cash flow. In this case, fortnightly payment cycle results in $2642 of monthly outflow of cash which is $222 less than the monthly repayment cycle.

For people who receive their wages monthly or have other financial commitments, the monthly repayment option may suite better. The other thing to keep in mind is that the overall payment of interest to banks in 30 years would be more than in 25 years.

Positive cash flow doesn’t necessarily mean profit but a careful management of incomes and expenditures. This also means that you can allow for any unforeseen contingencies such as sudden loss of income.

Next month, we will discuss the importance of Family Welfare in managing debts or property loans. 


The writer is an entrepreneur, financial influencer and manages regulated businesses and commercial property portfolios

 

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