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Posts Tagged ‘managing cash flows’

It is important to keep track of your assets and investments and how they are performing and how far they are helping you in achieving your goals but it’s equally important to keep a check of your liabilities. Your cash flows at any point in time will be greatly impacted by the way you manage your liabilities.

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Let’s broadly classify liabilities into two parts to make it easy for us to understand.  Your ongoing home loan, car loan, education loan or your personal loan could be one type of liability. Your pending credit card bills or any other kind of unpaid bills could be the second type of liability.

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Let’s talk about the second type of liability first. There is a very high interest rate that they charge on the unpaid credit card bills. It is important to get rid of these as fast as possible. The amount will multiply much faster than you realize and you will get into the loop where you will pay of a part of it and by the time you decide to pay the rest of it already a huge interest might just get added to it. In short it leads to drain of wealth of an amount much higher than your original liability. Another important implication of this is on your credit scores. Every individual who has ever taken a loan has a credit score. This depends on your financial behavior and the way you service your existing debt. Going forward the debt score will determine your loan taking ability and the rate you will be charged for the same.

The other type is your home, personal, car, education loan, etc. Most commonly people have either a home loan or a car loan. The way you can manage them will depend upon the rate of interest that you have been paying on your existing loan and what are the current loan rates in the market. If there is a scenario similar to the current one where there is an expectation of further rate fall then you should take a new loan at a lower rate to repay your existing loan where you may be paying a higher rate.

If you have some goals, so you can choose to pay either higher EMIs or lower EMIs depending on the need for cash flows at a particular point in time. In any loan the EMI that you pay services your interest portion in the beginning and then slowly it starts servicing your principal component. Therefore you might notice after few years of regular EMI payment your principal may have reduced by a very small amount.  If you have a surplus cash inflow at any point in time then you might want to prepay some part of your loan. Its appraisal time now in some of the organizations. If you receive a salary raise then you might choose to pay a higher EMI to speed up your loan repayment.

If the rate of return on the investment is higher than the rate of your loan then you should consider investing instead of prepaying. But if it is the other way round then you should consider prepayment.

Also recently Marginal cost based lending rate (MCLR) has been introduced and is applicable from 1 April 2016. The MCLR linked loans are at least 0.10% cheaper than base rate linked lending rates. Only floating rate loans can get linked to MCLR. It has a reset clause which means your rate will get reset on every reset date. Reseat date depend from bank to bank. MCLR rate is calculated based on deposit rate of the respective bank plus a spread instead of base rate as it was done earlier. At every reset date when your rate changes it will alter your loan tenure and not your EMI. But if you want a change in EMI you can inform the bank. The new loan applicants will get loans linked to MCLR Rate. The existing investors can also shift to this rate by paying a fee. Most banks are charging close to 0.5% fee. So if there is a difference of at least 0.25% in the rate that you are paying currently and the new MCLR rate then only you should consider switching.

Last but not the least,

Don’t just keep paying EMIs. Take a look at available cash flows, need for cash flows and your goals and then decide how you want to manage your liabilities.

 

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Meeting deadlines, adding value, juggling priorities, wearing different hats are a part and parcel of every entrepreneur’s life. Whilst there is a certain high that comes with all of this, it is also crucial for an entrepreneur to critically manage money, both for the business and himself/herself and dependents. Whilst efficient use of capital is one of the most crucial elements along the entire entrepreneurial journey, we believe there are two phases where managing money is absolutely critical. Money management during these two phases can go a long way in ensuring that the business can reach a stage where it is robust enough to survive, grow and flourish over longer periods.

Phase 1: Whilst you are planning to set up

Phase 2: In the first 18 -24 months of the business

Money management during both these phases can be fairly similar. Entrepreneurs still need to lead their personal lives, even as they go about building the blueprint for the business that is closest to their heart. With a significant number of entrepreneurs today quitting jobs to find their true calling, planning the capital requirements for their business, as well as to sustain their personal lives whilst positive cash flows from the businesses are yet, to happen are crucial. We would recommend that entrepreneurs focus differently on their personal and business finances.

Personal finances

1  Create a large contingency fund – Have 12 to 18 months of personal expenses ( including personal EMIs ) in financial instruments, wherein they can be accessed immediately, as well as have no significant risks of capital loss. Instruments like PPF and EPF accounts are not great friends of early entrepreneurs as access to funds in these accounts tend to be rather difficult and time consuming. Instruments like bank deposits and debt mutual funds without a lock-in are superior options during this phase. You may need to start drawing a small compensation during the latter part of this phase, so seek tax efficiency as well.

 2  Ensure that you are covered against risks in your personal life – Have adequate life insurance (buy term insurance as it is the most cost efficient) so that debts and living expenses of your family are adequately covered. Ensure that you have health insurance cover for your family and dependents in place for an adequate amount.

Business finances

1  Avoid risky investments with your business finances – Remember, the best returns over a period tend to come from your business so avoid other risky investments in this stage with funds which are needed for your business. For example, do not temporarily park funds into equity markets or real estate. At the same time, optimize your returns depending on your cash flow requirements, by building a tiered investment strategy. In case you cannot do this yourself, use the services of a financial planner. Liquid and debt funds can be very useful tools to consider.

 2  Focus on good costs, eliminate the bad costs -With a large number of businesses, getting started without external funding and needing to sustain using internally generated cashflows, it is crucial to keep costs under control. Look at costs as good costs and bad costs. Good costs are those that have a high probability of a success outcome, whereas bad costs are those with a low or no probability. This definition may vary from business to business, for example a swanky office may be a good cost in a consumer business, and a bad cost in a B2B model.

3  Use technology tools to the maximum – Through the use of mobile technology and the internet, it is now possible to manage your cash flows efficiently, with minimal commitment of your most precious resource during this phase i.e. entrepreneur’s time. Understand how you can use technology to manage cash flows and get superior returns on your temporarily idle cash in this phase.

Remember, whilst all rupees are equal, but some are more equal than others. More so, when you are a new entrepreneur.

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