Love it or hate it, cashflow modelling is an integral part of the modern financial planning client journey.

Yes, I know some of you are in the latter camp and will be rolling your eyes at what I’ve just said, but the majority of financial planning firms now see the value in modelling tools and if you’re not using one, you’re not keeping up with the times!

However, there is quite a major elephant in the room. Cashflow modelling tools are unregulated, so how do you make sure they are fit for purpose in a regulated environment?

Deterministic vs stochastic

There are two types of cashflow modelling tools currently available to firms wishing to invest in specific software to do the job.

The most common and widely available are deterministic tools. The term is derived from ‘determinism’ or the opposite of random and that means they calculate a future event without considering any variables. You enter a specific input and you get a specific output.

As we all know, markets are complex, ever-changing and irregular, which means the results these tools provide are too simple and tend to overestimate the level of sustainable income/growth expected. Yes, they might be easy for clients to understand, but ultimately, they don’t meet the requirements of COBS4, the financial promotions rules.

Cashflow modelling based on the stochastic, or Monte Carlo method, as it is sometimes known, is harder to come by and requires you to have deeper pockets. These systems are built around random probability patterns that have the capacity to handle uncertainties by using past market data to simulate what could happen in the market. The results are far more realistic, however at present, they still have their limitations.

Your regulatory requirements

The FCA has yet to set clear and precise rules about the use of cashflow modelling. It has been the subject of some scrutiny in relation to DB transfers, but we are left to interpret the wider legislation to determine how it should be used in a regulated space.

The main area for consideration is the COBS4 rules, specifically COBS 4.6.7, which refers to future performance. It requires you to ensure any information giving clients an indication of future performance satisfies certain conditions. They are:

  1. It is not based on, nor does it refer to simulated past performance
  2. You are using reasonable assumptions, supported by objective data
  3. The effect of commissions, fees and other charges is disclosed
  4. Performance scenarios are provided using different market conditions, reflecting the nature and risk of the relevant investment type
  5. It contains a prominent warning that it is not a reliable indicator of future performance.

For deterministic cashflow modelling tools to meet these criteria, you must manually set stress testing that is based on a standard set of assumptions and is backed up with reliable data, to show clients the impact different market conditions will have on their investments. For example, if you are using a growth rate that is outside the parameters preferred by the FCA, you must be able to justify why.

Put policies in place

No matter which type of modelling tool you are using, it is important that firms act consistently. You cannot allow cashflow tools to be used and abused, to manipulate the outcome.

We would urge you to consider the assumptions you implement to stress test the data at a firm level and document your decisions in the form of company policy, justifying why these conclusions have been reached.

If you are using cashflow modelling without recommending a product, the results remain unregulated. However, when it becomes a financial planning tool, you run the risk of future complaints if you haven’t met the COBS4 requirements. This means you should add individual factors or scenarios manually, such as a future inheritance, major expenditure like putting kids through university, or retiring early, to demonstrate adequately how the growth projected will be impacted by these variables. This is particularly important if you are providing a client with an indication of future performance on a product you have already recommended.

Whilst stochastic tools remain relatively rare and out of the budget of the average advisory firm, we would urge you to take care with cashflow modelling. Focus less on the package you use and more on the assumptions you set and the stress testing you undertake.

If you would like help creating policies that standardise your firm’s use of cashflow modelling, don’t hesitate to contact us on (0161) 521 8641 or email:


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