Cash & Liquidity Management

Cash flow forecasting

Published: Apr 2013
Stack of coins

Portrait of Daniel Blumen, Partner, Treasury Alliance Group
Daniel Blumen, Partner, Treasury Alliance Group:

The best way to improve cash forecasting is to evaluate the current process against five best practices of cash forecasting.

  1. Simplicity.

    A cash forecast requires two pieces of accurate information; the amount of cash on hand and the amount to be received net of expenses. Add the dimensions of time and currency; when will the cash be received, and in what currency and you have a reasonable and very effective cash forecast. When asking business units to forecast cash, keep it simple. Don’t ask for a detailed weekly flow of funds report requiring forecasts of inter-company receipts/payments, loans/investments and third-party receipts/payments.

  2. Cooperation.

    Good quality forecasting input is the primary determinant of a good quality forecast. And the quality of the input is in the hands of your business partners. Building trust is an important step in this process. If forecasting accuracy is used as a punitive tool by treasury, units will hedge forecasts and refrain from sharing key strategic insights, diluting their value.

  3. Communication.

    Forecasting in a global company adds the challenge of multiple currencies, language and culture. It is critical that all business units adopt common definitions in the cash forecasting process. Cash in bank ledgers and available cash are two different concepts, familiar to treasury associates but less familiar to accountants or others involved, so make sure everyone completing the forecasts understands and uses the same definitions.

  4. Structure.

    Cash forecasting problems arise when business units lose faith in central treasury’s ability to respond to their urgent funding needs in a timely manner. They respond with excessive caution in forecasting receipts and even hold onto their own cash reserves, diluting the accuracy and value of the forecast. The solution is to have an efficient account structure serviced by a reliable network of banks. This can take time to develop but results in reduced administration, transaction and other costs.

  5. Technology.

    You can increase simplicity, cooperation and communication with the effective use of technology such as gathering forecast information through an intranet or file-sharing site. Using an intranet adds security and administrative efficiency as well. Work with your technology team to develop a form for collecting the forecast input. These are relatively simple to develop and the data gathered this way is typically stored in a database on one of your servers. This is a winning approach from a number of perspectives; it’s consistent, enterprise-wide, secure and administratively efficient.

The best practices outlined above won’t get you perfection but will give you a good start.

Portrait of Paul Stheeman, Independent Treasury Executive and Consultant
Paul Stheeman, Independent Treasury Executive and Consultant:

Quite often treasurers will seek to improve the quality of their forecasts by adding details to their calculations or by looking for enhanced tools such as new or better software. But do these ideas really help solve the problem?

Adding detail may lead to more complexity and have the opposite effect – ie is less transparent, more prone to errors and more difficult to understand or disentangle when questions are raised. The treasurer should always stick to the motto “keep it simple”. He should regularly review the detail and critically ask whether it is required.

A new enhanced software tool may give a false sense of security. It is the information going in which will decide on the quality coming out.

When preparing a cash forecast the treasurer will seldom amass all the numbers himself. Typically he will have to aggregate information received from subsidiaries or operations. He is dependent on the high quality of this information. Therefore the most meaningful instrument he has are his communication skills. He will need to build a framework which the people from his operations will understand and he will need to communicate with them. It is not sufficient to send an email or a spreadsheet around once a month. The treasurer has to talk regularly with the experts from operations, firstly to ensure they understand what his requirements are and why he regularly needs them. He should give these experts an opportunity to communicate back to him, for example telling him why certain numbers cannot be provided with the degree of accuracy expected or why some may be fixed and others uncertain.

The detail and complexity around cash forecasts today mean that it is essential that communication lines work well. Good relationships make it easier to pick up the phone and share information. The treasurer must have confidence in his own numbers and he can only achieve this if he fully understands them himself. He must therefore proactively build relationships with the correct people and ensure a collaborative communication style with them. He should provide feedback on each report he receives, so that the operations people can see their input is valued.

Portrait of Ryan Smith, Treasury Manager, Mitsubishi Corporation International (Europe)
Ryan Smith, Treasury Manager, Mitsubishi Corporation International (Europe):

Accurate cash forecasts are necessary to improve the liquidity management of the treasury function. In recent times it has become more important than ever to avoid unpleasant financial surprises and thus avert the spectre of expensive emergency funding or cash surpluses earning next to zero credit interest.

For best practice, a treasury should utilise the cash forecasting capabilities of their TMS as it will already hold the majority of the information required – for example: maturing loans, deposits, fx contracts and some future payments and receipts.

Using the TMS for forecasts will enable the treasury team, not just the individual who prepares and checks the forecasts, the opportunity to view the most up-to-date position.

The most difficult part of the process is to capture any further relevant data that should be part of the cash flow forecast. This can include:

  • Accounting system data not automatically fed to the TMS
  • Future business opportunities that may require additional finance.
  • Unpredictable flows to/from suppliers/customers.
  • To ensure an accurate forecast, the treasury team needs to educate persons within their company (or any relevant subsidiary) on the importance of providing accurate and timely information. This would include traders, accounting personnel and any other staff members whose daily business can provide the treasury team with future information of material monetary flows. Any information provided should be added to the TMS forecast (via manual entries) to provide the most accurate view of the company’s future position.

Precautionary note: no forecast will ever be perfect, so the management of a company’s assets and liabilities should always provide enough flexibility to allow for life’s little surprises!

Portrait of Conor Deegan, Director, Cash Analytics
Conor Deegan, Director, Cash Analytics:

The human element of a cash forecasting process should never be ignored. Challenges such as forecasting unexpected expenditure, capturing unpredictable flows and modelling external influences are common to most companies but large multi-location organisations, who are reliant on the inputs of personnel in business units, must contend with a range of other factors that can compromise the quality of their cash forecasts.

For these larger organisations the quality of the reporting output from a forecasting process is therefore dependent on the quality of information provided by each and every person involved. There is no doubt that forecasting cash movements can be problematic, even for companies with reasonably predictable cash flows, but ensuring the process is engaged with in a meaningful way by all contributors will give a treasurer comfort that the information on which decisions are based is of the highest quality.

A focus on the following areas should allow treasurers to achieve their long and short-term forecasting goals:

  • Gain visible executive sponsorship.

    Generally the requirement for a cash forecasting process will be driven at executive/board level but gaining visible executive sponsorship is an important first step on the path to successful process implementation.

  • In-depth initial review.

    Before committing to a group wide forecasting structure, time should be spent understanding the operations and constraints of each business unit. Find out if cash forecasting already takes place and whether existing resources can be leveraged for the overall process.

  • Education.

    Cash forecasting is a knowledge intensive exercise and as an investment made in ‘educating’ both personnel at business unit level and head office with regard to the nature of cash movements, will contribute to the quality of forecast information reported.

  • Make it part of the day job.

    Forecasting can sometimes fall outside of the day-to-day remit of contributors to the process. Ensure sufficient time is committed to the compilation and review of cash flow information for efficient and accurate benefits.

  • Provide value to participants.

    A process that relies on contributions from multiple sources but only provides value at head office level can deteriorate over time due to a lack of engagement from business units. Finding ways to provide value to business units – such as through actual versus forecast reviews – will boost the quality of the overall cash forecast.

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