Cash forecasting is important and can be one of the key skills and value-adds supplied by a treasury department. It delivers insight into future cash flows for the business that enable an entire series of improved financial decisions to be made quickly and easily. Good cash forecasting is a benefit that all finance teams know is truly worth having. It does beg the question, however, that with so much at stake why do large numbers of corporate treasurers still struggle to accurately and confidently forecast cash?
Interestingly, not every corporate treasurer or chief financial officer (CFO) does necessarily fully believe in the value offered by cash forecasting, which serves to further compound the problem of getting the budget to make it an effective procedure. This isn’t to say that it is perceived as unimportant – it’s more a matter of how important it is seen to be and if there are return on investment (RoI) benefits to be had.
For example, it’s not uncommon for some treasurers to say, ‘We’re cash rich, so we don’t need to forecast’. Yet, this rationale implies that the outcome of forecasting is only to uncover cash shortfalls and repay debt. In reality, there are numerous other opportunities to create value for the business – even within ‘cash rich’ organisations. These include:
- Earning additional returns through managed investing. Experience shows that corporates can identify returns up to two per cent greater compared with allowing overnight investing of otherwise idle cash.
- It is also possible to protect against changes in cash value (if in foreign currencies, or based on the value of commodities). In reality, if all inflows and outflows are in the same currency as your financial reporting – and you don’t have any commodity exposure as part of your business operations – then this won’t be a concern. However, very few corporate treasury departments are that insulated. For the majority, there is real value to hedging foreign exchange (FX) or commodity exposures, which can be derived from accurate cash forecasting.
- Optimising supply chain discounts. Almost every organisation will take advantage of early payment terms from suppliers (e.g. receiving a one per cent invoice discount by paying 20 days early) and more and more treasurers are helping to proactively shape supplier discount programmes that offer ‘attractive’ terms to suppliers to receive payment early. The returns on excess cash and liquidity are some of the best that a treasurer can hope to attain.
Improving The Accuracy of Cash Forecasting
Assuming that the importance of forecasting is accepted, the critical question a treasurer should ask themselves is: ‘how do we improve our forecasting capabilities’? There are three components to an effective cash forecasting programme:
- Collaboration:bringing the right people together.
- Consolidation: bringing the right data streams together.
- Feedback loop:implementing forecast variance analysis and communicating that feedback to the people/data sources to improve the forecast.
The first step to building a successful cash forecasting programme is to determine where the required information is going to come from and who is going to provide it to you. Inevitably, colleagues outside the treasury function have valuable insight, either directly or indirectly, through the systems they control.
For this reason, forecasting needs to be a strategic process with visibility to the CFO and senior management, so that forecasting accurately becomes part of others’ formal job responsibilities. Only with this top-down mandate will treasury garner the cooperation it needs to deliver corporate-wide insight.
An accurate cash forecast must incorporate internal information from a variety of data sources – all with varying degrees of data consistency and format. Decisions on what data streams to use must be made before integration can occur. Data should be consistent and repeatable, to avoid manual effort or variations in format, content, or timing. Technology can, of course, help automate the integration of data streams once these decisions have been made. Examples of this include:
- Import data from enterprise resource planning (ERP) systems: gaining visibility into accounts payable (A/P) and accounts receivable (A/R) imports is important for short term cash forecasting. Many treasurers use ERP data to support working capital metrics and decision-making as well.
- Extrapolating historical data: for medium and longer term forecasts, evaluating historical patterns is best done for specific line items rather than the entire forecast. Historical transactions can be averaged, extrapolated forward for the same time in the coming year and updated for growth rates.
- Forecasts by remote controllers: non-treasury users often contribute to forecasts, especially for globally decentralised corporations. A web forecasting tool can be deployed to remote users giving them a standardised form to enter forecasts in a consistent and regular manner. Consolidation automatically occurs, allowing decentralised and centralised views of forecast information.
The most important step in the equation is an evolving feedback loop. This not only reconciles the cash forecast with actuals for the same time period (i.e. taking a snapshot of what was thought to occur and comparing to the cash flows that actually materialised) but also feeds this variance analysis back to those individuals that contributed (or own the systems that contributed) to the original forecast.
By identifying the detailed forecast variances and incorporating this insight into future cash forecasts, accuracy is improved going forward. The exercise is continuous as forecasting is always a work in progress. However, most corporates that employ the feedback loop reach their variance targets – and desired confidence in the cash forecast – within just two quarters.
The key is that the feedback is paid attention to and incorporated into future forecasts, which may present a challenge when people or systems lie outside of treasury. Thus, the treasurer acting as a strategic partner in a collaborative environment has a better opportunity to influence behaviour and results.
Conclusion: Stronger Performance
Overall, accurate cash forecasting offers the insights necessary to make better financial decisions, driving value for the entire organisation. Working collaboratively – with the right people and the right streams of forecast data – will improve the quality of forecast information and the treasury can play a key role in this.
Actively measuring forecast variances and establishing stronger inter-company relationships will generate more accurate forecasts, improving accuracy. Armed with confidence, the treasurer will find themselves in a much more powerful position when it comes to predicting future performance, even in the most turbulent of markets.
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