Cash Forecasting and Planning: How Much Liquidity is Enough?

The chart below shows how cash continues to grow on company balance sheets. At the same time, the percentage of small business collapsing is on the rise as business is under pressure due to inadequate cash flows. According to the Australian Securities and Investment Commission (ASIC), 41% of companies stated inadequate cash flow or high cash use as a driving factor for bankruptcy.

Figure 1: Total Liquid Assets of US Companies, 1975-2012

ANZ liquid assets of US companies
Source: Are US firms really holding too much cash? – Professor Laurie Simon Hodrick, Stanford University

Ultimately liquidity risk is what is driving the above extreme situations – a stockpile of cash or collapse due to inadequate cash. Reducing costs and increasing cash flow were cited as the two most important priorities by chief financial officers (CFOs) of major companies in the UK, according to The Deloitte CFO Survey 2013 outlook: Cash, costs and the search for opportunity’.

The amount of cash needed in a business differs for many reasons. For example, research and development (R&D)-intensive companies require a greater cash buffer against future shocks as raising money from capital markets at a fair price can be difficult when people externally know far less about the potential of an idea or innovation.

A good cash flow forecast allows the company to plan for maximising the yield of surplus cash. Growth companies with a high price-earnings (PE) ratio and significant piles of cash have a large part of the enterprise value contributed to by the return on their cash. Hence planning for cash flows is important whether there is excess cash or too little cash.

Fail to Plan, Plan to Fail

Ultimately a robust cash flow forecast and plan to deal with a surplus or deficit situation ensures the company can navigate the future.

Cash flow forecasting that is of a high quality and dynamic needs to drive the strategy of a company. A forecast of potential cash flow problems provides management with the right guidance on the need for action, such as further funding or tighter controls. Every activity that a treasury does from investment, hedging and funding decisions flows from a cash flow forecast and plan.

Cash is different from profits. It has an element of timing. When will cash come in and in what order will obligations be addressed? For example, cost of goods sold (COGS) on a profit and loss (P&L) statement does not really tell how much direct materials, direct labour and selling expenses went in. Profits have accounting techniques that mask actual cash position – for example capitalisation of interest costs by property companies where the interest cost is added to the cost of the property and is not charged to the P&L account. Such a company might be profitable but the cash flow could be negative.

Management can sleep easy if they are able to rely on internal sources of cash rather than seek funding from banks and shareholders to grow or expand. Understandably, corporate predators maintain large war chests of readily available cash for acquisitions backed by substantial undrawn or standby borrowing facilities. For instance, Samsung Electronics holds US$39bn in net cash to pursue more deals as the group seeks to grow beyond core consumer electronics. Predicting the size of the forecast should be an important element in planning acquisitions.

A cash flow forecast plan has to cover the short term (up to 13 weeks), medium term (up to one year) and long term (up to five years). Short term forecasts determine the amount of operating cash required by the company over the coming weeks. This is what keeps most treasurers awake at night. A medium term forecast determines the overall funding/investment patterns and the size of the short term cash facilities needed. Long term forecasts cover periods greater than a year and aim to forecast the long term outcome of business plans and strategies and to plan long term capital structure and the balance sheet.

Implementing a Cash Flow Forecast and Plan

Cash flow forecasting is a specialised activity and over time the experienced cash flow forecast practitioner can turn it into an art. There are many models that can be used, from a simple tracking of receipts and disbursements to a more complex statistical analysis (regression model) which plots cash flows as a correlation to several input parameters. In order to smooth the variances between actual cash flows and forecast, moving averages or exponential smoothing of forecasts can be used.

Ultimately, irrespective of what model is used appropriate to the size and complexity of the business, the objective is to ensure there is a clear picture of cash needed for operational, precautionary and strategic purposes. Assumptions for each of these need to be clearly documented.

Operational cash requirements are affected by the business environment. Companies that are in credit-oriented business will require less cash than those operating in a cash-oriented environment. Companies that generate revenues from multiple small transactions are likely to require more cash for their business than those deriving it from relatively few but large transactions. Since there are economies of scale, larger companies tend to hold less cash. Many different assumptions need to be made regarding cash flows that are based on historical payments, credit terms, seasonality and sales.

Then there is the need for reserve cash, or cash for precautionary purposes. Companies dependant on the capital markets for their funding needs can suddenly find themselves locked out of them. The global economy has become extremely volatile and a debt crisis, for instance in Europe, can lower the enterprise value of a company in Asia making it difficult for it to issue a bond for instance. Research has shown that in times of increased volatility a typical company loses 20% of its enterprise value. Cash is then needed to tide over such periods of uncertainty.

Companies also need cash for strategic purposes beyond regular business operations. Microsoft paid for the acquisition of Nokia entirely in cash from its US$60bn in offshore holdings. Multi-jurisdiction companies need to also account for the tax and regulatory issues that prevent them from accessing certain pools of cash.

While all of the above is done at an individual entity level, group forecasts will need to include cash flows dealt intra-group. In a multinational corporation (MNC) each entity needs to make its own forecasts in its own currency, which is then consolidated at group level with consideration to the transfer of flows between the entities. This adds another level of complexity to cash flow forecasting. Procedures for transferring cash between the subsidiaries when not clearly laid out result in cash often being inaccessible. If business units hold on to their own cash and transfer funds only occasionally to the group treasury, a consolidated cash flow forecast for the group should recognise that the company could have cash surpluses in some business units and deficits in others.

Where the business units manage their own bank accounts, cash surpluses could be idle unless action is taken to transfer them immediately to the central cash pool that is under the management of the group treasurer. It is not uncommon for tension to exist between management in the subsidiary companies and head office that has the job of ensuring that cash flow planning within the whole group is optimised.

Integrated Liquidity Management Solutions

A cash flow forecasting plan needs to link into a strong liquidity management solution. Potential obstacles to optimal utilisation of cash across the group include multiple currencies, banking relationships, legacy accounts and different online platforms. Usually, the greater the complexity, the more the opportunity for tightening processes within the company.

A liquidity management solution from the bank fits in to provide the necessary pooling and control of cash across the organisation. Treasurers cannot afford to have sophisticated cash flow forecasting models only to find they do not have access to the cash predicted by the model due to inefficient banking arrangements.

A liquidity management solution also ensures tighter control is maintained on the cash when business units’ forecasts predict poor cash flows. When individual entities are not tightening the generation or use of cash, the liquidity management solution can exercise control through transfer pricing mechanisms that create a powerful incentive for business units to pay close attention to their operating cash flows.

In addition, a liquidity management solution provides reliable data on the actual cash position that then calls out the variance to plan. Cash flow forecasting logically needs to be coupled with a liquidity management solution to complete the value proposition.

Identify Resources and Systems

Having understood what really goes into a cash flow forecast, we can look at what drives resource requirements for the activity.

Cash flow forecasting, when dependent on manual interfaces for data capture, burdens the team with laborious tasks that take time and attention away from the decisions needed in response to the outcome of the cash flow forecast. For larger, complex organizations, collating the information on Excel spread-sheets can make the exercise prone to human error, creating a lack of confidence in the forecast and destroying the validity of the budgeting process.

As mentioned earlier, a good cash flow plan takes in many inputs as a balanced operational strategy. Many individuals provide these inputs, to whom eventual ownership has to be assigned to deliver on the plan. This includes sales, engineering, purchasing, production, distribution and many more.

There has to be the ability for stakeholders to monitor variance to their respective inputs so that a cycle of continuous improvement can apply to the cash flow forecast and plan. It means it is highly dynamic.

The cash flow forecasting system must therefore be able to integrate with multiple data sources and provide access and visibility across the organisation in real-time. In determining a suitable system, decisions may need to be made between hosted solutions and in-house implementation that are based on factors of technical requirements, costs and value-added services.

A strong cash flow forecasting plan, along with sufficient analytical capabilities, can automate scenario testing and stress testing based on known liquidity demands like operational flows, dividends, interest payments, royalty payments and non-routine costs relating to new investments and acquisitions.

Importantly the system should be able to condense reporting into short form but without missing important details. Hence reporting flexibility determines a key parameter in deciding the system.

Connectivity to mobile could be a parameter considered for the globe-trotting senior manager.

Cash flow forecasting and planning is an intensive activity and to derive benefits, sufficient training to the staff in techniques and systems should be planned.

Finally treasurers need to plan to ensure that the liquidity generated from internal sources is as per predictions, accessible and protected. A robust liquidity management solution that provides visibility to the cash, reduces costs, ensures efficient balance sheet management and diversifies risk will ensure there is a tight feedback loop to the planning and budgeting activities explained above.


A cash flow forecast and plan represents a company’s overall business and strategic plan. Once all the factors are considered, the gaps (need for cash or surplus cash) are plugged either through funding facilities or suitable investment options. Where future plans consume expensive capital, the cash flow forecast becomes a tool to identify where inefficiencies in the cash conversion cycle can be eliminated, such as driving sales or customer service teams to improve the collection process.

A good cash flow plan serves as an effective communication about the hard strategies and decisions a company must take to achieve its objectives. Sometimes cash flow plans can provide a dose of reality to management teams that are in denial. It can illustrate the weakness in the company’s business plan in the short to medium term.

A cash flow forecast can be a scorecard to monitor progress and accelerate growth especially for underperforming companies in difficult economic conditions.

A comprehensive cash flow plan that is ambitious, yet within the realistic, financial and operational constraints of the company is self-propagating to help achieve the goals of the company.


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