Cash forecasting

Background A simple search on google analytics shows that interest in cash flow forecasting as a search term over the last 10 years has remained high – despite economies generally growing during the latter part of the last decade. So, although the COVID-19 pandemic has reinforced the importance of cash flow forecasting, it has always clearly been a necessary activity. This is supported by the annual ACT survey – the Business of Treasury which shows that once again, cash management (of which cash flow forecasting is a key component) remains the number one focus for most organisations surveyed. So why is cash flow forecasting so important? During this pandemic, understanding future cashflows has been a major focus for boards and investors as they try to work out if there is sufficient liquidity to fund the business. For companies lucky to have treasury functions, identifying this has typically fallen to the treasurer. The cash forecast can help treasurers assess if and when they need to draw on bank facilities and if any of the government schemes are required. Whilst it is easy (relatively speaking) to use the crisis as an excuse to draw down fully on all available credit facilities, most treasurers recognise that this short-term response is not helpful in the longer term. Talking to lenders, we know that many of them see this as a sign of a lack of confidence over the ability of the company to properly assess its financial risks. It also brings in an element of trust as many boards recall events during the Global Financial Crisis in 2008/9 when some banks found reasons not to lend (including, for example, citing a Material Adverse Change clause in their agreements). It is also a drain on the bank’s own liquidity, which typically does not contemplate all borrowers drawing down all facilities at the same time. This is covered in more detail in a blog written by Clare Francis - chief executive officer U.K. & regional head global banking Europe at Standard Chartered Bank - which suggests that corporates are better working with their banks to draw down funds as and when they are needed. Cash forecasting can offer key insights on how the business is performing and the resilience of the value chain. Identifying suppliers wanting to get paid early and customers that are increasingly slow to settle invoices can provide early warning indicators about the health of these companies. Is technology the key? Many C-suite members believe that the implementation of a technology solution can transform the delivery of an accurate and useful cash forecast. Most of us that use / have used forecasts will acknowledge the importance of technology but more as an enabler of an effective forecasting process. A forecast that involves large data files, and a high degree of manual intervention can lead to questions over the reliability over the forecast and make any changes to the data being collected and how it’s reported on, difficult to implement. They can typically take two to three days which, during times of crisis, is often too long - as the data rapidly becomes out of date. From my experience as a treasurer, the most important factor is managing people and their behaviours. If those submitting forecasts see little value in forecasting, they will inevitably invest their time and attention in other activities they deem more important (and which they may be rewarded for). Once cash forecasting becomes a checklist activity, it loses all value. Changing behaviours is never easy and requires a multi-pronged approach. This can include: Getting senior management to communicate their support for the activity and why it’s important to the business; Insisting on variance analysis that compares one forecast with the actual result and includes an explanation for any significant variance; Sharing the aggregated forecast results, along with the overall variance analysis. The purpose of these is not to identify those who have performed better or worse than their forecast but to encourage accountability for getting a forecast that reflects the best available data available. I have spent many hours talking with CFOs to ensure they recognise that forecasts would invariably be wrong but the most important thing is knowing what caused the variance and if it was a result of an assumption by the forecasting team. Once the culture of the forecasting process has been improved, technology can support the process by improving data integrity, aggregating the data easily and enabling scenario planning which can use the forecast provided by the front line business units and then apply different central assumptions over business growth. In addition, I know from conversations during this pandemic that the treasurer has often been required to overlay confidential plans for closing plants, offices and reducing headcount; this requires a cash forecast that can cope with changes to modelling assumptions. Is there a standard cash flow forecast template and approach? In the same way that no two businesses are the same, no two approaches are the same. The key is finding an approach that is proportionate to the needs of the business and can be resourced effectively. In its AwardICM qualification, the ACT sets out key components of a cash flow forecast. This then needs to be flexed according to the specific requirements of the business. Frequency: Is a monthly forecast sufficient? Is there enough data for a more frequent forecast? Should one only update the forecast for significant changes in timings and values? How important is the forecast? I know one treasurer who has been running two forecasts every week since the start of the year! Timeframe: Typically, many companies build rolling 13-week cash forecasts comprising the first month of daily information with the other two months of weekly data. The danger with not starting with daily information is that weekly or monthly aggregated flows may disguise a large borrowing requirement on a specific day. Data owners: Depending on the resources and skill available, creating local accountability for the provision of forecasting data can ensure that changes in how customers and suppliers deal with the business can be reflected very quickly. If forecasts are created centrally, it can take away the local ownership of data. Level of detail: Often this is a function of the data that is available. However, it is not necessary to have the same level of detail. For example, some companies forecast their top 10 customers and then roll the remaining into an aggregate total. The main consideration is focusing on the largest line items that can result in the largest variances. There are a number of different approaches that can be used. Data analytics: This is becoming more widespread as companies begin to use the large data sets of history they have to predict the future using algorithms and in some cases Machine Learning tools. These have the benefit of not requiring effort by local finance teams and can be continually adjusted to take account of new information and customer behaviours. P&L derived: Given the effort that most companies invest in their forecast income, it is useful to derive a cash forecast based on a number of assumptions regarding the cash conversion cycle. It also provides a consistency between the two financial statements which other methods can often lack. Range forecast: The business decides how good and bad potential results could be – thus creating a range of outcomes. Discussions over this range requires an understanding of the business and its key cash drivers – something which the provision of numbers in a spreadsheet can often fail to articulate. You then discuss what is the most likely outcome which forms a statistical probability curve, and which can then be aggregated the different parts of the business. This is covered in more detail by Caroline Stockmann (chief executive of the ACT) in a recent blog she wrote. Payments and Receipts: This is probably the most popular forecast approach as it is principally derived from items in the general ledger – the accounts payable and receivable with overlays for central activities including salaries and treasury activities (such as currency hedges and bond interest payments). Summary Cash forecasting remains a critical activity for most businesses and typically falls under the responsibility of the treasurer. The basics requirements for a successful forecasting programme continue to be the proportionate use of technology to support a culture that recognises the importance of a forecast but also accepts that despite the efforts involved, most forecasts will turn out wrong.