Cash forecasting continues to be the one area that many senior treasury and finance professionals struggle to do well. Some would go as far as to say, it’s better not to forecast at all than forecast inaccurately. An inaccurate forecast can have financial consequences from both a risk management and opportunity-lost perspective – borrowing when you don’t need to or investing excess funds that you have forecast but which don’t exist in reality. If you don’t get it right, there’s a potential price to be paid.
Be prepared for the unexpected
As the global economy dives deeper into the realms of low to negative interest rates, deciding not to forecast may appear to be an acceptable option. However, nothing lasts forever, and it remains good practice to use organisational liquidity as efficiently and effectively as possible, regardless of current economic conditions. We live in a world of increasing financial volatility where the risk always remains that market rates might fluctuate, business environments make a quantum shift, or that geopolitical events continue to influence economies in ways we once thought unimaginable. It might even be something as simple as the CEO enquiring as to how much cash will be available in three months’ time in order to fund a quick acquisition. Maintaining a clear and pragmatic view of liquidity allows your business to be prepared for the unexpected.
Make it matter
So, if you’re now convinced that forecasting is necessary, then what should you be thinking about? At it’s most basic level, cash forecasting is simply understanding the cash position of your organisation for given points in the future. Cash forecasting frequency needs to be defined according to your organisation’s requirements, i.e., three-monthly, monthly, weekly, every other day, daily, etc. Treasury and finance leaders need to pre-agree forecasting frequencies that are of significance to the business, provide value, and are meaningful, rather than just “doing it for the sake of doing it.” Accurate forecasting takes effort and commitment from all concerned, including business partners, subsidiary heads, and stakeholders. It requires much thought and deliberation around forecast horizon and forecast granularity, so make sure it’s a useful effort that provides tangible insights for your business. Having the right forecasting framework in place and the ability to forecast and re-forecast the cash position quickly and with relative confidence, is crucial.
A stitch in time saves nine
For organisations that are ‘cash poor’ or where there is maybe the possibility of a covenant breach, the business will look to cash forecasting to gather a detailed insight into the likelihood of the event becoming a reality. If forecasts are accurate, then they can enable processes and contingency planning to mitigate the potential challenge. Having the luxury of time and foresight to mitigate risk and avoid problems is much better than being unprepared for a nasty surprise! Also, companies that have tighter cash margins tend to understand and appreciate the importance and benefits of accurate forecasting because they have to regularly think about volatility, and possibly even survival, as part of their forecasting processes. Here you tend to see a forecasting framework that is as granular in nature and regular in frequency as business needs dictate.
Getting the R.A.M. technique just right
There are three key factors that influence an accurate forecast – Reliability, Accuracy, and Methodology.
Reliability: Treasury and finance departments often depend on other parts of the organisation to provide forecast data, but they don’t always have control over how and when this is done. This can be a major issue as forecasts have to be reliable. Business units need to understand why their timely data is so important. Building strong business partnerships requires mutual understanding, clear instruction, and support to reach a position of synergy and numbers ownership amongst all concerned.
Accuracy: is the second dimension. How accurate should forecasts be? 100%, 90%? To get 100% accuracy may seem an impossible task, therefore, many treasuries & finance departments start at a level that is realistic and then seek to improve their accuracy as they become more confident with the process and framework. The key to success is to start with something that is achievable then, through variance analysis, measure how close to accurate the forecast actually was and identify where improvements can be made through additional training or development. Publishing variance results from each forecast can be helpful so that all parties involved in cash forecasting, know that the accuracy of their forecasts will be carefully monitored. You should provide regular feedback on the quality of forecasts provided to motivate reporting units to develop and take ownership of their individual efforts.
Methodology: forecasting tools and solutions are vital for the accuracy and reliability of any forecast, in particular, getting buy-in from the subsidiaries and stakeholders providing data inputs for a consolidated liquidity view. Moving away from spreadsheeting, reducing human error and access to real-time reporting via the cloud have revolutionised the cash forecasting process.
Accurate and real-time visibility of future cash flows provides many benefits to companies from reduced transaction charges through netting of flows to improved returns by taking advantage of interest curves. As mentioned previously, there are other benefits too, including giving management more time to identify future cash management issues and put in place remedial action.
Cash forecasting really does matter.
VP, Sales & Marketing at Analyste
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