William Booth, senior vice president and head of Product Strategy and Innovation at Atlantic Community Bankers Bank said, “Over a relatively short time, cash forecasting has shifted from a function of survival to the ability to be nimble and react to strategic opportunities.”
Since the process hasn’t been entirely automated by most companies, the process can be time-consuming and resource heavy. To help you become more nimble, we put together a list of the 10 best practices in cash forecasting.
1. Define the purpose of the forecast to drive the outcome.
Cash forecasting means many different things to companies depending on their size and complexity, though the main purpose is generally liquidity management. Sit down with all involved in the process and talk about what you want out of the forecast. Discuss how much time and effort should be put into it and at what level you need to forecast. Identifying the degree of granularity management needs will help you avoid spending unnecessary time getting bogged down in details. Reach agreement on everyone’s definition of the cash forecast, acceptable output and accuracy measurements.
2. Use appropriate detail to make the process simpler and faster.
Understand where the numbers come from, and the processes others use to create them. Judiciously integrate technology to gather key data, exhibit financial acumen, and encourage team participation to best reflect the reality of your financial business needs.
3. Understand the types of receipts and disbursements in terms of predictability and timing.
To arrive at the forecast, companies look at their bank statements and determine where cash is coming from and where the outflow goes. The problem with looking at other indicators, such as percentage of sales, is that it’s too theoretical. Tag each transaction, and create a cash flow statement that runs parallel to the accounting statements.
4. Disclose assumptions, understand actuals and dive into their history.
In order to be better at telling a story with your data, make notes of the timelines and sources. Also, be sure you know of any large changes in the past and be able to explain them to your supervisor so they can communicate them as well.
5. Validate and make necessary adjustments using variance analysis on a timely and consistent basis, but focus on its materiality to cash flow.
The underlying situation will help determine the frequency of the variance analysis — weekly, monthly, quarterly or yearly — it all depends on the type of forecast data to be shared or explained. Making this determination requires an understanding of what’s important in terms of cash flow as it relates to the amount in question.
6. Ensure usability.
Make sure you know what the model output is used for so you can provide the correct information for users — and explain it effectively to different audiences. If strategic reasons are driving the output, then the data is likely to be higher level; if it’s more tactical in nature, a more granular explanation may be needed. In both instances, it’s best to know the data.
7. Align the short-term cash forecast with the long-term corporate model.
The frequency and horizon of forecasts varies among different organizations, depending on size and needs. One example of this is aligning the annual or operating plan to the five-year strategic plan and reconciling discrepancies and assumptions. This will likely require assistance from FP&A, or other departments, for some of the inputs and assumptions.
8. Use statistical analysis, for example regression of historical patterns.
The problem with looking at other indicators, such as percentage of sales, is that it’s too theoretical, according to Jeff Cappelletti, a principal with Upper Third Consulting. “By looking at historical data, you get a realistic road map of where the company was,” he said. “Only then can you look at receivables and future purchases. But you look at the past first and then look forward.”
9. Make the forecasting process simple yet detailed, and understand your variances — dig into the actuals.
“Practitioners need to stay in touch and abreast of business changes,” said Greg Lattanzi, CTP, senior treasury analyst at IGS Energy. To keep the forecast “honest,” treasury should do a variance analysis that looks at actual A/P, in addition to any trends that may be drivers of the business but that are not incorporated into the forecast.
10. Don’t make it a one-way street.
Rely on business units to supply their input, but don’t forget to return the important forecast information to ensure they can make decisions that will positively impact cash flow. For example, showing them improvements to the forecast from implementing working capital improvements is one way to share and collaborate with the business unit, especially if it’s tied to incentive compensation.
Learn more about cash forecasting with AFP’s Treasury in Practice series.