Making sure your organization has enough cash to meet its obligations over a set time period is the goal of cash forecasting. It’s a pretty important goal, and one that carries with it a few fundamentals in practice — and a whole lot of variables.

There are set time periods to choose from, most commonly used approaches in the short term, and tasks that need to be met regardless of the method you opt for. That said, whether you choose to integrate one or more of the great technologies and tools available to treasurers today, or collaborate with FP&A to the benefit of the entire company, is entirely up to you.

“We run an auto reconciliation on a daily basis, but for management’s review, we run a comprehensive every Monday,” said one treasury professional. “So Monday is the day we make our decisions.”

Cash forecasting methods

Treasury’s primary goal is to ensure the organization has enough cash to meet its obligations over a certain time period. There are three time periods used to develop forecasts: short term, medium term and long term.

“At the end of the day, from a cash flow management perspective, it should be short term or medium term,” said a treasury manager. “You cannot systemize your forecast; it's impossible to 100% customize the forecast. There's always an aspect of human intervention to say, ‘Okay, I have the business acumen. I know of some other AP accruals. It's not going to be paid, or there will be delays, there will be litigation. There will be discrepancies.’"

Short-term forecasts are likely to be the most accurate. With a clearer view of the underlying cash flows that constitute short-term forecasts, treasury can better make strategic decisions in the following areas: working capital management, supply chain management and short-term funding strategy.

Medium-term forecasts are more difficult. Why? Because the medium term usually describes the period when payables and receivables are primarily forecasted from either budgets or previous years’ data, rather than contracted procurement and sales. When developing a medium-term forecast, you have to build it out from sales and procurement in order to understand the expected physical transactions (e.g., raw material costs, production costs) and anticipate cash flows over the next 3-12 months.

Long-term forecasts look out over a period of more than a year. They’re used to support decisions made regarding capital allocation, long-term fundraising and to identify the scope for mergers and other capital actions. Long-term forecasts help management understand the risks associated with different business strategies.

Cash forecasting doesn’t adhere to a one-size-fits-all approach. Your company’s focus on cash will best determine the approach to take and how much scrutiny there needs to be in planning. That said, there are three methods most often used, at least in the short term. They are a receipts and disbursements methodology, sometimes referred to as a working capital approach; a bank data approach; and a business intelligence or statistical modeling approach.

How do you know which method or model to use? Well, there’s actually no single “right” way to build a cash forecast. The forecast method you choose is determined by the quality of the data and the time period of the forecast. If the data is reliable, there won’t be as much need to manipulate it; when it’s less reliable or incomplete, you will need to manipulate it to some degree in order to produce a meaningful forecast. Be sure to consider any technological constraints in your decision, too; although statistical modeling can be done using spreadsheets, dedicated forecasting software is generally more powerful.

To help you determine which one is right for your organization, think through these seven items/tasks:

1. Identify the data available and necessary to complete the forecast. 
2. Establish the best sources for data.
3. Classify the data for accuracy and completeness.
4. Set the forecast timeframe.
5. Select the method to create the forecast.
6. Daily management of the system.
7. Review and identify the forecast output.

Working with FP&A to strengthen strategic forecasting

Treasury and FP&A both generate forecasts; however, both their objectives and general approaches to the task are different. Yet the fact that treasury and FP&A approach cash forecasting so differently actually leads to expanded benefits for the company as a whole, including more accurate forecasts over every time horizon, more understandable forecasts due to increased consistency, increased resilience as potential problems are identified in the short term, and identification of the key financial risks associated with potential projects.

Let’s look at this a little more closely. Here are five ways in which collaboration will benefit both treasury and FP&A:

• Scenario modeling: Treasury’s ability to provide more detail about how individual cash flows behave under stress enhances the accuracy of the models used by FP&A. And FP&A will be able to model the impact various potential strategies have on cash with more confidence, therefore helping to identify risks that threaten the achievement of corporate objectives.
• Operational enhancements: Companies want to optimize their use of cash and working capital, right? Possible improvements stemming from operational improvements in treasury include the adoption of standardized payment processes and increased automation within workflows generally, which helps lower costs and reduce the risk of error and fraud. As FP&A often serves as a finance business partner with teammates embedded in the business, they can share with treasury any early warnings of potential disruptions.
• Supply chain efficiencies: Insights regarding payment patterns along the supply chain can help support the ongoing review of its resilience. Any problems along the supply chain will likely have cash flow implications; treasury can help the business act to identify and manage those risks.
• Borrowing base: While calculating the cost of capital is often a shared responsibility between treasury and FP&A, treasury understands the obligations arising from different types of borrowing that can help inform models around the preferred capital structure, thus ensuring an appropriate balance between debt and equity. They also have the ability to structure borrowing in such a way as to avoid unnecessary stress when servicing and repaying the debt. FP&A then uses the cost of capital calculation in its decision and project valuation models.
• Risk management: This is all about protecting the corporation’s assets by way of a prudent approach — creating value in excess of the cost of capital, or alternative use of that capital. Treasury can support FP&A by identifying financial risk exposures and natural hedges in different scenarios and potential business strategies as FP&A seeks to forecast and project financials forward.

Improve the process with technology

Technological advancements have significantly changed the practice of cash forecasting. Today, treasurers have much improved visibility over bank accounts and cash positions — even in the most multinational of organizations. With bank technology, we now have access to real-time information, while treasury management systems (TMS) and other specialty software collate and combine data from multiple sources quicker and more accurately than ever. And machine learning tools are available to identify patterns, and changes in established patterns, thus improving the accuracy of the underlying data on which forecasts are built.

All this said, and with all the great tools available, many treasury professionals are still using Excel. “We don't have a TMS solution; we do it manually on a comprehensive Excel-based spreadsheet,” said one senior treasury analyst. “It's the kind of a dashboard that has bank reconciliation in it, so we extract the data from the bank portals and integrate it with our SAP modules for accounts payable and receivable. A manual payment plan from all the concerned teams is incorporated, and we’re able to see the cash position on a weekly basis.”

And others have created a hybrid system. “It's a mix for us, a hybrid way,” said a treasury manager. “We use a system-based tool for AP/AR, which gives us our baseline. We use Jedox and Power BI, then we make a lot of manual adjustments. That's for short-term forecasting.”

Perhaps your company has some reservations about using technology or new-fangled tools, but there are so many reasons why you should — access information in near real time, connect and centralize all your source systems so your financial data is combined to make accurate cash forecasts, automate the data collection process to give you insight into your cash position without manual processing, create visuals of value to all your business partners (e.g., infographics, dashboard, reports) automatically, and the reallocation of resources to analysis means better and faster analyses.

Learn more with AFP’s comprehensive guide to cash forecasting.