Thinking About Cash Flow Forecasting

Cash flow forecasting often puzzles and disappoints many treasury managers and their bosses. On the surface, forecasting doesn’t seem so impossible.

You’d think it would be simple to fix or enhance your forecasting. However, this is often not the case. You and/or other users may be wedded to the format, timing, etc. of the current forecast. This creates a bias that can be difficult to overcome. One way to try to work around this barrier is to try to recreate the forecast with a different approach than you currently use. What do you and other users want to get out of the forecast?

The first question you need to answer is how [bad] have the forecasts been? Have there been any wild errors? How routine has the forecasting process become? If it’s well ingrained, the process may be tough to change.

The next question you should answer is, “What is it worth to you to produce accurate, reliable cash flow forecasts?” I’ve run across treasury managers who have had to justify changing their forecasting system by how much dollar benefits will result. This is not how you should try to justify your forecasting system. Forecasting should be a core treasury activity and not subject to a cost-benefit evaluation.

How active are you with your forecasting system? Many treasury managers are too passive and are willing to accept forecasting inputs without questioning suspicious numbers. If you accept what you’re sent and never give any feedback, you are telling the sources that the forecast is acceptable. You need to be “hands-on” with your forecasts and let people know that accuracy is required. Otherwise, the forecasts will not be valued very highly.

How do you know if your forecasting is effective? If you are the ultimate user of the forecast, this is an easy question to answer. You know if it helps or doesn’t do much. If you prepare the forecast for someone else, you need regular feedback from the users of the forecast. You may have to meet with potential forecasting sources to gauge the level of accuracy and reliability.

Sounds tedious, right? Well, there really are no shortcuts. When I first joined my company, a large multinational, the treasurer said, “You know all about statistics, etc., so I’m giving the forecast to you.” It took a few years to develop a solid system. It was something I never stopped tinkering with.

One approach might be to try to forecast from two different perspectives. If you currently are using a top-down approach, which estimates cash flows based on some basic financial flows, such as sales, try to prepare a bottom-up forecast. This approach isolates key cash flows and develops estimates for them.

For more ideas and approaches, see “Cash Flow Forecasting: A Hands-on Approach” and models.

Good cash flow forecasting takes time and effort. Most of the tools are pretty crude. I often say that cash flow forecasting is not quantitative; it’s numeric. The benefit is that an effective cash flow forecast has the potential to make your job easier and your contributions to the company’s overall financial performance more substantial.

Kenneth Parkinson
Copyright 10-02-14

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