For corporate treasurers, cash forecasting continues to be a hot topic. According to recent and numerous, global surveys, cash forecasting (along with financial risk management) ranks either number one or number two in improvement focus for Treasurers in 2012. So why? Given the tumultuousness of worldwide markets, having an accurate and confident cash flow forecast is no longer a luxury.
Critical and optimized investment, debt, short term liquidity, payment flow and hedging decisions all require a solid view into the anticipated flows of the business. Additionally, Treasury is now being called on for longer term / strategic insight include pre-deal M&A analysis, divestitures, stock buyback, etc. Creating a forecast is only half the battle. Best practice organizations analyze the best set of flows to build their forecast off of. Mostly, it’s a combination of a number of sources including historical extrapolation, maturity schedules of financial flows, modeling of recurring inflows and outflows, large one-off flows, internal system imports (AP/AR/Budget) and consolidation of business unit/sub forecasts. Unfortunately, most organizations stop here and this is a big mistake.
In order to drive and sustain accuracy over time, forecasts must be performance tested regularly. Put simply, don’t forecast unless you are going to test. I know this is extra work on top of an already crazy day, but again this is the only way to achieve on-going forecast accuracy. In today’s market, unreliable and untested forecasts can have severe consequences. The best of the best put rigor into testing the accuracy of forecasts and then make adjustments based on performance analytics. The good news is that it’s not as difficult as it may sound. Essentially it requires comparing snapshots of forecasts against bank account actuals:
- Identify your data sources and block of time (daily, weekly, etc.) and match the forecast to the actual flows.
- View the variance and then pinpoint where the issue lies.
- Decide whether the issue was a one-time event or more normalized.
- Adjust and test again the next block around.
An additional practice employed by many organizations is building staff incentives (or penalties) on forecast accuracy. You’d be surprised to see how accuracy increases when dictated by merit or recognition.
Cash flow forecasting and liquidity planning is an ever-changing process. You are never done and are never going to be perfect. However, the organizational and financial benefits of accuracy and confidence are tremendous.