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Cash Flow Forecasting - 1: From strategy to implementation

Cash forecasting has since long been the Holy Grail of many treasury departments. It doesn’t matter whether  you are a global, international company or a midsize, domestic company, whether you have centralized or decentralized treasury operations, whether you have advanced processes and tools in place such as in-house banking or payment factories, cash forecasting remains a challenging exercise for many treasurers.
This article is the first in a series of four, in which some of the most frequent pitfalls will be discussed. Here we will cover the concept of ‘forecasting assumptions’.

Cash Forecasting is gaining importance beyond the finance walls

Cash management and in particular, cash forecasting, are at the core of every treasury department. It is what drives business growth and globalization. Cash is a very important information basis to drive strategic decisions, making alignment with business goals a crucial KPI for every treasury department. Effective cash forecasting will enable proper liquidity management, which could in turn make the difference between being dead or alive. Enterprises worldwide are becoming increasingly aware about the potential of smart cash management. In 2014, the Association for Financial Professionals, together with consulting firm Oliver Wyman, conducted a survey amongst over 200 senior treasury professionals. 84% report that treasury is playing a more strategic role in the company, 69% attribute this enhanced role to a greater emphasis on cash management and liquidity and 62% stated that cash forecasting will be an area of focus in the coming years.

“62% stated that cash forecasting will be an area of focus in the coming years”

These numbers show that a treasurer’s responsibility is expanding and expectations are building up. However, most treasury departments are not yet there. Cash visibility and forecasting are persistently listed as one of the biggest challenges in treasury. PWC’s 2014 Global Treasury Survey reveals that 89% of the respondents still use excel-based spreadsheets for their cash forecasting activities. Other research conducted by EY indicates that half of large companies do not have uniform cash forecasting procedures.

A good start is half the battle

This shows that most companies still have a long way to go. But what exactly makes predicting future cash flows so challenging? Which obstacles are so insurmountable that they impede companies to leverage cash forecasting as a strategic instrument? Most of the time, these obstacles tend to show up at the very beginning of the cash forecasting process. Cash forecasting is all about assumption setting. If such assumptions do not make sense, the cash forecast will not make sense either.

A first key requirement for relevant assumption setting is to have a good understanding of the forecasting objective. However, when asked the ‘Why-question’, it often remains unanswered. Yet, there are many good reasons to build a cash forecast: a budget exercise, a financing optimization process, dividend policy enhancement, preparing for bank negotiations, and many more. Real case experiences show that the people preparing the cash forecast are often not sufficiently or not at all informed of the objective. As a result, there is no use case defined with the risk of the forecast not having a relevant business value.

That’s why answering the ‘why-question’ is of utmost importance. The involvement of business stakeholders is crucial at an early stage to determine for what reason the forecast is going to be used and which possible consequences its outcome may have.

“The involvement of business stakeholders is crucial at an early stage to determine for what reason the forecast is going to be used”

Another requirement for good assumption setting, closely related to the objective, is setting the right forecasting term. The objective will determine whether you need a short-term, mid-term or long-term forecast. The term in combination with the goal will give an indication about which data is relevant to include in your forecast. For example, including actual payment behavior may be relevant in a short term forecast, yet less relevant in a forecast for budgeting purposes. Therefore, alignment between treasury and the business is key to define an appropriate forecasting term.

Managing the unknown

Finally, forecasting assumptions are vulnerable to continuous changes in the company environment. Changes range from new alliances and changes in legislation to new financing strategies. Treasury needs to be informed to ensure proper assumption setting. The key to manage unforeseen circumstances is communication. Keeping business stakeholders informed about how changes beyond their control impact the forecast will ensure continuous alignment between the treasury department and business operations.

This seems like a manageable approach to follow. However, collecting the correct information mentioned above at the right time may well be a challenge on its own. This is an intriguing topic, which we will cover in the next article. We will also dive into the topic of cash insights. 

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