For years, we have been reading in all treasury-related surveys from around the world that cash flow forecasting is the next project that treasury departments will be tackling. These good intentions however are then shelved in response to yet another IFRS amendment, an acquisition or a carve out. We also often hear that the implementation of cash flow forecasting would be not pay off in terms of the expected benefits. Or, that a two-month intern with excellent Excel skills will take on the project in the near future.
Whatever the case, the core question which should and can be answered quickly is whether you can actually afford not to have cash flow forecasting. No, of course not. It certainly isn’t necessary for a company to already be facing a cash flow crisis. In such cases, it is often too late in any case. The best time to introduce cash flow forecasting is when you don’t need it. It’s as simple as that. The time when you will be happy to have such a tool at hand is sure to come. For example, when it’s time for the next IFRS amendment, the next takeover or the next carve out.
“It is better to be approximately right, than precisely wrong”
The quote “It is better to be approximately right, than precisely wrong”, stems from none other than Warren Buffet. Although he wasn’t referring to cash flow forecasting per se, this statement nonetheless hits the nail on the head. In fact, if this saying didn’t already exist, we would need to come up with it exactly for this purpose. Without forecasting, you are certain to be “precisely wrong”.
In discussions with various corporates, we often hear that they don’t use cash flow forecasting because the results, “based on experience”, would in any case be too inaccurate. Which leads us to Fundamental Misunderstanding #1: What exactly is “accurate forecasting”? Forecasting which is nearly entirely free of deviations? And does “inaccurate forecasting” have to be worse than no forecasting? Good and evil, right and wrong, these are certainly not the criteria to apply when the goal is gaining an insight into the financial future of a corporate group. They only apply in terms of whether to forecast or not.
So, is cash flow forecasting a question of corporate culture?
You bet! Even in 2018, cash flow forecasting is primarily not about Big Data and Machine Learning; it’s about communication plus a healthy pinch of common sense, expertise and plenty of social intelligence. It’s about communication between the finance department, treasury and numerous other departments and divisions which may not be too enthusiastic about interference from outside from someone who wants to know when and in which currencies incoming and outgoing payments are expected. There’s a business plan for that, isn’t there? And there’s also a cash pool!
Anyone who thinks that their forecasting is on track after introducing a system is of course wrong. It would be great if that was the case, but that tends not to be so in real life. In real life, you need to talk to your production, purchasing, sales, logistics, marketing people and many other departments. And that means really talking to them. Not only writing emails and sending them complex spreadsheets which probably don’t fit the business model; but really talking to them. And it is exactly this communication which is a question of corporate culture. When this communication is promoted and also demanded by a company, then the forecasting process will also be sound. In cases where those involved simply hide behind their desks and knock up some sort of model which might, possibly, be able to forecast cash flows from some obscure sources, it isn’t going to work. Period!
Back in the mid-1980s, when I was responsible among other things for the cash flow forecast at Hewlett Packard in Austria, the most important (and useful) information I got my hands on was always over a coffee during an 8:45 daily coffee break organized (and paid for) by the company. 15 minutes and, as a result, much of my forecast was usually as good as done.
Bean counting vs. a discussion of really important questions
Finally, I would just like to add a few words about buzzwords such as the Big Data and Machine Learning mentioned above as these obviously also play a role in ensuring that the issue of cash flow forecasting remains ‘scary’. There are certainly business models in which these trends are worth paying attention to if you want to predict the future based on past events. But these business models per se are so simple that the question of complex algorithms no longer even arises. If your company has grown by eight percent per year in the last ten years, the probability of this not being the case in the eleventh year can be regarded as very low.
But there is another question where Big Data & Co. would definitely be warranted, but they tend not even to be mentioned in this context. Perhaps because many people are convinced that their forecasts are sufficient, in as far as they have one. But are they really? Was that really ever the case? No. A forecasting process is only sound and practical when, at the end of this process, you ask yourself the following question: “Which events could arise which will lead to my forecasting assumptions not materializing?” And this goes far, far beyond how the Dollar, Euro, Pound Sterling or any other currency is going to develop in the coming months. Bonus points for anyone who has already integrated such models into their cash flow forecasting. This is, however, where Big Data can substantially help, if applied correctly and, more importantly, in a meaningful way.
But it goes far beyond that. Because this issue is so current, be honest here: Could you have imagined a year ago that American import tariffs might have a significant impact on your business model? Who would have thought that such policies could be introduced at such short notice, or, depending on which side of the bed Mr. Trump’s got out of this morning, revoked again in one of his late-night Tweets? OK. You’ll no doubt be thinking that there isn’t a software package in the world that can forecast what Trump is going to twitter tomorrow, and you are of course absolutely right. On the other hand, these examples also highlight how sensitive and volatile markets are and how fast changes can happen.
Either way, there is also a wide range of potential factors which could indirectly have a sustainable impact on your business. And these are the factors you should be focusing on. Only when you can take these factors into account and at least partially evaluate their impact, whether positive or negative, can you consider your forecasting, in terms of the forecasting method, to be sound. If not, then your forecasting is probably not worth all the time you and everyone else invests in it.
As the old sayings goes: “It’s not the fall that kills you, it’s the sudden stop.” With this in mind, make sure that you are never surprised by a sudden stop in terms of your cash flows.
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