Cash & Liquidity ManagementCash ManagementCash ForecastingThe Quest for Accurate Cash Flow Forecasting

The Quest for Accurate Cash Flow Forecasting

Cash is the lifeblood of business, a fact that has been brought into sharp focus by the current economic climate. Cash flow forecasting is therefore a vital role of the treasury function – by being able to accurately map incoming and outgoing cash flows through collecting as much relevant information as possible, treasurers can ensure that their organisation is operating at maximum efficiency by putting in place the necessary short-term funding measures.

This information isn’t anything new for treasurers, who frequently cite cash flow forecasting as a key area for improvement within their department. Despite this awareness, progress seems slow, judging by a recent survey from APQC (see Figure 1). With 25% of respondents finding problems with their company’s ability to forecast cash flow ‘very weak’ or ‘problematic’, and a further 25% describing it as ‘adequate’, hardly a ringing endorsement. What obstacles are preventing these treasurers rating their cash flow forecasting ability as ‘strong’ or ‘very strong’? This article will examine these causes, look at how treasurers can overcome these problems, and take a broader view of liquidity management.

Figure 1: Corporate Cash Flow Forecasting Ability

Common Roadblocks to Successful Cash Flow Forecasting

There are certain common problems that treasurers can come across in their cash flow forecasting activities. One of the most cited reasons by treasurers for the lack of accuracy of their cash flow forecasts is that the information they receive from their business units can be late and inaccurate. However, Timo Hämäläinen, founder and CEO of Exidio, suggests that business units are the best and only experts on their cash flows. “It is a question of motivation, priority and guidance,” he advises in his article, The Cash Forecasting Challenge: Build a Business-to-Treasury Bridge.

Another common complaint from treasurers is that they have not found a suitable cash forecasting system yet. On this point, Hämäläinen warns treasurers against seeing cash forecasting as a systems project. “Start by building the business-to-treasury (B2T) bridge and continue by finding practical, quickly deployable tools from your bank or technology providers,” he suggests.

When cash flow data comes to treasury from a huge number of enterprise resource planning (ERP) systems, it can be problematic to come up with accurate forecasts. Despite this, Exidio’s Hämäläinen suggests that simply integrating systems may not be the full solution. “Integration of systems may be helpful but without the human touch of an expert within the business unit, the integrated data can still be unreliable if it comes from any other system than the TMS [treasury management system] where all cash flows are fully committed,” he says.

Clearly the relationship between the treasury department and business units within the organisation is vital for accurate cash flow forecasting. It is fortuitous, then, that the role of the treasurer has risen in importance as a result of the credit crisis. Investment and funding is now one of the most important areas of corporate strategy at board level, which enhances a treasurer’s mandate to explain to business units the important role they play in providing accurate information and, even, ensure that they know why this is so vital and feel invested in the process. With the support of management, treasurers are in a much better position to establish or reinvigorate their department’s relationship with the business units it relies on.

Adopting a Best Practice Approach to Maximise System Efficiency

Once the business units are fully aware of their role and the importance of the quality of their data, the treasurer then has to ensure that they have the suitable forecasting system for their company and, just as importantly, that they are using it optimally. At a time when organisations are increasingly diversifying and moving into new markets in an attempt to make themselves bullet-proof in the face of the recession, old parameters that treasurers use to model cash flow forecasts may no longer be relevant and, in the worse case scenario, could lead to wildly inaccurate reading of the data. Taking a non-parametric approach is one way to avoid this potential pit-fall, which is something that Michael Arben, director of strategic initiatives for CSC Financial Services in Europe, Middle East and Africa, advocates in his article, Once Bitten… The Cautionary Tale of Cash Forecasting. This can involve using a system to take all relevant business data and add in real-time information, which is then fed into a non-parametric representation of the ‘real world’ to show the likely future outcomes along different decision paths.

CSC’s Arben says that the key difference with this model is that it uses extremely powerful constructs for handling time so that the possibilities built into the model provide more factual and more rigorous forecasts. “So, instead of them working on ‘what might be’, they work more on ‘what is’ and ‘what will be’ in a real world scenario,” he explains. To make sense of the huge quantities of data required for accurate cash flow forecasting, it is vital that corporates understand the rules that govern this data in order to ensure that what they are analysing is of real value to the business.

However, the strategic decision-making skills required for these types of models are quite rare. There is now a demand for what were previously thought of as individual ingredients, but which are now recognised as needing to be combined. “The resultant mix is very hard to find in the treasury sector,” comments Arben. Clearly there is no quick fix to problems such as this, which is why it is important that treasurers think carefully about which system is best suited for their organisation’s cash flow forecasting needs

Cash Flow Forecasting Systems

Treasury management systems (TMS)
  • Tendency to focus more on financial risk management than on operational cash flow.
  • TMS tend to focus on real cash flows rather than cash flow forecasts.
  • However, they are improving in their support for the forecasting process and continual improvement in this area is expected.
Enterprise resource planning (ERP) systems
  • Sometimes support cash forecasting, but problems can arise if a company uses many different ERP systems.
  • Corporates looking to migrate onto one common ERP system can find this to be the best option.
  • Can lack flexibility – if a company needs a special report, these normally need to be built as bespoke solutions.
  • Unlike TMS solutions, ERP systems are not designed to handle the financial cash flows, which can limit the system’s ability to provide a comprehensive cash forecast.
Specialised cash forecasting systems
  • As the label suggests, these are specifically designed to provide comprehensive operational and financial cash flows.
  • Cash forecast systems vary in how standardised they are and thereby how much you can tailor the system to your needs.
  • Abilities to automatically fetch data from different data sources, such as bank, TMS, and ERP systems, also vary.

As the cash flow forecasting systems box shows, there are a large number of factors that treasury departments need to consider when choosing a new or replacement system. To start with, the treasurer needs to be clear on what their specific requirements are, and then draw up a list of possible suppliers based on that. Then, by writing a request for proposal (RFP) for these suppliers, the company can get a greater insight into how each supplier can service their requirements, as well as find out the relevant costs involved. Despite the technical nature of this selection process, Krister Backlund, finance consultant at OpusCapita, points out in his article, How to Buy a Cash Forecasting System, important role the treasury department has to play here: “It is important for the treasury function to stay in the driver’s seat during this process and not let this be run as an IT project.” After all, it is the treasury function that will be managing the system once it is in place, so their knowledge of what is required for their specific cash forecasting needs is vital in the selection of the system.

Once the selection of a cash flow forecasting system has been made, the implementation process can begin. Again, this requires careful preparation and delivery, as the execution of the implementation process can have direct consequences for the final efficiency of the forecasting system. OpusCapita’s Backlund suggests the following template to achieve a successful implementation process:

– Scoping – getting all details settled with the vendor:

  • How the forecast process should be set up.
  • Cash flow models.
  • Company structure.
  • User information and user rights.
  • Bank information.
  • Type of forecasts needed.
  • Calculations in forecasts.
  • Other elements.

– Planning: The timetable for the project and planning of internal and external resources needed to implement the system.
– Delivery: System implementation, including installation and tailoring of the system.
– Pilot: Running the system with pilot entities, and making updates on the basis of input from the pilot.
– Rollout: Starting the forecasting in the new system.

If the treasury department has correctly identified their company’s key cash forecasting requirements and has ensured these are catered for in the cash flow forecasting system that has been commissioned, they should now be able to make improved forecasts.

Conclusion

Cash flow forecasting has long been an area that corporate treasurers have sought to improve upon. Today this quest has intensified due to the global economic recession and the enhanced focus on corporate cash that this has created. Access to credit has been limited and banks can ask to see a corporates’ cash forecasts before making any agreements. It is therefore important that treasurers tackle any roadblocks to efficient and accurate forecasting directly.

If a treasurer is having problems with the data supplied by their business units, they should take the time to impress upon these units the importance of supplying timely and accurate data. Boards of directors are looking to their treasury departments to efficiently manage the forecasting process. Treasurers can use this mandate to manage their relationships with business units, as well as ensuring that they are at the forefront of any decisions taken over which cash forecasting system to use. With everything that has happened to the global economy in the past two years, treasurers should reassess the forecasting models they are using, because many old certainties no longer exist. Even if the data they receive from business units is accurate, putting that data through statistical models that are no longer relevant could have a negative effect on the overall results. Like in many areas of the treasury function these days, flexibility is key to a successful cash flow forecasting operation.

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