By Jessica Segebarth, CTP, and Steve Phillips, CTP, FPAC
Yogi Berra was talking about baseball when he said, “It is difficult to make predictions, especially about the future,” but given the economic curve balls of the past few years, these words are more relevant than ever when it comes to the art of cash forecasting.
Dramatic changes in supply chain, the rising rate environment and tightening capital markets have left many companies relying even more heavily on the accuracy of their cash forecasts. Depending on the complexity of the company, forecasting can feel like a daunting task; however, by implementing a handful of key foundational strategies, you can create forecasts that allow you to easily keep an accurate pulse on your company’s cash position, thus reducing carrying cost and/or improving your ability to maximize the value of excess liquidity.
Here are five key components to building an effective cash flow forecast.
1. Understand core drivers of cash flow.
In the simplest form, the way companies generate cash flow is a standard recipe. A widget is made/a service is developed (cash-out), the widget/service is sold (cash-in), and money is borrowed or invested depending on the ending cash position. To ensure an effective forecast, it is best to remove noise that can be caused by including too much information. Instead, focus on the core inputs that truly drive your cash balances.
2. Define the degree of certainty and timing of cash flow events.
To get an accurate forecast, it is important to identify which flows are known, which can be predicted and which are difficult to forecast. Leveraging historical data, you can weigh the certainty of cash flow line items and identify the timing of these flows to generate a conservative and reliable forecast.
3. Ensure source data is easily accessible and accurate.
Depending on the company size, organizational structure, and bank account structure, this can be easier said than done. Reducing the time it takes to access accurate data will not only improve the quality of your life, but also the quality of your forecast. Consider automating the delivery of transactional data from your banks (e.g., API integration to the ERP) and leveraging ZBAs to consolidate cash inflows and outflows for easier visibility.
4. Communicate and collaborate to ensure end-user expectations are understood and achieved.
When it comes to cash forecasting, like most things, communication is key to success. Before committing to a model, you must have a clear understanding of what questions the end users want answered with your forecast. Once expectations are aligned, collaborate with internal teams to ensure timely access to accurate data.
5. Frequently test and validate.
A model is inherently a best guess; therefore, it is imperative that you routinely compare your forecast to actuals and evaluate the drivers behind any significant differences. If there is a justified reason for the differences, try incorporating this into the model so that you produce reasonably accurate forecasts going forward. The use of variance analysis against the baseline assumption is the primary tool for validation.
Where Can I Learn More About Cash Forecasting?
Ultimately, a cash forecast is very much a living breathing thing. The more attention that is put into developing a sound core model and the more frequently you test and validate, the more likely you are to generate a forecast that can be leveraged to help the company achieve optimal outcomes.
Join us at AFP 2023 in San Diego for our session “Cash Forecasting Is Hard (Or Is It)?” and we’ll take a deeper dive into the key components and best practices you can implement to improve your cash forecasting process.
- Steve Phillips, CTP, FPAC, Assistant Treasurer, AZZ, Inc.
- Jessica Segebarth, CTP, VP Senior Treasury Sales Officer, Commerce Bank
Check out the full lineup of AFP 2023 sessions on the Session Explorer.