Cash Flow Forecasting - Most Common Mistakes?

The three most common mistakes in cash flow forecasting might be:

Under-committing

Cash flow forecasting is a major undertaking and should be viewed as a key strategic treasury initiative. As such, it should be allocated sufficient first-tier resources. Too often I’ve seen cash forecasting relegated to junior level staff who don’t have an adequate understanding of the organization or to an already-overloaded senior staff member who doesn’t have sufficient time to devote to the cash forecasting exercise. From much experience I’ve learned that a half-hearted attempt at cash flow forecasting can often be worse than no attempt at all.

In a similar vein, the cash forecasting initiative should have the full support of C-level management. If it does not then it is almost inevitable that forecasting will eventually be pushed to the back burner where it will stagnate and ultimately lead to inaccurate and unreliable results. Having the “buy-in” of senior management will protect the process and ensure that it is not usurped by other projects.

Operating in a vacuum

In theory, cash flow forecasting should be simple – the company controls what cash goes out the door and, at least on an organizational level, we should have a fair understanding of how and when our customers pay us. However, this doesn’t often translate into accurate cash projections. While it is probably true that someone, somewhere in the organization has foreknowledge of specific cash flows the channels for communicating that information are not developed. For example, an account rep. in Texas may have known that one of his customers was paying late because of a dispute over item counts but this information may not have made its way to Treasury.

Developing these communication channels, then, is a key function of the treasury group and an essential component of the cash forecasting process. The cash forecaster’s job is to understand the financial supply chain of the organization, develop contacts at key nodes of that supply chain that will inform him/her of significant cash flow events and integrate that knowledge into a formal cash forecasting model. A cash forecaster who operates in a vacuum without outside knowledge is doomed to fail.

Incentives

If a cash forecast is a nexus of information sourced throughout the company there must be incentives in place for contributors to provide this data both accurately and on a timely basis. Unfortunately, this is rarely the case. For our account rep. in Texas, communicating cash flow information to Treasury is probably last on his priority list. However, this doesn’t have to be the case. Adequately incented, information can and will flow through the organization and reach the cash forecaster in time to be effective.

Dear All:

Success in Cash Flow Forecasting is dependent upon:
**Understanding the business: Map and understand: AR, AP, Inventory processes
**Controlling cash, understanding the relationship between Working Capital and cash
**Understanding the Statement of Cash Flows

End of the day you have to understand these key attributes prior to any attempt to forecast.

Direct problem areas:
**Failure to clearly define objectives, tenor, line items under forecast, distribution group.

Success in the 95% range over 3 months is possible applying a top down direct method that links Working Capital to Cash to Cash Flow Forecast.

David L. O'Brien

Does your company sell small transactions to a large number of customers, or large transactions to a small number? If you have a few payers from whom you derive a large % of your incoming cash, it pays to know their behaviors. Not knowing them, and using generic assumptions in your models, will lead to significant variances. For instance, if some of your top customers are publicly traded, knowing when their quarter ends may be handy knowledge for your forecast.

On the payables side, the same general pricinple holds: know thyself. Where can you delay payment and where can't you. Are you going to drive to improve payments to vendors so that you can ask them favors down the road? what is your payments strategy? Thinking about this ahead of time leads to better forecasting.

Understanding accounts receivable and accounts payable patterns is very important, but mistakes arise from not considering adequately the difference in timing of expense recognition and cash payment for items like interest on debt, payments to benefit plans trusts, and payments for insurance coverage. A good understanding of the working capital requirements of changes in business volume or produt mix is also very important.

Randy, thanks for the comment. To explain myself better, you can readily concentrate all U.S. cash flows to ONE bank account even if you have a number of different subsidiaries. Use "collection only" and "disbursement only" bank accounts to directly funnel funds to/from the single commingled corporate-wide bank concentration account. Electronic DTC's lets the funds be concentrated from outlying accounts nearly automatically. Use an in-house bank setup to keep track of each subsidiary's share of the central cash pool.

With the above setup you really do have perfect corporate-wide historical cash flow information that's readily available from one place (the corporate-wide cash concentration account). This "perfect" information gives you a sound basis for making a cash forecast for the next 90 days (and for judging how accurate it was).

Note: I quite agree with your comment on segregating disbursement accounts.

Exidio Trezone

Brenda:

By my experience in global cash forecasting a both an At as well as a consultant, you can reduce the cash forecasting effort by:
*Ensuring that the independant data is captured in the cash forecasting tool as a by-product of underlying cash and financial statment activity;
*Use "smart" forecast algorithms to rationalize the data;
*Ensure mandatory updating to Treasury of forecast information from relavant departments
*Use corporate intranet panels to communicate data

Best wishes....................

David L. O'Brien, CTP

If you do not have cash reserves it is important to develope a weekly/daily cash forecast. I have seen a company get in trouble by relying on a month end figure while ignoring the cash flow requirement spikes shen payroll hits (which was their largest expenditure). If you have sufficient reserves this is not necessary.

Joan

Dear All:

I suggest that regardless of the firms' cash position, due attention to cash forecasting is a criticall activity.

David L. O'Brien, CTP