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Cash is the lifeblood of every company. It’s no secret that, reported profits notwithstanding, the real financial viability of a company lies in how it manages cash to meet its strategic objectives. Profitable companies can still face cash crises, and it is often at this point that crisis management takes precedence over long-term strategies.

So how is cash managed?

Most of those who work within a treasury environment can answer this question simply. We invest surplus cash, borrow as funds are required, and ensure cash is available to meet capital expenditure, scheduled acquisitions and the like. Treasuries have traditionally focused on operational cash management. However, in order to add value to the strategic objectives of a company, it is imperative that those in more traditional cash management roles become actively involved in cashflow forecasting. In doing so, the objectives of the treasurer should align with corporate objectives, and the role of treasurer becomes more proactive than reactive.

Forecasting is always a challenge. It is the uncertainty of events that engenders this challenge, and is often the deterrent in even attempting to forecast with any accuracy.

Some believe that the annual budget is a sufficient forecast. However, it is important to draw a distinction between budgeting and forecasting. A budget is set annually on the basis of where a company would like to be, and is set with the planned events, activities and interventions required to achieve those targets. A forecast is based on actual events, without intervention, and should have real cash movements factored into the process.

The process for forecasting cashflows involves a number of factors that can include dedicated resources, integration of business units, possible technology upgrade, and, more often than not, culture change. So, why should we bother? As noted in the Coles Myer Annual Report 2004: 'Creating shareholder value ... has been primarily achieved through increased cashflow ... efficient management of ... working capital contributed to a very encouraging improvement of cashflow.'

Indeed, accurate cashflow forecasting can become a key tool to support the operational and strategic objectives of any business. When undertaken in a disciplined manner, cashflow forecasts will increase profitability, provide information to support acquisition opportunities and capex programs, and even improve customer relations. The cashflow forecast can become an operational driver of a business and can assist in performance measurement.
Properly designed cashflow forecasts do provide real benefits. These often fall into three categories: financial, operational and strategic. Most that work within the finance profession will easily identify the financial benefits, which include reduced reliance on external funding, more efficient transaction processing, improved credit rating, less sensitivity to interest rate movements and optimisation of corporate financing. Most importantly, a cashflow forecast provides early warning signs to potential cashflow crises.

Identifying the operational benefits can be more difficult. How can a cashflow forecast improve the operations of a business? If a company has some certainty around business cashflows, it will be able to plan production runs with confidence, hence reducing income volatility. Through analysis of the cashflow forecast, factory efficiencies can be improved and inventory levels reduced. Ultimately, this will lead to an enhanced competitive profile.

From a strategic viewpoint, cashflow forecasts are an effective tool for risk management. The forecast will provide relevant information to business executives to assist in proactive management to enhance business performance. Management can re-plan and re-allocate resources across the business units to meet business targets and regularly review the performance of each business unit in accordance with these targets. Furthermore, the cashflow forecast will provide information to the business that will assist in developing key messages to manage expectations of external stakeholders.

Many companies forecast cashflows. However, these benefits are not realised. Why is this the case? More often than not, cashflow forecasts are poorly designed, and an inaccurate cashflow forecast can create significant business risk. By the time a company has realised the cash targets are not being met, there is little that can be done.
Poorly designed cashflow forecasts can lead to increase borrowing costs, excessive transaction costs, and can subject the company to risks that cannot be fully controlled, such as rising interest rates. To make matters worse, an inaccurate cashflow forecast can place a company in a difficult negotiating position 'in the event' – the very thing the forecast is supposed to prevent. Furthermore, companies could be subject to legal implications if they are to send the wrong message to the market based on the information from the forecast.

It is for all of these reasons that we need to ensure that we design a cashflow forecast that will provide accurate information to the business. To assess the accuracy of a forecast, compare past cashflows with what really happened. This will provide an insight into the predictability of the forecast. Issues that may be highlighted during this process could include:

• Inaccurate assumptions on the timing of cashflows
• Poor quality of provided data (for example, overstatement of sales)
• Systems integration issues
• Lack of internal communication and/or commitment

In order to improve its forecasting process, a business must consider standardising the information requirements where possible and using systems integration to keep the process simple.

Through developing or improving cashflow forecasting, certain business benefits will be evident. Financial statements will improve with lower debt, reduced interest cost and lower income volatility. In addition to these 'real' improvements, intangible benefits may include increased credit rating, improved 'cash' culture within the business and improved operations.

The key to successful forecasting will lie in dedication to the process through personnel resources, systems integration, “real-time” culture, and commitment. Remember this in any business.

Five steps to improving your cashflow forecast

1. Keep it simple: Remember your objective for forecasting cashflows and then assign the level of detail required. More detail does not necessarily mean improved forecast.

2. Standardise: To improve accuracy, ensure procedures across all business units are the same for compiling cashflow data. This will ensure that the consolidation of data is simplified and less exposed to error.

3. Measure your accuracy: Determine the acceptable level of accuracy and continually monitor it. Don’t forget to follow up on variances to encourage improved future data.

4. Provide incentive and reword for favourable behaviour: The business units are more likely to respond to your requests for accurate cashflow data if they have a benefit. Increased budget allocation due to increased “cash” in the business would be a real incentive.

5. Automate and integrate: Consolidation will be easier and quicker if data collection and systems integration is automated. This will leave less room for error and more time to analyse and act on the results of the cashflow forecast.

Reference: July 2006, volume 76:06, p. 63-64

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