Cash & Liquidity Management

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Because It's Worth It! It is often argued that cash flow forecasting is not worth the effort, as the time and energy needed to achieve a meaningful forecast is disproportionate. The author categorically debunks this myth.

It is often argued that cash flow forecasting is not worth the effort, as the time and energy needed to achieve a meaningful forecast is disproportionate. Ask an accountant about a consolidated cash flow, and you will hear a long list of reasons why it is not as simple as it sounds, and takes longer than anticipated. Just think of what cash items have been parked in the balance sheet, pending clarification. If it is hard to do a cash flow statement using historic actuals, then relying on our own guesswork is even harder.

My personal experience as a tutor in corporate treasury, speaking about cash flow forecasting, is that delegates sometimes attend a workshop on cash flow forecasting with, broadly, the following mindset:

  • cash flow forecasting in my organisation is poor. Actuals are nowhere close to what had been projected.
  • attending a cash flow forecasting workshop will help me find that magic formula that will make my forecasts more accurate.

To help these delegates understand their real issue properly, I like to respond by asking, What is the objective of cash flow forecasting? Is it about guessing a number as accurately as possible? That is sometimes the vague idea in the treasurer’s mind when starting a cash flow forecasting process. It is then hoped that businesses are able to forecast inflows and outflows, so that treasury can define whether there will be a cash deficit or excess and take appropriate decisions; borrowing or investing surplus funds to optimise interest returns. That view of cash flow forecasting is often at the root of the problems that follow: we are looking at the bottom line with a magnifying glass.

If it is hard to do a cash flow statement using historic actuals, then relying on our own guesswork is even harder.

One then wonders where to obtain the numbers. Some obvious sources are quickly addressed, and may even volunteer a projection of their work. However, the modus operandi of different businesses and departments is likely to vary, plus there are gaps in the areas covered, and the treasurer is at risk of getting bogged down with detail: What system should I use? How do I capture receivables: down to customer level or estimates based on historic patterns, adjusted for other known factors? What about the non-trade items in the business other than M+A and share buy-backs which we already covered?

The uses for cash flow forecasts

I have found it helpful to start by defining uses for cash flow forecasts depending on the time horizon, and then building the process accordingly:

  • Long-term forecasts, covering several years, help project long-term funding requirements, monitor bank covenant compliance, and capital structure
  • Medium-term forecasts by month, capturing seasonal peaks and troughs of cash flow during the year, and
  • Short-term forecasts for cash management and operational purposes

The process of making it work is often like peeling an onion: Start with a very simple model for the long-term forecast, where good quality data should be available at group level. It is by nature a top-down approach, starting with EBITDA, adding capital expenditure, interest, tax, M+A spend etc. What sounds easy in theory will soon reveal that the devil is in the detail, with some data being prepared on a different basis from others, with non-cash items yet to be taken out, not to mention the circular logic inherent in interest and tax. The final result then invites us to run some initial scenarios: What if our capital expenditure doubled, or halved? How much would the cash position change if we accelerated, or deferred, our acquisition plans?

We are beginning to build a better understanding of the dynamics at work in our organisation, albeit on a high level.

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