SEB: Grasping the Forecasting Nettle

by Robert Pehrson, Global Head of Liquidity Products

Cash flow forecasting has been at the top of treasurers’ lists of priorities for a number of years. For example, it was identified by 55% of treasurers in the SEB/gtnews Cash Management Survey 2007 as their primary objective. According to the same survey a year later, in the light of market events, forecasting was, for the first time, superseded by liquidity management. However, as the previous article highlighted, forecasting and liquidity are closely interlinked, and to be effective at gaining control over cash flow, and ensuring appropriate access to cash, requires treasurers to create regular cash flow forecasts. But why has forecasting been so elusive in the past, and how can this be resolved?

Forecasting challenges

It is not difficult to see why forecasting has remained on the ‘to do’ list for so long. Despite everyone’s best intentions, there are always other priorities and opportunities that arise during the course of a year. For example, over the past ten years, treasurers have made substantial progress in centralising cash into both physical and notional cash pools, with demonstrable value to the business, as well as centralising financial functions such as payments. In contrast, forecasting has the disadvantage that the benefits are more difficult to measure, and tend to be progressive as the forecasting process is refined.

Forecasting is rarely a single process, and is handled in different places within the company. Even within treasury, short-term forecasts may be put together as part of the cash position process, while medium- to long-term forecasting is likely to be a separate process, often undertaken by different individuals. The problem of forecasting being a divided responsibility extends beyond treasury too. Many parts of the business will conduct cash forecasting for various purposes: sales, inventory management, etc. but there is rarely a common basis for constructing this information. This leads to a lack of consistency in presentation, the level of detail, and assumptions used, so those trying to construct and make decisions using the consolidated forecast are rarely confident in the trustworthiness of the data.

There are other challenges too relating to the fragmentation of the forecasting process (fig 1). Frequently, information is held in disparate systems, which store data in different ways, and it can be a complex process to integrate systems in a way that allows data to be transmitted reliably and consistently. Transferring data between systems could also lead to quality deterioration which again reduces trust in the consolidated forecast. Even when using a common systems infrastructure, such as an ERP, there are often different versions or instances in place, or the system does not cover the entire company, particularly in the case of companies with significant merger or acquisition activity.

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Creating ‘win-win-win’ in forecasting

These challenges are not insurmountable, however, but the first hurdle to overcome is to ensure that decision-makers across the business recognise the value of cash flow forecasting. In the past, when liquidity was cheap and freely available, it may have seemed less compelling than today. Forecasting is essential to liquidity management and needs to be closely aligned with investment and borrowing decision-making. Investment in the forecasting process not only benefits treasurers but is also essential to their banking partners. The more efficient and robust a client’s forecasting process, the more confidence a bank can have in the accuracy of their liquidity needs, so that they can plan their liquidity provision accordingly and provide greater commitment to their clients.

If treasury is one ‘winner’ of the accurate forecasting, and the bank is another, the third ‘winners’ should be the business units that contribute to the forecasting process. Gaining business unit support is the most difficult element of any forecasting improvement project, but it also results in the greatest benefits, as the more reliable and complete information is at grass roots level, the higher the quality of the consolidated position. By getting this part of the project right, business units derive value by having a reliable and well-constructed view of information on which to base their own business decisions.

So how are companies enhancing their forecasting and creating these benefits? SEB has constructed a Roadmap to Excellence which provides a template for our clients to approach forecasting in a systematic way and derive the maximum benefit from the forecasting process. This is an integral element of SEB’s Corporate Value Chain™ approach described in the previous articles.

Tackling forecasting challenges

1) Establish a forecasting process

Companies’ starting points when looking to formulate or enhance a forecasting process can differ considerably. Some will have a very rudimentary process; others will be using a forecasting tool as part of a treasury management system or ERP; others still will use spreadsheets with varying degrees of complexity. Our general recommendation is to start with a straightforward, transparent forecasting process, so that individuals both contributing to, and using the data, develop familiarity and confidence in the integrity of the process. One of the challenges in companies we work with is that often people do not have a common view of forecast information. For example, a spreadsheet may have one or two core users; a treasury management system will only be used in treasury, without widespread visibility outside the department. We help our clients to address this by providing them with our forecasting tool, WebForecast, which incorporates a common forecast input and reporting tool. This provides access to forecast information across the business via a company’s intranet, and ensures that a consistent approach is taken to inputting/uploading, amending and reporting of forecast information.

2) Trust your forecast

A forecast has no value in itself: the value comes from the decisions which are taken based on the information. By using real-life data, such as actual balances, then layering in known flows, such as accounts payable and receivable data, and treasury flows, followed by forecast information with various levels of confidence, a reliable picture of future cash flow information can be developed. [[[PAGE]]]

3) Automate

Having established a reliable and sustainable cash flow process, which is clearly understood by all its participants, this can be automated more fully, for example by establishing links to associated systems, including making use of industry-recognised integration standards such as those based on XML.

4) Continuous feedback and improvement

This is perhaps the most important element of a forecasting process. The business will evolve over time, in response to changing market conditions, changes to business organisation and staff turnover, and the forecasting process needs to be adapted continuously to take into account the developing needs of the business. More detail may be included, and the process extended more widely across the company.

It is vital to feed back regularly to the originating departments and business units from which forecast information is derived, in order to demonstrate how information is being used, and to understand variations from the forecast. For example, if a business unit’s cash flow requirements are continually 10% different from the forecasted position, or flows are very volatile, the assumptions when collating the data can be refined accordingly. As people across the company understand more fully how forecast information is used, and the benefits to the business of forecasting accurately, dialogue becomes easier.

Creating consistency through diversity

Every company looks at forecasting in a different way, reflecting the systems infrastructure, business organisation, underlying business processes, industry and culture. In addition, the way in which the data is used will differ, depending on whether a company is cash-rich or cash-strapped, looking to finance normal working capital requirements or finance major project expenditure. Consequently, it is unrealistic to implement a ‘standard’ process or system that lacks sufficient flexibility to take into account the specific needs of the business. By putting in place processes that can become part of the everyday routine, and systems that are aligned with the systems infrastructure as a whole, the forecasting process can be a catalyst for positive communication, decision-making and financial advantage. At SEB, we have built up significant, practical experience derived from working with many of the world’s most respected companies over a number of years, which we can use to help clients to optimise their processes, develop trust across the business and enhance decision-making.