New Focus for an Old Process

In cash flow forecasting, many companies experience a disconnect between forecasts' creation and their use. It’s time to rethink this crucial process.

The forecasting of cash flow has long been a staple at many companies. Few people pass through the treasury department of any organization without participating in a cash flow forecast. Nevertheless, the accuracy of these forecasts varies widely.

Many companies’ forecasts are developed through arcane processes and disconnected spreadsheets. Putting them together requires a great deal of effort, yet the forecasts’ creators lack accountability, and process ownership is unclear. The constant across companies is that treasury professionals generally try to avoid being saddled with this responsibility. Usually, treasury professionals see little upside for coordinating a company's cash flow forecasting efforts, yet they may face the wrath of C-level executives if forecasts are missed or come in late.

Even a highly efficient process can result in large variances if it does not identify slippages in business performance. If the forecasting effort fails to incorporate the impact of key business drivers, all the process improvement in the world will not produce an accurate projection of where the company is going. Thus, when trying to improve the forecasting effort, companies should pursue a portfolio solution rather than a simpler, one-dimensional “accuracy fix.” To have a significant impact on cash flow forecasting, companies should invest in four main areas:

  • Improving the methodology, access to cash flow forecasting data from the businesses, and related systems around the cash flow forecasting process.
  • Developing aggressive variance-analysis methodologies. One such methodology might be a requirement for business units to automatically provide an analysis to the treasury department when the variance is above a certain percentage.
  • Identifying key business drivers, then incorporating them into a monitoring system that provides alerts early enough so that the company can recognize cash flow shortfalls and take corrective action before the end of the reporting period.
  • Expanding the role of cash flow metrics in the company’s internal performance management processes so that business unit leaders are effectively motivated to deliver high-quality forecasts.

Emphasizing these four areas in concert will in most cases result in more accurate forecasts.

Top-down trend analysis. This approach centralizes cash flow forecasting within the treasury function. In this approach, the treasury function performs an analysis of high-level financial forecasts to identify relationships between different components of the data. For example, analysts might note correlations between projections and the timing of certain events in the sales-receivables-collections cycle, or they might see a relationship between inventory and the COGS as a percentage of sales. When these types of relationships are apparent, the treasury team can use models to project future movement in balance sheets, profit and loss (P&L) statements, and cash flows. Note that this approach is dependent on the availability of high-quality, high-level, current year forecast data.

Upon reviewing these approaches, you may decide that they are interesting but are hardly rocket science. That is exactly the point: Good cash flow forecasting is more about process improvement, methodology selection, and technological support than it is about high-end algorithms or arbitrarily selected benchmarks for accuracy. A review of the pros and cons of each method should help reveal the one that will work best in your company’s environment. From there, you’re ready to develop a road map to solid forecasting in your company.

When trying to determine which method is appropriate for your organization, keep in mind that the best option may be a combination of the approaches. Even if you choose the bottom-up option for the company as a whole, an abbreviated version of one of the other two methods may serve as a high-level sounding board, developed by the treasury department and used to evaluate the accuracy of business unit cash flow projections. This approach would enable senior management to validate the forecasts provided by the business units and provide support for executives to push back with some hard questions when the business units submit their numbers.

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