Cash forecasting is an art that is rarely perfected. Every organization talks about forecasting more effectively, but few allocate sufficient people, time, and technology to build an effective program. Understanding the importance of an accurate cash forecast that can confidently be relied upon for key financial decisions is critical to making the right investments in forecasting.

To appreciate the importance of forecasting, it is imperative for CFOs and Treasurers to understand the link between effective cash forecasting and bottom line financial performance. Excuses such as “we’re cash rich” or “interest rates are too low” no longer satisfy hungry investors who demand that cash be deployed or returned to them. Without adequate visibility of forecast cash and where cash needs to be deployed to meet growth targets, CEOs and CFOs risk looking foolish in front of shareholders and analysts.

While there are many reasons to forecast, such as aggressive regulatory demands and volatile finance environments, there are a few key areas that should be especially focused upon to help CFOs and Treasurers further make the connection between accurate cash forecasting and bottom line financial performance.


Reduced earnings due to poorly executed hedging programs

Cash forecasting is a key driver to making effective hedging decisions that protect the value of projected foreign cash flows. Understanding the gross inflows and outflows will help determine net cash flows by currency. A good cash forecast will determine with confidence the amount and timing of global cash flows so that treasury teams can protect the value of incoming cash flows through effective hedging programs. This is especially important for organizations that are USD- and GBP-based, which have appreciated against global currencies.


The impact of Basel III

With Basel III, banks must hold collateral to offset the potential runoff of a corporate’s deposits, meaning that it costs banks more to hold corporate cash post-Basel III. As a result, banks will offer different incentives to attract deposits than they do today for operational and non-operational deposits — assuming they want non-operational cash at all. On the lending side, this same compliance increases the costs banks must incur to lend money. These costs are passed on to corporates, more so to those with lesser credit ratings. It is also possible that Libor may increase as similar effects will be seen in interbank lending. In combination, the cost of capital from bank financing will rise.


How forecasting helps post-Basel III

There are two exercises that Treasurers can perform:

1. Separate cash into operational and non-operational buckets

Banks are already categorizing your cash held with them; it is important to understand how they view your deposits so you can proactively make better decisions, rather than be caught with lessened interest returns or — worse — a “Dear John, we are closing your accounts” letter.

Forecasting cash will allow segregation of operational and non-operational cash into time buckets as well as deliver the needed accuracy to allocate cash to longer duration investment strategies. This will help preserve previously realized investment returns or help to find an alternative for cash balances that are no longer wanted by your bank!


2. Identify future shortfalls early

If borrowing costs are to increase, then efforts that minimize the need for borrowing will create value for the organization. Greater certainty of the amounts and timing of projected shortfalls will better match inflows and outflows across regions, maximizing the use of intercompany funding instead of borrowing externally. Many organizations are already turning towards working capital programs to unlock liquidity. Further, a good cash forecast will offer the longer term certainty to be able to borrow more proactively — creating the opportunity to explore less expensive external financing options.


Be a strategic partner through effective forecasting

Certainty in projected cash balances drives the CFO’s ability to anticipate and prepare for corporate actions and strategic investments. Without this confidence in cash forecasts, one of two things happen:

  1. CFO and Treasurer are not relied upon to contribute to key organizational decisions
  2. The CFO ends up being volunteered for commitments that treasury has to react to — often times inefficiently and without maximizing business value

With an effective forecasting program the CFO, supported by the Treasurer, can be an effective strategic partner to the business by providing guidance on the components of cash/debt/equity that should be optimized to minimize acquisition costs in M&A scenarios.

Share repurchases and dividend increases are also a good opportunity for Treasurers to offer strategic insight to the CFO. When cash is held globally, organizations are commonly finding it cheaper to borrow domestically than repatriate overseas cash — yet this analysis requires certainty into forecasted cash balances in all global regions. Further, CFOs need an effective cash forecast in order to make commitments on how to reinvest cash in the business to meet organic growth targets. Lack of confidence will lead to unnecessary borrowing or equity financing, which erode shareholder value.


Final thoughts

Treasurers have many reasons to forecast. When performed accurately, forecasting enables greater certainty of projected cash balances, higher returns on excess cash, reduced borrowing costs, more effective hedging programs, and better mobility of global cash. Armed with a reliable forecast, CFOs can confidently provide accurate earnings and free cash flow guidance, improving credibility with the investment community.

The ROI of cash forecasting is very high and can be measured by investing longer to yield higher returns on cash, repaying debt, earning implied returns from early supplier payments, and improving profitability through effective hedging. Cash forecasting is especially important if you are “cash rich” with a high percentage of non-operational cash deposits, as the impacts of Basel III will affect interest income.

There is no single best practice to build a forecast. Flexibility to align your data and the accuracy of the inputs will determine the best methods to build your forecast effectively. However, as important as it is to build an effective forecast, measuring the forecast is the most important part of the exercise. Without measuring forecast accuracy, it is impossible to know if you are good at forecasting or further need to perfect your forecasting process.


About Bob Stark, Vice President of Strategy, Kyriba
Bob Stark, KyribaBob Stark is responsible for global product strategy and market development at Kyriba. Bob is a 17-year veteran in the treasury technology industry having served in multiple roles at Wall Street Systems, Thomson Reuters, and Selkirk Financial Technologies including product management and strategy. Bob is a regular speaker at treasury conferences including AFP National, Sibos, and regional AFP events. He holds a BBA in finance and marketing from Simon Fraser University in Vancouver.