Does cash forecasting really matter?​

​By David Kelin

Cash forecasting continues to be the one area that many treasuries struggle with.  Treasurers often say that it is better not to forecast at all than forecast inaccurately.  An inaccurate forecast has financial consequences – borrowing when you don’t need to or investing excess funds that you have forecast incorrectly.  

​What is Cash Forecasting?

Forecasting is a method for organisations to estimate how much cash there is now and there will be in the future.  Good forecasting therefore enables the good practice of utilising internal cash as efficiently as possible?  In addition, we live in a world of increasing financial volatility.  The risk that market rates will fluctuate, or the business environment makes a quantum shift or that geo-political events continue to influence economies hence business in a way that once thought unimaginable.  Forecasting forces treasuries to look at these risks and plan strategies for mitigating them.

Simple questions such as the CEO enquiring as to how much cash there will be in three months in order to fund a quick acquisition can be answered by having good cash forecasting plans in place.  The point is that treasury should know the answer or at least have an intelligent view on the matter.  Having the right forecasting framework in place and the ability to forecast and reforecast the cash position quickly and with relative confidence is crucial.  

So, if you agree that forecasting is necessary then what should you think about in order to establish a cash forecasting culture?  

Get the timing right

At its most basic level forecasting is understanding the cash position of your organisation at given points in the future.  These intervals need to be defined but typically will fall into the following:  three monthly, monthly, weekly, every other day, daily etc.  The decision around frequency will depend on the nature of the business.  Forecasting takes effort so make sure it’s useful effort.  

For cash poor companies forecasting provides an insight into the timing of events, for example, interest repayments., dividend payments, tax etc.  If forecasts are accurate then they can enable processes to be put in place that mitigate potential problems (like ensuring that cash is available to pay the interest).   Having the time to do this in advance is so much better than getting a nasty surprise.  

​Companies that have tighter cash margins tend to understand the importance of forecasting because they regularly have to think about volatility and possibly even survival.

​Companies that have tighter cash margins tend to understand the importance of forecasting because they regularly have to think about volatility and possibly even survival.  Here you tend to see a forecasting framework that is granular in nature and forecasting is more frequent because the business dictates it to be so. 
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​The RAM effect

There are three things that affect a good forecast – Reliability, Accuracy, and Methodology.  Treasury is often dependent on other parts of the organisation to provide the forecast in the first place and they don’t always have control over how and when this is done.  This can be a major issue; forecasts have to be reliable. 

Accuracy is the second dimension.  How accurate should forecasts be?  100%, 90%?  To get 100% accuracy may seem an impossible task so many treasuries start at a level that is realistic and then seek to improve it as they become more confident with the forecast framework.  The point is to start with something that is achievable then measure how to close to accurate the forecast actually was and then improve and get better.

Finally, the methodology or tools that used to forecast are vital.  Providing simple and easy to use forecasting tools with the ability to report their accuracy and reliability makes it easier to get buy-in from the entities within the organisation that have to provide the forecasts. 

Accurate visibility of future cash flows provides many benefits to companies from reduced transaction charges through netting of flows to improved returns by taking advantage of interest curves.  As mentioned previously there are other benefits too including giving management more time to identify future potential cash management issues and put in place remedial action.

Cash forecasting really does matter.

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​David Kelin interrogates three leading cash flow forecasting systems in the September episode of Treasury Dragons.