Cashflow forecasting and budgeting. Two things which many businesses, especially in times of plenty, tend to put on the back burner. But why is this? After all, a cashflow forecast is a report which identifies the expected flow of cash over the short, medium and long term, and a budget reports where the management of a business would like that cash to be going. The unfortunate truth is cashflow forecasts especially, can be time-consuming to complete (especially for the uninitiated) and budgets tend not to be reviewed beyond their preparation.
But what happens when the times of plenty come to an end? Say for example, when a COVID-19 or similar hits and the economy is effectively stopped in an effort to curtail it’s spread. In these times businesses are suddenly needing to understand their cash requirements in order to ensure they have enough money to see their business through the interruption.
What is Cash Forecasting?
So what exactly is cashflow forecasting? Well very basically, it’s a method of identifying the expected cash in-flows and out-flows of a business through the short, medium and long term. With, as a general rule the:
- short term being daily up to the next 30 days;
- medium term being one month to one year; and
- long term being a year.
Depending on the organisation, it’s liquidity and volume of cashflow, it may be handy to have quarterly and/or six-monthly reports as well.
Why Undertake Cash Forecasting?
A cash forecast is generally considered to be essential to understanding and managing the liquidity risk of a business. It also allows businesses to plan for a range of scenarios and helps them to understand the funding requirements of any activity.
It also helps the finance function of a business to identify periods of cash shortages and provides them with the time they need to find solutions to the expected cash shortfall (for example short-term debt, the use of intercompany loans etc). Conversely it helps them to identify periods of surplus and affords them the opportunity to allocate the additional expected funds. We’re talking about having the right amount of money in the right place at the right time. Together with a budget, this capability helps businesses to understand their cashflow and allocate funds for growth.
The ability of a business to effectively manage it’s cash also provides it with opportunities for growth using either cash surpluses or borrowed funds. The latter of which is generally more affordable as a business with a healthy balance sheet will generally speaking have a better credit rating and is able to command lower interest rates. Thus making debt more affordable.
Understanding Short and Long Term Forecasts
A short-term forecast is used to manage the day-to-day cash requirements of the business. It identifies the amount and timing of cash in-flows and cash out-flows and is intended to:
- make sure there are enough funds to meet all short-term obligations and avoid the need to access emergency funding such as overdrafts;
- provide the opportunity for surplus cash to be put to optimal use and does not sit in low or non-interest bearing accounts;
- take a global view of the business and as such ensures the right amount of funds are in the right place at the right time; and
- identify areas of concern, track differences and address issues as they arise rather than when they become too difficult.
In-turn this allows the finance function and person managing the cash accounts of the business to:
- look for other surpluses from within the group;
- search for alternative sources of funding to assist with expected cash shortfalls;
- invest funds at the most appropriate time; and
- ensure cash is available as and when needed.
A long-term forecast is used to identify cash shortfalls and surpluses including identifying funds required for existing finance obligations. This ties to the budget and identifies the impact of strategic decisions and initiatives made by the management of the business on the company’s:
- long-term liquidity and cashflow;
- working capital position;
- balance sheet;
- credit rating; and
- leverage ratios.
There are a number of problems associated with cashflow forecasting, not least of which because it can be a little bit like crystal ball gazing. So, here is a list of the most common problems:
- the eternal problem of profit v cash generation;
- internal communication of and respect for the cashflow forecast to ensure it is used and met by all levels of the business;
- systems problems and derivation of accurate information;
- data quality and integrity; and
- lack of expertise or ability to develop the forecast.
For a cashflow forecast to work, every level of the business must use and understand both it and the budget. It must have buy-in. Clear and frequent communication between the finance team and other functions, especially during the project-planning stages is essential for it to work.
In doing so, the finance function should undertake a degree of training to ensure other functions understand the need for accurate information, how to prepare it and where to source it from. This will ensure the end forecast is accurate as possible making it a more useful tool for the business.
The use of spreadsheets to prepare a cashflow forecast is by far and away the simplest way for it to be prepared. In addition, any half-way decent accountant can assist a business to prepare a cashflow forecast and teach the business how to maintain it.
That being said: Garbage-In-Garbage-Out, it is essential the most accurate information possible is included in the report otherwise it becomes meaningless.
So, Should You Be Preparing a Cashflow Forecast?
A cashflow forecast is undoubtedly one of the most useful reports a business can maintain. But, and it’s a big BUT, only if it is maintained each month (it’s not a “set and forget” thing). This is the only way to make it useful. It will help a business to understand:
- the timing of it’s cashflow;
- when it needs to source external funding;
- when it has cash available to drive strategic growth; and
- where to put surplus funds for the best effect.
It will only be and provide all these things when timely, accurate and reliable information is provided to create it.