foundation of successful cash flow forecasting

Foundation of Successful Cash Forecasting

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Valerio TrinchiGlobal Treasury Advisory [email protected]

R.B. EricksonDirector of North American [email protected]

Today’s speakers


Fads


stra·te·gic /strəˈtējik/adj. relating to the identification of long-term or overall aims and interests and the means of achieving them

“Treasury groups report that their function is more strategic than ever before, with an increased focus on scaling the treasury organization”

“The role of the corporate treasurer has fundamentally and irrevocably transformed […]to one that is significantly more visible and highly strategic.”

“There’s increasing emphasis on having the treasury function play more of a strategic role in the organization.”

“Treasurers are increasingly taking on a more strategic role within their organizations. Strategic thinking is becoming business-as-usual for corporate treasurers.”

Everyone wants to be strategic…


re·ac·tive /rēˈaktiv/adj. acting in response to a situation rather than creating or controlling it.

Can’t be strategic without looking longer term For liquidity management (cash, debt,

investments, hedging, etc.) forecasting is the means of achieving a longer term view

…and nobody wants to be reactive


Why is cash forecasting important?

Objective Critical for treasury? Critical for management?

Capital / long term investment Yes Yes

Company valuation / credit rating Yes Yes

Debt covenant compliance Yes Yes

FX exposure management Yes Yes

Management performance reporting Yes Yes

Shareholder dividend planning Yes

Short-term investment yield Yes

Short-term liquidity management Yes

Strategic investments planning Yes Yes

Subsidiary dividend repatriation Yes


Limited accountability / understanding of objectives reduces forecast accuracy / validation Businesses aren’t well versed in the cash flow process and there is no clear understanding

of ownership / accountability Frequent disconnect between forecast process objectives and the performance metrics in

place to measure the success of the process– Lack of emphasis on cash flow results or variances to expected outcomes– Limited incentive to invest more time to maximize the quality of the forecast

Lack of clearly defined process between HQ, business units and shared services to validate cash flows

Cash flow forecasting challenges


Cash flow forecasting challenges (cont.)Lack of standard, centralized processes and systems limits visibility into timing of cash flows Cash flow projections (especially for profit remittances,

intercompany and dividends) are inaccurate without standard / central process and systems to capture and report data

Low visibility of both sides of intercompany transactions and undefined validation routines (manual or automated)• Low intercompany counterparty projection consistency• Drives inaccurate forecasting

Inefficient use of team in developing the forecast Many contributors adding small amounts of information


Management / business unit reporting may be out of sync with cash pool management Management reporting structure may not support treasury’s cash flow view requirements

by cash pooling structures, legal entity, country, and/or currency Complexities in bank account structure and co-mingling of funds creates challenges in

segregating flows by legal entity and transaction type for management reporting purposes along business or product lines

Multiple data sources + Manual processes = Greater risk of mistakes Cash flow forecasting is not performed as part of a formally, structured, coordinated

activity, but rather on an ad hoc, as-needed basis Multiple sources of cash flow data leads to inconsistency Lack of communication between HQ, shared services and business units reduces visibility

into cash flow decisions Lack of standard processes means more time spent on data capture, not cash flow analysis

Cash flow forecasting challenges (cont.)


No recognition / adaptation to the variability of forecast: Forecast data targets moved, formal schedule not adhered to Key emphasis on annual plan forecast, much less on updates / variance from planFocus of most forecasts is primarily on accuracy, e.g. variance reduction Focusing on forecast accuracy can’t be done on its own. Business volatility will

always impact the reliability of the forecast. The focus should be on factors such as:– Improve the process and related systems architecture– Develop aggressive variance analysis methodologies– Identify and monitor key business drivers and incorporate into an “early warning system”

If these steps are followed, forecast accuracy will improve by default

Cash flow forecasting challenges (cont.)


1. Work out what is required and why

2. Develop a strategy to achieve it

The fundamental approach for successful forecasting


Understanding the effectiveness of cash flow forecasting involves evaluating four key process steps.

Early warning indicators

Cash flow forecasting process - overview

Know your business

Cash flow and forecasting needs

Organizational structure

Business objectives and cycles

Forecast methodology

Principal forecasting elements

Source for forecasting elements

Workflows to obtain data

Variance analysis

Actuals vs. forecast

Results vs. forecast objectives

Forecast uses

Forecast objectives and goals

Forecast audience


Business objectives → cash flow and forecasting needs M&A IPO Manufacturing RetailBusiness cycles Strategic planning (1 / 3 / 5 year): FP&A indirect method Seasonal (annual, quarterly, monthly): direct method Immediate (monthly, weekly, daily) daily cash positioning: direct method Reconcile strategic-plan forecast with direct-method seasonal and immediate forecastsOrganizational structure – forecast participants Regions, entities, countries, currencies Centralized vs. decentralized

Know your business


Linked to business objectives and needs Forecast uses– FP&A– Wall street reporting– Effective use of debt and investments– Etc…

Forecast audience– Executives and management– Business units, subsidiaries and regions– Treasury

Forecasting objectives and goals


Sample cash flow forecasting goals:– An accurate estimate of the organization’s annual

cash flows and related long-term borrowing requirements or investment opportunities

– A reliable cash flow target that senior management can provide to financial markets

– Advanced warning signals of cash flow forecast shortfalls, which enables treasury to proactively implement corrective measures

– A tool to manage the on-going cash and financing activities of the company on a short-term basis

Forecasting objectives and goals (cont.)


Forecast methodologyPrincipal elements Data source Workflow

Collections

Client 1 Sales Delivered monthly via spreadsheet

Client 2 Sales Delivered monthly via spreadsheet

Other Clients Sales Delivered monthly via spreadsheet

Investment Income TMS Update from Investment module

Disbursements

Capital Expenditure AP Daily feed from ERPContractors AP Daily feed from ERP

M&A FP&A Updates via email, as needed

Payroll TMS Historic trending model

Leases TMS Update from Debt module

Rent AP Monthly feed from ERP


“Measurement is the first step that leads to control and eventually to improvement. If you can’t measure something, you can’t understand it. If you can’t understand it, you can’t control it. If you can’t control it, you can’t improve it.”

H. James Harrington

Variance Analysis


Forecast vs. actual– How did we do?– Initial forecast accuracy affects treasury MBOs

and compensation Forecast vs. forecast– What changed and what can we do to get better

information earlier– What-if analysis

Forecast results vs. forecast objectives– Poll forecast stakeholders – did they get the

information the needed?– FP&A vs. treasury

Variance Analysis


Forecast complete…Now what?

Scenario one: excess funds uncoveredInternal opportunities External opportunitiesInter-company investments Investment market (e.g. money

market funds, bonds)In-house banking / pooling

Supply chain financing – dynamic discounting


Forecast complete…now what?

Scenario two: insufficient funds availableInternal measures External measuresInter-company loans Public debt (e.g. bonds,

commercial paper)In-house banking / pooling Private debt (e.g. credit facilities,

revolvers, term loans)Capital injection Supply chain financing – reverse

factoring


Additional Resources

White Paper: Short Term Forecasting - Best Practices and Pitfalls to Avoid

Learn how your team can optimize cash management processes for all markets, while ensuring the smooth running of treasury operations and complying with local regulations.

Download the white paper at: http://kyri.ba/cash-forecasting-paper


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foundation of successful cash flow forecasting

Business

cash flow process

strategic role

liquidity management

strategic investments

cash flow results

strategic strtjik

strategic thinking

treasury organization