Term Paper on "Cash Forecasting"

Term Paper 7 pages (1903 words) Sources: 7 Style: APA

[EXCERPT] . . . .

Cash forecasting refers to future projections of a company's cash flow. This activity is crucial to insure a healthy business. The cash flow is the engine that keeps the company working. Ideally, a company would finance its cash necessities from income of sold products and services. However, in the real world there is a delay between the moment in which its financial obligations become outstanding and the moment in which the company cashes in its income. The delay is due to the fact that customers don't clear their financial obligations to companies on time. Thus, it becomes important for a company to maintain a liquidity level that allows for all activities to be performed normally.

Reasons to forecast cash flows

The most important reasons can be divided as follows:

To minimize financial risk by anticipating exchange rates and interest rates fluctuations; by preventing liquidity crisis.

To increase revenues by minimizing borrowing costs and maximizing investment yields; by keeping the assets with high returns invested and by redirecting the funds from the low returns investments to other with higher return rates.

3. To insure financial control by detecting unexpected negative events and rectifying the situations created;

by analyzing the current activity and suggesting means for improvement;

by providing conditions to fester positive and consistent financial results (i.e. cost control, impact of investment decisions measurement).

III. How to perform an efficient cash forecasting

1. Insure good data comprehension. This task implies that the company has to understand the data subject to analysis very well. To do so, it has to resort to reliable data forecasting sources, it has to measure this reliability and last, but not least, it has to detect key facts related to the cash flow and use those in an efficient manner.

Some of the best forecasting sources can be resumed as follows:

Financial instruments, such as settlements;

Business plans - for the month, quarter or year;

Company and industry trends - forecast results based on the company or the industry history;

Treasury department - source that provides information about all transactions that have been initiated in a given period of time (i.e. transactions initiated automatically such as direct debit or transactions that are initiated at request);

Accountability - to provide information about periodic payments, such as salaries, rents, interest rates, mortgage, taxes, etc.

The reliability of the forecasting sources mentioned above can be divided into: power to warn before event, actual information and forecast future occurrence. Thus:

Financial instruments, such as settlements - high power to warn before event, high actual information provided and high power to forecast future occurrence;

Business plans - high power to warn before event, medium actual information provided and low power to forecast future occurrence;

Company and industry trends - medium power to warn before event, low actual information provided and medium power to forecast future occurrence;

Treasury department - mid power to warn before event, high actual information provided and low power to forecast future occurrence;

Accountability - high power to warn before event, medium actual information provided and high power to forecast future occurrence.

The cash flow key facts to be taken under consideration by a company in order to get an optimal cash forecasting refer to its frequency and the possibility to forecast its changes in advance.

2. Perform repetitive activities automatically. By doing so, a company can redirect human resource to high value-added activities and indirectly reduce salary costs and buy time to predict unwanted negative events. Also, the error probability is reduced dramatically when activities are performed in this way, which implies that human error-related cost will reduce.

3. Link information coming from various internal systems. This will enable the company to provide more accurate data that will be used in the cash forecasting. Some of the systems that can be linked are: CRM (Customer Relationship Management) and Accounts Receivable to improve customer relationship on the financial side; ERP (Enterprise Resource Planning) and Account Payable to optimize resource allocation; and for the large corporations, the Mergers&Acquisitions activity with the Capital Expenditure system.

4. Communicate with your team(s) about changes and company's performance. It is essential to let business units know about all the changes to be implemented and the impact of those on the company's performance. Follow-up reporting has to be made for any change. Its purpose is to measure change impact on performance indicators. The reports need to be analyzed, the results obtained through the analysis need to be compared to those of the competitors and finally made public to create change awareness.

5. Consolidate cash forecasts and determine the impact on treasury. This step is important because it helps reducing the borrowing necessities and indirectly the borrowing costs and it improves performance rates (i.e. solvency ratios). To consolidate the cash forecasts and minimize the impact on treasury, a company may chose to join all cash sources from all business units into one, or to temporarily allocate resources from one business unit to another instead of resorting to loans.

6. Adjust the company's technological level to its current needs. The company's environment is in a permanent change and for it to keep up with the competitors, the technological level needs to be upgraded frequently. Every upgrade is translated into increased personnel and processes' efficiency, into more consistent rules and mechanisms and into access to a larger pool of data, which will eventually increase the company's performance through more accurate results.

One way to upgrade the technological level is to use web-based tools. These tools permit access to everybody as long as there is an internet connection and minimum security requirements. Also, they centralize data from subsidiaries through simple procedures.

One other way to upgrade the technological level is to centralize the treasuries' activity. The advantage of doing so is that instead of having several treasury databases, there is one centralized database. The reporting process becomes easier and the payment approval process becomes shorter.

7. Resort to long-term forecast models. The forecast models are useful because they improve the cast forecasting accuracy. Also, they are able to extend the forecast period.

To create appropriate forecasting models is important to use data from a large number of sources because the outputs coming from these models are based on historical results. It is also very important to use appropriate forecasting methods while defining the models. Some of the most popular methods are the following:

Extrapolation based on historical data;

Seasonal forecasting methods;

Forecasting for certain days in the week or month;

Simple regressions based of predicted factors that can influence cash flows.

8. Compare cash forecasts to business plan outputs. By doing so, a company will take under consideration current business trends, rather than historical results. Usually, extrapolation based on historical results needs to be adjusted to all changes in the business environment. That is why comparing the cash forecasting results with those from the business plan can be useful. There is also the advantage of adjusting the results from the business plan to those from the cash forecasting by engaging the business units in this process, if the gap between the two methods is large.

Last, but not least, the comparison is important to check the current business status against the forecasted results. This is particularly important for business units as they deal with the operational part of the company's activity and therefore are responsible for the operational results.

To resume, cash forecasting is very important for companies that wish to maintain their activities' flow constant. However, the forecasting needs to be accurate to be useful and for that to happen, the company needs to insure a good information flow, from inside the company to exterior and viceversa (partners/suppliers - such as banks treasury operations - sales) and within the company, from the supply chain treasury to clients (CRM system).

IV. Success stories

NCC is a construction group of companies with activity in Northern Europe. The company restructured its treasury activity in 2005, by implementing the OpusCapita Cash Forecasting Program. The idea of having a complex tool to handle the treasury activity was to optimize the use of NCC's funds and improve overall performance.

NCC centralized the financial group activity and one of its treasury department's roles is to act as a bank for the group entities (see section III.4.-consolidate cash forecasts). This department is running periodic liquidity forecasts at group level. To do that, data from multiple sources needs to be analyzed for accurate results (see section III.3.-link information from various systems). In the past, the liquidity forecast was done in Excel, but as the volume of data increased, the process became more difficult and it did not allow for comparison between forecasts and actual outcomes (see section III.8.- Compare cash forecasts to business plan outputs). The new cash forecasting tool represented an important technological upgrade, which led to more consistent data analysis and time savings (see section III.7.- Adjust the company's technological level to its current needs). This tool has the advantage of being compatible to almost… READ MORE

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