Making sure a business has enough cash to meet its obligations over a set period of time is the primary goal of treasury, and cash flow forecasts help treasury professionals meet this goal.

Creating a cash flow forecast helps you know whether you have enough cash to fund an expansion or pay your main supplier. This knowledge is inarguably critical to every function of the organization.

Ways cash flow forecasts are used

Being able to accurately predict cash flows is essential to a number of tasks handled by treasury, including capital management — investment decisions and borrowing requirements cannot be made without knowing your net cash position.

Another key task of treasury that is aided by cash forecasting is planning, organizing and controlling cash assets in order to meet the strategic objectives of the company. Strategic objectives can differ between organizations, but generally, you’re either seeking to maximize the return on available cash or minimize interest costs. Whatever the goal, a cash forecast provides the timing and amounts of both anticipated cash surpluses and deficits, allowing you to project future funding requirements and make operating decisions to support the strategic plan.

Cash forecasts are also helpful in budgeting capital and managing currency exposure. Treasury professionals can help identify problems such as unanticipated inventory changes, delays in collection, the mistiming of payments, and fraud or embezzlement by using a variance analysis that compares actual cash flows with projected cash flows.

And then there’s compliance. Cash flow forecasting is nearly always used as part of a company’s internal control procedures in order to comply with loan covenants, meet their minimum capital requirements, or meet the requirements of imprest accounts.

Whether we call it maximizing returns, managing liquidity or controlling financial activities, what we’re really doing is making sure the lights stay on. There are a number of valid ways to describe that, but what it really all boils down to is supporting the business.

Want to learn more about cash flow forecasting? AFP members can watch the Cash Forecasting Fundamentals course and earn an AFP Digital Badge.

Things to keep in mind when creating a cash forecast

Why are you creating this cash forecast? This is a key question to answer as it determines how accurate it needs to be. For example, it’s more important that a short-term forecast being used to manage the daily cash position be precise than it is for a long-term forecast being used to figure out how much capital is available for future expansion. Always ask yourself: What are the benefits of a more accurate forecast versus the cost of improving the accuracy?

Additionally, consider the format and technology that will be utilized to create the cash forecast. Treasury teams that use a TMS/ERP are finding that being more centralized and having a single source of truth that’s easily accessible to a larger global organization improves the cash forecasting process. After all, maximizing visibility of cash is central to any improvement in cash forecasting.

Another thing you always want to make sure of is that your forecast is simple enough for the end user to understand while maintaining a reasonable level of accuracy. Forecasts convey a message to decision-makers that allows them to see the parameters the company is operating within.

For example, the supply chain group needs to understand the forecast, so they know what the company’s liquidity needs are to ensure they’re supporting it, and operations need to understand the forecast to make sure everything is where it needs to be as well as convey any upcoming changes. Forecasts provide critical information to every business unit operating within the business, but what one business unit needs to get out of a forecast may differ from another.

Collaboration and communication with other business units is another key factor when creating an accurate cash forecast. For example, if you don’t know about impending payments or delays in collecting, your whole forecast could be thrown off. In order to ensure collaboration, you need to develop relationships with other business units, such as Payroll, AR, AP, tax and FP&A. To build these relationships, be sure you’re communicating clearly, setting expectations and using common terminology. The last one may require training staff to ensure you’re all on the same page.

It is also really important to understand forecast variation stemming from differences in assumptions. Make sure you understand why you were off, even if it was in a favorable way. What might be today's favorability could be tomorrow's unfavorability. Having the mindset of not just being right, but also understanding why you were right is really important because there will be a time when you're wrong, and it will help you tremendously to have already developed the skill set to understand the variations.

Finally, be consistent. Non-treasury departments often develop forecasts on their own, different people using different inputs and assumptions develop forecasts, and if you’re a multinational, you could have staff in other countries developing forecasts. While the end purposes of the forecast might be different, you should all be using the same information and assumptions to ensure consistency across the board.

Creating a cash flow forecasting policy

A best practice to ensure your cash flow forecast is current, consistent and accurate is to create a cash flow forecasting policy. The following should be included in your policy:

• Goals of the cash forecast.
• How frequently the forecast will be generated, e.g., daily, weekly, monthly.
• The format the forecast will follow.
• A schedule for updating the forecast.
• Acceptable forecasting methods.
• Variance analysis.
• Directions for forecasting cash flows in foreign currencies.