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Short-term cash flow forecast – because while profit is an opinion, cash is a fact

As we discussed in our previous article – Managing cash flow in the wake of COVID-19 and how to prepare for the next big disruption – forecasting and managing cash should be high on managers agendas this year and going forward.

Although sales and profitability will continue to be a top priority, companies’ ability to convert profit into cash in a timely fashion will be a divider going forward: it can mean the difference between survival and bankruptcy in times of crisis, and a decisive competitive advantage when times are back to what normal will look like post COVID-19. Situations can change fast, and when they do, control over cash is key.

Case example: A solvent and profitable multi-billion SEK company [pre-COVID-19] was rapidly expanding geographically.

Sales started to decline in home markets and failed to pick up in new locations as per plan. A week before the payroll run, management realized it would not be able to make payments to neither employees nor suppliers, resulting in halted supplier deliveries and subsequently cancelled customer shipments.

External support was brought in to define and facilitate implementation of relevant cash measures – including stakeholder management. The situation was resolved, and payments were finally made – albeit at a high cost to external relationships, reputation, and shareholder value. Looking back, it was clear that the situation could have been avoided, if management had access to proper cash forecasts and an ability to make the right decisions at the right time.

While a company’s cash flow statement will provide a snapshot overview of a company’s ability to convert its P/L into cash, it is a blunt instrument for reporting purposes only, and provides little assistance to day-to-day operations. This is where short-term cash flow forecast modelling comes into play.

Short-term cash flow forecasting (STCF) is fundamentally about providing visibility of a company’s cash position within a chosen forecasting horizon – typically 13 weeks. Correctly applied, a STCF will support and strengthen business decisions, provide early warnings of upcoming cash constraints – enabling timely counter measures – as well as manage external stakeholders such as banks and shareholders.

Also, the wide variety of data sources feeding into the 13-week cash forecasting tool requires cross functional collaboration – supporting build-up of a healthy cash culture in the organization.

Forecasting horizon – Most short-term cash flow forecasting models, regardless of industry, company size and/or location, are based on a 13-week rolling forecast horizon. This choice is not random:

  • The 13-week forecast is geared towards optimizing both accuracy and range. Forecast accuracy generally deteriorates the further away in time you look. The 13 weeks can be considered a sweet spot: close enough in time to allow for sufficiently accurate forecasts, while offering enough range to support mid-term planning and corrective actions when needed; also

  • A rolling 13-week forecast horizon always runs over next quarter-end. This is a key reporting date for many companies, as key stakeholders (e.g., investors and banks) look at quarterly reports to provide insights into the business performance and growth. Also, banks often use quarter-end cash forecasts to gauge covenant risk, as well as companies’ ability to service debts.

Reporting categories and input data. A STCF model is based on cash inflows (receipts) and outflows (payments) and is built up from part actual and part forecast data.

Always start with what you know – there is often a large portion of data on known future cash in- and outflows spread across the organization, that could and should be captured by the STCF model, i.e.,

  • The opening cash balance from accounting system (reconciled to bank account);

  • The Trade Payables and Receivables ledgers (adjusted for payment terms and ageing);

  • Other known receipts or payments that will take place in the forecast period and do not go through the payables or receivables ledgers, e.g., Payroll runs, VAT payments and refunds, interest on loans and/or principal repayments, planned maintenance and/or Capex, etc.

Once the known data is input into the forecasting tool, it is time to estimate future receipts and payments beyond ledger information, i.e.,

  • Cash receipts from future sales: based on best available information from sales, adjusted for payment terms, and/or estimated customer payment behavior;

  • Cash payments from future purchases, based on best available information from purchasing, and any other potential buyers, adjusted for payment terms.

Using the STCF and the rapid cash toolbox – A STCF should be updated and actively reviewed on a weekly basis in a formalized format. The STCF forum should – from a cash perspective – assess and confirm the organizations’ ability to operate as planned in the forecast period.

If, or when, the tool identifies a period with low or negative cash, the forum should trigger corrective actions to either resolve the issue, or at least push the needle forward long enough to buy time to find a solution. It is therefore also the role of the forum to keep a toolbox of short- and rapid cash release actions to quickly improve a pressed situation.

Successful implementation of these corrective actions should then be followed up and secured through short-interval feedback loops: more on how to develop the short- and rapid cash toolbox in coming articles!

Tips and tricks to get started with STCF

  • Successful STCF data mining and forecasting depend on the involvement of stakeholders outside of finance and treasury departments – any assumption or forecast data should come from the function closest to the issue, e.g., sales on sales forecast and purchasing on future spend.

  • Automate where you can. However, do not fall in the trap of overcomplicating the installment of a STCF – get the process moving quickly rather than accurately. It will improve fast with regular analysis and feedback.

  • Routinely sanity check the output: Does the forecast trend make sense? What can we learn from deviations? Continuously update model assumptions to better reflect reality.

In summary, while short term cash control may not always feel top of the agenda, it can mean life or death for a company when the tide turns. An ongoing STCF in combination with a solid short- and rapid cash release toolbox will prepare your well for this situation; and when the tide does turn, like it did for many companies in 2020, you will be happy that you came prepared.

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