There are two main methods when it comes to cash flow forecasting.
Learn about when to use direct vs. indirect cash flow forecasting for your business.
Cash flow forecasting is a way to learn where a company stands in terms of its financial position by keeping track of the finances of a company and predicts where a company is heading.
Generally, there are two categories of cash flow forecasting techniques:
Direct cash forecasting shows cash positions at a specific time. It’s also called as receipts and disbursements method.
Time period: The direct method of cash forecasting is useful for 3 months.
Inputs: It involves transactions like bills, invoices, and taxes.
Benefits: It predicts when payments will be made and when that amount will reflect in your bank account. For instance, it estimates when the payment will be received in hand, rather than when the invoices were sent.
It is built bottom-up by rolling up regional forecasts into a global forecast. This provides cash flow visibility at a granular level.
The most commonly used method for cash flow forecasting is the indirect method.
Time period: It is used for long-term forecasts, which range from one year to five years.
Inputs: It is conventionally used for a high volume of transactions. It uses the balance sheet and profit and loss statements to predict cash flows including investments and loans. The gathered data from the balance sheet is converted to the cash flow by rearranging the net income to a cash basis.
Benefits: It shows the amount of cash required for working capital and helps in long-term expansion, repatriation, FP&A, and M&A planning.
To pick the most appropriate cash forecasting method and cash forecasting tools, you would need to analyze the size, mission, performance, and budget of your firm first.
Big enterprises that have more transaction data will avoid the direct method as the volume of the data is too high to be gathered and incorporated in forecasts. They will most likely choose the indirect method for cash forecasting as their goals are to:
On the contrary, a smaller firm lacks adequate baseline data, has unclear expectations, inconsistent tools for forecasting, and lacks technical expertise. So they would prefer the direct method due to the need to:
It is necessary to understand what benefits are more favorable to your organization to decide between the two since both provide different advantages:
Artificial intelligence is widely known for improving business processes and operations.
These are the top 5 reasons how it makes indirect and direct cash forecasting easy:
AI integrates readily with ERP, TMS, banks, payroll and tax systems, etc, and provides automated data aggregation.
Since all the data is stored in one place, it improves visibility and makes room for making smart decisions for using idle cash and increasing ROI.
Machine learning keeps evolving to improve the accuracy of the cash flow forecasts by factoring in real-time data, which makes it more promising and dependable.
It provides a clear variance analysis globally and reduces the variance over time by studying previous results.
Risk management becomes easier through AI-based scenario planning which is done by tweaking some minor changes to the data in a spreadsheet.
Artificial Intelligence is progressing rapidly and is being adopted as an integral technology by many businesses since it is instrumental in reducing a great deal of effort and failures from the treasury realms, and yields significant productivity gain to treasury leaders.
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