Improve the accuracy of your cash projection reports by leveraging AI to predict invoice level delinquency of your outstanding receivables
A cash flow projection is an estimate of the amount of money you expect to flow in and out of your business over a particular period and includes all your projected income and expenses. A forecast usually covers the next 12 months, however, it can also cover a short-term period such as a week or month. It estimates an organization’s future financial position based on anticipated payments and receivables.
In larger companies, the management of a cash forecasting process is controlled by the head office treasury or finance team. The work to be done in terms of assembling a forecast position generally involves sourcing data from both systems and people. The easiest way to prepare a cash flow forecast is to break the task into several steps. Then bring all the information together at the end.
Typically, cash flow projection can be broken down into 5 simple steps as follows:
For existing businesses, look at last year’s sales figures and make adjustments based on past trends, such as increasing or decreasing, or flatlining sales growth.
For new business, when you prepare your cash flow forecasts, start by estimating all the cash outflows. This gives a rough idea of the amount of cash that needs to come in to cover the cash going out, and therefore what sales you’ll need to make
Sources of cash inflows vary from business to business such as:
The period to be covered in the forecast is decided early on. Since cash flows are all about timing and the flow of cash, businesses would need to have an opening bank balance (i.e. actual cash on hand), add in all the cash inflows and deduct the cash outflows for each period, usually by month. The number at the end of each month is referred to as the closing cash balance and this number becomes the opening cash balance for the next month.
This is the most important step of all. Once cash flow forecast is done, revisit and compare the estimated and the actual cash flows for the period. This helps to highlight any differences between estimated and actual cash flow, and further helps to understand why your cash flow didn’t meet your expectations.
Ensuring accurate cash flow projection is no mean feat! As per a survey by Kyriba, Six in 10 treasurers think that their cash flow forecast has either “significant” or “major” inaccuracies. The consequences of this lack of accuracy can’t be overly emphasized and can cause a company to require a lock-up huge reserves of cash. When many millions or billions of dollars are at stake, this lack of cash visibility can have a dramatic impact on how much “idle” cash an organization is forced to have on hand, to cover for unknown cash needs. The knock-on effect from this is that a company’s cash can’t be used optimally, for instance, for paying down debt or funding growth or M&A initiatives.
The following enlists the 4 primary causes of the same:
Despite the potential for error, the majority of treasurers continue to rely on Excel spreadsheets for their forecasting requirements. Some companies opt to develop their own cashflow forecasting tools based on existing systems. However, that needs extensive IT resource investment. Even with a straightforward system, another key challenge is to ensure adequate training for the staff.
The Credit, AR, and Collections teams use static estimation metrics such as average days delinquent (ADD) and consider other static factors such as customer type- large or small, payer type- regular, fast, or slow to predict the payment date for each customer. However, ADD does not give a dynamic picture of customer payment behavior.
Cash inflows are added to the projection based on these payment date predictions. As a result, inaccurate data on incoming receivables based on static assumptions leads to inaccuracies further trickling down into the cash flow forecast.
Basing your cash flow forecast on an average estimate of can come back to bite you if that average suddenly changes. For instance, in AR, when a customer takes 29 days on an average to pay, after being invoiced and then suddenly begin stretching payments to 45 days, it can hit the business’s cash account pretty quickly.
One of the keys to creating accurate cash flow forecasts is having historical data about revenues and expenses. Furthermore, having enough historical financial data to capture the effects of seasonality (such as inventory purchases ahead of a busy season) and occasional uses of cash (such as ad campaigns) provides a clear pictures of expenses. However, businesses typically do not have a centralized repository to store all the information. Data integration is a critical pain-point in cash flow projection.
Advancements in technology such as predictive analytics enable payment pattern-analysis to be performed at an invoice line item level allowing for micro-cash forecasting and a drill-down visibility to customer segments, individual customers and invoices.
The power of historic customer data is harnessed from multiple sources, to predict, the likely payment dates across all invoices thereby being able to project with increased accuracy, the possible cash inflows for the future. The real power comes in bringing together data (e.g. big data and data warehouse) into one centralized repository.
Analytics derive their outcomes from extensive mathematical modeling and computations utilizing advanced statistics and machine learning. They provide us with sophisticated visualizations that open up a world which allows us to understand patters and generate accurate cash projections. Today’s spreadsheet forecasts only provide single-source, two dimensional tabular reports on current period information
“Micro-cash forecasting leverages AI to gain 360 customer view and predicts possible payment delays at an invoice and account level”
An effective cash forecast directly impacts many key performance indicators that CFOs and senior finance executives regularly measure, and on which they are themselves measured, from return on investment and cost of funds through to liquidity and solvency ratios, cash flow and working capital metrics, amongst others. It is therefore in every CFO and senior finance executive’s interests to ensure that treasury is equipped to produce the most accurate, complete and timely forecasts possible to improve key performance indicators and make high quality decision-making.
An accurate cash forecast provides treasurers with a dependable and complete view of the evolution of the organization’s capital position and planning into the future. Moreover, treasury can plan and execute effective hedging operations to mitigate the risk. Efficient cash flow forecast process can both improve treasury efficiencies and reduce duplicative efforts from the global subsidiaries.
Forecasting cash requirements and anticipated cash flow on a weekly, monthly, and yearly basis will give your business the tools to make better business decisions and head off problems before they arise. Having this detailed cash roadmap will allow you to manage debt effectively, plan for the use of excess cash, and as already stated, head off problems before they arise.
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