
The term ‘economic crisis’ refers to a period of national or regional economic breakdown in which the economy is in difficulty for an extended period of time, ranging from a few years to many decades. It refers to a situation in which the market’s key financial assets experience a sharp decline in market value over a short period of time, when businesses are unable to pay their massive debts, or when financing institutions face a liquidity crunch and are unable to return money to depositors, all which cause panic in the capital markets and among investors. During an economic crisis, asset prices plummet, firms and individuals cannot pay their loans, and financial institutions face liquidity shortages.
Examples of economic crisis
Examples of an economic crisis include some major events including:
Finance and liquidity are among the top three impacted areas during an economic crisis, according to PwC’s Global Crisis Survey 2021. A ‘black swan occurrence,’ such as Covid-19, has demonstrated the need for treasurers to be vigilant when it comes to crisis management and business continuity strategies. Pandemics, recessions, and macroeconomic swings can all have an unexpected impact on firm cash flows.
The major challenges that companies face during a crisis are:
As the crisis develops, corporate executives should not rely on their intuition to make key decisions. Treasury can handle uncertainty better by monitoring its cash position, anticipating its future liquidity status, and mapping and measuring its responses.
In uncertain times, an organization’s ability to navigate severe volatility can be a catalyst for long-term financial health. A cash flow forecasting technique can provide an important reminder of a company’s future business health by applying a diagnostic perspective to cash balances under a variety of future scenarios.
Cash flow forecasting techniques that help in responding to market volatility
CFOs can use these cash flow forecasting techniques to respond to a crisis in the following ways:
Direct method: Direct cash flow forecasting uses the company’s cash receipts and disbursements to compute cash flow. The time period for direct or short-term forecasting is usually one to six months.
Indirect method: The indirect technique calculates cash flows by detecting non-cash transactions in the net-income calculation and then removing them from the equation. The time horizon for indirect or long-term forecasting ranges from one to five years.
An indirect method of forecasting provides for future strategic planning, but it is more prone to inaccuracy due to longer time periods. Direct cash flow forecasting allows for more precision and consistency in predicting future cash flows. To ensure survival during a potential cash-flow crisis, struggling enterprises should start with short-term forecasting by using the cash flow forecasting technique and then create long-term forecasts to be proactive in decision-making.
2. Choose a scalable and flexible system: To be scalable, a company must focus on enhancing service profitability and efficiency even as its workload grows. When a process is resilient and provides granularity to the lowest level of data, it is said to be scalable.
How cash flow forecasting technique assists in increasing scalability
The following are some of the ways a treasury cash forecasting software improves scalability:
3.Select best-fit models for each cash flow category: Treasury employees may lack technical competence and the bandwidth and tools required for proper modeling. Treasurers can utilize AI forecasting software for difficult-to-forecast categories like A/R and A/P and heuristic models for easier-to-forecast categories like Taxes and Payroll.
4.Create multiple scenarios and implement them in the forecasts: A cash-flow projection should be modeled with many what-if scenarios for planning purposes. This enables a company to examine several outcomes of its expected cash position based on probable unknowns by using corporate treasury software. As a result, a business can quickly adapt processes and develop contingency planning protocols.
5.Perform variance analysis for multiple time horizons: In the time of crisis, the CFOs should perform frequent variance analysis using treasury cash forecasting software to mitigate the impact of high variance in cash forecasts. Proper variance analysis provides better use of idle capital for R&D, securities and stock investments, overnight sweeps, and other purposes. Investigate the core causes of variance between forecasts and actuals to improve decision-making.
Speak to a solution expert to learn more about how automated cash forecasting can assist CFOs in avoiding negative consequences during times of crisis.
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