A cash flow forecast is a projection of an organization’s future financial position based on anticipated inflows and outflows. Cash forecasting helps to ensure that the business has enough cash to meet its obligations. Forecasts are also essential for growth, as they guide strategic financial and investment decisions, shaping the future of the company and boosting the bottom line.
Cash forecasts allow organizations to better understand their cash flows and prepare for potential problem areas. With forecasting cash, you can
Identify and plan for cash shortages Forecasts help in understanding operational and investment cash flows, thus enabling sufficient time to plan for financing requirements and avoiding unfavorable terms or penalties.
Manage working capital Working capital is efficiently managed through cash flow forecasting, by understanding the cash conversion cycle and the overall trends in current assets and current liabilities.
Predict receivables and payables Operational cash flows like A/R and A/P are hard to forecast due to numerous areas that drive variability, such as customer payment behavior, credit quality score, different payment methods, rebates, time of purchase and delivery of goods, etc. Including these variables in the forecast will help you stay prepared for future events.
Mitigate risks by hedging Understanding the potential cash effects of changes in interest rates, foreign exchange, or commodity price volatility can inform various risk mitigation strategies, including hedging.
Make investment and funding decisions Accurate forecasts enable investments, and funding can be done smoothly to ensure short-term and long-term objectives.
Common Cash Flow Forecasting Challenges
Projecting cash flows is difficult because of the following reasons:
The unpredictability of A/R and A/P due to various factors like different payment terms, business cycles, seasonal demand, etc. makes it difficult to understand operating cash trends.
Inaccurate forecasting leads to maintaining high cash buffers which may lead to lower business investment or higher borrowing costs.
Low confidence in public forecasts may affect investor perceptions.
Inaccurate cash forecasts may reduce the internal credibility of the forecast team
Tips to improve your cash flow forecasting
Cash is the lifeblood of a business. Thus it is essential to monitor it with cash flow forecasting. Following are some tips to improve your cash flow forecasts:
Understand the need for forecasting at your company, and learn the areas where it can provide its benefits. Input daily fixed and variable expenses and ensure it is up-to-date so that forecasting can be done accurately. Forecasting helps in reserving money or borrowing loans for cash deficit situations.
When planning and projecting your cash flow, remember that if you have investors, they’ll want to see high potential for ROI. It’s to everyone’s advantage that your reports demonstrate growing reserves of available cash over time. Logically, you want to make the case that the more your business spends today on growth, the more revenue you’ll see in the future. With this in mind, it might make sense to adopt a discounted cash flow (DCF) model, whereby market appreciation is taken out of the picture using dynamic logic.
Look at the forecast vs actuals, and drill down to the root cause of variance in between them. Variance analysis will help in identifying potential risks in order to mitigate them, and taking proactive decisions against the changes required in business strategies.
Leverage best tools, models, and methods to perform the forecasts. Choose a flexible and robust technology that aligns with your purpose of forecasting, and provides a granular level view across regions and entities. Automated technology reduces the scope of errors and improves reporting.
Why do some businesses avoid cash forecasting?
Cash flow forecasts are affected by various factors like economic volatility and limited historic data that contribute to increasing the variance in forecast and hindering decision making. Prediction always comes with a high probability of uncertainty, so many firms lacking accurate forecasting processes express low confidence in their forecasts, especially long-term forecasts.
What are some common errors when evaluating projected cash flows?
The mistakes while evaluating cash flow forecasts are:
Not updating forecasts regularly.
Not accounting for delayed payments and taking proactive measures.
Not comparing projections to actuals exhaustively to find the cause of the variance.
Not updating to technology that can reduce human errors in financial reporting.
Why is tracking cash flow so difficult?
Cash flow is difficult to track mainly because Accounts Receivable and Accounts Payable are unpredictable, making it difficult to forecast.
The factors that make A/R difficult to project are:
Too many variables that are hard to predict like:
Customer payment behavior
Discounts and Rebates
The factors above add to the unpredictable nature of A/R. The issues while forecasting arises due to the following reasons:
Data scattered across various data sources
A high volume of invoices fed in error-prone Excel sheets
A/P is inaccurate in the long-term due to the following factors:
Changes in :
Time of purchase and time of shipment of goods
Maintaining working capital thresholds
Discounts and Rebates
The unpredictability of the above factors leads to inaccuracy in the forecast. The challenges to forecast A/P are:
Difficulty in predicting payments for which the invoices haven’t rolled in
Inconsistent payment dates for working capital
Thus, it is important to rely on automation that allows having a high-level view across various regions and cash flow categories; and consider Artificial Intelligence to predict A/R and A/P accurately, and generate forecasts efficiently and confidently.
The HighRadius™ Treasury Management Applications consist of AI-powered Cash Forecasting Cloud and Cash Management Cloud designed to support treasury teams from companies of all sizes and industries. Delivered as SaaS, our solutions seamlessly integrate with multiple systems including ERPs, TMS, accounting systems, and banks using sFTP or API. They help treasuries around the world achieve end-to-end automation in their forecasting and cash management processes to deliver accurate and insightful results with lesser manual effort.
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