Cash flow forecasting is a method of determining a company’s financial status by keeping track of its finances and predicting where it will go in the future. There are two types of cash flow forecasting methodologies in general:
|Parameters||Direct cash forecasting||Indirect cash forecasting|
|Time frame||The time frame is short for direct forecasting. (It is usually between one and three months.)||The time frame is long for indirect forecasting. (It is usually between six months to five years.)|
|Objective||To identify operational cash requirements and cash required to fund working capital.||To identify cash required to fund longer-term growth strategies.|
|Pros||It predicts when payments will be made and when that amount will reflect in your bank account. It is built bottom-up by rolling up regional transaction data into a global forecast. This provides cash flow visibility at a granular level.||It shows the amount of cash required for expected business activities and helps in long-term expansion, repatriation, FP&A, and M&A planning.|
|Cons||Direct forecasting can be challenging to reconcile with long-term financial plans as it only forecasts for the short-term.||The accuracy of indirect forecasts is lower than direct forecasts. Moreover, variance analysis for long-term is difficult. Indirect cash forecasting also can’t assist in daily cash management.|
Direct cash forecasting provides more extensive analysis and visibility, as well as the prevention of cash shortages during volatile situations. It helps treasury in the following ways:
The indirect technique is essential for long-term decision-making since it reveals the cash needed to fund long-term growth and capital projects like long-term investments and mergers and acquisitions. It helps treasury in the following ways:
The answer to choosing between cash flow forecasting direct vs. indirect is straightforward:
Most businesses begin with direct cash flow forecasting to comprehend their daily cash movements — this aids in the identification of borrowing and investment opportunities. As the company grows and plans acquisitions, it will eventually transit to indirect cash flow forecasting to identify growth opportunities.
Cash flow scenario modeling is generally used in financial modeling to estimate changes in the value of a firm or cash flow, particularly when potentially favorable and negative events could affect the company. The approach is based on three basic scenarios:
Determining what will happen to cash flows in all scenarios allows the organization to undertake preventative measures to avoid liquidity shortages. Treasury can simulate multiple cash flow forecasting scenarios using data-driven forecasting analysis and determine the impact on cash flows.
Research by CBI Insights highlighted that 30% of businesses fall flat on cash while 60% of businesses don’t have proper insights on their finance or treasury workflow.
Enhancing the selection of proper methods and cash flow forecast solutions for estimating cash flows is critical for detecting future crises since it aids in making wise decisions for limiting risks and recognizing potential opportunities.
Points to consider when selecting a cash flow forecasting software:
AI cash forecasting system is built for treasury and finance teams to manage cash flows and enable real-time visibility through dashboards and reports. It helps understand trends based on past information and reduces the complexity of controlling finance by reducing manual and time-taking tasks. Besides, it provides automated data upload and consolidation and allows drilling down to line items for detailed analysis.
The treasury department can benefit from HighRadius’ cash flow forecast solution in the following ways:
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.