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A Beginner’s Guide to Cash Flow Forecast Solution

What you’ll learn


  • Learn the basics about cash flow forecasting and how to improve it.
  • Learn the difference between direct and indirect cash forecasting.
  • Discover how an AI cash flow forecast solution drives a company’s growth.

What is the meaning of cash flow forecast?

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:

    1. Direct cash forecasting
      Direct cash forecasting is a way of anticipating cash flows and balances used to manage short-term liquidity. Direct cash forecasting is often known as the receipts and disbursements approach.
    2. Indirect cash forecasting
      An indirect cash forecast is generated from a number of predicted income statements and balance sheets as part of the planning and budgeting process.

Cash flow forecasting direct vs. indirect

 

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.

 

Outcome of direct cash forecasting

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:

  • Examines daily cash flows with a high level of granularity
  • Identifies slow-paying customers by analyzing consumer payment patterns
  • Works closely with banks for balance or credit management
  • Increases visibility into cash requirements to manage debts easily

Outcome of indirect cash forecasting

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:

  • Utilizes information from the income statements and balance sheets
  • Makes decisions on currency exchange rates and cash distribution
  • Enables long-term decisions related to cash deployments and investments
  • Reduces borrowing costs which leads to a better quantification of profits

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.

How do you make a cash flow forecast more accurate?

Cash flow scenario models

 
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:

What is scenario modeling?

  • Best-case scenario
    It’s the ideal scenario which implies it’s what the organization wants to happen and is striving towards. For example, the share value of an XYZ company is $113 this year, and they want it to rise by 20% the following year. The best-case scenario for XYZ company would be if they were able to obtain the 20%.
  • Moderate-case scenario
    It is a moderate scenario based on market assumptions. For instance, the share value of an XYZ company is $113 this year, and they want it to rise by 20% the following year. The moderate case scenario for XYZ company would be if they were able to obtain only 5% out of 20%.
  • Worst-case scenario
    This case considers the most severe outcome in a given situation. For instance, the share value of an XYZ company is $113 this year, and they want it to rise by 20% the following year. If the share price fell from its current level, that would be the worst-case scenario for XYZ Company.

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.

The PMA method for cash forecasting

PMA method for cash forecasting
  • Publish
    Before publishing a cash flow forecast, a company should thoroughly analyze the cash inflows and outflows. In addition, cash flow forecasts must include revenue from sources like sales, interest, and asset sales, as well as expenses from sources like materials, wages, and marketing.
  • Monitor
    Once a cash flow forecast is published, it should not be continuously used for future predictions since customers may fail to pay, sales may not materialize, or unexpected expenses may happen. Once the company publishes a forecast, it needs to continue to monitor results in real-time as much as possible. This allows businesses to identify opportunities and market trends to improve the process and take advantage of a better cash position.
  • Adjust
    To mitigate potential losses, concentrate on both short and long-term forecasting. Manual adjustment (stress testing) allows tweaking minor data changes in a spreadsheet-like interface, which helps predict scenarios. This minimizes or reduces possible losses due to uncontrollable causes by proactively analyzing and avoiding worst-case scenarios.

How to find a cash flow forecast solution to fit a company’s needs?

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:

  • Understand the purpose of cash flow forecast
    Determine the purpose of cash forecasting. Suppose the company is required to track its day-to-day cash flows or prevent overborrowing. In that case, it should forecast cash daily or weekly, but if the priority is an investment or business expansion/M&As, then the forecast can be done monthly or yearly, depending on the company’s needs.
  • Research about the vendors
    Search from AFP, Strategic Treasury, Bob’s Guide, or other treasury technology tools for a reliable vendor solution that can handle all cash forecasting operations, generate precise projections and provide granular visibility. Also, visit vendor websites to obtain product information and read customer testimonials to understand the cash forecasting system’s capabilities better.
  • Evaluate various vendor solutions
    Using a vendor scorecard, determine the scores of the various vendor solutions. If it has the flexibility and scalability to align with your KPIs even if they change in the future, it will smoothly integrate with the current system.
  • Estimate ROI
    Analyze how quickly the company can recover the investments from the chosen tool/technology and if the technology would reduce the variance in forecasts vs actuals, hence increasing the gross savings.

How can HighRadius cash forecasting system help?

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:

  • Data-driven decision-making
    Treasurers can make data-driven decisions for managing capital, and risks, and improving corporate treasury management by using automated reporting and continuous data access.
  • Accurate scenario analysis
    Treasurers can identify a variety of scenarios and their influence on the company’s cash flows by cash forecasting. This facilitates proactive decision-making. In addition, the system enables frequent cash flow predictions, allowing for quick decision-making.
  • Frequent variance analysis
    Users can get a more detailed look at their financial flows using the drill-down and dashboard features. Treasurers can then look at the differences between cash flow projections and actuals for various currencies, cash flow categories, regions, and time periods. Furthermore, accurate variance analysis aids in enhancing the accuracy of cash flow projections by identifying the variance drivers.
  • Increased forecast accuracy
    The scope of human errors is reduced because data is obtained directly from data sources. To improve the accuracy of the sales forecast, customer-specific information and external components such as raw material price fluctuations can be gathered. Furthermore, the cash forecasting software uses a feedback loop model that analyses past and current results and modifies estimates to improve cash forecast accuracy by up to 95%.

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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.