A crisis needn’t hit your company directly for you to be impacted. The recent outage on the Visa network across Europe was the start of what could have been a considerable problem for many treasury teams across the globe. In the end, this problem didn’t escalate into a full-blown crisis, but an outage on a key payment channel during a busy time of the week presents a substantial risk to the cash flow of a business. Had it lasted more than a few hours, drastic action would have been needed.
For a large, multinational company, there is always a crisis looming around the corner. Scale brings many advantages, but it adds exposure to many more risks. Having a high profile increases a company’s likelihood of being a target for a cyber-attack, having a global presence increases geo-political risk, heavy reliance on haulage and shipping can make a company vulnerable to wild fluctuations in oil prices, the list goes on.
Not every risk will become realised, of course, but inevitably there are some that will hit, and some that will miss. In this blog post we explore what a treasury department can do to ensure that it is ready, when the worst happens.
Carillion’s collapse in January caused huge problems, not just for its suppliers but also for companies seen as operating similar business models. Carillion’s customers faced an immediate cash crunch, leading to the failure of numerous businesses. Carillion’s contemporaries faced intense market scrutiny, leading to falling share prices and major questions over their long-term viability.
Incidents of this scale are rare, but disaster can strike in a variety of ways. It can hit you directly, like the NotPetya cyber-attack struck Maersk in June last year, costing $300 million. Or it might be a data breach, such as the incident at Equifax, which could be the most costly in corporate history (estimates currently sit at over $600 million). Alternatively, it might be internal practices that trip the company up, like the emissions scandal that rocked VW, costing a whopping $30 billion. In all of these instances, from a treasury perspective, it is the impact on cash flow and how you can respond that matters.
Treasury is a department familiar with managing and mitigating financial risk. A crisis in the business will ultimately have a financial impact, and therefore the attention will quickly turn to the Treasury department.
When the crisis hits, and the focus quickly turns to cash, the executive leadership and other key stakeholders (banks, shareholders etc.) will ask:
If the cash and liquidity processes are running like a well-oiled machine, the treasurer will be able to give confident answers to these questions. As with any good crisis response, the key is preparation.
First and foremost, managing cash in a crisis is about knowledge and fast access to information. While the Visa network issue a couple of weeks ago didn’t cause a full-blown crisis, it would have directly impacted the liquidity of many businesses and had it lasted longer would have no doubt caused a crisis for some.
In this situation, an understanding of the following would be necessary:
Reaching out to the business quickly to gather on-the-ground analysis of the true impact will be central to the message delivered to executives while also allowing a plan of action to be crafted quickly.
For the top four or five potential threats to any business, be it a payment channel outage or a cyber-attack, a similar cheat sheet of KPIs will be needed to ensure treasury’s response is as valuable as possible.
Ultimately, the response to the crisis, over and above quantifying the potential impact, will be the headline measure of treasury’s effectiveness. The response to a cash crisis will typically rest on access to internal and external liquidity.
You’ll want to know your current cash reserves (across all business units, in all locations and all currencies), and you’ll want to know them in real-time. That way you’ll know where you stand at the point of impact, and how much runway you have left.
From an external point of view, you’ll need to know how much undrawn liquidity is immediately available and how much support will financial backers provide if the situation deteriorates. Getting cash quickly into the business is the only action that will stave off a true crisis. Banks will want to know the potential impact on covenant and profitability levels so these will need to be close at hand.
Preparation is all about making sure that all of your cash and liquidity processes are running smoothly and your cash reporting and forecasting is comprehensive and accurate. A good cash forecasting process will include a clear view of accounts receivable, so you’ll be able to quickly factor that in to your incomings. A good forecast will also show what your accounts payable are, and where they can be delayed. Finally, you should be able to easily factor into the cash forecast which revenue streams have been shut off (or diminished) and what impact the impact on working capital will be.
Unfortunately, however, if disaster strikes now and you aren’t fully prepared, if your cash flow reporting and forecasting processes are manual, slow, and inaccurate, it will be too late. Making sure the house is in order before a crisis hits will enable Treasury to respond confidently when called upon.
Setting up a new cash flow forecasting process can be achieved within a few weeks. The key to managing the roll-out project smoothly is to have buy-in from key personnel from the outset. Outlining the value that can be added in a crisis is a good way to contextualise the benefits the new process will bring.
Many treasurers still run their cash forecasting processes manually on spreadsheets. However, in a crisis scenario, the CFO will want real-time reporting, across all business units, and a degree of forecasting accuracy that just cannot be achieved without the use of specialised software. To ensure a best-in-class cash forecasting process, it is therefore best to use dedicated cash flow forecasting software....
Accounts receivable forecasting is one of the most important, and the most challenging, elements of a cash flow forecasting process for head office finance and treasury teams.
It is the element of a company’s cash flow forecast that estimates the amount of cash it is due to receive over a set period. The majority of these receivables will come from the company’s customers.
In this blog post we’ll outline some simple steps for increasing the accuracy of accounts receivable forecasts.
Accurate and reliable accounts receivable forecasting can have a large impact on the working capital of a business. In particular, clarity on short term upcoming accounts receivable can reduce reliance on short term external financing facilities. Therefore, improved accounts receivable forecasting not only allows a business to be become more nimble and efficient with regards to how they use cash, it also directly impacts the bottom line.
The challenges for a head office team managing a forecasting process are numerous due to the sheer volume of data, range of systems, and number of entities involved. Accounts receivable forecasting is particularly challenging as much of it is out of the receiving company’s hands. While payment terms are agreed, they may not always be adhered to.
It is easiest to break receivables forecasting into two parts: short-term and long-term. Long-term forecasting tends to be more straightforward as customers will, by and large, eventually pay their bills. Short-term forecasting is more difficult because there can be variability in when those bills are paid as well as variability on when cash will actually be received. A customer may delay payments because of difficulties in the supply chain (i.e. they themselves are awaiting payments from third party vendors), because they are holding cash for reporting purposes, or for many other reasons.
As forecasting is a forward looking activity there is no silver bullet that will solve all issues. However, based on our experience helping large companies to set-up and manage forecasting processes, taking the following basic steps can dramatically improve the quality and accuracy of accounts receivable forecasts.
Developing an understanding of past accounts receivable behaviour is the first step in trying to more accurately forecast future customer receipts. There is no hard and fast method for this analysis but ultimately what is learned is more important than how it is done.
At a base level, an analysis of historic accounts receivable data should highlight:
The goal of this exercise is to define what areas of the receivables ledger cause the most problems and are the most difficult to forecast. This will allow improvement efforts to be focused on these areas. Applying the 80:20 rule to all aspects of this analysis will significantly speed up the process.
The historic analysis will facilitate the accounts receivable ledger to be broken into various reporting sub-categories, depending on what needs to be focused on and improved.
A common sub-categorisation is based on customer size. Looking at accounts receivable as a single number is challenging as, even in mid-sized companies, it comprises many moving parts. A simple 80:20 split will quickly focus the analysis on the largest customers and their payment behaviour.
Further or additional customer categories can include:
This type of categorisation is key to the efficient ongoing analysis of accounts receivable behaviour.
Accounts receivable analysis and forecasting is an ongoing exercise. The steps outlined above lay the foundation for ongoing analysis which in turn leads to adjustments to forecast assumptions, or to actions that improve cash flow collections.
Variance analysis is the primary piece of analysis that will be carried out as part of any effort to improve accounts receivable forecasting. Variance analysis demonstrates how forecasts perform versus actual data. This in turn shows how assumptions have performed and what needs to be changed for the next forecast iteration.
This process of ‘monitor – update – iterate’ will help cash forecasting accuracy measurement and move a forecast from low to high quality, over a relatively short period of time.
As with most parts of the cash forecasting process, accounts receivable forecasting can be done manually on spreadsheets by collating all of the required input data and entering it into your models.
However, the use of specialised software can help not only by automating the data collection/collation process across numerous data sources, but also with analysing and improving accuracy. The use of specialised software also enables predictive analytics as a method of analysis, offering in-depth insight into what may be affecting forecast accuracy.
If you are considering setting up a new cash forecasting process, we have written a cashflow forecasting setup guide, which we welcome you to download....
We were pleased to exhibit at the ACT Annual Conference in Liverpool on the 15th and 16th May 2018, and were delighted to be visited by some of our clients who took the opportunity to visit our stand and let us know how well they are getting on with our software.
The conference gave us the opportunity to engage with prominent figures within the industry and hear the key issues that corporate treasurers are currently facing.
The panel discussions in particular offered some great insights into how the industry as a whole is changing.
If you were at the conference but missed the chance to see a demo of our software, please contact us by clicking here....
Accurately forecasting cash positions becomes increasingly important as interest rates rise, due to the opportunity cost of holding uninvested cash.
At its recent monthly meeting the U.S. Federal Reserve increased the Federal Funds rate from 1.5% to 1.75% and indicated rates will rise faster than previously anticipated. The new Fed Chairman has taken more hawkish stance on rates than his predecessor Janet Yellen as he attempts to cool a U.S. economy that is growing faster than originally forecast.
In an environment where rates are rising and are expected to do so for the foreseeable future, the direct cost of debt and the opportunity cost of holding uninvested cash both increase significantly. Therefore, the quality and accuracy of cash forecasts used to plan for future liquidity needs come into sharp focus.
In other words, as rates increase, the cost of inaccurate cash forecasting can become a significant penalty.
In large organisations, cash forecasting requires the collection of vast amounts of data from a wide array of sources. Because of this, measuring the accuracy of a cash forecasts is not a straightforward task, simply due to the volume of data points that have to be analysed and the amount of work involved in carrying out a thorough analysis.
As actual cash data is required to measure the accuracy of forecasts, the level of data available to a treasury and finance team will determine which elements of the forecast can be analysed. For example, if only closing cash balances can be accessed, it is only the closing cash positions in the forecast that can be measured. Whereas if transactional cash flow data is available, other components of the forecast, such as operating and investing cash flows, will be able to be analysed for accuracy.
Choosing what to measure, and how frequently to measure it, is the first step in understanding forecast accuracy. Analysing closing cash positions and net cash movements will provide a good gauge of overall forecast accuracy. Cash generation and working-capital based analysis will give a better understanding of cash flow performance, although this will require more forecast and actual detail.
Choosing the component of the forecast that means most to a business, and then measuring it, is a good starting point.
Once metrics are chosen, the time horizon will need to be selected. As with choosing a component of the forecast to focus on, it is important to select the time-period or date that matters most to the business. Whether this is month-end, year-end, or a monthly debt rollover, once the key dates/times are identified, the forecast reporting processes should be built around them.
There are various methods that can be used to measure accuracy. Below is a high-level view of two of those methods, “Single Period Actual versus Forecast” and “Count Down Accuracy Analysis”.
As would be expected from the name, a single period versus actual forecast is useful for single period analysis such as week-on-week or month-on-month. Forecast accuracy is best described through a percentage and can be calculated by dividing the gap between the actual and forecast figure, by the actual figure.
A count down accuracy analysis involves measuring a number of different forecasts which are made in the approach to the target date. These forecasts can then be analysed for accuracy as soon as the actual figure or flow on the closing date is known. For example, the table below shows four forecasts made for the December 31st closing cash position in the lead up to the target date. The actual figure for 31st December in this example is €13,500,000.
Date of forecast
Days to target date
Forecast for 31st December
Difference vs actual
As could be expected, the accuracy percentage increases as the target date approaches.
Presenting the results of the analysis as a graph helps to give a clearer picture of trends in the forecasts. In this example, each of the forecasts was overly conservative, and achieved only 49% accuracy four weeks before year-end, rising to 89% accuracy one week before year-end.
To provide high quality analysis, the forecast reporting processes should be targeted. If the methodology is overly complex, it can prove difficult to identify trends and make the necessary improvements. Choosing the most important metric, and the most relevant time horizon, enables accuracy measurements that are easy to understand and straightforward to explain.
You can download our full whitepaper on measuring cash forecasting accuracy here....
Cash-flow based metrics now feature prominently alongside traditional revenue measures of business performance in the key figures or financial summary pages of any public company.
On the financial summary page of its 2017 annual report, US supermarket giant Walmart listed operating cash flow and revenue as its financial key performance indicators. Indeed, cash-flow based metrics now feature prominently alongside traditional revenue measures of business performance in the key figures or financial summary pages of any public company. In the recent webcast accompanying Royal Dutch Shell’s 2017 results, CEO Ben van Beurden highlighted cash flow from operations and free cash flow as two of Shell’s three headline financial results – alongside revenue.
While these cash flow KPIs aren’t new, their renewed prominence in recent years has been driven by investor appetite for simple, easy to interpret measures of financial performance. Private equity investors are well known for their focus on cash flow – using it as a primary measure of business performance and, ultimately, value. The increasingly active role investors are playing at a board room level in large public companies, alongside record levels of private investment and deal making, are two of the macro trends supporting this renewed focus on cash flow in most companies.
Finance and treasury teams – seeking to better understand their own business, and contribute to strategic conversations happening in their organisation – are now using a range of cash flow-based metrics to measure and forecast profitability, valuation and efficiency KPIs on an ongoing basis. A short guide recently published by CashAnalytics outlines some of the most commonly used cash flow ratios and KPIs.
Any measure of cash flow profitability can be used to calculate these KPIs – the most commonly used being operating cash flow and free cash flow. Which one is more suitable will depend on the business and the audience. Some of the most common cash flow KPIs, using free cash flow as the basis, are:
This is calculated by dividing free cash flow by the total number of outstanding shares in a company.
This allows an investor to quickly understand how much of a company’s free cash flow can be attributed to their share-holding.
This is calculated by dividing free cash flow by market capitalisation or another measure of company value.
This is a very simple way for both internal and external stakeholders to understand the cash flow return on a business, informing a range of investment, fundraising or asset sale decisions.
Cash flow margin is a measure of profitability calculated by dividing free cash flow by revenue.
Reductions in cash flow margin can be a leading indicator of poor business performance or upcoming cash flow challenges. This is useful when presented alongside traditional operating and net margin figures, and is sometimes seen as the true measure of business profitability.
While providing insight into the health and performance of a business, cash flow-based metrics allow for a simple comparison to the performance of other companies or industry benchmarks. Comparing cash flow-based metrics to those of competitors – leading companies in the industry or companies of a similar size – is a simple yet powerful way to benchmark performance and financial health. Consider including these industry comparisons in management reporting to ensure that cash flow is always in focus.
You can download the short guide here....
We’re delighted to launch the CashAnalytics Working Capital Monitor which is an openly available resource on our website tracking the headline working capital KPIs for the world’s largest companies and most working capital-intensive industries.
The Working Capital Monitor Includes:
Our motivation behind developing and launching the Working Capital Monitor is to highlight working capital trends across a broad range of industries so that all companies can better plan for the future.
The world of cash and working capital management is highly interconnected and the actions of one company can directly impact the cash flow of a broad number of suppliers and customers. This in turn causes these companies them to adjust their future cash flow expectations and behaviour.
The Working Capital Monitor will be updated on a monthly basis with annual results release by companies in the monitor, released in the previous.
We hope you find it useful and welcome all feedback. Click here to access the monitor....
As the role of the corporate treasurer continues to become increasingly complex, many are turning to automation and software in a bid to keep on top of day-to-day tasks.
A common example is cash management software – a solution often turned to by time-pressed treasurers looking to improve efficiency, and security in an operating environment where organisations are facing cash management challenges daily.
Successful treasury cash management involves gaining clear visibility of the cash management situation so that the cash flow situation is known, liquidity can be enhanced, days in account receivables reduced, collection rates increased, and overall financial profitability boosted. All of the above can be helped with the right cash management solutions.
An effective cash management solution, or ‘payment factory’ enables an organisation to centralise, automate and streamline payments and cash management within business units or across an entire organisation. This results in improved operational efficiencies, mitigation of risk, greater cash visibility and reduction in costs.” According to Craig Jeffery, managing partner of Strategic Treasurer, the benefits of cash management software fall into each of the elements of the FIVEC model: flexibility, insight, visibility, efficiency, and control. Some key examples provided by Jeffery include:
The benefits of cash management systems are clear – so what steps can a company take to ensure they end up with the right software solution? “Start with the ultimate business case and business goals and work backwards,” says Conor Deegan, managing director, Cash Analytics. “The features offered by cash management software can be quite broad and therefore the benefits provided will depend on the exact use case. So, clearly define the top one, two or three things the new software solution must do and engage with vendors who have a clearly demonstrated offering and track records in these areas.
After this, you will want to see the product in action, understand how company specific requirements can be met while also getting an insight into how other clients of the vendor use the solution. “A full suite cash management solution will have payment, bank reporting and cash flow forecasting capabilities. The market demand is for better and more advanced analytics solutions, from all vendors. Simply automating a process is no longer good enough. Companies now want vendors to help them do things dramatically better than done in the past, not just slightly better.
Jeffery adds: “For any company seriously considering the adoption of a cash management solution, there are two primary questions that must be answered. “Firstly, what does my technology infrastructure need to look like so that my current requirements are met without jeopardising future developments and growth? This question requires treasury to consider both their current and future requirements. What functionalities and capabilities do I need now and in the foreseeable future, so we intentionally avoid creating systems that become obsolete in the short-term. “Secondly, who are the major players in the space and how do the vendors themselves compare to one another?
Once a firm has a solid understanding of both current and future state needs, they must then look at the vendor landscape and determine which solution provider is in the best position to meet their needs. “For effective research it is important to include multiple points of analysis. For instance, factors in focus should include areas of functionality, customer service structure, number of current clients, financial strength, cost and the trajectory for future growth and R&D. The benefits of adopting a solution depends on more than just the solution itself. Researching various elements of the landscape can help identify the right provider and solution.”
To help with choosing the ideal cash management solution, Marshall says there are several significant requirements for any cash management solution:
As well as the features of the software solution, Deegan points out that it’s important for treasury departments to have access to effective ongoing support – and to look for this during the search for a suitable solution. “Business hours phone and email support from a vendor provided to all users of a system is now the industry norm,” he explains. “Service has become a huge part of software offerings and companies now have very high expectations regarding the service provided by their software partners.
From a technical perspective, Service Level Agreements (SLAs) should outline official response and resolution frameworks but in most instances, the customer should not need to reference an SLA due to the vendor taking a proactive approach to solving the problem.”
Cash forecasting remains a challenge for most large companies, particularly those with complex operations covering multiple locations with cash flows in numerous currencies.
Treasurers and other finance executives strive to use the forecasts they generate to support high value, mission critical activities across their organisations.
Forecasts that are used for high value activity will need to be a supported by a high-quality data collection and reporting process. High value cash forecasting is used to support high value activity such as liquidity planning, foreign exchange hedging and investor reporting.
Forecasting processes in this category tend to involve a lot of manual work such as spreadsheet consolidation and reporting. The data and reporting output is typically high level and prone to error.
In this category, the focus of a forecasting process is to producing an output that is distributed outside of the head office treasury team and as such the focus is on reconciling with other reports generated within the organisation. Consolidation tools or other software solutions may be used to assist with parts of the process but the majority of time is still invested in manual tasks.
3) Decision Making
A focus on analysis characterises the most valuable forecasting processes we have worked on. Time is still invested in the overall process but the majority of this time is spent on data analysis and interrogation with the ultimate goal of gaining a crystal-clear understanding of future cash flows and requirements.
Moving from the administration category to the analysis category is the goal for most companies. The key question is, how is it done? High value analysis focused forecasting is a function of an environment that assists and supports the people providing information to the process. Therefore, the conditions created are central to the overall quality of the forecasts and the value the process ultimately provides. We have identified four key conditions necessary for high value cash forecasting. 1. Accurate and reliable information input
Ultimately the value provided by any reporting process will be determined by the quality of data it produces which is dependent to a large extent by the quality of data input by people or gathered from other systems. A high value forecasting process produces a high-quality output by ensuring that the input is also of the highest quality.
2. Full meaningful engagement from participants
Accurate and reliable information input is to a large extent dependent on each business unit or subsidiary engaging in a meaningful way with the process. Gaining initial buy-in and ensuring ongoing engagement with a forecasting process can helped by:
3. Appropriate tools, process and support
Forecasting can be a challenging task, even for seasoned practitioners. Providing support to the people contributing to the forecasting process while ensuring they have the tools necessary to contribute in the best way they can, will be critical to the ongoing success of the process.
4. Analysis, performance reviews and feedback
An emphasis on analysis is the key characteristic of a high value forecasting process. The analysis not only produces key insights that helps guide day to day to day decision making but is also used to create a “feedback loop” that continuously drives improvements in data quality. This feedback loop is the missing link in most forecasting processes.
This focus on support, efficiency and analysis lies at the heart of sustainable, high value forecasting in large organisations. You can download the CashAnalytics whitepaper on high value cash forecasting here....
A decline in the return on capital employed of globally listed companies over the last decade has been noted in recent EY and PWC reports.
This is despite businesses taking an increased focus on balance sheets since the financial crisis in 2008.
Research published by PwC in 2016 reported that, despite considerable improvements during the financial crisis, companies’ global working capital performance has “progressively deteriorated” over the past 10 years – although small improvements were seen in 2014 and 2015.
However, in 2017 there were small signs of improvement in the UK. A 3% improvement in the cash-to-cash cycle of UK companies released £8.8bn which was previously tied up in working capital, according to Grant Thornton’s latest UK Working Capital Survey.
Since the financial crisis, UK companies have placed more focus on the health of their balance sheets, partly due to increased scrutiny on working capital by executives and investors.
This focus on company balance sheets will become increasingly important as the US, UK and Europe are all expected to see interest rate rises in 2018 following a prolonged period of historic lows.
“While cash and credit appear to be plentiful, both public markets and private investors now have a laser-like focus on cash and working capital based metrics,” Conor Deegan, director of CashAnalytics, tells GTNews.
“In the past, these metrics were used to gauge the efficiency of a company’s financial operations, but investors now monitor them as an early warning signal for future profitability and balance sheet issues,” he explains.
In challenging markets, efficient working capital management can be used very effectively to free up cash within organisations. This cash can either be invested or used to reduce the company’s external funding needs.
“Ultimately, all of the facilities supporting working capital and supply chain finance come with a cost that is tied directly to interest rates,” comments Deegan.
“The expected increases in interest rates this year will increase the cost and, in some cases, call into question the viability of current working capital financing arrangements, particularly in lower margin industries where they are most relied upon,” he adds.
However, the current low interest rate environment means that companies have little to gain by investing excess cash in investment vehicles which pay little or no returns.
When struggling with trapped cash in a low interest rate environment, using internally generated cash to fund working capital is always the optimal solution, argues Deegan.
“Working with colleagues in local entities and in other departments such as tax to devise strategies to release trapped or unused cash, with the explicit purpose of funding working capital, will be a key activity in 2018,” he says.
“A working capital cycle that maximises the use of internally generated cash will ensure that the company’s operations are funded in the most efficient and cost-effective manner possible, while also allowing key metrics to be closely managed and predicted,” he adds.
Treasurers will need to stay up to speed with these changes and develop a full understanding of the working capital landscape so that they can provide insight and context to working capital discussions within their organisation.
Businesses not only need to stay on top of their own working capital but also that of suppliers, customers and the market in general when forecasting and building a picture of future liquidity requirements.
“The largest companies in the world have a huge impact on global working capital flows and understanding current metrics and long-term trends is an essential part of effective forecasting and planning,” explains Deegan.
CashAnalytics has launched an openly available online Working Capital Monitor through their website to help treasurers improve both their understanding of the broader working capital market and ultimately their business forecasting.
The Working Capital Monitor contains 10 years of working capital information on over 350 of the largest companies in Europe and North America. Alongside this, it provides an analysis of close to 50 industries which provides a telling insight into broader market trends in each of the industries.
“We believe that data sits at the core of effective forecasting and planning. The Working Capital Monitor makes some this data easy to access and interpret for anyone with an interest in the area,” says Deegan.
The CashAnalytics Working Capital Monitor is the largest openly available resource focused on corporate working capital data available on the web today, according to Deegan.
The data is designed to be easy to understand and interpret for busy professionals seeking to gain insights to better understand the future cash flows, positions and requirements of all aspects of their business....
When considering sources of data for a cash forecasting process we need to have clarity regarding what are the key inputs, and what purpose they serve. Obviously we need forecast information, but to get maximum value from the process, we need to measure our performance, and we do this by recording the actual cash flows (actuals).
So the question becomes two-fold; where do we get our actual data and where do we get the forecast data?
Actual Cash Flows
The goal with actual cash flows is to minimise human touch as typically this information already exists in bank files, financial systems and Enterprise Resource Planning (ERP) software. Looking a little further into each:
ERP / Accounts Systems
Most large organisations run on an ERP system and are often using one of either SAP or Oracle, but there are many others. These systems have built in data inputting/outputting capabilities as standard.
If for example your AP and AR information is contributing to your cash flow forecast, it makes sense to have these cash flows mapped to your cash forecasting software. This is normally done via an Application Programming Interface (API) or a file load, depending on your cash forecasting software provider.
There will often be a mapping exercise to pre categorise and group the data from the source system into the appropriate grouping for your forecasting system. For example you may be forecasting in weeks but you ERP records transactions at a daily level. That is just a case of grouping the days into weeks before loading the information into your forecast.
Bank File Downloads
Most banks can provided bank statements in electronic formats. The two main formats are BAI2 and MT940s. In general, but not exclusively, BAI2 tends to be favoured in the U.S. and MT940s in Europe. Each of these standards have their differences. In the case of MT940 there are structured and unstructured formats, relating to how the data is organised in the files.
Unfortunately some banks have slight differences in their implementations, particularly in the case of MT940 structured files.This can be an inconvenience if you bank with multiple different banks, but again that is an issue of implementation rather than a treasury problem.
Forecast Cash Flows
There are obviously less data sources providing forward looking or future information. The knowledge of future trading exists mainly in planning departments. There are still some systems which can provide information however.
Treasury Management Systems (TMS)
Your TMS system will have treasury and financing related cash flows such as interest and capital payments on loans or FX cash flows for example. These cash flows can be integrated into your forecast data via an API.
Data Modelling Software
There are some modelling applications which allow you to extrapolate from previous information to produce a forecast. Whether this will be accurate enough to provide any meaningful data will depend on many factors including; regularity of business, forecast duration, quality of models, quality of input etc. In many cases models will only offer a reasonable forecasts for a short period.
When it comes to forecasting the main source of information will be the people in the various business units/subsidiaries/projects (depending on the organisation). It is critical that head office gets buy-in from all people involved and explain to them the value and importance of the forecasting process. Then it is up to the various controllers or people responsible to produce their forecasts and this information then needs to be collated by your forecasting software.
People bring the thinking power to the process, for example an ERP system might provide 10-15 days forward looking AP/AR information but it is the insight and experience of the collections team who are best placed to make a judgement call on any cash flows that go beyond that period.
The treasury team need to review existing systems to see what information they already have access to and what can be used in the forecasting process. The value of connecting these systems really needs to looked at on a cost benefit basis. Any connection of systems will involve an overhead. It will come down to ease of integration versus the amount of usable data retrieved.
Once all automated data feeds are connected it is then down to people. The final piece of the puzzle is getting the right people involved in the process to maximise the use of your organisation’s knowledge of future trading....
Cash forecasting is often described as an arduous task. However, it is a critical process that shows how much cash a business will generate and what cash will be needed to fund future working capital and expansion. In most organisations cash forecasting has a bad name due to the amount of time it takes to do it properly and the poor results it often produces. As with forecasting of any type the results calculated will never be 100% accurate and, in a world where absolute precision is demanded at all times, this can be disheartening.
The flip side of lack of confidence is over confidence. Forecasting with 99% accuracy the day before an event isn’t very impressive and ultimately provides little decision making value. Somewhere in between this false confidence and the valley of despair lies the point of most value for your company.
In this post we look at three key elements to cashflow forecasting best practice. A process that combines direct human input with cash flow information stored in systems and the projections generated by forecasting models will produce the most accurate and reliable results. The mistake most companies make is to focus too intently on one element, ignoring the others, in the hope that it will produce a respectable forecast. In many cases it will but it won’t produce something that you can use for decision making or strategic planning on a daily basis.
It could be argued that humans sit behind each of the three elements we discuss, which they do, but for this discussion we will treat them as the source of information that doesn’t sit in a system or can’t be modelled. Generally this information relates to special projects, acquisitions or seasonal events.
In many cases domain or situational knowledge, such as knowing a specific customer’s payment patterns, allows adjustments to be made to a forecast that will dramatically improve its accuracy. This critical thinking is the essential ingredient in any planning based discipline.
Many companies fall into the ‘over-automation’ trap when designing a forecasting process by assuming that they can fully automate their way to an accurate forecast. This often leads to huge amount of time and money being spent on projects that will only be judged successful if 100% automation is achieved.
Systems don’t provide a silver bullet solution but are important for two reasons. Firstly they contain information necessary to complete the forecast itself and secondly they help with the automation of manual processes and analysis of data. As such they play a very important role but only as part of an overall solution.
Modelling your way to an accurate cash forecast is almost as difficult as full scale automation. It’s convenient to think that a sophisticated spreadsheet model will provide the right answer as this would save a lot of time and effort. Modelling can produce a believable projection but it is unreliable for short and medium term forecasting where a greater level of timing precision is required.
Modelling is necessary however for certain components of a cash flow. Revenue and input prices are typically dependent on external factors such as customer demand, raw material costs and FX movements which can be modelled and then tweaked using the latest available information.
A cash forecasting process that captures information from humans, systems and models will produce the most accurate projections of future cash flow. No two companies will have the same cash forecasting requirements but an understanding of what each element can provide as well as its limitations will allow you design a process that provides maximum value to your organisation....
Head office treasury and finance teams often find themselves in a frustrating position when it comes to managing working capital across their organisation. While they play a critical role in the provision of liquidity, they sometimes have limited ability to influence the efficiency of the working capital process they fund. Ultimately the cost of a poorly managed working capital cycle will have a constant drag on earnings and if treasury is required to fund shortfalls, external interest costs will increase.
The terms cash management and working capital management are often used interchangeably in a corporate environment. This can be slightly misleading as while they are closely related disciplines, cash is simply one aspect of working capital management. Therefore head office controllers and treasurers seeking to initiate working capital improvements will firstly need to understand the behavior of the short term assets and liabilities that drive the process – notably accounts payable, accounts receivable and inventory.
In large companies, many people will play a role in the working capital cycle. The exact makeup of stakeholders will vary depending on the company and industry but typically people in the following departments will have the largest influence:
Sales – Sales teams agree payment terms to new and existing customers. The payment terms offered by sales teams form a key part of commercial negotiations, particularly in low margin industries, and will influence future working capital.
Credit and Collections – Credit teams play a dual role in managing working capital. Firstly, they should be involved in setting acceptable credit limits and terms that can be offered by their sales teams to customers. Secondly, credit and collection teams monitor customer invoices versus credit terms and chase up overdue payments when required.
Procurement – Procurement teams have huge influence over working capital as they, for the most part, control the stock levels maintained by companies. For a manufacturing based business, with large raw material requirements, procurement will typically be the biggest spenders and control the largest budgets.
Any improvement proposal or strategy must be backed up by facts. By gaining an understanding of the metrics that influence working capital within your organisation, you will be in a better position to positively influence the overall process. Start with the simplest metrics first and focus on the largest sections of your business or the areas that experience the most volatility.
Gaining visibility over the following metrics and understanding their variability will provide the basis for any improvement efforts:
Days Sales Outstanding (DSO) – DSO shows how long it takes to collect cash from customers. Faster sales collections have a positive working capital impact.
Days Payables Outstanding (DPO) – DPO shows how long it takes to pay customers. Longer payment durations have a positive impact on working capital.
Days of Inventory Outstanding (DIO) – DIO shows how quickly inventory is sold. Selling stock faster has a positive impact on working capital as it means that cash is not tied up in unsold goods.
Cash Conversion Cycle (CCC) – The CCC uses DSO, DPO and DIO to demonstrate how effective a company is at managing its short term assets and liabilities. This is a key indicator of management efficiency.
A short cash conversion cycle indicates that a company is managing their working capital cycle in an efficient manner and cash is being converted quickly from raw materials to cash sales receipts.
To make working capital improvements, finance and treasury teams must be firmly aligned with the people managing the various components of the cycle while also having a firm grasp of the performance metrics and KPI’s. Without access to, and an understanding of, the metrics that govern your working capital cycle it will be impossible to initiate positive changes....
When setting up a forecasting process, there are two main forecasting methods to be considered – direct and indirect. In this blog post we look the attributes of each method including; when they should be used, how they differ, and the pros and cons of each.
Direct cash forecasting is a method of forecasting cash flows and balances used for short term liquidity management purposes. Direct cash forecasting, sometimes called the receipts and disbursements method of forecasting, aims to show cash movements and positions at specific future points in time.
The inputs into a direct cash forecasting process are typically upcoming payments and receipts organised into units of time such as a day, week or month. These units of time are then aggregated to the length of time that the forecast is set to cover. The time frame for when a direct method of cash forecasting is useful is generally less than 90 days, however it may stretch to one year.
An indirect cash forecast is one that is derived from a various projected income statements and balance sheets, generally done as part of the planning and budgeting processes. There are three methods of deriving an indirect cash forecast:
Adjusted Net Income (ANI): This is in effect a projected cash flow statement, it is derived from operating income, either EBIT or EBITA, changes on the balance sheet are then applied, such as Accounts Payable (AP), Accounts Receivable (AR) and inventories to forecast cash flow.
Proforma Balance Sheet (PBS): The PBS method looks at the projected balance sheet cash account at a future point in time. If all other balance sheet accounts have been projected correctly, cash will be too.
Accrual Reversal Method (ARM): The ARM is hybrid of the ANI and direct methods and uses statistical analysis to reverse large accruals and calculate the cash movements for individual periods.
In the very short term the direct method is a useful tool for treasury and cash managers to manage the day to day cash and funding requirements of a business and also assist with borrowing and investment decisions. Often actual cashflows are captured as part of the process and through variance analysis used to determine how accurate the forecasts are.
Medium term forecasts, either weekly or monthly are used for the purposes of liquidity management and assisting with investment decisions for companies with surplus cash. Medium term forecasts are also useful as an early warning signal for the purposes of covenant and net debt reporting.
Longer term indirect forecasts, greater than one year, are carried out on an accountancy basis. They are often linked to the strategic goals of the business, such as the capital expenditure that is accounted for over a number of years. The major downside of longer term forecasts is a drop off in accuracy.
The key attributes of direct and indirect forecasts are summarised in the table below:
|Direct Forecasting||Indirect Forecasting|
|Time Horizon||Short to medium term, generally less than 1 year||Longer term generally more than 1 year in the future|
|What Should it Show||Operational cash requirements and cash required to fund working capital||Cash required to fund longer term growth strategies and capital projects|
|How is it Constructed||Analysis of upcoming receipts/ debtors and payments/ creditors||Various income statement/ balance derivations (adjusted net income, pro-forma balance sheet etc.)|
|Pros||Easily understood High accuracy can be achieved over short term periods Can be very detailed and only focused on cash Gives a forecast of cash balances at various points in the future.||Aligned to financial plans Suitable for longer term planning|
|Cons||Can be difficult to reconcile with financial plans Not an appropriate tool for longer term planning.||Accuracy not as high as direct forecasts Difficult to perform variance analysis Limited us in assisting with operational day to day cash management. Limited to the intervals of the financial plan|
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