Albert Einstein was once credited with saying that compound interest is “man’s greatest invention” and that “whoever understands it, earns it…he who doesn’t, pays it.” While there are questions as to whether Einstein actually coined these phrases or whether instead a crafty banker high-jacked his good name in order to encourage savers, the validity of the claims have never been in doubt. The phenomenon of compound interest has benefitted investors for centuries by allowing them to earn income on already earned income.
Another phenomenon that magnifies value by ‘building’ on closely related past events is the concept of rolling forecasts which drive improvements in forecasting accuracy and efficiency on an ongoing basis. A recent trend has seen rolling forecasting and budgeting processes replacing traditional fixed term processes as companies seek to better understand their own future financial performance. Much like their financial planning and analysis colleagues, treasurers can also benefit from this by applying rolling techniques to cash forecasting.
Focus on What Matters
Before delving into the benefits of rolling cash forecasts let’s recap on what matters from a cash forecasting point of view. Cash matters when it is available or “cleared” in a bank account. The goal of cash forecasting is to gain visibility over future available cash and which facilitates effective cash management. Most organisations use a cash forecasting process or model to gain visibility over upcoming cash movements and plan their liquidity requirements. The majority will also admit that whatever tool or process they use it never produces results that are 100% accurate – even 90% accuracy will be out of the question in most cases
Commit to Continuous Marginal Improvement
The good news is that cash forecasting does not need to deliver absolute accuracy to provide significant value. However, to derive maximum value from their forecasting process an organisation needs to commit to a policy of continuous marginal improvements in accuracy rather than attempt to generate results that are expected to be 100% correct, all of the time. Rolling cash forecasts facilitate the shift to a policy of continuous marginal improvement. Unlike traditional fixed term forecasting where it is easy to get disheartened when projections seem wildly off the mark, rolling cash forecasts changes the mind-set to one focused on learning and not dwelling on the past
Measure, Understand and Move-on
To achieve continuous marginal improvement using rolling cash forecasts consider following the MUM (Measure, Understand and Move-on) principle:
1) Measure – “If it can’t be measured it can’t be fixed.” Ensure that a process shows how accurate forecasts are on a business unit and line item basis. This helps focus attention on problem areas.
2) Understand – Accurate measurement allows interrogation of the component parts of a forecast and through direct dialogue with business units, an understanding of where and why forecasting inaccuracies occur can be developed and the tweaks considerations necessary to drive improved forecasting accuracy can be made.
3) Move-on – This is the critical step missing from most forecasting processes. Treasurers may be able to measure where things are going wrong and understand why but without a process for implementing these learnings, they will never be of any use. Rolling forecasting, by its very nature, encourages planners to ‘move-on’ and benefit from lessons learned next time around.
Explore a New Approach
The story goes that had Christopher Columbus invested one penny at 6% compounding annually when he first stumbled across the Americas in 1492 it would have been worth a staggering seventy billion dollars at the turn of this century. While even the most patient CFO is unlikely to afford this much time to a treasurer the path to forecasting success is quite similar – rolling forecasts facilitates continuous marginal improvements which equates to compounding value. A small investment today in a change of process and thinking will yield significant value in the not too distant future.