Having a strong cash management gives way to many benefits. If the company has done its job right it should be able to identify its sources of inflows and its expected outflows and causes; thus, being able to schedule payments based on the forecasting of its expected cash balances. Budgeting will be easier since the business will have defined the expected income and expenditures for the month. I’ve also found it beneficial for hedging and investing when the financial models have passed accuracy tests and the company is confident on its cash positioning.
Gathering the Basics for Cash Flow Forecasting
If you read some of my previous posts you probably have noticed that I tend to do a lot of emphasis on researching and analyzing the necessary background before jumping right into action. The reason for this is to be both efficient with your time and so your work ends up stronger and with few or no revisions necessary due to findings you didn’t consider beforehand.
Your cash flow forecasting model begins of course with the starting cash position for each of your banks. If you handle more than one currency definitely separate it into different spreadsheets. It will also require both the expected inflows and outflows. For the former you need to consider which sales are to be paid in cash and for those customers that are given credit you should also analyze if they usually do pay in time; and if not, usually how long after the deadline do they take to issue a payment. Also make sure to be aware of any discounts or deals that the customer may deduct, it’s always best to be conservative in your calculations. Ideally all the expected income should be available in an ERP, but if not then those involved in handling AP and Sales should be sending updates.
With the earnings you estimate low, but with the expenses you want to make sure you don’t underestimate any disbursement that might happen and that you have considered variable costs and tentative expenditures (better to have a positive variance in your budget than an overdraft in your bank account). Even if you’re one of the lucky ones that works in a company where budgeting is a common practice, the recommendation is that you create a catalogue of the expenses with both a category (department) and subcategory (vendor, type, etc.). Having a catalogue is not common practice and it really is quite helpful, especially when you consider tools like analytics or business intelligence. With the catalogue you can work on insights (ex. tendencies, the most common expense, seasonality), cost efficiency, and scheduling. If your business doesn’t have budgeting or the corresponding departments don’t keep track of what they spend, banks provide previous bank statements in excel or csv format from which you can extract the necessary data.
Use of Cash Flow Forecasting
Your model should provide both your daily cash positioning and the future balances. If you have this, then you can advance to topics such as investing or hedging since now you know when the company will have a higher liquidity and when it will be short on cash.
The primary goal of cash management is to fulfill financial obligations and provide liquidity, while also considering how to best maximize the return of the available funds. By knowing the number of days in which you have idle funds you can now evaluate investments not only on the return and risk but also the liquidity provided. If you handle two currencies and you require making use of hedging options, such as a forward, by having a cash forecasting model you can find the optimal window based on your needs and when payment is not a risk or problematic.
Visualizing Cash Flow
You can also have fun with cash management by creating visualizations. There are various elements that can be illustrated through charts; such as, the behavior and history of cash flows or the accuracy of the cash flow forecast.
One of the analysis you may want to carry out to see any trends or seasonality is the change over time of the cash coming in and going out of the company. With a line graph, for example, it is easier to spot the behavior of both the disbursements and income.
In this scenario we observe that the company tends to carry a good balance between the cash that comes in and what it pays out, except in September when it came really close to spending almost as much as it received.
On the following chart we see an illustration on how accurate the company was at forecasting the cash balances:
Even though there were positive variances, the business should take a look at why they ended with way more cash than expected. The more accurate the forecasts, the more efficient the company can be in its operations. September in this case raises a red flag since they ended up predicting more cash than what they actually ended up with.
The importance of creating a chart is that it is far easier to communicate and pinpoint the problem when there is a visual representation. For more tips make sure to read the previous post Tips on how to Present Data.