Better forecasting: know your cash flows.

• Author: Hunstad, Michael
• Position: Treasury

Having problems with your cash flow forecast? If your answer is "yes," then you are not alone. Most organizations, both public and private, have ineffective forecasting processes and methodologies. A recent survey by Treasury Strategies Inc. indicates that more than 70 percent of treasurers have plans to review or improve their cash flow forecasts this year. The good news is that all forecasts can be improved--regardless of how sophisticated or complex.

This improvement may come just in time. Rising interest rates and a general expansion of economic activity have elevated the need for cash flow transparency. Better returns on short-term investments, combined with an upward-sloping yield curve, provide strong financial benefits to those companies that can term out their cash portfolios. An increase in M & A activity, compliance requirements of Sarbanes-Oxley and the American Jobs Creation Act also require firms to be highly cognizant of their future cash positions. Treasurers that can best predict the state of their short-term liquidity will excel in this new economic climate.

Reaping the benefits of forecasting may require your organization to overcome significant challenges. In many companies, a centralized cash forecasting process exists but has achieved poor results. Variances to the forecast are frequent, and the source of the variance is unknown or not easily identified. When the source of the variance cannot be pinpointed, the root cause is often not readily explained.

The solution to this pervasive problem lies with an intimate understanding of the specific cash flows that make up the forecast. While inadequate models and quantitative techniques are often blamed for inaccuracies, the real culprit is the information that enters the forecasting tool. When variances do occur, the forecaster must have sufficient knowledge to immediately identify the root cause of the variance. Good cash forecasts are intuitive and yield no real surprises.

Specific Cash Flows

The first step to obtaining this detailed understanding of cash flows is a comprehensive mapping of all receipts and disbursements. This process will reveal the existence of "bad" data and suggest ways it can be cleansed.

For example, it may be found that a certain bank account is being used for both lockbox collections and small tax payments. The commingling of these inflows and outflows makes it difficult to isolate the true level of receipts. Using this data will require that...