In 2014, we conducted a survey of corporate treasuries. One of the most surprising results was that only 32% of the responding treasurers viewed their cash forecasts as accurate. The reasons for forecast inaccuracy range from poor use of technology, not sourcing the right data, or in many cases building a forecast but not measuring its effectiveness on a regular basis.
Before resources can be invested towards improving cash forecasting, it is important to build a business case detailing the ROI of an effective cash forecast (and the impact of an ineffective forecast).
Poor cash forecasting practices mean that proactive cash decisions aren’t made. For cash rich organizations, idle balances are left in the bank earning money market rate returns or offsetting bank fees. Even in this interest rate environment, there are better options that comply with investment policies.
Improving forecast accuracy will prove that idle balances can be reduced, making the ROI simple to calculate.
As a net borrower, forecasting is important to ensure debt levels are optimized and that need for financing is provided with sufficient notice to find the cheapest source of financing – working capital, credit facility, long term issuance, etc.
Inaccurate forecasting will mean that too much financing was raised, incurring higher than necessary financing charges. Alternatively, a poor forecast will mean that emergency financing is needed, which incurs a whole different set of costs.
Either way, borrowing costs increase, and can easily be computed by calculating the debt levels that could have been avoided by the cost of carrying that debt.
The most obvious bottom-line impact for poorly projecting foreign cash flows is when an organization underhedges future cash flows, leaving foreign cash unprotected and at the mercy of volatile currency rates. This is the example most corporates are seeing in 2015 with the appreciation of the US Dollar against virtually every other currency in the world. Better forecasting creates more certainty in what is being hedged – and therefore more effective hedging programs. The costs of improvement are similarly easily to measure.
Overhedging is just as damaging as underhedging. If you hedge exposures that don’t materialize, you incur FX gains/losses which must be accounted for in the current fiscal period (i.e. no hedge accounting treatment). Overhedging is rare for this reason – and in fact you will see treasury teams underhedge just to avoid the remote possibility of overhedging their exposures. The result: inefficiency and financial loss.
What may be often overlooked is using USD for foreign expenses. Many organizations who aren’t able to rely on their cash forecast will find that expenses in foreign markets “surprise” them – because they weren’t forecasted properly. These surprises end up being financed from valuable US Dollars held domestically (incurring cross border payment costs too). The optimal scenario is to use offshore cash to fund offshore expenses. FX costs, payments costs, and tax liabilities are optimized this way – all of which can be easily calculated when compared to using domestic cash.
In fairness, credibility and perception of treasury’s effectiveness by management may not be as easily calculated to the bottom line. However, if you value your job and career progression, this should be the easiest to measure. Simply put, if treasury isn’t able to provide meaningful contribution to free cash flow, projected financing (including cash flow) for M&A, or vastly understates the effectiveness of a cash flow hedging program – someone has to take the fall.
CFOs want reliability and timeliness. And if your team can’t deliver it, they will find someone who can.
Most treasury teams (and the CFOs they report to) recognize that forecasting is an area for improvement. Armed with a solid business case and compelling ROI, treasures have the tools to gain approval to invest in cash forecasting. This may mean an investment in technology and process, both of which will collaborate to offer more reliable and confident cash forecasts.