Six Questions Every Treasurer Should Ask About How to Forecast Cash Flow

Consistent cash flow forecasting is arguably the holy grail of corporate treasury. Treasurers are tasked with a tremendous responsibility to predict the future cash flow performance of their organization. From securing liquidity for internal customers to providing free cash flow guidance and variance analysis to the board of directors, cash forecasting in treasury management is a critical component of an organization’s operations.

In this blog, Kyriba introduces six questions every treasurer should ask about how to forecast their cash flow. Successfully addressing these questions helps treasurers with forecasting cash flow and optimizing the overall process. In addition, they are primed to realize other benefits, including greater confidence from senior management, reduction in interest expense, increase in interest income and improvement in treasury resource effectiveness.

1. What Am I Solving for?

Cash and liquidity forecasting involves significant input time and effort from across the organization. Before requesting complex itemized forecast submissions from throughout the business and asking for yet another deliverable from your already busy staff and colleagues, it’s critical to clearly determine the decisions the cash flow forecast information will facilitate and benefits it will bring to the organization.

The challenge, however, is organizations often focus on excess details in forecasting the cash flow and lose sight of the forest through the trees. Therefore, it is essential to define the objectives first, what problems the forecast will solve and how the forecast result will benefit treasury’s customers: both internal customers including CFO, board of directors and internal legal entities who depend on treasury for adequate liquidity to support their businesses.

Risk

Burning out resources for non-value added work (NVA)

2. Am I Repeating the Same Forecasting Mistakes?

One certainty with any forecast is it will not be 100% accurate. As forecasting cash flow is an iterative process, variance analysis and understanding the root causes responsible for forecast error is an essential step in the forecasting process to avoid making the same mistakes next period and improve forecasting accuracy going forward.

Once forecast objectives are clearly defined, measuring the effectiveness of the forecast is a critical subsequent analysis. Establishing clear and relevant variance attribution analysis is an effective foundation to identifying the root cause of the forecast error. Variance attribution analysis often focuses on several items, including regional cash flow performance, changes in working capital and timing considerations. Inclusion of simple yet comprehensive variance analysis technology can often reduce the time and stress of identifying culprits of the forecast error and reduce the likelihood of repeating similar cash forecast errors in the future.

Risk

Repeated mistakes lead to poor information and flawed business decisions

3. Do I Understand My Business Good Enough?

Corporate strategy will drive the flow of corporate cash. Treasury is that unique corporate finance department that balances the interaction with external counterparties (e.g. banks and credit agencies) with corporate fiduciary responsibilities. However, corporate treasury should not operate in a corporate silo. Understanding the strategy, the financial targets and the regional growth objectives is a critical exercise to any successful cash forecasting in treasury management.

As companies introduce new product lines, execute M&A strategies and expand internationally, it will greatly impact the future cash flow and liquidity needs and performance of the organization. From increases in inventory balance to secure a new product launch, to expansion to DSO regions, understanding the underlying business for which your treasury department supports is a critical step in securing an accurate cast forecast and positioning treasury as a strategic internal business partner.

Risk

Lack of insight to underlying corporate strategy will increase probability material variances

4. Why Fund Your Business with External Funds?

Stop leaving money on the table and reduce interest expense. Internal cash is cheaper than external financing. With an accurate and comprehensive forecast, treasurers are able to confidently manage global cash balances at the optimal level to support their local businesses and consolidate incremental excess cash at the corporate or regional levels.

This enables corporations to better utilize their cash balances to pay down credit lines and short-term debt, and fund external expenses and corporate capital allocation strategies including share repurchase, dividend and M&A activity without taking on additional external debt and interest expense.

Risk

Unnecessarily high interest expenses, opportunity risk, potential P&L impact

5. Direct or Indirect or Both?

In addition to serving as a vital liquidity planning function to ensure global working capital requirements are met, treasury can serve a vital role in contributing and measuring the performance of the global cash budgeting plan.

By aligning the indirect method commonly used to budget operational and free cash flow from the FP&A budget perspective against the traditional treasury direct method, treasury has the unique strategic opportunity to align these methods and provide guidance to executive leadership and board-level audience on cash flow performance, risks and opportunities.

It’s also important to determine how the FP&A plan translates to global currency risk management objectives. Once determined, treasurers can align those objectives with global FX cash flow programs.

Risk

Misalignment in corporate finance department: similar information being disseminated to different finance teams, inefficient alignment / measurement

6. Do I Have Real-Time Insight to Free Cash Flow Performance?

Having real-time cash visibility and cash flow allocation automation can ease the quarter-end concern of “will we hit our free cash flow target?” These targets are increasingly tied to executive compensation and public guidance provided to the investor community. A comprehensive cash flow forecast and the ability to measure actual performance from bank statements provide greater assurance to treasurers, CFOs and CEOs alike that previously committed operating or free cash flow targets will be met and executive compensation bonuses will be paid.

Additionally, the ability to measure forecast accuracy within the quarter provides CFOs and treasurers with the “actionable information,” from which other cash flow techniques can be deployed, including working capital techniques such as supply chain financing and receivable financing, to shorten the cash conversion cycle and improve free cash flow for the current quarter.

Similarly, if cash flow is ahead of target, treasurers and CFOs may elect to speed up vendor payments at quarter end to ease the cash flow pressures of the following quarter.

Risk

Possibility of missing quarterly cash flow targets, negative investor reaction, executive compensation risk

What are Your Answers to the Six Questions?

Through proactive actions and commitment to addressing these key questions surrounding how to forecast cash flow, treasury leaders can successfully transform the organization’s treasury management processes. As a result, senior management gains greater confidence in the accuracy of forecasts, which leads to optimized resource allocation and reduced capital expenses.

By embracing technology and real-time analytics tools, treasurers’ action-driven approach paves the way for enhanced financial stability, strategic decision-making, and improved performance across the organization.