In its newly released AFP Guide to Strategic Global Cash Position Forecasting, the Association for Financial Professionals (AFP) notes that accurate and timely cash forecasts are critical to effectively addressing a range of risks, including liquidity, credit, country, currency, counterparty and compliance risk.
Most short-term cash position forecasts follow one of two techniques: receipts and disbursements, or statistical modeling, the Guide notes.
Receipts and Disbursements: As the title implies, this technique requires the treasurer to list anticipated cash inflows and outflows; these are combined with the existing balance from the previous period to arrive at the forecast. Inflows will include collections from customers, as well as interest earned, and one-off inflows from, for instance, asset sales. Outflows should include operating expenses, as well as payments for taxes, loan repayments and dividends, among others.
While this technique can be used to forecast cash up to several months out, its accuracy tends to fall as the time horizon lengthens, the Guide notes.
Statistical techniques: Among the most common is a simple moving average, in which the average is updated as new information is received. One critical step is deciding how many data points to include. Too many, and the results may mask changes. Too few can produce greater variance between forecasts.
Another technique is exponential smoothing. This expands on the moving average by weighting some or all of the data to increase the accuracy of the results.
Regression analysis takes historical data, determines a relationship to current data, and extrapolates to forecast future data.
While it’s impossible to identify a single, correct process for forecasting cash in different organizations, several steps are key to most, according to the Guide:
1) Identify the data to be captured
2) Identify the data sources
3) Evaluate submitted data
4) Set the forecast time frame
5) Select the forecast technique
6) Check the input data
7) Review the forecast
Of course, accurate cash forecasting is complicated by several factors, the Guide points out. For starters, it’s often necessary to collect data from multiple sources, and often across countries, cultures, currencies and time zones. The logistics alone can be daunting. It’s likely that at least a few business units may drag their feet when providing data, submitting incomplete reports, or missing whatever deadlines are set. Bringing the information together to create a unified forecast for the company often means working across different systems.
And, each treasury organization needs to determine the appropriate level of detail needed to complete the job. This should help to guide the investment in systems and time allocated to the process.
Done effectively, cash forecasting can have a positive impact on the organization. “Cash position forecasting is one of largest value-added functions a corporate treasury operation can perform,” says Jason Torgler, vice president of strategy for Reval and a contributor to the AFP Guide. “Accurate and confident cash flow forecasts can lower borrowing costs, increase yield, control volatility on foreign currency gains and losses, lower transaction fees, minimize credit and counterparty risk, assist in acquisition strategy and many, many others.”