Six key steps to better cash flow planning

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A couple of times in my career, I’ve been a member of an executive team that decided to forego awarding themselves an annual salary increase. But only once have I been part of a company that was so short of cash the CFO resorted to selling the furniture back to the supplier and leasing it instead. All of these companies were profitable, and all were subsequently sold for very generous price earnings multiples, giving their owners and investors the returns they were looking for. So, it was all good in the end—even if short-term liquidity made it a bit of a roller coaster ride along the way.

While start-ups rely on external funding, large companies usually have a cash cow or two that finance growth. But in either case, investment in growth initiatives needs to be tightly aligned with net cash flow; all the time exercising sufficient prudence to preclude running headlong into a liquidity crisis. That means diligent cash planning with the ability to quickly model different scenarios, such as how fast to pursue growth initiatives without having to resort to external funding, or how the loss of an individual key account would impact cash flows. Clearly, the financial reserves that a company can call upon will determine the type of cash flow planning they need; however, here are some best practices collected from the most recent articles on the topic:

1. Forecast at least every week

How often cash flow forecasts need to be run depends on the financial security of the business. If it is struggling, it might be necessary to forecast the cash position on a daily basis just to be sure there is enough to pay staff and suppliers–something that I can assure you is really not fun. But if the business is more stable, cash-flow forecasting every week may be viewed as sufficient. Less frequent analysis has the potential to hide situations where difference in the weekly inflows and outflows of cash could cause short-term issues.

However, there are considerable benefits from automating the process as much as possible and running it daily as it will give earlier warning of negative variances that require attention, as well as revealing pockets of cash that can be invested overnight to earn a return for the company rather than standing idle.

2. Forecast well into the future

Whilst looking at cash flow on a weekly basis will give insight into short-term liquidity, it is essential to look well into the future to identify whether external funding will be needed. That way, facilities can be sourced and put in place well before they need to be drawn upon. Being able to feed on the output of a rolling reforecasting process will improve the accuracy of cash flow forecasts.

The ideal situation is to have a model that combines both weekly and monthly forecasts. However, most cash forecast solutions that are built around an inflexible planning and budgeting solution are limited to a single time dimension–days, weeks, or months. But with the Anaplan platform, the time hierarchies are very flexible and easy to manipulate so users can easily combine daily, weekly, and monthly data in their models. This makes it easy to model scenarios such as how opening their stores an extra day every week would impact a retailer’s month end cash position.

3. Mix different approaches

Forecasting short-term cash flows usually starts with the company’s cash receipts and disbursements from the accounts receivable and accounts payable ledgers. Forecasting cash flow over longer periods, on the other hand, tends to use indirect methods, such as modeling various assumptions about the income and expenditure line items in a forecast profit and loss account. Having the flexibility to interchange between the two methods, using different time periods, gives the best of both worlds.

4. Forecast at an appropriate level of detail

Modeling cash flows at a highly aggregated level produces poor results that are not very useful for decision making. Working at a finer level of granularity such as business unit, customer type, or payment method produces more predictable results, and gives insights into problem areas requiring remedial action. When payments from key customers form a large proportion of the accounts receivable, they should be modeled individually, taking analysis down to another level. And now there are in-memory solutions such as Anaplan available, it is easy to import and analyze the entire Accounts Receivables and Accounts Payable ledgers.

5. Make it real time

In an uncertain economy, the assumptions that underpin cash flow planning need to be constantly updated to reflect actual trading conditions. And they should be easy to amend to produce different scenarios. That means being able to quickly change the business rules that underpin the model–such as regrouping customers by different attributes and forecasting new values for key metrics for DSO and bad debt provision–and get the results back immediately. Such scenario analysis is impractical where cash flow forecasting is built into a legacy planning and budgeting solution that requires advanced scripting skills to make changes to business rules, and where calculation is done in batch mode.

6. Monitor the accuracy of your model

The assumptions that underpin your cash flow forecasting model need to be based on reality. Monitoring variances between the forecast and the actual cash flow, as reflected in account balances during the first few weeks of any forecast, will quickly uncover opportunities for improvements. Those with commercial or customer-facing roles should be involved in revising the assumptions. After the changes are implemented, their impact should be monitored to ensure they are valid.

Measuring forecast accuracy is just one element of the functionality that our partners, PricewaterhouseCoopers, built into their app for short-term cash flow planning which is now available in the Anaplan App Hub. It provides a fully integrated approach to forecasting accounts receivable and accounts payable balances, and can be customized to fit specific business needs. If my former employer could have had access to an app like that, who knows, we might never have hocked the furniture.

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