Over the last two months, the need to prepare an accurate short-term cash flow forecast for my board of directors and CEO has never been greater. The ability to prepare or adjust these forecasts quickly has allowed us to make better and more informed decisions about our cash needs, investments, and expenditures in a time of crisis.
Short-term cash flow forecasts are an art as much as they are a science: In addition to the calculation of cash-flow inputs and outputs, it takes good communication and a realistic eye to where your business stands today — especially when yesterday’s certainties have been largely swept off the table. This month, we break down the fundamentals of this form of forecasting and explain why it is in every company’s best interest to shrink the cycle time for this process as much as possible.
According to APQC’s Open Standards Benchmarking® database, top performers on this metric can develop a short-term cash-flow forecast in about two hours and fifteen minutes or less, while bottom performers take four hours or longer to generate theirs.
It may seem like the gap between top and bottom performers is marginal — what difference does an extra hour or two make? The short answer is that it can make all the difference, and there are at least two reasons why.
First, while faster cycle times for this process are always preferable, they are critical if a company needs to generate short-term cash-flow forecasts more frequently. A company with 9 to 12 months cash on hand might consider 60 or even 90 days “short term,” and perform these forecasts less frequently. But a company with a month or less cash on hand may need to generate a forecast weekly or even multiple times a week as it works to keep the business above water.
Either way, a short-term forecast that takes half a day or longer to produce is going to leave less time for more value-added activities and analysis, which take on more urgency in the midst of a crisis.
Secondly, delays in cycle time are often the result of delays in getting critical information from departments or business units in a timely way. If finance or treasury leaders aren’t getting the data they need quickly enough, there is likely to be more subjective guesswork built into the forecast, causing it to take longer and possibly be less accurate as a result.
Put simply, forecasting well and forecasting quickly are often linked. If you find yourself among the bottom performers for this metric, you may have some work to do on your short-term forecasting process to ensure both speed and accuracy.
A realistic, accurate understanding of your cash inflows and outflows is the bedrock of an efficient short-term cash flow forecast — and may be challenging during the COVID-19 crisis, for several reasons. It would be easy for any company to overestimate or engage in wishful thinking about how quickly receivables will be paid right now. It is critical to work with accounts receivable to understand which of your customers may not be able to pay or will be asking for extended payment terms.
Understanding cash inflows will also require you to calibrate and forecast your sales for the next 30, 60, or 90 days. What you may have anticipated for your second, third, and fourth quarters has likely shifted overnight. It’s incumbent on you as a finance leader to adjust these and work toward a reasonable set of expectations for your sales as you prepare the forecast.
While taking an honest assessment of your cash inflows, you’ll also need to make decisions around your outflows. Prioritizing these outflows and understanding what’s due right now — whether it be debt servicing, payments to a strategic supplier, or payroll costs — is what allows you to formulate and understand your short-term outflow calculation.
As you build a short-term forecast from the organization’s inflows and outflows, it’s important to do so in a way that allows for new inputs and outputs to be turned around in a day or less and quickly integrated into the forecast. Automation can help by reducing the amount of number crunching you’ll need to do and the speed with which data comes in. Keep in mind, though, that a lack of integration between systems will result in a process that remains largely manual and will not necessarily save time.
While 100% accuracy isn’t a feasible goal, you should strive for as much accuracy as possible for these forecasts. If you’re overly optimistic and you end up being wrong, the cost to the company, your customers, and your employees could be high. While the penalty for being overly conservative is not nearly as punitive, it may leave you with excess cash that you could have been investing. Erring on either side means more variances that will need to be explained, which leaves less time for you and your finance team to guide the business during a turbulent time.
Perry D. Wiggins, CPA, is CFO, secretary, and treasurer for APQC, a nonprofit benchmarking and best practices research organization based in Houston, Texas.