Forecasting Cash Flow Vital to Surviving the Storm

Sep 01, 2020


Cash is king! Without cash, you are done: turn out the lights, lock the doors, and go home. Monitoring cash and modeling future cash flows can provide an early warning regarding the health of your organization, so accurately forecasting your company’s cash flow is a business imperative. Indeed, accurately forecasting cash flow, especially as you continue navigating COVID-19 and its economic impact, is a matter of corporate survival.

Was this introduction a touch too melodramatic? Maybe, if your company is among the fortunate few that experienced a minimal drop in business due to COVID-19 or you entered the pandemic with either a stockpile of cash or easy access to liquidity. Most businesses, though, are facing stressful days and sleepless nights wondering how long they’ll have enough cash to meet payroll, pay vendors, and keep the lights on.

Assuming you agree cash is the lifeblood of your company, and that having enough of it will be an ongoing concern at least until the COVID-19 economic uncertainty dissipates, the question becomes one of how to mitigate this risk. How do you effectively monitor cash inflows and outflows? How do you effectively forecast your cash needs into the future? How do you make smart decisions, protecting liquidity in the short term without sacrificing your company’s ability to win in the long term? What actions should you take now and going forward?

This feature offers practical ideas and insights on how to more effectively forecast and manage your cash. If you leverage these ideas and insights with an appropriate sense of urgency, I am confident you will increase your organization’s probability of weathering the COVID-19 storm and other economic uncertainties.

The First Step

The first step in forecasting cash flow is to, well, start forecasting cash flow. No joke! I have seen smaller companies where “monitoring cash” meant reviewing the monthly bank statement to see the balance. Days later, they then wonder why they were bouncing checks.

Here is a story I’ve heard along the way; I’ll call it the New Year’s Eve nightmare. A private company’s corporate controller received a call from the bank early on New Year’s Eve afternoon. The customer service representative was calling to alert the controller that the bank was trying to process a large check but, if cleared, the company’s cash balance would go negative. Fortunately, the controller was able to transfer funding from a sister company (i.e., make a temporary loan) to resolve the cash crisis. The controller had been monitoring the bank balance each day, but, unfortunately, hadn’t taken outstanding checks into consideration. In addition, the company had a working capital line of credit, but had fully depleted it just a few months back. Finally, the finance team hadn’t closed the books for the last few months, and, even if they had, forecasting and variance analysis were not part of the protocol. In short, while the warning signs were there, the controller didn’t see the New Year’s Eve nightmare coming.

Again, the first step in forecasting cash flow is to simply start forecasting cash flow.

Creating a Cash Forecast

David Lewis, in his CFO story “Dynamic Cash-Flow Forecasting – A Must-Have in Times of Crisis,” says “Having a [cash forecasting] model that is dynamic, easily updated for changing conditions, and able to support iterative scenario analysis isn’t a luxury; it’s a necessity – as vital as a fire extinguisher in a furnace room.”

Once you decide to move forward with creating and maintaining a cash forecasting model for your organization, you need to make a few preliminary decisions before really getting started.

Select a method – Will you be using the direct cash forecasting method (whereby you schedule cash receipts less disbursements at a granular level) or do you prefer the indirect method (where you start with forecasted net income and then add or subtract expected changes to the balance sheet accounts such as accounts receivable and accounts payable)? Before making this decision, consider the next choice you need to make.

Select a timeframe – What will your time horizon be for the cash forecast? Traditionally, you may have focused on the medium to long term in conjunction with future strategic planning. As such, you likely used the indirect method of forecasting cash flow. In times of crisis and economic uncertainty, though, a much shorter time horizon (monthly, weekly, or even daily) may be warranted. When focused on a short-term horizon, where actual data is known or can be estimated with confidence, the more granular direct method of forecasting is likely appropriate. You need to balance between forecasting accuracy and range. You want to ensure the time horizon is short enough to support agile, tactical decision-making, but long enough to drive smart long-term choices as well. “If updated on a weekly, rolling basis, the … cash flow projection … offers companies the ability to prepare for, if not rectify, issues before they materialize.”1 I suggest the sweet spot may be to start with a 13-week rolling projection model, especially knowing many banks require 13-week cash forecasts.

Select a tool – The goal is to find a solution that is simple but impactful. You may want to research the many software tools specializing in cash flow modeling, or you may want to use Excel, which is also highly effective to forecast your cash flows. Even if the goal is to ultimately leverage a third-party forecasting tool, initially using Excel may help you determine what your real needs and desires in such a tool will be.

After determining the time period for your cash flow forecast as well as the method and tool you will use in creating it, it’s time to get started. Let’s assume the goal is to create 13-week rolling projections using the direct cash forecasting method. These steps will help you create the initial forecast.

Confirm the starting cash balance – In simple terms, leverage your current bank account balance(s) as the starting point, taking into account any outstanding items. Converting foreign bank accounts into a common currency may also be a consideration.

Project collection of customer receivables – When preparing a medium- to long-term cash flow forecast, you will likely leverage your sales forecast to project customer receipts. For a 13-week cash forecast, however, you want greater precision. Start with projected customer sales, but take into consideration payment terms – knowing revenue and cash flow are not the same. For existing customer receivables, prepare an aging analysis, taking into consideration actual payment history relative to stated payment terms. To the extent your open receivables are concentrated among a handful of customers, especially if these customers have unique terms or payment patterns, consider itemizing collections from each customer in the forecast.

Estimate other cash inflows – Cash inflows are not limited to the collection of customer receivables. You should also estimate cash inflows related to tax refunds, royalties and license fees, investment income, proceeds from the sale of an asset, government grants, and other relevant items.

Project payment of payroll and accounts payable – With appropriate granularity, estimate payroll, benefits, and payroll taxes, as well as rent, utilities, supplier payments, and other charges. The timing and amount of payroll, benefits, rent, and similar expenditures is often predictable. Likewise, for manufacturers, raw material costs and freight charges can likely be estimated based on your short-term production schedule. Otherwise, leverage an analysis of aging accounts payable to project upcoming payments, taking into consideration whether you typically pay in accordance with terms, early, or late.

Estimate other cash outflows – In addition to recurring operational expenditures, you should also include other estimated cash outflows in the forecast. For example, a capital investment may entail freight, customs, setup, and qualification expenses in addition to the cash outlay for the equipment itself. Or, you may be entering a new lease agreement that requires a down payment. Other cash outflows may relate to tax, loan repayments, owner distributions, special tax assessments, merger and acquisition legal fees, or engaging a top management consultant. Beware! Too often it is these nonroutine cash requirements that catch you off guard.

Calculate net cash available – Calculating “net cash available” is simply a mathematical exercise. Starting with the opening balance of actual cash for the period, add projected cash receipts and subtract projected cash outflows to calculate your ending cash balance. When preparing a 13-week rolling cash forecast, the ending balance for the current week becomes the opening cash balance for the subsequent week, and so on.

Pressure-test results – The value of your cash flow forecast is limited to the quality of the underlying data and assumptions used to prepare it. With that in mind, it’s critical to pressure-test the results, especially until preparing the forecast becomes part of the team’s routine procedures.

Once you have prepared the initial forecast, you should consider the following steps.

Update the forecast often – Whether you’ve chosen a daily, weekly, monthly, or some other time horizon, it’s critical to update the cash forecast regularly and timely. For example, if you have aligned on issuing a 13-week rolling cash forecast, then commit to updating and issuing it each week accordingly.

Analyze actual vs. forecast variances – By analyzing actual versus forecast variances, you can identify opportunities to continuously tweak and improve your modeling, leading to more accurate forecasts going forward. In addition, you will identify anomalies that require immediate action. For example, if you received payment from your largest customer who historically pays its balance timely and in full, but this week they only paid a fraction of the forecasted amount, it should trigger an immediate follow-up to determine the reason. Maybe they didn’t receive an invoice. Or maybe they are disputing the charge.

Maybe they are facing cash flow challenges. Whatever the reason, you want to know and respond accordingly.

Share forecast and drive action – The goal of a cash flow forecast is to provide insight on where your company is headed as well as an early warning if the business is about to go off track. To that end, you want to share the forecast with your cross-functional partners on a consistent and timely basis, engaging with them to ensure their understanding and to gain insights that can be incorporated into the underlying forecast assumptions going forward. “An intuitive cash flow forecast will help drive ownership, as well as accuracy, through incorporation of operational knowledge,” Lewis says.2 The ultimate goal, though, is to drive action. If the company is about to face a cash crunch, you want the leadership team to know and take appropriate action.

Other Considerations

In addition to the basic process of cash forecasting outlined above, the following represents additional thoughts on best practices and other considerations.

The art and science of cash flow forecasting – Although you can certainly leverage a highly complex model to build your cash flow forecast, in reality cash forecasting is both an art and a science. Indeed, the “art” of the forecast (defining the underlying assumptions and interpreting the results based on your general business acumen acquired with years of experience) may well be the most critical factor of success.

What if” scenarios – Cash forecasting requires significant judgment and knowing the underlying assumptions that drive the outcome. Forecasting a range of “what if” cash flow scenarios may prove beneficial. To supplement your “most likely” (i.e., realistic) cash flow forecast, consider preparing scenarios that are optimistic (“best case”) and pessimistic (“worst case”) as well. By having a range of potential cash flow outcomes, and engaging in relevant contingency planning, you can quickly react to the extent actual cash flow varies widely from your base expectations.

Dynamic forecasting – To facilitate creating multiple “what if” cash flow scenarios, you want a forecasting model that is both simple and impactful, one that is dynamic and easily updated as new information becomes available.

Data analytics and automation – Technology is becoming more sophisticated, cheaper, and easier to use by the day. You may be able to enhance the accuracy of your cash flow forecast by analyzing customer payment histories, spending trends, working capital requirements, seasonality, and anomalies. In addition, there may be an opportunity to automate the collection and consolidation of various cash inflows and outflows impacting your forecast. From both an efficiency and effectiveness perspective, consider automating where automation makes sense.

Cash flow forecasting horizon – During times of crisis, such as the COVID-19 pandemic, your focus should likely be on the short term. In reality, though, cash flow forecasts should provide both a short-term view with granular accuracy and a medium- to long-term vision to provide strategic direction.

Collaboration – As previously noted, you should proactively engage your cross-functional business partners in the cash flow forecasting process, incorporating their insights into the forecast itself, driving them to own the results, and enabling them to take appropriate action. To overcome a short-term cash crunch, for example, collaborate with your peers in identifying and pulling the levers that impact cash inflow and outflow, respectively. Ultimately, though, you need to remain in business. So, you also need to collaborate with your partners in analyzing and making decisions to invest in those opportunities that will drive the business forward.

Sense of urgency – When you are in a comfortable cash position, it is easier to forgo tough decisions such as consolidating operations, flattening the organizational structure, or streamlining your product mix. When facing a potential cash flow deficit, however, there is a whole new sense of urgency. The beauty of formalized cash flow forecasting, especially in the midst of a crisis, is that you are forced to identify and isolate those decisions impacting cash. There is obvious incentive to make the decisions you should have made all along.

Challenge every decision impacting cash – Your cash forecast generally provides a thermometer of the business. During the COVID-19 pandemic and other economic uncertainties, effectively managing cash is a business imperative. Knowing this, you should be motivated to identify those levers that make a difference to your cash flow. For example, do you need to backfill “in-kind” the employee that just left? Instead of purchasing that new piece of equipment, might a capital lease be advantageous? When is the last time you analyzed your spending in detail to identify opportunities to renegotiate supply agreements or outright forego a given purchase? And when is the last time you reviewed your customer base to determine which customers are worth working to keep and which to let fall away? You should be challenging every decision that impacts cash.

Call to Action

“The more clearly [you] know where [your] cash is and what [your] cash requirements are over a certain period of time, the better [you] can steer [your] corporate ship through otherwise murky waters.”3 Make a commitment today to effectively use a cash flow forecasting model or enhance the model you already have. Also commit to applying the insights gleaned from your cash forecast, in collaboration with your business partners, to make better decisions with a greater sense of urgency going forward. 

1 Tara Bollinger, CPA, CMA, CGMA, “Cash is Still King,” Clark Schaefer Hackett Business Advisors (May 27, 2020).

2 David Lewis, “Dynamic Cash-Flow Forecasting – A Must-Have in Times of Crisis,” CFO (March 31, 2020).

3 Mary Ann Rydel, “Efficient Cash Flow Forecasting – A Best-Practice Guide” (February 2013). www.treasury-management.com


J. Stephen McNally, CPA, CMA, is chief financial officer of the PTI Family of Companies in Toledo, Ohio, chair-elect of the Institute of Management Accountants’ global board of directors, and a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at j_stephen_mcnally@att.net.

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