Ask any finance professional what regular task gives them the most pain, and chances are they’ll reply: ‘Building an effective direct method cash flow forecast.’ Direct method forecasting is frustrating because while the concept is simple: collate the data, analyze the data and predict your cash positions over the coming days and weeks, execution is typically extremely challenging. Gathering and unifying data from multiple disparate sources is complex and tedious, and analysis of that data is time-consuming and especially challenging if it’s not easy to move fluidly from high-level trends to individual transactions. Still, forecasting is also essential - in these uncertain times, even more so – as managing cash is critical to the success of the business. So what tools help make building an accurate, and effective, cash flow forecast easier?

Preparing a Cash Flow Forecast in three ‘easy’ steps

Let’s go back to basics.

Define what you want. And what you’re trying to achieve. Specifically, this means deciding the period for which you want to forecast – next day’s balances, or next week’s, or next month’s – and the level of accuracy and detail you need – likely determined by factors including whether the company is cash-rich/cash generative. These decisions will influence how often you update your forecast, and how dynamic your forecast needs to be.

Structure the forecast. No forecast will work without implementing a consistent approach to the forecast process. Establishing a standardized procedure will allow for variances to be identified and adjustments to be made. Put simply, the forecast process needs three things:

• Relevant data. Identifying the data required to build an accurate forecast requires a deep understanding of your business, and, importantly, how cash flows through it.
• A method of collating data. You’ve identified what data you need. What is your next step? Recognizing the best sources of the data required and establishing a process to collate that data as efficiently as possible. Data sources are likely to be both internal (e.g. from the ERP system) and external (e.g. from banks).
• A tool to compute the data. Finally, you need to compute the data you have gathered. Many organizations use spreadsheets to calculate their forecasts. Others rely on modules within their treasury management or ERP systems, and, increasingly, some leading finance teams employ dedicated cash forecasting solutions.

Refine the process. Forecasts should be compared with actual outcomes. Any variances can be examined so that the collation and/or computation processes can be improved.

So far, so good. But’s what’s changed?

How It All Changed in 2020

Global events in 2020 have compelled us all to focus on what’s most important, and to innovate to achieve our goals. Three trends stand out:

A greater focus on cash, and cash forecasting, across all organizations. The uneven economic impact of the pandemic has elevated the importance of cash, as organizations prioritize liquidity as they seek to ensure survival in volatile times.

Finance growing in importance within organizations. In addition to protecting the bottom line, finance teams are being asked to be more strategic by improving their use of cash and working capital, and by providing greater financial context and insight to fuel real-time decisions across the business. Luckily, advances in technology over recent years have given finance departments greater visibility, and control, over cash throughout their organizations.

Increased use of digital tools. CFOs everywhere have a growing imperative to enable their teams with better tools, and the pandemic has shown businesses that many core tasks, such as creating the cash forecast and initiating payments, can be done remotely, as long as the necessary data and tools are in place. Digitization is critical to be able to operate remotely and cohesively, so the pandemic has accelerated this trend, with the adoption of data analytics, including machine learning and AI, increasing rapidly too.

The Future of Forecasting

Taken together, these accelerated trends have positive implications for the future of direct method cash flow forecasting.

First, control of cash has become critical in more organizations. Without cash, there’s no business. At the height of the pandemic’s impact, many CFOs wanted regular, even intraday, cash forecasts. As the use of instant payments grows globally, for example, real-time forecasts are set to become a permanent feature of the finance department’s remit.

Second, finance now has the tools to be able to forecast effectively, continuously, and in real-time. In the past, forecasting was simply too time-consuming. Today, finance can automate data capture, rather than be reliant on others to provide information, and use machine learning tools to create useable forecasts in real-time.

Third, forecasts allow a more forensic view of a business. A dynamic cash flow forecast gives a real-time view of how a business is performing across all departments, allowing companies to take immediate action to mitigate or manage any problems as they emerge.

So, the principles of forecasting haven’t changed. But it’s more important than ever – and finance now has the tools to forecast more effectively in real-time and the mandate to share insights across the business.