MODULE TREASURY MANAGEMENT

Cash Forecasting
Chapter 3

Objectives:
a. Know the importance of cash forecasting and possible actions to take
to obtain, analyze, and report on business cycle forecasts.

Cash forecasting is absolutely crucial to the operation of every organization. If there is

ever a cash shortfall, payroll cannot be met, suppliers are not paid, scheduled loan
payments will not be made, and investors will not receive dividend checks. Any one of
these factors can either bring down a business or ensure a change in its management in
short order.
Conversely, if a company is burdened by too much cash, it may be losing the
opportunity to invest it in higher-yielding, longer-term investments unless it knows its
projected cash balances. A quality cash forecast ideally allows the treasurer to determine
how much cash is available for short-, medium-, and long-term investments, each having
progressively higher returns. Since longer-term investments may have less liquidity, it is
imperative that the treasurer be able to invest the correct amounts with confidence.

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In order to avoid these problems, this chapter covers how to construct a cash
forecast and automate the creation of some of the information contained within it, and
how to create a feedback loop for gradually increasing the accuracy of the forecast. We
also describe several related topics, including the bullwhip effect and the integration of
business cycle forecasting into the cash forecast.

BUSINESS CYCLE FORECASTING

The cash forecasting period is generally quite short—anywhere from one to six months. The
level of accuracy of this forecast declines markedly if it projects multiple months into the future.
However, it is possible to incorporate longer-range business cycle forecasting into the cash
forecast in order to introduce a higher degree of accuracy into the more distant parts of the cash
forecast. Here are some possible actions to take to obtain, analyze, and report on business cycle
forecasts. They are listed in ascending order of difficulty:

• Report on published forecasts. There are forecasts published by nearly every major
business magazine for the economy at large. Several key advantages are that the
information is fairly accurate for the entire economy, it is prepared by professional
forecasters, and it is essentially free. The problem is that each company operates in a
smaller industry within the national economy, and as such is subject to “mini” business
cycles that may not move in lockstep with that of the national economy. For this
reason, the reported information may be only generally relevant to a company’s
specific situation.
• Subscribe to a forecasting service. A company can pay a significant fee, probably in the
five- to six-figure range, to a forecasting service for more specific reports that relate to
the industry in which it operates. This is a good approach for those organizations that
do not have the resources to gather, summarize, and interpret economic data by
themselves. However, some industries are too small to be serviced by a specialized
forecasting service, or the fee charged is too high in comparison to the value of the
information received.
• Develop an in-house forecasting model. In cases where either a company wants to run its
own forecasting model or there are no forecasting services available that can provide
the information, it is time to try some in-house forecasting. This effort can range from a
minimalist approach to a comprehensive one, with each level of effort yielding better
results. The first step is to find the right kinds of data to accumulate, followed by
implementing a data-gathering method that yields reliable data in a timely manner.
Then arrive at a methodology for translating the underlying data into a forecast. This
forecast should include the underlying assumptions and data used to arrive at the
forecast, so that any changes in the assumptions are clearly laid out. Finally, there
should be a methodology for comparing the results against actual data and
adjusting the forecasting methodology based on that information. Though this
approach is a time-consuming one, it can yield the best results if a carefully
developed forecasting system is used.

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For more knowledge please follow the link provided;

https://www.youtube.com/watch?v=fmeyUtqZX60

Example

The treasurer of a sport rack company has elected to use the last of the pre- ceding options for creating forecasting
information. Sport racks is a very small niche market that creates and sells racks for skis, snowboards, bicycles, and kayaks
that can be attached to the tops of most kinds of automobiles. The treasurer wants to derive a forecasting system that will
give management an estimate of the amount by which projected sales can be expected to vary. She decides to subdivide the
market into four categories, one each for skis, snow- boards, bicycles, and kayaks. Based on a historical analysis, she finds
that 25 percent of ski purchasers, 35 percent of snowboard purchasers, 75 percent of bicycle purchasers, and 30 percent of
kayak purchasers will purchase a car-top rack system to hold their new equipment. The typical delay in these purchases from
the time when they bought their sports equipment to the time they bought sport racks was six months. The treasurer finds that
she can obtain new sports equipment sales data from industry trade groups every three months. Given the lag time before
users purchase car-top racks, this means that she can accumulate the underlying data that predict sport rack sales and
disseminate it to management with three months to go before the resulting sport rack sales will occur. Thus, she concludes
that these are usable data.
The next task is to determine the company’s share of the sport rack market, which is readily obtainable from the industry
trade group for sport racks, though this information is at least one year old. Given the stability of sales within the industry,
she feels that this information is still accurate. She then prepares the report shown in the following table. It shows total
sports equipment sales for the last quarter, uses historical percentages to arrive at the amount of resulting sport rack
sales, and then factors in the company’s market share percentage to determine the forecasted sales of each type
of sport rack. By comparing this information to the previously forecasted sales information, the report reveals that the
company should significantly ramp up its production of snowboard sport racks as soon as possible.

Sports % Buying Company Forecasted Original

Equipment Sport Market Company Company
Description Unit Sales Racks Share Unit Sales Forecast Variance
Ski 3,200,000 25 40% 320,000 300,000 +20,000
Snowboard 2,700,000 35 40% 378,000 300,000 +78,000
Bicycle 2,500,000 75 30% 562,500 550,000 +16,500
Kayak 450,000 30 30% 40,500 45,000 −4,500

The example used was for an extremely limited niche market, but it does point out
that a modest amount of forecasting work can yield excellent results that are much more
company specific than would be the case if a company relied solely on the forecasts of
experts who were concerned only with general national trends. For most companies,
there will be a number of additional underlying indicators that should be factored into the
forecasting model; however, the work associated with tracking these added data must be
compared to the benefit of more accurate results, so that a manager arrives at a
reasonable cost-benefit compromise.
Business cycle forecasting is useful for a cash flow forecast only if the forecast
extends a considerable distance into the future. Such information will have a minimal
impact on a cash forecast having a duration of three months or less, but can be quite
useful for more extended periods.

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CASH FORECASTING CONTROLS

The daily cash forecast usually is assembled quickly, using the preceding day’s forecast
as a template, and with only minor updates. A less frequent forecast may be assembled
“from scratch,” without attempting to roll forward the old forecast; this increases the risk of
errors. Also, the person who prepares a cash forecast on an infrequent basis is less
familiar with the process, and so is more likely to make a mistake. These characteristics
allow the treasurer to mandate a reduced set of controls for a daily cash forecast and a
more comprehensive one for less frequent forecasts.
If a forecast is issued on a daily basis, then the treasurer should focus controls on
the incremental daily changes in the forecast. This can be achieved with the following
two controls:

1. Investigate significant variances from the preceding day’s forecast. This is a side-by-side
comparison of the current day’s forecast and the immediately preceding day’s forecast.
If there are significant changes, the preparer should verify that the changes are
reasonable.
2. Obtain the approval of a knowledgeable person. Another person should briefly review the
forecast, initial it, and retain a copy. The reviewer may not necessarily be the
preparer’s supervisor; it may make more sense to have someone else with significant
and recent cash forecasting expertise review it. Alternatively, the reviewer could be
someone with considerable knowledge of the information feeding into the forecast,
such as the person responsible for collections, payables, payroll, or capital
expenditures.

CASH FORECASTING POLICIES

The treasurer should implement policies that will assist in the management of two
aspects of cash forecasting, which are the issuance frequency and review frequency of
the forecasts. Sample policies include the following:

• Cash forecasts shall be issued on a [daily/weekly/monthly] basis. This policy ensures that cash
forecasts are issued with sufficient frequency to match the periodic updating of a
company’s debt and investments. A larger company with significant transaction volume
may need daily cash forecasts, while a smaller one may only require a monthly issuance.
• Cash forecasts shall be structurally updated at least once a [month/quarter/ year]. A cash forecast
may gradually become less accurate over time, due to changes in the business that are
not reflected in the cash forecast model. This policy requires the treasurer to engage in a
periodic updating that “fine-tunes” the forecast to make it more accurately reflect actual
cash flows.

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These policies should be integrated into the treasury’s policies and procedures
manual, and can also be integrated into the job descriptions of those responsible for the
cash forecast.

For more knowledge please follow the link provided;

https://www.youtube.com/watch?v=dLHZy4DWKRM

https://www.cashanalytics.com/what-is-cash-flow-forecasting/

https://en.wikipedia.org/wiki/Cash_flow_forecasting

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