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Improving cash forecasting by tracking actuals

October 08th, 2015

Reliable cash forecasting requires continuous development of the forecasting process. One key ingredient is tracking the actual accuracy of the forecasts. Tracking lets you identify potential problem areas and focus on improving them. These problem areas can include the poor quality of forecasts from certain subsidiaries or the constant late payments from given groups of customers.

Make sure that the reporting subsidiaries understand the importance of cash forecasting

The point of tracking the actuals is to improve the reliability of the forecasts.

If subsidiaries do not consider cash forecasting an important process, you are in for trouble.

You need to ensure that all business units giving forecasts have sufficient working instructions that also include a motivational part. It is up to you to describe in no uncertain terms why reliable cash forecasting is important for the company and how the subsidiaries can contribute to its success by their own actions.

Long term cash forecasts

When tracking the actuals of long term cash forecasts, the key purpose is to measure how accurately the subsidiaries are able to forecast their income and expense flows during longer periods. Depending on the business you are in, the typical period is between 12 and 36 months.

The more reliable picture you have of the company’s long term cash flows, the better you can optimize the balance sheet and lower funding costs.

If the long term forecasts you are getting are unreliable, remember to instruct the reporting units to update their latest budgets and forecasts also to the cash forecast.

Short term forecasts

When tracking the actuals of short term cash forecasts, the key point is to track how well the reporting units are able to forecast the actualization of their forecasts. The more accurately you know your daily cash flows, the more effectively you can manage your liquidity.

Short term forecasts can be improved by e.g. taking into account typical payment practices and patterns for incoming [link] and outgoing [link] payments and also considering overdue invoices [link] in the forecasts.

Actuals tracking on different organizational levels

The primary interest of the HQ or the treasury is to follow the accuracy of the overall forecasts of the reporting units. Especially when tracking at the long term forecasts, it is useful to use a so-called water fall model to see how the total of the forecasts changes over time (see the picture below).

In addition to understanding the importance of cash forecasting, the reporting units need to have proper tools for forecasting. The quality of the forecasts from the subsidiaries will be improved, if the units can track the accuracy of their own forecasts on a detailed level. Because of this, it is important that your forecasting application enables actuals tracking on per-transaction basis.

The easiest way to build this detailed tracking is to import actual cash flows to the forecasts from your AP and AR systems. By utilizing the invoice IDs from the AP/AR you can link actual cash flows with forecasted cash flows accurately.

Stick and carrot

To get the process started, you need to make sure all parties involved in cash forecasting know that the accuracy of the forecasts will be carefully monitored. You should provide regular feedback on the quality of the forecasts to motivate the reporting units to develop their forecasting.

The motivation can be done with either a stick or a carrot. The stick often involves different public shame lists that unsuccessful forecasters want to get out of by improving their results.

As in motivation in most situations, the carrot approach usually works better here. Public lists of fame naming the best forecasters combined with personal feedback often work well. Some companies have gone so far as to tie a part of the subsidiary bonuses to the accuracy of their cash forecasts.