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7 steps on how to make Cash Flow forecast a success
| 15-02-2021 | Bas Kolenburg
Last year was a good example to remind organizations that cash flow forecasting is important, although, very little were prepared for the unprecedented, sharp and abrupt changes in turnover and cash flow due to the Covid-19 pandemic.
CFO’s have been asking:
In many treasuries, cash flow forecasting is a well-established basic core process, but from my experience it is often a “struggle” where the results do not always outweigh the efforts. Why is this process so difficult and more importantly: how can you make the cash flow forecast process a success?
Here are 7 steps that will help your organization:
1. Set your purpose and the horizon
Allow yourself to describe what the purpose of the cash flow forecast is as this will define also the horizon and the data that you need to build your forecast. The purpose will also be the guiding framework what level of tolerances you are prepared to accept.
Setting up a cash flow forecasting for quarterly reporting of covenants or to prepare for short term liquidity shortfalls means a different horizon and sometimes also a different set of data. Horizons can vary as much from the ‘standard’ 13-weeks to monthly or quarterly to even years. With a longer horizon, the level of accuracy will diminish.
2. Identify the cash flow drivers
This is the most essential and valuable step in the process as the right identification will largely determine the success of your forecasting.
Prepare a list of all (forecasted) cash in- and outflows and label them with priority, currency, predictability and identify in what entity and from what source you will be able to find actual and forecasted data.
3. Collect systematic and consistent data from all cash flow drivers
As you have, in the previous step, identified what will drive your cash flow, then we reach the really difficult part and that is obtaining reliable data on actuals and forecasts on these drivers.
You often hear : “I do not know when our clients will pay our invoices” and “If we win the tender then contract turnover will be X, however timing of the tender and outcome is unsure” and “Forecasted volumes of our product, I can give you but prices will be determined at the sale on spot basis”.
Don’t confuse sales and profit with cash. Most organizations seem very well equipped and organized to close each accounting period their books and forecast somehow the main profit and loss items going forward, however translating that into cash items, in the right currency with the right timing is not always easy.
My experience is that the process of obtaining these data gives you great insights on how cash driven the company really is and what role cash is playing in the KPI and rewards throughout the organization. You will often find that cash is, except for the treasury responsible, not on top of each minds.
Find also the right balance in detail of the data you want to forecast, as you can define a lot of cash flow categories, but that also means that you will need to label your actuals for all these categories. Manual labelling is often undoable (unless you have unlimited resources) and automating this labelling with tools is often easier said than done.
4. Focus on cash balance visibility
Your starting point for your cash flow forecast is the cash balance you have today and without adequate cash balance visibility on your today’s cash balance you will not be able to project future cash balances. Cash visibility means that you have access to – real time- information of all cash balances in your organization. When you have 1 or 2 banks, the Electronic Banking tools of these 1 or 2 banks will provide you all the information that you need. However, often certain bank accounts are managed on a decentralized level and information on these accounts are provided only at the close of the reporting period. Multi-banking tools that function as an information overlay can help you to overcome these kind of situations but you can also set up you own cash balance reporting consolidation.
5. Include analysis for variances
Analyzing the actuals versus your forecasts gives you a better insight how well the predictions have been and which data were reliable in the previous forecasting period and which were not. The sources that provided these data need to receive feedback on the variances from you to understand what was causing this difference so that their data can be improved going forward. Otherwise, it is only your problem. Sometimes a sort of “carrot and stick” feedback can be used to strengthen the reliability of the data collecting and create co-ownership for the process.
6. Prepare for scenarios
For treasurers, being prepared for the unknown is part of their DNA. So setting up scenario’s next to a base case in the cash flow forecast is essential to understand the headroom and even more important, what are the main drivers affecting the headroom. Because one thing is certain: Covid-19 will not be the last crisis they we will face.
7. Let systems work for you
There is no one-size-fits-all solution. Each process and tool must be tailored to the needs and objectives of each specific business. Many organizations work with Excel sheets because of the flexibility, it’s easy to use, the low costs and because it can manage massive amounts of data. Basically there is no problem with that, except when you would like to follow the steps, I described above, in more complex and multi-currency environment, then Excel will fall short to “let systems work for you”.
Nowadays there are multiple solutions (in various price ranges) for tools that can support your cash flow forecasting process from dedicated cash flow forecasting tools to more generic treasury systems and also payment hubs and banks provide (parts of) the solutions to support the cash flow forecasting process. Sometimes the tools include also artificial intelligence features that use actual company data to determine and support the forecasts. But often the tool is just a blank template sheet that needs to be filled with the actual and forecasted data. Then the added value is limited as “garbage in” means often also “garbage out” .
Conclusion
My advice is to revisit the cash flow forecast process in your own organization with the above mentioned 7 steps. If not ideal, there might be a strong business case to change (parts) of the process to be better prepared for the future.
Bas Kolenburg
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Looking for an Interim Treasurer
12-02-2021 | Treasurer Search | treasuryXL
Our Partner Treasurer Search is looking for an Interim Treasurer (m/f) for a successful infrastructure company with a global presence.
Tasks Interim Treasurer
Our client grows fast, there is a lot to do. Experienced treasury and funding colleagues are present. Main tasks will be:
Ideal Interim Treasurer
The ideal candidate for this position will quickly be able to connect with all internal and external stakeholders. She can ask the proper questions about business operations & projects and knows how treasury should be involved. She will take responsibility and, together with her colleagues, cover regular and project tasks. She is able to do so because of her relevant education and corporate treasury track record, preferably also in smaller organisations.
Our Client
Our client is a successful infrastructure company with a global presence.
Remuneration and Process
The expected hourly candidate fee for this project lies between €80 and €100. Our client will search for a permanent candidate for this position. The expected minimum period is 3 months.
Contact person
Pieter de Kiewit
Location
Tilburg
APPLY HERE
How do Foreign currency exchange rates work?
11-02-2021 | treasuryXL | XE |
For the first question, you can easily do that on Xe’s Currency Converter. The second question? That’ll take a little more time to understand. We’ll try to make it as quick (and painless) as possible for you!
Currency exchange rates: what they are, and how they work
Exchange rates indicate how much your currency is worth if exchanged into a foreign currency. For example, on December 30, 2020, 1 U.S. dollar was equal to 0.748067 British pounds.
Currency exchange transactions happen 24 hours a day, seven days a week in a market that transact over $6 trillion a day. Exchange rates are constantly fluctuating as foreign currencies are actively traded. Various trading activities boost or lower the values of different currencies.
Institutions and traders buy and sell foreign currencies in the global market 24 hours a day. For a trade to be completed, at least one currency must be exchanged for another. For example, in order to buy the U.S. dollar another currency is required for payment. Whatever currency is used, either the euros, yen, or Canadian dollar, etc. will create a currency pair. For example, if you use U.S. dollars (USD) to buy the Japanese yen, the exchange rate will be for the JPY/USD pair.
How are international exchange rates determined?
Foreign exchange rates are determined in various countries using two key methods: flexible and fixed rate. While flexible exchange rates are constantly changing, fixed rates hardly ever change. (Though you probably figured that out from their names.)
Flexible exchange rates
The foreign exchange market or forex determines most currency exchange rates. These rates are known as flexible exchange rates. These rates are constantly changing from one moment to the next. Flexible exchange rates are influenced by the open market through demand and supply on world currency markets. As such, if the demand for a specific currency is high, the value of such currency will most likely increase. But if the demand of a particular currency falls, its value in the foreign exchange market falls too.
Most major global currencies often have flexible exchange rates. These include the British pounds, Mexican pesos, European euros, Japanese yen, Canadian dollars, and others.
The government of these countries and their central banks do not interfere to keep their exchange rates fixed. Though their policies can affect rates in the long run, for most of these nations their governments can only impact and not regulate exchange rates.
Fixed exchange rates
Countries that use fixed or pegged foreign exchange rates do so via their central bank. These countries set their rate against another major world currency like the United States dollar, euro or yen.
To regulate and maintain the fixed exchange rate, the government of these countries buy and sell their own currency against the foreign currency to which it is pegged. Only the governments of these countries can determine when their foreign exchange rates should change.
Countries that use the fixed exchange rate method include Saudi Arabia and China. These countries ensure that their central banks have sufficient amounts of money in their foreign currency reserves to determine the amount their currency is worth in the foreign exchange market.
Okay, but what causes the rates to change?
Rates change when currency values change. There are several key factors that affect the movement and values of local and foreign currencies. These include three key factors known as:
Interest rates
Money supply
Financial stability
Due to these factors, the demand for a particular country’s currency, depends on what is happening in that country.
Interest rates
The interest rates a country’s central bank is setting is a key factor that will influence the country’s exchange rate. Higher interest rates have positive impacts on the value of the country’s currency. Investors are more likely to exchange their currency for one with higher interest rates, and then save it in that country’s bank to benefit from the higher interest rate.
Money supply
The money supply made available by a country’s central bank can influence the value of the currency in the foreign exchange market. For example, if there is too much money in circulation, there will be too much of it in exchange for very few goods.
Currency holders will most likely bid up the costs of goods and services which will trigger inflation. In the event that too much money is printed and in circulation in a particular country, it triggers hyperinflation and drives down their currency value in the foreign exchange market. Cash holders prefer to invest in countries with little or no inflation.
Financial stability
The financial stability and economic growth of a country can affect its foreign exchange rates. Investors are more likely to buy goods and services from countries with a strong and growing economy. This means they will need more of such a country’s currency to buy from them. this will increase the demand for such currency and ultimately boosts its value in the foreign exchange market.
If the economy of the country is in a bad shape, investors are less likely to trade with them. Investors are only interested in trading with countries that can provide gains from holding government bonds in that currency.
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