Cash flow planning is king

chessIn my experience, when companies build their plans, they are first concerned with the income statement. This is only natural. Most people outside of the finance department either don’t understand or don’t care much about the balance sheet or other statements such as the sources and uses of funds. Managers are much more likely to have their compensation related to revenues and profits than the accounts payable balance.

However, there is one item on the balance sheet that can be of major interest—this is cash. As the old saying goes, “Cash is king,” and everyone likes to know that they have enough in the bank to meet the payroll. When a company has debt covenants, other balance sheet items can also be important. For instance, if your bank pulls your loans it can be catastrophic. So planning the balance sheet, at least for finance, is extremely important.

Yet when most companies plan, whether using spreadsheets or Corporate Performance Management (CPM) software, the balance sheet is almost an afterthought. Organizations forecast receivables and payables using simple days of sales or days of payables, and term debt is easily forecast—as is equity and most of the other balance sheet accounts. Finally, to make the balance sheet balance, cash is calculated as a plug.

Using this conventional approach, unfortunately, companies do not obtain a detailed explanation of forecasted changes to cash. For most companies this represents only an intellectual exercise and, for practicalcash management, they produce a separate cash forecast based on what they know about short term cash inflows and outflows. The budget (and/or the monthly rolling forecast) is irrelevant when it comes to forecasting the balance sheet.

To accurately forecast a balance sheet (and hence understand the company’s cash position) more detail is needed than companies have available in an income statement that simply forecasts at the general ledger level of detail. For example, different sales channels will have different payment terms (cash from Internet sales will arrive sooner than receipts from invoiced sales) so separating sales in this way is essential. Seasonality also pays a part since Internet and retail sales may peak before the holiday season. This works similarly with payables. Rent is usually paid immediately while other payables may be based on time-based contractual commitments.

To accurately forecast cash (and hence the balance sheet) companies require information about sales and purchases that may not be readily available to the finance department. To do this properly:

  1. Understand your business and analyze which types of sales and purchases affect cash. You don’t necessarily need details of every single forecasted transaction, but forecasts that aggregate common types of transactions will be adequate.
  2. Model your business. Make sure that your cash inflows and outflows are based on the different transaction types. Extend this to include functions such as revenue recognition.
  3. Find a way to regularly collect information from people outside of finance about the expected values of each type of transaction that you have identified. Get them involved.

Companies can achieve the second and third points with CPM software like Prophix 11. You should be able to get started on the first objective yourself. If you do this, your cash and balance sheet planning will be much more accurate and can easily encompass your short term cash flow forecasting.



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Paul Barber

Paul has worked in the software industry for over thirty years in such areas as Decision Support Systems, Executive Information Systems, Business Intelligence, and Corporate Performance Management.

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