The key objectives of short-term cash forecasts are to:
Generally, some version of a receipts and disbursements model is used to predict short-term cash requirements. While the objective is to forecast short-term cash flows as accurately as possible, given the complexities in obtaining accurate data, such models are often limited in outlook to just a few days or sometimes a few weeks.
Any data that is included in the forecast needs to be monitored and compared with actual data and adjustments made in the light of experience
The period covered by a short-term forecast will largely be determined by the terms of the organisation’s borrowing and investing arrangements. For example, if an organisation is required to give five days’ notice of a drawing under its revolving credit facility, any forecast will need to extend beyond five days to allow sufficient time to give notice to lenders.
The precise details included in the forecast and the process used to compile it will vary from company to company, but should be based on:
Ideally, the short-term cash forecast should be updated on a daily basis, although this may not be practical in all cases.
To be useful, a forecast needs to be accurate, but any of the following issues can materially affect the reliability of short-term cash forecasts:
All of the above mean that any data that is included in the forecast needs to be monitored and compared with actual data and adjustments made in the light of experience. For example, close liaison with the accounts payable and receivable teams will provide accurate estimates of payment and receipt patterns where there may be peaks at the end of the month when customers pay their bills and the organisation also makes its disbursements.
The following pro forma can be adapted to the requirements of the individual’s organisation:
Once the forecast is compiled period by period, showing whether the organisation is expected to be in a surplus or deficit position at the end of each period, some companies will factor in a minimum cash holding to cover unforeseen circumstances (headroom), while others may seek to run cash at zero or slightly overdrawn – a decision to be based on a clear understanding of just how accurate the forecasts are.
In day one, if cash carried forward from the previous period is 200, cash receipts are expected to be 2,000 and outgoings 1,740, the cash balance at the end of the period will be 460. If company policy is that there must always be a minimum balance at the bank of 100 (headroom), there will be a forecasted 360 surplus available for investment at the end of the day.
For day two, the ‘cash at end’ balance in day one of 460 (which does not include the cash reserve) is brought forward from the previous period, to the ‘cash at beginning’ balance for day two. The forecast shows an end-of-period deficit of 240. The cash reserve is extended for all periods, meaning that the forecast for day two is a deficit (and hence borrowing requirement) of 340.
The level of detailed information needed for a receipts and disbursements model, while of huge benefit for short-term forecasts, is rarely suitable for long-term forecasting since the costs of establishing an accurate forecast in this way will generally outweigh any benefit.
Therefore, for longer-term forecasts, the starting point is generally the management (or, less commonly, the statutory) reporting statements, which are then rolled forward over a number of periods using a series of high-level assumptions.
Sarah Boyce is associate director of education at the ACT