How to optimize cash flow with better forecasting

The rewards of accurate cash flow forecasting may have never been greater than they are today. For example, companies may find that the current scarcity and cost of short-term funding alternatives make it more important than ever to predict, manage and optimize their cash flow, says Gabe J. Galioto, vice president and treasury management officer for PNC.

“In today’s economic climate, the behavior of customers and vendors — even those you have worked with over the long term — can be hard to predict,” says Galioto. “And given the pace of change, relying on historic trends may also be inadequate.”

Smart Business spoke with Galioto about some cost-effective techniques for dealing with the challenges of improving cash flow forecasting.

Why are conventional systems inadequate?

Traditional reporting systems typically focus on accounting-based, or book, cash balances and don’t recognize actual cash on hand. At the same time, conventional bank reporting systems and databases don’t typically retain adequate historic data, and nonbank solutions have not yet advanced to support more effective forecasting. Further, more than 10 years of corporate restructuring has reduced the availability of treasury resources.

What is the first step toward cost-effectively improving forecasting?

It’s possible to significantly improve the precision of your forecasts without incurring prohibitive costs. You might start by taking inventory of your resources.

  • Re-examine your forecasting tools and their level of precision. What data do you have available?
  • Define your requirements in terms of how frequently the forecast should be updated and the length of the forecast horizon.
  • Make a candid assessment of your current process. How accurate, effective and timely has your recent forecasting been?

As you advance this effort, you may find you will need to strike a balance between the cost of improving effectiveness and the business penalties incurred by lack of precision.

Once you have a handle on your available resources, what is the next step?

Forecasts can be more effective when they are focused on underlying in-flows and outlays rather than on aggregate net cash flow. At a minimum, segregate and evaluate primary cash flow components, including lockbox receipts, supplier payments and payroll.

Once primary components are established, consider how to focus your forecasts. Is historical trend analysis alone sufficient? Should you consider fundamental analysis of key events/dependencies? This requires combining a focus on data with discrete business analysis. Examples include known payroll cycles, check run frequencies and loan payment commitments.

You might look at day-of-week and day-of-month dependencies. For example, day-of-week collection patterns of a typical lockbox operation may show large concentrations of Monday deposits. You may also want to consider day-of-month patterns, noting deposit concentrations surrounding the dates that follow statement-based billings.

Consider the merits of a fundamental view of primary customer/vendor terms and behaviors. Focus on major trading partners and assess behaviors that stray from long-standing practices. Once you improve your understanding of primary cash flow components, residual balances can be addressed through more simplistic historical trend analysis.