The state of cash flow forecasting
Accurate and timely cash position and cash flow forecasting (CFF) information is paramount for multinational corporations (MNCs) to guide funding and investment decisions, to manage cash and liquidity optimally and to be on top of financial risks.
Moreover with the amendment in IAS 7, effective as of 1st of January 2017, which is aimed to improve information disclosure on changing financing liabilities, MNCs should have a structured and clear insight in their cash flow. In order to map the current state of cash flow forecasting at MNCs, Zanders conducted a cash flow forecasting benchmark study, encompassing governance, processes and systems with all different market sectors included.
Cash flow forecasting solutions
Efficient cash flow forecasting is facilitated by standardization of the process and deployment of treasury technology. Despite efforts and investments made by MNCs in treasury management systems (TMS) and enterprise resource planning (ERP) integrated solutions, only 10% of the companies report having a CFF solution fully integrated in the TMS or ERP. Most companies (69%) use an ERP system or TMS in combination with MS Excel. MS Excel functions as a flexible input source to feed the cash flow forecasting module of a ERP/TMS. In addition, MS Excel is typically used to generate customized reports to support analytics and reporting. On the other hand, MNCs are reluctant to use MS Excel for the full end-to-end process as it is prone to error, lacks an audit trail and is not as robust as the ERP or TMS-based solution.
Next to ERP and TMS-based solutions, we see a large market potential for ‘best-of-breed’ CFF solutions, especially for companies seeking a relatively cost-efficient, easy to implement, ‘out of the box’ solution. Best-of-breed solutions, typically offered as ‘Software as a Service’, have a user-friendly interface, solid reporting, and in-depth analytical possibilities, including, for example, variance and scenario analysis. Disadvantages include the limitations in terms of integration with the ERP/TMS and a potential lack of flexibility in customizing specific client needs.
Cash flow forecasting process
For most MNCs, the cash flow forecasting process is a joint effort of subsidiaries and group treasury, starting with input of the forecasted cash flows at subsidiary level followed by consolidation and analytics at group treasury. It is best practice to ensure that the structure and level of granularity (detail) of the CFF matches with its objectives. To achieve reliability it is important that subsidiaries use the various line items (cash flow categories) in a CFF template in a consistent manner. By reducing the number of lines to the minimum required for financial information, the chance of inconsistent use is minimized. Moreover, a company should always balance the required level of detail vis-à-vis the effort of maintaining the CFF. This ‘less is more’ philosophy can also be observed in the benchmark study, which found that 80% of the MNCs have fewer than 25 line items in their CFF.
More than 50% of the MNCs in the benchmark study indicate performing variance analysis. Variance analysis includes forecast vs forecast analysis, forecast vs actual analysis and/or period vs period analysis. Variance analysis provides insight into the accuracy and reliability of cash flow forecasts and should identify breaches in trends/realizations of budgets early.
Forecast time horizon
Companies’ underlying business cycles drive the cash flow forecast time horizon and frequency of forecasting. As a result we observe a broad variety in horizons and update frequencies. Despite these differences, the large majority of the companies in the benchmark study do not perform forecasting for a period beyond one year.
Financial risk management
Since the financial crises, financial markets have become more volatile. With the increased volatility in the foreign exchange markets, for example, Zanders observes an increased focus on financial risk management. Crucially, transactional FX exposures can be identified via cash flow forecasting. For best in class FX management it is vital that no exposure information is lost during the identification phase. By forecasting in the original currency of the cash flow, as opposed to the functional currency of the subsidiary/group, potential loss of FX exposure information is avoided. According to the benchmark study, 55% of the companies indicate that they forecast the original currency of the flow instead of the functional currency of the entity.
In conclusion, most companies acknowledge the importance of a solid cash flow forecasting process. It is essential for every company to achieve their cash flow forecasting objectives, taking into account the specific context and business cycle. Despite company specific differences, a vast majority of companies in the benchmark deploy a robust cash flow forecast application (ERP/TMS) but still rely on MS Excel for more flexible reporting, analytics and data input. Zanders therefore sees ample potential for more integrated ERP/TMS solutions. The market for best of breed cash flow forecasting systems is promising, however still in its infancy. Next to seeking a good system solution, the governance and the process design is equally important for long-term success.