I have had a number of clients request cash flow forecasting models. This invariably leads to a deeper conversation around what is truly needed to manage the business. Here are FIVE key questions I typically ask and client coming to me for cash forecasting needs:
- Do you have an effective, repeatable and tightly controlled close process? This question may seem obvious but no forecast can be done for a three statement model without a solid understanding of historical actuals. Similarly, a weekly cash outlook without an understanding of historic inflows and outflows makes the projection on cash position difficult to nail down.
- Why is the cash forecasting needed? It can be the case that cash is tight and has to be closely controlled as on a weekly basis. Or, the answer might be that management wants a high-level understanding of the company’s expected cash position on a quarter by quarter basis. Is the information needed for day to day operational decision making or is it for a longer term outlook reflecting the health of the balance sheet?
- Who is the target audience? Is the target customer for this information the C-Suite (CFO’s office in particular) or is the data being developed as a part of formal three statement modeling for investor or board of director consideration?
- What Stage is your company in? One of the dependencies of three statement modeling is having a business that has enough maturity to have predictability in accounts receivable, prepaid expenses and accounts payable. To have that you need an accounting organization that closes the books regularly and has consistency of process in booking entries. Said differently, if your top line has no predictability and your expenses are erratic, it is pretty hard to build three statement models with a cash flow output that is accurate. Early-stage companies struggle in this area because of a lack of understanding in key cash flow model assumptions such as DSO and DPO. Such organizations are likely better off with a more simplistic weekly cash flow modeling comprised of projected invoicing, estimated collections and expenses.
- How is your company capitalized? If your organization is capitalized by a very large parent company at an advanced stage, it is likely that you need to have three statement model that is updated on a rolling forecast basis. More formally, if you are publicly traded then it is expected by shareholders and investors that you have a good handle on all three financial statements. If you are small and newly growing however, weekly cash forecasting may be more appropriate for your needs until you have some stability in A/R and A/P (the primary drivers for your understanding of working capital and cash flow from operations).
Using the questions above as a filter allows me to judge what the true needs of the business may be. In the end, some CFOs (if they have the requisite resources) might want both a weekly cash forecast model and more formal three statement modeling. Even if the company is early stage, more formal cash flow modeling is achievable with a list of key assumptions, but the results in terms of accuracy can be limited.
If your business is in need of a review of your cash forecast that’s where FP&A Expertise can assist.
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