Fundamentals of Cash Forecasting

Transcription

1 Fundamentals of Cash Forecasting May 29, 2014 Presented To Presented By Mike Gallanis Partner 2014 Treasury Strategies, Inc. All rights reserved.

2 Cash Forecasting Defined Cash forecasting: the modeling of a company or entity's future financial liquidity over a specific time frame. 2

3 Cash Forecasting Overview Cash forecasting is an extremely important tool for public and private sector organizations. A majority of organizations have ineffective cash forecasting processes. Many organizations face the same kinds of forecasting challenges: Insufficient resources Poor information access/exchange Ineffective forecast methodology Poor internal knowledge of cash flows 3

4 Cash Forecasting Why? Cash forecasting supports key Treasury activities: Funding operations Short-term investment and borrowing Cash concentration/balance transfer scheduling Non-discretionary payments planning - P&I repayments - Taxes - Acquisitions 4

5 Forecasts and Liquidity Decisions 5

6 Cash Forecasting Objectives Financial Control Liquidity Management Meeting Strategic Objectives Cash Forecasting Objectives Managing Currency Exposure Capital Budgeting Managing Costs 6

7 Effective Cash Forecasting An effective forecast answers the following questions: Do we have adequate liquidity? Do we have adequate working capital? Can we meet the requirements of our creditors and shareholders? Can we support our business plan? 7

8 Effective Cash Forecasting Distinction between forecast precision and forecast effectiveness and accuracy: P r e c i s i o n Forecast precision is less vital than forecast effectiveness for funding beyond today. E f f e c t i v e n e s s 8

9 Effective Cash Forecasting New mindset required: Forecasts that support quarterly earnings projections or focus on intricate details of cash flows are no longer valuable today. Effective cash forecasting must address Treasury mission-critical decisions: How much cash is needed to fund today s activities? How much liquidity is needed for the business to operate? When do we need to repatriate cash from foreign operations and from where? 9

10 Benefits of Cash Forecasting Maximizes the value of cash assets - Greater investment income o Reduces idle cash o Improves use of yield curve - Minimizes borrowing costs Avoids unanticipated emergency borrowing or premature investment liquidation situations Supports decision making across financial functions - Budgeting - Timing of capital expenditures Improves risk management effectiveness Provides an early warning mechanism 10

11 Sources of Data Bank Transactions and Balances (Bank Portals) Sales Forecast (Sales Department) Accounts Receivable System (ERP & A/R Department) Investment & Debt Maturities (ERP & Treasury) Cash Forecast Accounts Payable System (ERP & A/P Department) Interest Flows (ERP & Treasury) FX & Derivative Settlements (ERP & Treasury) Repetitive Payments (Various Sources: Tax, Payroll, Insurance, Accounting, Finance) Capital Expenditures (Business Planning) 11

12 Forecasting Techniques Balance Sheet Method Receipts and Disbursements Method Statistical Methods 12

13 Balance Sheet Method 1. Project Balance Sheet Items Ratios and other metrics Budget information Known components 2. Incorporate capital structure changes into projection 3. Solve for cash 13

14 Balance Sheet Method The Pros: Simple process Actual-to-forecast comparison easy Significant knowledge regarding balance sheet line items Historical data abundant The Cons: Daily forecasting not feasible Book cash is forecast output 14

15 Receipt and Disbursement Method Create a schedule of known inflows and outflows: Capital Flows Operating Flows Capital expenditures Bond maturities/interest payments Collections Disbursements Stock issuance Dividend payments Other 15

16 Receipt and Disbursement Method Evaluate the inconsistent flows to identify: Trends No trend Rising trend Falling trend Seasonality Patterns within a quarter Patterns within a month Day of the week cycle 16

17 Quiz Time How Well do you Understand Your Cash Flows? 1. Can you tell me accurately what month of the year contains the largest % of seasonal influence in your annual cash flows? 2. What is the % of seasonal influence present in your most seasonally-impacted (cash flow) month? 3. If asked to, would you know the steps to take to de-seasonalize your monthly cash flow data? 17

18 Ratio to Moving Average Technique Time Jan Feb Mar Apr May Jun Mo. 2-Mo. Seasonal Avg.* De-seasonalized Deposits M. Avg. M. Avg. Index S. Index Series Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun July Avg. Seasonal Index = Deposit # $160 divided by 2-Mo. Avg = SI ( )/2=1.157 July Index *MUST NORMALIZE ALL SI AVERAGES TO FORCE THEM TO ADD TO 12 DESEASONALIZED SERIES = ( ACTUAL DATA/AVG SEASONAL INDEX ) 18

19 Receipt and Disbursement Method The Pros: Accuracy Incorporates seasonality and other noise in data Daily forecasts are possible Bank cash is forecast output The Cons: Historical data requirement is large Significant knowledge of cash flows required Complex methodology Time-consuming process Initial development & ongoing production Review/fine tuning 19

20 Statistical Methods 1. Determine business variables that correlate with cash. 2. Identify sources of business variable data. 3. Select statistical methodology/tools. 4. Set confidence intervals. 5. Develop forecast. 6. Test model for significance. 20

21 Statistical Methods Time Series Averaging, weighted averaging Exponential smoothing Decomposition Regression Linear, Multiple, Bayesian Other Techniques Box Jenkins ARIMA (autoregressive moving average) Census X-12 Probabilistic models Qualitative models 21

22 Statistical Methods The Pros: Accuracy Incorporates seasonality and other noise in data Error parameters/significance levels can be set Any time period can be forecast Bank or book cash is forecast output The Cons: Complex methodology Statistics knowledge required Time-consuming process Initial development & ongoing production Review/fine tuning Difficult to understand for non-technical users 22

23 Which Technique Should Be Used? What is the goal/purpose? What resources will be used? What is the information available? What tools are available? What do the cash flows look like? 23

24 What Can Affect Forecasting Reliability Data quality Availability of data Confidence decay over time Timeliness of reporting Cost of preparation Precision Interpretation of results 24

25 Steps for Continuous Improvement An iterative process Comparisons to actual - Historical data - Objective function/coefficients Variance analysis Fine-tuning through other means 25

26 Quiz #2 How Do You Tell If Your Forecast is Improving or Not? 1. Do you currently measure the monthly improvement or decay in your forecast accuracy? 2. Do you periodically adjust the factors, methodology or formulas driving the projections? 3. Do you have a process in place to research the causes of your forecast-to-actual variances? 26

27 Variance Analysis Variance analysis refines and leads to greater accuracy of the cash forecasting process: Variance Analysis Responsibility: All material variances should be reviewed and reconciled on a timely and regular basis. Applying Materiality Thresholds: Variances can be measured as a certain dollar amount or as a % of deviation from an acceptable cash flow parameter. Two statistical techniques to measure the magnitude of cash flow variances: Squared Error Absolute Deviation 27

28 Variance Analysis Process Actual Forecast Mean Absolute Deviation Mean Squared Error Observation Value Value Abs. Val =( ) =( )^ =( ) =( )^2 1, =( ) =( )^2 1, =( ) =( )^ =( ) =( )^ =( ) =( )^ =( ) =( )^ =( ) =( )^ =( ) =( )^ =( ) =( )^ =sum(1-10) =sum(1-10) 5,016.4 MAD MSE 5,016.4 The goal is to minimize the sum of the MAD or MSE 28

29 Data Decay Data Decay: An increasing degradation of managed information over time due to lack of proper attention. To minimize data decay, regularly monitor and track variances and their magnitudes on the forecast. Assumptions presently assigned to the data may require re-evaluation in order to adjust for external forces that have caused the precision of the forecasting methodology to decay. 29

30 Critical Success Factors 1. Clearly defined objectives and benefits Goal = Benefits of forecasting > than cost 2. Articulation of scope and expectations 3. Focus on relevant items/those which can be easily compared to actual 4. Efficient, systematic data flow 5. Relevant and consistent forecast horizon 6. Awareness that precision is only as good as least precise items 7. Understanding of the true nature of cash flow volatility 8. Endorsement by senior management 30

31 Cash Forecasting Best Practices Optimal Cash Forecasting Process Data Collection Methodology Variance Analysis & Analytics Execution Data Inputs Business Units (Scheduled events) Financial Units (Scheduled events) 4 Forecast Refinement Process Fine-tuning Reporting Investments 5 6 Systems (e.g., Oracle, FXpress) Bank Data (Historical data) Centralized Collection Tool 5 Forecasting Model Variance Analysis 6 Output Reports to User 31

32 Cash Forecasting Summary Significant benefits Critical success factors Best methodology Continuous improvement No longer optional 32

33 Assessing the Results A Client Example Cash forecasting has greatly improved accuracy: forecast-to-actual cash position volatility has decreased sharply. Data confirms the project was successful. 10 Cash Flow Volatility After Implementation 5 Variance from Actual ($Millions) 0 (5) 6/23 (10) (15) 7/3 7/13 7/23 8/2 8/12 8/22 9/1 9/11 9/21 10/1 Prior to Forecasting Model Implementation 10/11 10/21 (20) 33

34 Questions 34

35 Discussion Leader Contact Information Mike Gallanis, CPA, CTP Partner Treasury Strategies, Inc direct main 35

36 About Treasury Strategies, Inc. Who We Are Treasury Strategies, Inc. is the leading treasury consulting firm working with corporations and financial services providers. Our experience and thought leadership in treasury management, working capital management, liquidity and payments, combined with our comprehensive view of the market, rewards you with a unique perspective, unparalleled insights and actionable solutions. What We Do Corporations We help you maximize worldwide treasury performance and navigate regulatory and payment system changes through a focus on best practices, technology, liquidity and controls. Treasury Technology We provide guidance through every step of the technology process which includes creating a roadmap, selection, implementation and optimization. Our expert approach will uncover opportunities to optimize the value of your treasury through fully integrated technology solutions. Financial Services Our experience, analytic approach and benchmarks provide unique consulting solutions to help you strengthen and grow your business. Locations Chicago London New York Accreditations Connect with Us 36