Wednesday, December 02, 2009
Forecasting cash flow is essential, but few can do it

 

How top performers do it.

 

Compared to forecasting cash, revenue is easy.  A recent Hackett Group study finds that top cash flow forecasting organizations have these five characteristics in common:

 

1. Turn information into business insight.

Develop best- and worst-scenarios.  Weight these alternatives and use them in sensitivity analysis.

Be honest about the levels of risk posed by different projects and divisions, and use risk-adjusted discount rates (aka "hurdles").

 

2. Develop closer relationships with customers and vendors. Fewer disputes result and less working capital may be required.

 

3. Put information technology to use.  

This is easier said that done.  But 70% of organizations never achieve the desired outcomes with the information technology (IT) / enterprise risk platform (ERP) / performance measurement system (PMS).

Researchers have anecdotal evidence that these failures are caused by poor implementation.  The current body of literature provides a number of practical solutions to the known pitfalls.

Within the past ten years, research has yielded surprising findings. Companies that embed the IT / ERP / PM systems implementation in an overall cultural change effort have much better results; better implementation leads to better earnings.

 

4. Set targets for forecasting accuracy and link accuracy to compensation. This forces division managers to figure out the cause-and-effect relationships in their organizations for generating cash, e.g., how a change in one activity affects downstream cash flow.
 

 5. Institute performance measurement systems that link behaviors with cash generation.  Note the role of the 21st century finance department – responsible for budgets and cash forecasts, purchases and payables, sales and collections.  Yet every other corporate department generates revenues and / or expenses but has little or no knowledge of how their actions affect cash flow.

As part of the annual strategy review process (aka "strategy map" update) ensure that every other corporate function, ultimately every employee, understands his or her role in the generating cash and reducing working capital.    

 

These five characteristics of top cash flow forecasters show why few firms are able to accomplish it  -- very few organizations are capable of undertaking all of these actions.  Nonetheless, it's essential to make a concerted effort because, as noted in the Hackett Group's press release, "cash flow forecasting is good hygiene all through the cycle, but at the bottom of the cycle" it's a matter of survival.*

 

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*Kathleen M. Beans.  The RMA Journal.  Philadelphia:  Nov 2009.  Page 54.