Ask any finance professional what regular task gives them the most pain, and chances are they’ll reply: ‘Building an effective direct method cash flow forecast'. While the basic concept seems simple—gather the data, analyze it, and predict cash positions for the coming weeks or months—the practical execution can be daunting. Managing data from multiple sources and digging deep into it for effective analysis can be both complex and time-consuming. Yet, with an ever-changing business landscape, cash flow forecasting is essential, as effective cash management is the linchpin of business success.

But what tools and strategies can finance professionals employ to build a precise and efficient cash flow forecast? Here, we reflect on the basic steps for cash flow forecasting, how it has evolved in recent years, and what the future holds in 2024.

Preparing a Cash Flow Forecast in Three 'Easy' Steps

Let’s go back to basics.

Define what you want. And what you’re trying to achieve. Specifically, this means deciding the period for which you want to forecast—next day’s balances, next week’s, or next month’s—and the level of accuracy and detail you need—likely determined by factors including whether the company is cash-rich or cash-generative. These decisions will influence how often you update your forecast, and how dynamic your forecast needs to be.

Structure the forecast. No forecast will work without a consistent approach to the forecast process. Establishing a standardized procedure will allow for variances to be identified and adjustments to be made. Put simply, the forecast process needs three things:

1. Relevant data. Identifying the data required to build an accurate forecast requires a deep understanding of your business, and, importantly, how cash flows through it.

2. A method of collating data. You’ve identified the data you need. What is your next step? Recognizing the best sources of the data required and establishing a process to collate that data as efficiently as possible. Data sources are likely to be both internal (e.g., from the ERP system) and external (e.g., from banks).

3. A tool to compute the data. Finally, you need to compute the data you have gathered. Many organizations use spreadsheets to calculate their forecasts. Others rely on modules within their treasury management or ERP systems, and, increasingly, some leading finance teams employ dedicated cash forecasting solutions.

Refine the process. Forecasts should be compared with actual outcomes. Any variances can be examined so that the collation and/or computation processes can be improved.

So far, so good. But what's changed?

The Evolving Landscape: Post-2020 Developments

The global events since 2020 have made us refocus our priorities and innovate to meet our goals. Key trends include:

• Emphasis on cash flow forecasting: Given the uneven economic impact of the pandemic, organizations have prioritized liquidity, placing cash flow forecasting at the forefront of their strategies.

• Strategic role of finance: With advances in technology, finance teams can provide greater insights into the financial state of a business, fueling strategic, real-time decisions.

• Digital tool adoption: As the pandemic has shown, many core tasks, such as creating cash forecasts and initiating payments, can be performed remotely with the right data and tools. The increased adoption of data analytics, machine learning, and AI has been instrumental in this shift.

The Future of Forecasting: The 2024 Perspective

The developments in recent years have set the stage for an exciting future for direct method cash flow forecasting.

• Control over cash is paramount. In the face of unpredictable global events, many CFOs are requesting regular, even intraday, cash forecasts. As instant payments gain traction worldwide, real-time forecasting is becoming a vital part of the finance department’s responsibility.

• Harnessing technology for efficient forecasting. Technology has turned the tide in favor of finance, enabling automation in data capture and the use of AI and machine learning tools to generate real-time, usable forecasts.

• Forecasts for an in-depth business view. Dynamic cash flow forecasts provide a real-time overview of business performance across departments, enabling immediate action to mitigate or manage emerging issues.

So, the principles of forecasting haven’t changed. But it’s more important than ever before. Armed with sophisticated tools and a mandate to share real-time insights across the business, finance professionals are better equipped to navigate the challenges of cash flow forecasting.

Ready to take your cash flow forecasting to the next level? Talk to a cash flow expert today.