The COVID-19 crisis has put cash and liquidity front and center for many businesses.
Cash flow forecasts are an essential business tool to help you monitor your cash. They show how much money is expected to come in and go out of your business accounts, as well as when these flows are expected to happen.
In this article, we’ll be recommending a rolling 13-week cash flow forecast cycle — here’s why.
Weekly vs. monthly cash forecasts
Under normal trading conditions, monthly cash forecasting is ideal. This is because cash drivers, such as debtor days, creditor days and inventory days, typically operate in monthly cycles and are often performance measures for a business. But, more importantly, balance sheet reconciliation is usually most complete at the end of each month and a forecast cash balance is one element of a balanced balance sheet. This means you can test the reliability of projected month-end cash balances against these cash drivers within the overall balance sheet.
Also, once your cash flow model is built, it’s usually relatively simple to refine using the drivers, and to update with opening balances — and it remains robust. Most businesses budget monthly for a financial year and many do rolling forecasts to keep a year forward view. Therefore, integrating a cash flow forecast into a rolling 12-month calendar year business forecast automatically ensures that cash forecasts are the result of business performance forecasts. And business performance forecasts are usually done with budget holders who can be held to account for their performance against forecast.
Trading during the COVID-19 crisis is a lot more uncertain. If your business is close to breaching covenants or limits or is likely to do so imminently, and conditions are such that weekly cash volatility might be “smoothed” in a monthly forecast, then weekly forecasting is the way to go.
But because balance sheet reconciliation is usually, at best, done monthly, weekly cash flow forecasting cannot be integrated reliably within a balanced balance sheet — and therefore tested. Even if (and this would be very unusual) reliable balance sheet reconciliation is done weekly, you will then also need to contend with cash drivers weekly for this approach to work. So, the only realistic alternative is to manually factor in all cash flow events to get an accurate weekly forecast. This can be risky as it could be easy to accidentally omit events, particularly in a business that does not have predictable activity levels.
And, in contrast with monthly forecasting where budget owners contribute to the cash flow forecast through their business forecasts, weekly forecasts are often more likely to rely on informal dialogue with budget owners about weekly activity levels.
Finally, both because they are done weekly and because they are more manual, weekly cash forecasts take a lot more effort and time.
The advantage of weekly cash flow forecasts is that there are very clear event-based parameters against which to actively manage cash flow.
Can you do both weekly and monthly? One way of doing both is to run a 5–4–4 week financial quarter (13–week quarter) and integrate your weekly cash flow forecast into your monthly cash flow forecast. However, although you will get the benefit of event-based cash management this way coupled with the rigour of the balanced balance sheet test and cash driver monitoring, it is extremely difficult to fit an event-based forecast with a driver-based forecast, mainly because the rigour of a monthly balanced and reconciled balance sheet will, or should, override any conflicting cash event assumptions.
Updating forecasts with actuals
There are usually two main scenarios for most business where updating your cash flow model can be tricky:
- Monthly forecasts with a significant variance between forecasted and actual cash balances
In this scenario, you need to investigate if there are any variances in the cash drivers that you have used. If there is still a significant variance after adjusting these drivers to their actual values, other factors are at play. This is an opportunity to refine your cash flow model for future forecasts. This situation might also be caused by one-time changes in one or more of your cash drivers, which you can ignore in your future forecasts.
- Weekly cash-event based forecasts with a significant variance between forecasted and actual cash balances
In this scenario, you’ll need to review your cash event assumptions. Arguably in this situation, a significant variance would indicate a loss of control over your management of the cash events, which makes the use of weekly forecasts pointless. If you forecast by cash events, then you should manage by cash events.
Why 13-week forecasts in particular?
- If you pay VAT quarterly, this is usually a significant chunk that might be missed off a forecast if for fewer than 13 weeks.
- The cyclicality of your business’s activities must be reflected in cash flow models. If this is quarterly, then your cash flow must reflect this. Some sectors typically are longer cycles (fashion and aerospace, for example); if so, then a 13-week forecast may be inadequate.
- The COVID-19 crisis has introduced extreme volatility and cash stress for many businesses, and these volatility events are invariably cash events too. The presence of these volatile cash events makes monthly, business-as-usual cash flow modelling redundant; therefore, event-based weekly cash forecasts and management against these events is more relevant.
Rolling forecasts to prepare for the unexpected
As much as we’d like to prepare for the future, what the COVID-19 crisis taught all of us is that we can’t accurately predict events that fall beyond the forecast horizon.
By doing rolling weekly cash forecasts for 13 weeks, you will always have at least 12 weeks to deal with events that come into your forecast horizon. If you wait until the end of a 13-week horizon before starting your next 13-week forecast, and a new cash event becomes apparent on week 14 (week 1 of your new forecast), you will have very little time to respond.
Doing a 13-week rolling cash forecast will also help you to gain the trust of parties that can help you to finance your business, such as your bankers, potential investors or your shareholders. You will impress them if you can have conversations about your cash needs well before the event arrives.
Conversely, asking for help only when you have already breached a limit or covenant might make these parties think that you have lost control of your business, and they might be hesitant to trust you; or might charge you higher amounts to access additional funds.