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Improving cash forecasting (Part 2)

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16th Jul 2007
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coinsRefining and re-aligning business processes can yield further cash management gains, after initial steps to map the cash flows underlying the balance sheet and improve forecast accuracy. Mark Doyle of Parson Consulting concludes a two-part series by showing how management improvement can assist cash measurement and raise predictability.

As observed in my previous article, cash is vital for maintaining the ability invest in research, product innovation, marketing, top executive and specialist recruitment, and improved information systems that can drive growth in an increasingly competitive environment. The flow of cash, and ability to generate it, are also a key consideration for private equity houses, and those trying to escape their attention.

Four key areas need to be addressed in order to achieve sufficient cash forecasting accuracy:

  • Understanding the required level of accuracy over different time horizons, plus any external constraints e.g. covenants

  • Understanding the cash cycle behind all the key elements of the balance sheet – what is volatile and what isn’t

  • Changing business processes to produce more predictable cash cycles

  • Aligning the performance management process – accuracy is about effective management as well as prediction

Part (1) of this article, last week, tackled the first two issues, highlighting ways in which existing structures and reporting systems can be made to work better. In this follow-up, attention is given to business process management (BPM) improvements that can boost performance further once there are time and resources to adapt the organisation.

Changing business processes for more predictable cash cycles
Done effectively, this activity not only improves cash forecasting accuracy but can also have a significant benefit to your actual cash flow. Process changes can be categorised as external (e.g. debt factoring, outsourcing, offshoring, etc) and internal (e.g. purchase to pay, order to cash processes). Taking an external example of debt factoring, although there is obviously a cost to this process (and it is not the way to go for every business), it will both speed up cash receipts, hence boosting cash flow, and make the timing more predictable, hence improving cash forecasting accuracy.

From an internal perspective, a practical example of the benefits from changing the order to cash process is based on a large UK organisation that had centralised its five regional finance offices into one shared services centre. As a result, much of the local expertise and the personal relationships with customers had been lost and the quality of the invoicing suffered to the extent that it became very difficult to reconcile open invoices with cash received. The resolution to this problem required a detailed root cause analysis of the end-to-end order to cash process, which resulted in a series of process changes, two of which are outlined below:

  • Implementation of process KPIs enabled the tracking of individual and team performance. These efforts led to a doubling of the resolution rate in clearing out the backlog. In addition elements of the process were automated which resulted in halving the time required to allocate cash
  • Cleaning up the underlying data enabling the company to raise correct invoices. An automated data upload mechanism was implemented allowing the company to maintain its fee structure much more efficiently and correctly

The cumulative result of these changes was that within two months the significant backlog of open cash positions was reduced by over 90%. The increased quality of the invoices also resulted in a more reliable collections process and hence much more accurate cash flow planning going forward.

These are just two examples of the many ways in which process change can positively impact business results as well as improve forecast accuracy.

Aligning the performance management process
Very often, the bonus policies in many companies focus exclusively on revenue and profit targets. Unsurprisingly, senior management focus is on knowing where they are in delivering against these targets. Hence they ensure that sufficient attention is paid to the accuracy of profit forecasting. Balance sheet and cash flow forecasting, if done at all, is often left to junior accounting staff and receives little or no review.

The cash forecast target need not be part of the formal incentive scheme. An alternative approach is to include a forecast accuracy KPI into the management dashboard or balanced scorecard. Accountability for the measure should be wider than just the CFO and any significant variances from forecast (both up and down) should be challenged in management reviews at all levels in the business.

In a recent example, a company which had a forecast accuracy KPI for all managers and then restricted the accountability to finance staff found that accuracy levels fell away leading them to reconsider their approach in the following financial year.

Another performance management element to be considered in getting reliable cash forecasts is an increased focus on current balance sheets. This requires understanding the key drivers and their impacts; allocating management responsibility for performance and implementing effective reporting at all levels to establish links into action plans. This should also improve the level of communication between different functions within the business so that, for example, the credit team will be aware of the impact of an upcoming sales promotion. Achieving good forecast accuracy requires active management as well as prediction.

Summary
By focusing on the four key areas outlined in this article, finance directors will not only be able to gain credibility internally and externally for the accuracy of the company cash forecasts, but also generate significant business benefits such as:

  • improved cash flow, leading to an increased return on net assets and a favourable impact on share price
  • optimised internal resource allocation – multiplier effect from increased investment in, for example, marketing spend
  • improved balance sheet transparency, providing early warnings of broader business issues
  • closer cross-functional working
  • better risk management: stronger cash flow and greater balance sheet focus is a control in itself but also provides increased flexibility to respond to changed circumstances or one-off events

About the author
Mark Doyle is an engagement director with specialist financial management consultancy Parson Consulting, with expertise in BPM developed in over 20 years in senior financial roles with companies including Guinness and Diageo. www.parsonconsulting.com

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