Adding Value To Treasury Management And Small Business Customers

Forecasting Accuracy

Cash flow is the lifeblood of any corporate client. While understanding cash flow is the stock and trade of bankers, few bankers take the time to add this value to their small business, corporate or treasury management clients by leveraging this knowledge. Before you dismiss this as an unneeded item, consider banks like Well Fargo and Bank of America not only train their bankers on this very topic but offer a robust educational program around cash flow management (HERE for example). These large banks understand how critical cash flow management is for a business. Community banks need to keep pace.


Today, we uncover a simple cash flow management skill that can help set your business development officers and treasury management staff apart from other community banks. This skill is a simple lesson that bankers can impart that will not only highlight your financial advisory credentials but will help build deposit balances and reduce lending risk. Training your bankers to have an educational conversation around cash flow forecasting and its related accuracy, has proven to pay off healthy dividends in the form of thought leadership, cross-sell and higher product utilization.


Getting Cash Flow Accuracy Right


While most companies forecast cash flow, few track their accuracy. Knowing how accurate a company’s cash flow forecasting allows management to make better decisions regarding lines of credit usage, working capital decisions, investments and risk management.  The beauty of cash flow forecasting is that it can be quantified, and management can measure each period in the form of what is called an “actual-to-forecast variance.”


Step 1: Have A Forecast


Step 1 is to make sure your banking client has a set of projections. Cash flow forecasting methodology varies from industry to industry, but it is customary to forecasts at least three months of cash needs and often 12 months. While many businesses compare actual to projections, they don’t take the step to record and manage this accuracy. This is where a high-performing banker can add value.


Below is a simple net cash flow forecast.


Forecasting Cash Flow 


Step 2: Compare Estimates To Actual Results


To the simple forecast vs. actual summary that most CFOs or treasury managers maintain, we add a variance. The question is how much can the business rely on its estimates? Understanding the level of accuracy not only helps in treasury and business management but, more importantly, builds confidence in the finance process. To understand the level of accuracy, we get our business clients to add a variance column which compares Actuals less Estimates divided by Estimates. We then can derive something close to the table below


Cash Flow Forecasting Accuracy


Step 3: Track The Accuracy Over Time


All the above is fairly common. However, most businesses don’t track accuracy and this is an easy area where an astute banker can add value.


Of course, a business’s clarity is greater the first month after forecasting than Month 12. If we extend a typical forecast, we can see this below. While month 1 was 10% accurate, month 12 was more than 2x off. The black trend line shows the increasing lack of precision. This makes sense since the more time between actual and when the forecast was done, the more variables come into play such as rates, economic cycles, contract terms and so forth. 


Cash Flow Banking


Step 4: Update The Cash Flow Forecast On A Rolling Basis


Unlike budgeting, cash flow forecasting is a dynamic process and is constantly being updated. Thus, every month you take the previous month’s actual performance and variance and then revise the forecast.

With each update, we can then record the absolute (taking out the positive and negative variances) accuracy. We can see this in the 6-month example below the level of precision. Each month, it re-forecasts at least the next three months so accuracy can be improved.


The major process improvement here is that each forecast is tracked separately and its accuracy recorded. In this manner, the process itself can be improved.


By this business monitoring its forecasting performance, it was able to improve its one-month accuracy from 10% the first month to 3% for a 7% average. In addition to accuracy, confidence is improved. If it can keep up that level of precision, the business can be 97% confident in its ability to forecast its cash position. These means more efficient use of resources and a better return. In this case, the business learns that its average accuracy is 93% in its one-month projections and 91% confident in its two-month projections. Past that, the business now better understands to what extent accuracy drops. 


Cash Flow Forcasting


Putting It Into Action


By tracking accuracy, businesses can monitor trends and look for areas of improvement while gaining comfort in their forecasting abilities. Maybe there is a recurring “surprise charge” that can now be budgeted or more seasonality than previously known. If nothing else, understanding the extent of variance to forecast is helpful in gauging the amount of risk. As revenue and expense numbers come in, cash flow estimates can be updated and accuracy improved. 



Cash Flow Forecasting For Bankers


For larger businesses, there are a variety of software packages that bankers can suggest that does all the above automatically. While this might be overkill, it is another point of value for the banker to be able to lead this conversation.


By using this information, banks can now help commercial customers better budget for working capital lines and debt facilities. Like the chart above, highs and lows can be estimated so potential lines can be sized and excess liquidity can be invested. Banks too can monitor the accuracy of a company’s forecasting accuracy to be factored into underwriting.


Cash flow forecasting is mandatory to run a successful business and optimize items like investments, debt costs, and expense management. Bankers that help their business customers understand the accuracy of their forecast will be held in high regard. Monitoring accuracy just takes a little extra time and is yet another step that banks can take to compete on knowledge and service instead of price.