Cash Flow Forecasting Best Practices

Earlier this year I participated in a discussion on the Proformative.com site, titled: Cash Flow Forecasting Best Practices. A Proformative member asked a question which is very common in many finance organizations: What are the best practices when it comes to developing a cash flow forecast model? The person indicated that it was for a large publicly held company with global operations and that they have a comprehensive P&L forecast but struggle with a large and cumbersome Excel model which must be tied to the budget (P&L). This person was looking to start from scratch and build a more robust and manageable model. It was clear that they needed help. Does that sound familiar?

• Is your company struggling in forecasting its cash flow or is unable to forecast its Balance Sheet and the derived Statement of Cash Flows?
• Are you using home grown spreadsheets you inherited from a person who is no longer with the company?
• Have you noticed broken link messages and suspect that other errors may exist in these worksheets?
• Are you unable to maintain these spreadsheets, or add records without introducing new errors?
• Are these new additions properly linked into the model?
• Most importantly, is the output from these worksheets meaningful and reliable?

If you answered yes to any of the first four questions and no to one or more of the last two, you probably realize that you must make a change in this process. You also realize that you are not alone, which explains why many people responded to this question on Proformative.com and why the topic of cash flow forecasting is popular on that site.

The Limitations of Spreadsheets

What surprised me was that a good number of the answers were focused on developing a more robust spreadsheet approach to solving this problem, convinced that the spreadsheet is the answer to this challenge; some claiming that they have a model that works and is able to provide a forecast of the cash going in and leaving the organization.

What about the sources of this cash, or the inflows and outflows of cash into and out of each of the three main categories and in each forecasted accounting period? And what about the one or two people who suggested that a cash flow projection can be easily obtained if you have a reliable forecasted Balance Sheet? But how do you reliably forecast a Balance Sheet, complete and accurate, and always synchronized to your P&L forecast? Do you use another homegrown Excel model to do that?

Understanding Excel's Role

As I have written before on this blog and in other forums, Excel is a fine application with a tremendous amount of power and features. One, however, must understand its limitations (and their own limitations in using this application) when using Excel in certain financial processes such as financial reporting, planning, budgeting, and forecasting, processes that should always include a Balance Sheet and a Statement of Cash Flows. The blog post titled “Should Excel be Expelled” touches on this idea.

The Risks of Complex Excel Models

It seems to me that many finance professionals, greatly skilled in using and programming Excel, don’t realize that much of Excel’s apparent power and seemingly endless features may lead to a false sense of believing that anything can be done with the software. This results very often in gigantic models being developed, incorporating many workbooks containing many worksheets each. The risk of having material errors in these models increases exponentially as the complexity of the model increases. Add to that the often lack of documentation and rarely used change management controls, even in large organizations, and you begin to see the magnitude of these unmitigated risks.

Even in a perfect world with perfect Excel programming, a robust internal control environment, and other positive factors, a cash flow forecast, or more accurately, a forecasted Statement of Cash Flows, cannot realistically be modeled in Excel because it requires a complete and accurate forecasted Balance Sheet, perfectly synchronized to the P&L budget model.

Implementing a Purpose-Designed Solution

To me, it makes a lot more sense to implement a purpose-designed solution to accomplish the tasks of planning, budgeting, forecasting, and analytics. Many of the blog posts on this site cover this critical set of business processes. Before embarking on new, complex projects, we need to realize Excel’s strengths and limitations, and our own challenge of controlling our desire to solve any problem with this tool.

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