The euro just reached a 12-year low against the dollar, continuing its plunge since last summer, and other major currencies have weakened as well, creating a major impediment to accurate cash forecasting. According to treasury and risk software provider Reval, there are eight critical steps companies must take to accurately measure cash.
There are many reasons for companies to forecast cash, ranging from seeking the best return on investments, to minimizing external borrowing costs, to better controlling their business units’ cash flows, and the strengthening dollar highlights the need to manage currency exposures as effectively as possible. So the first step is for a company to determine precisely why it is forecasting cash, and then define its goals.
“The falling euro is another reason to forecast cash, especially for companies that weren’t forecasting before or may be expanding their businesses internationally,” said Eric Kaplan, solutions consultant at Reval.
Forecasts are all about data, so secondly companies must determine the most appropriate data and where to find them. Who owns the data, are they generated internally or by a third-party, and in which systems does the data reside? Then what level of detail is needed? Is data missing, and can missing data be simulated using models?Identifying the time range for cash forecasts is especially relevant in the context of extreme currency fluctuations.
For companies concerned about the impact of volatile markets such currencies or commodities are more likely to build shorter-term cash forecasts, Mr. Kaplan said. He noted that a company may have $60 million in outflows during an annual period when the dollar is set against the euro at one rate, but if 80 percent of those flows happen when the euro is at a low point, its forecasts won’t be accurate.
“A lot of companies will do five-day, two-week and four-week cash forecasts against a currency, and they’ll be able to understand better whether they’ll have a need to buy or sell that currency,” Mr. Kaplan said. “Where we end this year with the dollar is most likely going to be very different than where we are now, and shorter term forecasts have become much more prevalent.”
Next is choosing a forecasting tool. Before making any decisions, however, the company should determine the extent which its current technology supports its needs. Then it should consider issues such as whether the technology can consolidate data into a global cash forecast, how it can connect to data sources, how the company can minimize manual data gathering, and how its subsidiaries globally can feed information into the forecasts.
Mr. Kaplan said that clients who have adopted Reval’s cash forecasting tools tended to use Excel spreadsheets previously, requiring them to source the currency rate from a provider and ensure that all inputs to the cash forecast are made using the same rate. He added that having an automated tool to perform those functions is especially important in the context of foreign exchange (FX).
The fifth step is creating cash forecasts to meet the company’s specific needs. This includes both the layout of the forecast—by cash flow type, entity, bank account, currency, etc.—and the frequency of the forecast, whether daily, weekly, monthly, or another time period most relevant to a business’ operations. Ideally, Mr. Kaplan said, a company would want to forecast in the currency of the cash flow.
“For example, a company may want to forecast all of its operating lines in the functional currency of its cash flows, say euros, or Hong Kong dollars, to help it understand how a specific currency fluctuation can change its consolidated forecasts,” Mr. Kaplan said.
Next is analyzing variances and performance, so comparing actual results to earlier forecasts to understand where forecasts are accurate and where they need to improve. When variances arise, the company must determine why and how forecasts can be made more accurate and timely.
This step parlays easily into the seventh step, which is running scenarios and stress tests. Mr. Kaplan said for forecasts to be most useful, they have to be able to adapt to market events or changes in currency rates, perhaps by stress testing a forecast by applying a market scenario to the existing forecast and viewing the impact.
“A company can build its forecast off current rates and ask ‘what happens if’—using whatever currency FX rate it chooses—‘there’s an FX depreciation or appreciation of 10 percent or 15 percent?’” Mr. Kaplan said, “So as market events unravel in an actual environment, the company can see what impact that has against its cash forecasts.”
Lastly, a company must learn from its mistakes and fine tune its forecasting efforts. Is it more accurate to use prior-year actuals as a baseline for future performance, stress-testing certain line items, or should forecasts be built on a different foundation?
Find out, “which of the information sources at the beginning of the year built the most accurate forecasts for actuals, and then fine tune from there,” Mr. Kaplan said.