Chapter 12 Cash Forecasting

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Chapter 12Cash Forecasting
Order Order Sale
Cash Placed Received
Received

Accounts Collection lt
Inventory gt lt Receivable gt lt Float
gt

Time gt Accounts Disbursement
lt Payable gt lt
Float gt Invoice
Payment Cash
Received Sent
Paid
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Objectives of Cash Forecasting

• Liquidity Management
• Financial Control
• Strategic Objectives
• Capital Budgeting
• Cost Management
• Currency Exposure

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Steps in the Cash Forecasting Process

• Step 1
• Forecast Horizon and Intervals
• Step 2
• Variable Identification
• Step 3
• Modeling the Cash Flow Sequence
• Step 4
• Model Estimation
• Step 5
• Model Audit

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Short-Term Forecasting Horizon

• Daily or weekly forecast for a period of up to a
  month.
• Aids in cash concentration transfers, funding
  disbursement accounts, and making short-term
  borrowing and investment decisions.
• Helps in setting and managing balances used for
  bank compensation.

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Medium-Term Forecasting Horizon

• Also referred to as cash budgets.
• Forecast for 1 to 12 months.
• Used to determine the need for short-term credit
  or availability of funds for short-term
  investments.
• Can be used as a benchmark of performance by
  comparing actual cash flows to forecast cash
  flows.

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Long-Term Forecasting Horizon

• Forecast covers any period beyond one year.
• Are strategic forecasts used in long-term
  financial planning.
• Used by financial institutions and rating
  agencies for credit analysis and evaluation.

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Forecasting Philosophy

• Number and type of forecasts
• Expenditure on forecasts
• External versus internal forecasts
• Quantitative versus judgmental forecasting

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Degree of Certainty

• Certain Flows
• Predictable Flows
• Less Predictable Flows

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Data Identification

• Sources
• Identification
• Account Structure
• Reporting Requirements
• Historical Data

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Forecast Method Selection

• Establishing Data Relationships
• Selecting a Method
• Testing Relationships
• Managing the Costs of Forecast Systems and Data

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Forecasting Methods

• Methods for Short-Term Forecasting
• Receipts and disbursement forecast
• Distribution forecast
• Modified accrual
• Methods for Medium- and Long-Term Forecasting
• Pro forma statement
• Adjusted net income

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Statistical Tools

• Causal methods
• Regression
• Time-series methods
• Moving average
• Exponential smoothing
• Time-series regression
• Model estimation
• Model audit

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Forecasting MethodsReceipt and Disbursement

• Receipt Schedule
• Disbursement Schedule
• Both schedules are prepared on a cash basis.
• Completed forecast indicates the projected
  deficiency or surplus of funds in relations to a
  companys minimum cash requirement.

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Forecasting Methods Distribution Forecast

• The total estimated cash flow is spread over the
  days in the forecast horizon using proportions
  that are using actual historical patterns.
• Easy and inexpensive to prepare.
• Allows the incorporation of seasonality and
  trends.
• Large data requirements for proportion estimation.

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Forecasting Methods Pro Forma Statements

• Based on the percentage-of-sales method.
• Requires a sales forecast.
• Determine balance sheet and income statement
  items that can be assumed to be a constant
  percentage of sales.
• Assume other balance sheet and income statement
  items are constant or can be updated based on
  available information.

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Pro Forma Statements (continued)

• Generate projected balance sheet and income
  statements.
• If projected assets are greater than projected
  liabilities and equity, there is a projected cash
  shortage.
• If projected assets are less than projected
  liabilities and equity, there is a projected cash
  surplus.

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Statistical Forecasting Time Series Forecasting

• Simple Moving Average
• Gives equal weight to past observations
• Will always lag any trend in actual cash flow.
• Approach can be useful in identifying cycles and
  patterns of past data but does not take these
  patterns into account in the forecast

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Time Series (continued)

• Exponential Smoothing
• Allows the cash flow forecast to be adjusted by
  the prior period forecast error.
• Allows for more weight to be placed on the most
  recent actual cash flows by choosing a smoothing
  constant close to 1.
• Forecaster must select the smoothing constant.
• Simplest version of the technique will lag trends
  in the data.

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Forecast Validation

• In-Sample Validation
• Out-of-Sample Validation
• Ongoing Validation

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Summary

• The chapter began with a discussion of the
  philosophy and environment within which cash
  forecasts are made
• The value of forecasts is to borrow less or
  extend investment maturities
• The five steps of forecasting were developed and
  two major time intervals were presented
• Forecast models were divided in two categories
  causal and time-series
• We discussed daily forecasting in the context of
  the distribution method