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As we have navigated our way through the last 14 months, the old saying ‘Cash is King’ has proved to be so true. Organisations have been forced to concentrate on cash flow, understanding what drives it and adopting initiatives to maximise cash reserves to survive. Accurately predicting future cash requirements has been critical to survival.

This article looks at cash flow planning and how technology can be used to enable and improve this.

Cash planning capabilities

We have performed three research surveys in the last 12 months to assess the performance of the CFO and the finance team. From this, along with anecdotal evidence gathered during interviews and community forums, we can conclude that cash flow planning has been a challenge. However, through necessity, the situation has improved as time has gone on.

At the start of the pandemic, the issue was that most planning models were just not sophisticated enough. Fully connected plans, where the P&L automatically drives the balance sheet and cash flow (the ‘three statement model’), were a rarity. This resulted in the finance team quickly developing new models, often in Excel. For those organisations who had invested in enterprise planning software, this was particularly disappointing. Unfortunately, their solution did not meet their needs when they needed it most.

Direct or indirect cash flow?

Before we go any further, let us identify the two recognised cash flow methodologies. The direct method looks at the actual cash that is moving in and out of the business. The indirect method focuses on net income and the changes in assets and liabilities. I am assuming that the fact you are reading this article means that I do not need to explain how and when these two can differ.

As we know, the direct method provides the most accurate analysis of the movement in cash. If we take the reporting of actuals, the purest way of achieving this is to analyse the cash accounts at a transactional level in your ERP (or accounting) solution. However, to analyse cash flow to the granularity level needed, it is often the other side of the accounting entry that provides the required information. With a bit of report development, this problem is not insurmountable, but it does lie outside of the core functionality delivered by most ERP solutions.

On the other hand, the indirect method can be more easily automated as it uses balance level information. As a result, the direct methodology is less common and, where it is used, the analysis task is more difficult and likely to be highly manual.

When we look to combine the past and future, there is a mixed bag of methodologies used. I have spoken to an organisation recently who has a manually intensive direct cash flow that analyses actuals. Other actual information around debtors, creditors and non-operational items is used to drive the short-term cash plan (around 6 weeks). The period beyond that (to 6 months) is driven by a longer-term P&L model with adjustment for known non-operational items. The process works but is highly inaccurate and the finance team spend most of their time explaining actual variances to poorly created forecasts and budgets.

“To spend such a long time performing a task that adds little or no business value seems such a pointless exercise. Especially now, when there is so much pressure on the finance team. We need to use our scarce resources to add as much value as possible in the most efficient way”, says Andreas Ley, Managing Director at LucaNet UK.

We also have experience of organisations who use the indirect cash flow method for planning. The P&L is again the driver model, this feeding the Balance Sheet with built-in logic. Other adjustments are then made manually and then a cash flow is derived using the traditional cash flow method.

How to achieve accurate cash flow planning

The key to accurate cash flow planning is developing a connected model based on a ‘direct methodology’. The starting point, as it is now in most organisations, is the P&L. The more ‘driver based’ the P&L is the better, but this is an article for another day!

It is essential that there is logic built into the planning model. Firstly, all P&L accounts should have good old double entry logic attached. Secondly, payment terms need to be defined. An example of this would be:

Sales – DR Trade debtors, CR VAT, cash flow impact: 50% 1 month, 40% 2 months, 10% 3 months

“This accounting logic can be built into most planning solutions”, says Andreas. “However, only a few solutions, such as LucaNet, have pre-built, integrated business logic that automatically links the P&L, balance sheet and cash flow statement. This allows finance professionals apply the rules that fit their business.”

And the more granular the plan, the more detailed you can be with the cash flow. For example, if planning sales by customer, specific payment terms can be applied at this level.

With this information applied to all accounts, the balance sheet and cash flow statement will calculate automatically thus keeping the three statements in balance.

For completeness, you will also need to include non-operational cash transactions in the model. The most common of these is capital expenditure. To address this, you will require a model that includes a fixed asset movement analysis as minimum: additions, disposals and depreciation.

The most difficult element to overcome is that of the time interval adopted. Most planning models are designed to work on a monthly or periodic basis. As we found during the pandemic, this may not be granular enough and weekly, or even daily, cash flow may be required. Whether this is possible is dependent upon the agility of the model. The most efficient answer may be to have a separate short-term cash flow model driven by actuals that is as automated as possible.

The impact of technology

The major impact of technology is that the right solution will already have much of the modelling logic built-in as standard functionality. Without it, the design and development of a ‘three statement model’ can be complex and daunting.

“This provides a huge benefit when evaluating time-to-value and risk”, says Andreas. “And let’s not forget that these solutions offer a broad range of capabilities for the finance team like financial consolidation and reporting. These improve efficiency, whilst also improving accuracy and transparency.”

And how can advanced technology, such as AI and predictive analytics be used? Several banks already use this technology to predict future cash flow based on historical trends. Of course, this will only be of use in certain circumstances. Where we are beginning to see wider adoption is the use of predictive analytics in modelling. However, this often relies upon past data and information to predict the future. Unfortunately, the pandemic has made this extremely difficult, but we are in little doubt we will see more of this approach in the future.

We need to improve cash flow planning

It is clear that cash flow planning will continue to be important as we move forward. The finance team must be able to deliver this process efficiently and with increasing accuracy, especially in times of uncertainty.

This will only be possible if you have a planning model that is connected and calculates cash flow automatically using the ‘direct method’. Having the right technology in place will be key to your success in delivering this.

This article is sponsored by LucaNet.

If you want to learn more about the area of cash flow planning LucaNet recently published the whitepaper “The 5 success factors for your financial planning” covers how FPM software faces previously mentioned challenges effectively.

The 5 Success Factors for Financial Planning | LucaNet (UK)