Forecasting Short Term Cash Flows

  • Prediction and forecast form the major part of any business plan, the decision regarding the future are taken based on the past trends in the industry. This holds for the Working Capital management as well and the Treasury Department forecasts regarding the future based on past events.
  • However, the accuracy of the forecast depends on various factors that are outside the purview of anyone e.g. a Nation-wide lockdown. To manage such unforeseen situations a buffer or cushion is maintained by the company.

Illustration 1: Consider the following scenario:

  • The treasury department of XYZ Ltd. forecasted that in the next week, the total cash flow from sales will be 100 Crores which will not be sufficient to pay salary expenses of 195 Crores. XYZ Ltd. applied for a short-term loan in the market for Rs 110 Crores.
  • In the next week due to heavy rainfall, the footfalls in the market reduced drastically and the cash flow from sales reduced to 87 Crores. If XYZ Ltd. had not kept a buffer/cushion of 15 crores, it would have not been able to pay salary to its staff.

  • Many times, companies keep a buffer balance to manage such situations instead of borrowing the cash deficit from the market, this saves the cost of interest to be paid on the borrowed sum.
  • The forecast for short-term cash flows requires high levels of accuracy and reliability as the decision of short duration have a greater impact on day-to-operations as compared to the Long-Term forecast.
  • It should be noted that this buffer should not be large as a cost is being paid for the short-term advances. The limit of the buffer depends on the accuracy of the forecast, which in turn depends on the efficiency of The Treasury Department.

Methods and Process Involved

  • In the illustration above, the need for having a buffer is clarified. Companies prefer to have this buffer in the form of cash or the form of most liquid assets. This buffer meets two objectives of the company:
    1. Provide the cushion in case of variations between actuals and forecasts.
    2. Provide the opportunity to utilize the buffer in other opportunities in due course. (e.g. Purchase of raw supplies at a cheap price)
  • Another, important process involved in the identification of sources of cash inflows or cash outflows. The more the identified number of sources, the better is the forecast of the company. The treasury department considers all sources of cash inflows and outflows before forecasting.
  • For example, if the forecast is to be done for the last month of the financial year, payment of annual taxes is an important outflow to be considered, which may not be relevant for other periods.
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