2. Cashflow forecasting Why is cashflow forecasting important? To ensure a company has adequate finance (in the right time, place, amount, and currency (remember the definition of treasury management?). To ensure interest cost is minimised and investment income maximised, or that hedges are executed at the optimum time. To assist in budgeting for capital expenditure To monitor and set strategic objectives. For financial control (mgmt of debtors, stock, creditors according to policy) and to improve administration efficiency (e.g., fewer deals) To obtain the optimum finance and investment terms and facilities by being proactive not reactive. City University International Finance May-Jul 2011 P Singh ACT Handbook, 2003; PriceWaterhouse, 1989 copyright P Singh 2010

3. Structure of multi-national cashflow forecasts: Forecasts should be prepared twice: Once in the currency of the cashflow. Then with the cashflow converted into the home currency (to allow consolidation of forecasts). Types of cashflow forecast Strategic (> 1 year) Tactical (0-1 year) Operational –Quarterly –Daily PriceWaterhouse, 1989 copyright P Singh 2010

4. The more distant the time period, the less accurate the forecast is likely to be, and the less detailed it needs to be: ◦ the strategic forecast might include a planned acquisition of £10m +/- £1m, happening in either year 2 or 3. ◦ the daily forecast will show actual (cleared balances), plus a forecast of amounts clearing that day, and at individual debtor or creditor level (e.g., a cheque for £50,000 from ABC Limited). Sensitivity analysis Forecasts can be affected by: Interest and currency exchange rates, inflation, competitors, regulation, and seasonal effects. These factors should be modelled to determine the sensitivity of cashflow forecasts to each of them. ACT Handbook, 2003 copyright P Singh 2010

5. Reliability of cashflow forecasts Forecasts should be monitored against actual cashflows periodically to assess their reliability, and to identify the source of the unreliability and take remedial action (variance analysis). Cashflow forecasts might be prepared on a rolling basis, so that they always cover a fixed time period. ◦ The strategic forecast might always cover 5 years, starting in 1 year, and be divided into 3 month periods. ◦ The quarterly forecast might always cover 3 months from today, and be divided into weekly periods. ◦ The daily forecast might always cover the next 7 days from today and be divided into daily periods. ACT Handbook, 2003; PriceWaterhouse, 1989 copyright P Singh 2010

6. Receipts and payments method This is a common and simple method of preparing forecasts: 1 Receipts and payments are each identified and placed in time periods (also called ‘buckets’) according to when they occur. 2 The opening cash position is included and the closing cash position calculated. 3 This net cash position is carried forward to the next period. Steps 1, 2, and 3 are repeated. A cumulative balance is also calculated. The following spreadsheets illustrate this method of preparation: Methods for preparing cashflow forecasts copyright P Singh 2010

7. -ve sign = money received £ copyright P Singh 2010

8. Questions: Assume: the amount that can be borrowed on each day from the bank must be in multiples of £50,000; the company prefers an overdraft to a surplus cash balance; it wishes to keep any overdraft as low as possible. Then: i)how much should be borrowed from the bank each day? (row 11). ii)What is the cumulative net balance expected to be at the close of day 5 (inclusive of bank loans)? iii)What amount of funding should the company have in place so that it has neither an overdraft nor a surplus at the close of day 5? iv)What is the annual funding amount so that the company has neither an overdraft nor a surplus at the close of the last day of the year? copyright P Singh 2010

9. Questions: see spreadsheet on next slide Assuming the amount that can be borrowed on each day from the bank must be in multiples of £50,000, and that the company prefers an overdraft to a surplus cash balance, but it wishes to keep any overdraft as low as possible, i)how much should be borrowed from the bank each day? (row 11). Answ: 50K; 750K; 550K; 750K; 400K. Key is to adjust cum OD with the cum debt, to det. each day’s debt requment. ii)What is the cumulative net balance expected to be at the close of day 5 (inclusive of bank loans)? £0 iii)What amount of funding should the company have in place so that it has neither an overdraft nor a surplus at the close of day 5? £2.5m iv)What is the annual funding amount so that the company has neither an overdraft nor a surplus at the close of the last day of the year? £130m [£2.5M * 52weeks = £130m] copyright P Singh 2010

10. Day12345 Opening £80,00032,500 45,00025,000TOTAL IN-255,000-300,000-225,000-240,000-150,000 plus loan-50,000-750,000-550,000-750,000-400,000-2,500,000 OUT257,5001,050,000787,500970,000525,000 closing32,500 45,00025,0000 -ve = receiptannual-130,000,000