Understanding Cash Flow Forecasting Methods: Short Term Vs. Long Term

What is Short Term Forecasting?

Short term cash forecasting refers to planning and budgeting cash for a short period. The short period is less than a year, with a span of one to six months. This includes:

• Minimizing short-term debt, idle cash, and cash buffers. 
• Optimizing short-term lending/borrowing decisions.
• Planning adjustments for seasonal sales fluctuations.

What are the benefits of short term forecasting?

What insights could short term forecasting provide for your organization? 
The benefits are:

• Reducing working capital costs:  Staying ahead of the curve by effectively managing the working capital by minimizing credit borrowed for funding operating expenses.
• Measuring financial health:  Providing a fair analysis of the financial health of a company by determining the cash deficits or surpluses by tracking the cash flows.
• Performing scenario analysis to take proactive measures: Stress testing what-if scenarios to proactively avoid scenarios such as bankruptcy and prepare for a recession.

What are the disadvantages of short term forecasting 

The pitfalls of short term forecasting include:

• High upfront costs: Initial costs of leveraging technology are high, so cash-deficit companies often refrain from doing a regular forecast.
• The complexity of Accounts Receivable and Accounts Payable:  Accounts receivable and accounts payable are hard to predict long-term because of the sheer volume of invoices, trade cycles, disputes, discounts, etc.
• Requires accuracy at a granular level: Minor errors in data increase the variance in the forecast. If there are errors in the underlying data, it creates variance in the forecast at a higher level.
• Delayed decisions due to delayed collaboration: Time required for gathering data from different sources like banks, TMS, etc., and different teams like AR, AP, etc., result in delayed decision-making.

Which technique is used for short term forecasting?

Depending on the budget and complexity of data of a company, and the motive of their cash forecasts, various methods could be used in areas of businesses for their preferred purposes. The typical short term forecasting methods are as follows:

However, these three methods cause multiple challenges for small to medium-sized businesses.

What is Long Term Forecasting?

What are the benefits of long term forecasting?

Long-term forecasting is a method of predicting future events, trends, or conditions over a period of six months to five years. It involves analyzing historical data, market trends, and other factors to make informed decisions about investments, expansion plans, and resource allocation. Long term forecasting helps in avoiding last-minute hurdles. The advantages are:

• Multiplying gains by maintaining cash reserves: Planning outlays on capital expenditure projects in advance helps in staying economically secure. Taking action toward FP&A goals increases profitability.
• Evaluating variances to track performance: Understanding variances in forecasts and digging into the focal point of error to make corrections and mitigate risks.
• Better asset management: Reviewing the quality, update, or replacement dates of assets lets you save for new acquisitions and find buyers for depreciating assets. 
• Orderly deleveraging and leveraging: Eliminating the need to maintain a higher cash buffer saves interest costs.

What are the disadvantages of long term forecasting?

As the duration of the forecast increases, the accuracy decreases. Here are some disadvantages of long-term forecasting:

• Siloed data on excel serve as bottlenecks: Data crunching and consolidation into a single master sheet from various excel sheets is labor-intensive and reduces visibility. 
• Unpredictable nature of the economy: Due to unforeseen economic downturns, there is always a need for more reliability in long-term forecasts.
• Lack of historical information: This might create havoc for businesses that don’t have sufficient historical data. If the projections fall short, the firm can suffer monetary repercussions.
• Lack of the right set of technologies: Ideal forecast development boils down to selecting the best-fit forecasting method, but it’s difficult to choose the most suitable technology for your business.

Which technique is used for long term forecasting?

Generally, the adjusted net income method is used for creating long term forecasts. The data required for preparing the adjusted net income forecast is acquired from the corporate budgets. The net income method monitors working capital changes and foretells financial requirements. The major downside to this method is that it does not allow tracing individual cash flows despite it being a great tool in the arsenal for showing the aggregate impact of fund flows.

How Does Automated Cash Forecasting Help With Both Short-Term And Long-Term Forecasting? 

One of the major challenges, whether short-term or long-term forecasting, is the manual computations and the errors and inconsistencies that come with it. The innumerable spreadsheets to deal with, preparing templates for forecasting, and the humungous time spent in projections not only reduces cash flow productivity but also impacts the business outcomes and yields in the long run. 

This is where automated cash forecasting comes into play. It enhances cash forecasting practices while offering cutting-edge features for: 

1. Auto-ML Forecast

Auto-Machine Learning (Auto-ML) system leverages historical transaction data to deliver accurate cash flow forecasts by selecting the best-fit model for each category and time frame. For example, it may use “WeekOfYearAvg” for short-term forecasts (next 14 days) and switch to “SeasonalAvg” for mid-term predictions (15 to 90 days), ensuring precision across different horizons. Continuously reviewed and updated daily, this approach combines granular short-term accuracy with broader long-term trend analysis, providing reliable insights for financial planning.

2. No-Code Forecast Modelling

Features like No-Code Forecast Modeling simplifies data handling and model building with an intuitive, Excel-like interface that ensures scalability. It supports connected forecasting units with hierarchical consolidation, enabling seamless integration of cash categories and company codes. For example, a US AR forecast can roll up into a US net cash forecast and a global AR forecast, both of which consolidate into a global net cash forecast. This structure allows different users to access customized, role-specific views at various consolidation levels.

3. Advanced AI Forecast

Automation in cash forecasting helps enhance forecast accuracy for Accounts Receivables and payables cash flows by leveraging ERP data instead of relying solely on bank data. For AR, it uses customer invoices, sales orders, and promises to pay, while for AP, it incorporates vendor invoices and purchase orders. For instance, to forecast AR cash flows in the US, invoice data from the ERP is analyzed to predict account-specific payment patterns, delivering a more precise bottom-up estimate of cash inflows over the next 45 days.

Enhance Your Cash Forecasting With HighRadius’ Automated Cash Forecasting Software

Whether short-term, or long term cash forecasting, businesses need tools and solutions that will help them unlock accurate cash forecasting while cutting down on manual tasks and offering dynamic features like AI-led projections, bank integration, complete cash visibility and more. 

With this in mind, HighRadius brings you Automated Cash Forecasting Software, that not only helps unlock accurate and consistent cash forecasting but choose the best fit, ready-to-use customizable forecasting template to align with the business requirements. 

Our Cash Forecasting Software leverages advanced technologies such as artificial intelligence (AI) and machine learning (ML) and integrates with banks and ERPs to get AR/AP data, improve ML prediction rates, and enable treasurers to achieve accurate, real-time cash forecasting. Businesses can forecast cash into any category or entity on a daily, weekly, and monthly basis with up to 95% accuracy, perform what-if scenarios, and compare actuals vs. forecasted cash. 

Frequently Asked Questions:

What is cash flow forecasting? 

Cash Flow Forecasting measures an organization’s future financial position and determines its cash flow position. Cash forecasting is important for making informed decisions for investing and borrowing. It helps in handling a company’s capital structure, financial and interest rate risks, and making adjustments to the budget.

What are the best metrics for forecasting cash flow?

Using data from accounting statements, these metrics should be monitored regularly:

• Debt-to-equity ratio: Total liabilities / Shareholder’s equity = Debt-to-equity. The debt-to-equity ratio determines a company’s vulnerability to market changes. Liabilities should be less than equity.
• Days Sales Outstanding (DSO): It’s the average number of days to collect receivables. A shorter DSO ensures better liquidity.
• Days Payables Outstanding (DPO):  It’s the average number of days to pay the suppliers. DSO should always be shorter than DPO, which ensures enough money in hand to pay bills.
• Days of Inventory Outstanding (DIO): It’s the rate at which the inventory turns over. A shorter DIO makes a positive impact on working capital.

What are the best practices for cash flow forecasting?

Treasurers should focus on both short term and long term forecasting to offset potential losses. While short-term cash forecasting projects when money is going to hit your bank account, long-term forecasts support plans for expansion and hedge maturities.

Suitable variables must be used for forecasting. Selecting the correlated variables and finding the right model for performing the forecast offers better results. 

Why is a cash flow forecast important?

Cash flow forecasting is especially important for companies’ growth because it influences strategic financial and investment choices that alter the company’s course and boost earnings. Cash flow forecasting equips a corporation to operate without financial constraints and offers a path toward accomplishing both short-term and long-term corporate goals.

What are the best tools for cash flow forecasting?

Cloud computing is a win-win solution for forecasting since all the data are stored in one place. It eliminates the need for manual data aggregation and consolidation, thus minimizing the scope for errors. 

Automation serves as the right hand of the CFO. The presence of RPA, ML, and AI increases the accuracy of the forecasts, hence saving time for value-added activities. Appropriate models provide great assistance when there is a surge in complexity. This increases confidence and makes decision-making and reporting coherent.

What do short-term forecasts predict?

Short-term forecasts predict future events within weeks or months, analyzing current trends and historical data. They offer insights into near-future outcomes across various domains. These forecasts aid decision-making by providing valuable insights for planning and strategizing in the short term.