Financial Planning & Analysis

Cash Flow Management & Forecasting Q&A [Video]

In our new video, 8020 Consulting’s David Lewis and Mitch Browne discuss the importance of cash flow management and forecasting, particularly in times of economic disruption and uncertainty. Watch to learn how good forecasts are built and leveraged—and how a bottoms-up approach can better inform executive decision-making.

We’ve posted the full discussion below along with the full audio, but if you’re in a rush, you can also skip through the playlist for shorter segments featuring key questions.

Watch the Video

Listen to the Recording

We’ve also included the transcript (with time stamps) below for convenience. Happy viewing, listening, and/or reading!

Introductions (00:00 – 02:10)

David Lewis: Alright, let’s get started. My name’s David Lewis. I’m here with my colleague, Mitch Browne. We are with 8020 Consulting, based here in Southern California.

Today’s topic is cash flow forecasting. Our view as a firm is that this is something that it’s almost impossible to pay too much attention to, especially in the current economic financing, lending and capital environment. Not to mention the more-than-modest amount of uncertainty about future economic prospects. We’re optimists in our company, but it’s still good to be prepared.

Just a brief background on Mitch Browne. He’s an MBA from Washington. He has a very nice blend of corporate and investment banking and securities in his background. He worked at Wells Fargo Securities as an Analyst Associate and Investment Banking. He worked at Yahoo as a Senior Financial Analyst in the Corporate Finance area. He worked at Hulu as a Finance Manager. And at AECOM, which is now about a $20-billion global engineering services firm, he built experience in sell-side investment banking, buy-side corporate development, and corporate financial planning and analysis. So, he’s an excellent authority on cash flow forecasting and the subject of forecasting in general.

He’s been with the company for a number of years, and many of his projects have been around forecasting capital requirements for emerging growth and technology companies. He’s done a lot of transaction support on the sell-side, in which cash flow forecasting was an important part of determining the working capital peg—a key point of negotiation in M&A transactions.

So, Mitch, welcome to our remote and virtual world.

Mitch Browne: Thank you, David. Always good to see you.

Deficiencies & Opportunities in Cash Flow Forecasting (02:11 – 03:22)

David: The first question people might be asking is, what might be wrong or deficient with the way that we’re doing cash flow forecasting and reporting today, versus what might be going on in the environment, and what I should be doing?

Mitch: Good question. I think there are two main reasons we might think of it differently now than we would have a couple of months ago. Traditionally, companies consistently look at the P&L performance, they sometimes look at their balance sheet and they only occasionally look at cash. And as a result, many companies have cash forecasts that are essentially afterthoughts or backed in two types of calculations. And we’ll talk a little bit about what we mean by cash flow forecasts at 8020.

But the other way it is significantly different today is that forecast we built only 8 – 10 weeks ago likely didn’t incorporate all the variables and toggles that we would consider today. What I mean by that is, there are certain things that companies are reacting to today, whether it’s a decline in sales or trying to control costs. And there are things that we would want to plan for and assume that we just wouldn’t have taken into consideration a couple of months ago.

About Ground-Up or Bottoms-Up Cash Flow Forecasting (03:23 – 07:47)

David: Alright. Mitch, I’ve heard you say a lot about the fact that if a company hasn’t done this already, due to the change in economic circumstances, most companies should be rebuilding their cash flow forecasts “from the ground up.” Why is that and what does that mean exactly?

Mitch: Sure, this varies from what people might traditionally do with an annual plan, which is talking about our cash flow planning, we do it at a weekly level, and it is starting at the bottoms-up. So instead of taking prior periods and adding a percentage or taking away a percentage, we go at the most granular level and build up expected cash receipts and disbursements. That can be large items like rent and payroll and understanding exactly when they’re going to come out of our bank accounts.

It also includes future events for expected expenses that we maybe didn’t really think about. Whether it’s annual maintenance of some assets, whether it’s some sort of cash payments for taxes, things like that. In general, we add those things that when you’re planning at a bigger scale, either a quarterly or annual view, you might not care when those values are going to hit.

What we’re talking about is a bottoms-up cash flow analysis that lets you know what your anticipated cash balance is going to be every given week.

David: Why do you think that’s important now?

Mitch: Well, simply, it’s important because you don’t want to run out of cash. This is a consideration that is a reality for some companies all the time, but for many companies, this might be their first time or at least first time in maybe a decade where they’re looking at cash balances. And they really want to know: where is that turning point? Where are they going to need to ensure they have additional financing lined up?

Additionally, and we’ve encountered this with our small startup or high-growth companies, it also can inform when you want to raise money. You don’t want to raise too much money and over-dilute existing shareholders. And so whether it’s trying to conserve cash or trying simply just to know when your next round of financing is necessary, and how much—those are both valid reasons that the company would want to revisit or create a cash flow forecast.

David: Okay, that makes sense to me. And, I know that, particularly in Los Angeles, there’s a very large number of companies that are venture-capital-backed that may have paths to profitability, but the path may run out a few years into the future.

And so in a different kind of a funding environment, they might need to shift gears in terms of their burn rates and maybe getting to profitability, or at least cash flow breakeven much more quickly, which could necessitate some dramatic changes at the enterprise or a change in their business model.

What kinds of companies would you say are good candidates for this type of forecast?

Mitch: Well, it’s anyone who’s looking at cash a lot harder and maybe looking at cash balances for the first time. And it can be tempting to look at your traditional forecast and traditional P&Ls and do a proxy for cash, but it really doesn’t give you that same level of certainty. I think going through the exercise of bottoms-up comprehensive cash flow forecasting can expose the drivers of your costs on a true cash basis as opposed to a P&L, which one can exclude some cash costs for whatever reasons.

It also really articulates what level of investment is required. Instead of spreading investments over a longer period of depreciation, you’re actually saying, “Oh, I need to go spend a million dollars on this physical item or this piece of software.” You can see where those bumps are, and understand which of those things are truly necessary or may be pushed out, delayed or spread out over a longer period of time.

And similarly, you can think about headcount, hiring as well. Companies that, like you said, might be smaller, high-growth companies may have had a certain path to profitability. If they know they’re going to need to make that cash last a little longer, they may need to revisit some of the things they’re planning to do the rest of the year.

13-week cash flow forecast guide

Scenario Analysis and Changing to the Economic Conditions (07:48 – 09:50)

David: Okay, that makes sense. That’s a good point, in terms of making fixed asset investments or other things that get amortized over time. They may not look that consequential if you take them over their useful life and you’re just recognizing the expense every month. But that can be very significant cash outflow at a time your company should be looking at cash.

I believe it’s true that there are some very unusual things about the suddenness of the change in economic circumstances. And how it’s impacting companies operationally. And things that you would typically have extrapolated from an EBITDA forecast into a cash flow forecast today. There are risk areas, there may be opportunity areas, but there are certainly risk areas on the cash flow forecast that probably people were not thinking about two or three months ago.

You mentioned earlier in our discussion about some of the toggles and scenario analysis or input areas you’d like to have today that you might not have thought seriously about three or four months ago. Can you talk a little bit about what those are?

Mitch: Sure, there are some of the bigger-picture items. Maybe you’re thinking about expanding your footprint real estate-wise or making new hires—those are sort of the easier ones to wrap your head around. Those are maybe areas you to wait on or reduce.

A few of the areas that would be considered today that never would have crossed one’s mind perhaps eight or nine weeks ago would be things like furloughs or leaves of absence or having salary reductions across the board types of reductions. Even some relatively smaller things that no one may have thought of, like 401k matching contributions, or smaller areas of G&A overhead that in most traditional or typical budgeting processes don’t even come up as an option to toggle.

Incorporating Deterioration of Credit Quality (09:51 – 11:07)

David: That one makes sense. How do you integrate deterioration in credit quality of your customers? I’ve thought about that for clients in certain sectors, but can you talk a little bit about that and how you build that in your cash flow forecast?

Mitch: Yeah, that’s a great point really. In addition to the expense side, which does get a lot of the focus, is the receivables and collectibles. And so understanding is part of a cash flow forecast, we go at the creditor level and look at each amount owed to the company and owed out, and we work to be able to evaluate the likelihood of collecting and maybe revisit historical assumptions around bad debt.

If historically it was 3%, is that still a reasonable assumption? You really want to go account by account to understand the risk associated with each. The last thing you want to do is build out this cash flow forecast, assuming everything’s perfectly collected, and realize you haven’t really had a comprehensive approach and your data is not accurate. Because then you’re not going to collect the way you assumed you would have eight weeks ago.

Making the Case for Prioritizing Cash Flow Forecast Updates (11:08 – End)

David: So it could either be that you have business failures that are actually causing your write-offs to go up significantly—I mean by orders of magnitude—or you have a stretching out of payments, which obviously can come in cash. So all of a sudden, if you don’t have a revolving credit facility in place, now is not the best time to be going out looking for one. But I know that a lot of companies are drawing their facilities down so they have cash, part of which might be needed because even if their customers are paying them, they might be stretching out the payment terms beyond plan. So I think that makes sense.

Anything else in terms of thinking about the benefits of doing this exercise? Most of our people in finance, the CFOs and others that we know, generally are always trying to do more work than they really have the capacity to do. Most companies don’t exactly over-invest in the size of the accounting and finance team. If somebody is wondering what the benefits of doing this are versus the more urgent compliance and reporting and control requirements they have, what would you tell them about why cash flow forecasting is a worthwhile exercise?

Mitch: Good question. I think everything gets viewed with a certain level of urgency. And that’s only increased over the last couple of months.

If you’re asking me to defend a cash flow forecast, I’d say it’s probably the core analysis. What is the thing that keeps the light on? It’s cash, right? At the end of the day, that’s going to be as important, and I’d say probably more important, than any sort of traditional forecast or view on a prior period. Both of those are great to have, but you really do want to have a very certain idea of how long your cash is going to last and what your capital needs are. So obviously, it’s a little self-promotional, but I’d say put it at the top of the list.

David: I agree. It is self-promotional, but I think you’re right about that. Somebody once told me a long time ago, they said the number one rule in business is never run out of cash. It probably sounds obvious, but what I have found that, first of all, we know you can grow yourself right out of business if you’re not properly capitalized and financed.

The second thing is that, particularly in the middle market to lower-middle market, I think many companies don’t realize that you don’t want to wait to the last minute to find out that you need to go raise more cash. By that time, there are all kinds of bad things that can happen—including ending up losing operating or equity control of your enterprise to your lenders, for example.

It’s important to identify points in the future when cash might be at a premium well ahead of time. That’s one thing.

The other thing I would say is that one of the greatest gifts a CEO or CFO can have or give is the gift of peace of mind. I know that when we headed into this, one of the first things we did as a firm was build a very robust and dynamic cash flow forecast. So even though we don’t know with certainty how the economy is going to perform over the rest of the year, or how our business will perform, we’re quite confident we have a very long runway to operate, pivot the company if and as necessary and adjust the size of the enterprise if we need to do that.

It gave us the mental space to take the time to plan deliberately and let things play out. We were in a position from a financing cash perspective that we didn’t need to make any rash, deep or dramatic cuts in the organization. So that was good for us. And I think any company should have that. Because it tells you if you have a one-year planning or five-year planning horizon, but you’ve got six months of cash, that doesn’t work very well. So, I just think it’s a responsible thing.

One of the analogies you gave me—I know that you did a long project for a client of ours in the electric vehicle space—is that knowing exactly how much charge is left in your battery and how many miles that will get you is a lot better than wondering with some degree of imprecision. I think the same thing is true for an organization with regard to cash.

Did you want to add something else?

Mitch: I just wanted to add onto that. You made a comment that’s worth pointing out or re-highlighting. Getting this as early as possible is always better. Similar to the car example you just said, you want to know the news as early as possible because the longer you wait, the fewer options you have.

If you find out you have one week of cash left, there’s very little you can do. Your hands are going to be very forced as to what your possible remedies and actions are. The earlier you can find out that there is a potential crunch or problem, you’ll have a lot more flexibility for optimizing cash flow. You can make decisions that are good for the company in the long run, versus having to make last-minute drastic measures.

David: That is correct. Well, thank you Mitch, as always, it’s a pleasure to spend time with you. I hope that anybody watching this found it useful—and riveting in fact. With that, we’ll wish all of our listeners and watchers a great afternoon, evening or whatever the case may be.

Thank you, Mitch.

Mitch: Thanks David.

Learn More

We work with a variety of companies interested in getting more out of their cash flow forecasting tools. To learn more about cash flow forecasts, you can download our free guide below.

13-week cash flow forecast guide

If you’re interested in exploring working with us, you can also download our cash flow forecasting services explainer. Thanks for reading!

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