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The Importance Of Cash Flow Forecasting And ‘How To’ During COVID-19

15-Jul-2020 11:07 | Tracy Dawson (Administrator)

In this two-part series, William Buck Manager Business Advisory, Eric Flammang provides his recommendations for monitoring and managing cash inflow and outflows effectively during COVID19, using a three-way forecast.

Part One: Assessing your options and scenario testing

A recent survey by the Australian Bureau of Statistics revealed that 50% of all Australian Businesses have been adversely impacted as a result of the coronavirus – cashflow (and the lack thereof) being the major issue according to these businesses.

Around 86% expect to be further impacted in the coming months and while a business may not have been directly impacted, its customers or suppliers may have, and the impact may just be delayed. Cash flow is the lifeblood of any business and it is even more critical in times of uncertainty for ALL businesses.

Gaining visibility and control over cash flows and working capital is the most fundamental activity businesses should undertake during a time of crisis. Your business should prepare and regularly update a 13-week rolling cash flow forecasts to realistically assess its current situation and take corrective actions as and when required. The question is how?

Well, the best forecasting format is what we call in the industry a “Three-way forecast” as it combines three key financial reports into one neat summarised package. It links your Profit and Loss (P&L), Balance Sheet and Cashflow reports together giving these reports greater credibility and allowing you to predict your future cash position and the “financial health” of your business.

Forecasting will assist your business to stay “agile” in this rapidly changing environment in the following two major ways:

  1. It will provide you with a framework to assess and re-assess your business’s current position and available options; and
  2. It will provide you with a powerful tool to assess your options and compare alternative course of actions your business could take to come out of this difficult time as strong and financially stable as possible.

Assess your position

- Understand your cash flow and working capital requirements: Consider the three working capital elements – receivables, payables and inventory. You will need to work out a balance between these three areas so that there is sufficient use of cash to keep your business running.

- Manage your Receivables: It is critical to ensure that your collection process is working efficiently by considering the money owed by your customers, the recoverability of these and the ultimate impact on your cash flow. It also crucial for your business to regularly review its turnover projections, based on new business trends resulting from COVID-19.

- Manage your Payables: Review the amounts owed to your suppliers and forecast when these payments are due. Review all other non-trading contracts / commitments that have a cash requirement over the months ahead and reconsider their necessity. For the remaining commitments, your business should consider extending the time taken to pay its suppliers to preserve cash. However, bear in mind that delaying payments may damage the relationships with your suppliers, so it is important to negotiate with them to establish mutually beneficial agreements.

- Manage your inventory: Look at your business’s supply chain and consider if there may be any disruptions such as ability to obtain materials and delivery. It is critical to balance the need for buffer stock and holding cash in excess inventory. It is important to do a calculation/forecast of stock requirement needs for the future by considering the lead time, the time it takes to order and provide the goods/services to customers.

- Review your overhead structure: Make an accurate assessment of all expenses and outgoings needed to continue operating to sustain your revenue forecast. This may lead to pursuing alternative actions such as deferring large capital expenditure, reducing fixed costs, changing your staffing levels and switching to variables such as lease equipment instead of purchase. Like the above, it is important to note that this analysis should be done bearing in mind that these costs reduction(s) should not risk a decrease in your ability to generate revenue. Nor should they damage your business reputation. The long-term consequences would largely outweigh the short-term cashflow impacts.

Assess your options

Once your three-way forecasting model has been established, it is important to understand the options available to drive your business through the crisis and their impacts on your cash position and ability to remain solvable (also referred to as Scenario and Sensitivity analysis).

Scenario analysis utilises several tools and concepts that are relevant to COVID-19. These include identifying potential scenarios, critical assumptions, leading indicators, and potential mitigating actions.

The main available options during COVID-19 fall under the following three pillars:

- Understand the government and ATO assistance packages that can assist with cash flow: The Federal and State governments and ATO have announced various assistance measures such as job support loans, payroll / land tax relief and small business measures to support businesses during this time (JobKeeper, apprentices’ wage subsidies, Cashflow Boost and tax payment deferrals). It is important to understand and consider the different options available and forecast how the use of assistance will impact cash flow.

Negotiate lease arrangements: Contact your landlord and negotiate your rent terms including a reduction, variation to existing lease terms, or pause on rent for a short period of time. When doing so, you should outline the impact on your business including how rent relief will assist. Forecasting different scenarios will assist in demonstrating this to your landlord. Note that a outlining a set of good faith leasing principles has recently been released and should be taken into consideration when negotiating with your landlord.

Negotiate finance options: In this current environment, it is important to understand available financing options available if required. A reminder that previous options may not be available now so it is crucial to communicate regularly with your bank or finance provider. Some banks are offering deferral of loan repayments for a six-month period. This is also an opportunity to use forecasting scenarios to better understand how additional or new financing options available would be of use to your business.

Sensitivity and Scenario Analyses

The different scenarios should then be tested by ensuring you consider your variables and assumptions in the context of best and worst-case scenarios (e.g. what does it mean for my business cashflow if we only achieve X instead of Y?). This is called a “sensitivity analysis”

It is important not to confuse Sensitivity Analysis with Scenario Analysis. Although similar to some extent, the two have some key differences.

A Sensitivity Analysis is used to understand the effect of a set of independent variables on some dependent variables under certain specific conditions. For example, a financial analyst wants to find out the effect of a company’s net working capital on its profit margin. The analysis will involve all the variables that have an impact on the company’s profit margin such as the cost of goods sold, workers’ wages and managers’ wages, etc. The analysis will isolate each of these fixed and variable costs and record all possible outcomes.

A Scenario Analysis on the other hand, would require your business to describe a specific scenario in detail. Scenario Analysis is usually done to analyse situations involving major shocks such as a global market shift or a major change in the business’s operating environment (very relevant in the current economic context).

After specifying the details of the scenario, you’d then detail the variables so that they align with the scenario. The result is a very comprehensive picture of the future (a discrete scenario). The analyst would know the full range of outcomes, given all the extremes, and would understand what the outcomes would be.

Advantages of Sensitivity Analysis

There are many important reasons to perform a Sensitivity Analysis:

Sensitivity Analysis adds credibility to any type of financial model by testing the model across a wide set of possibilities.

  1. Financial Sensitivity Analysis allows your business to be flexible with the boundaries within which to test the sensitivity of the dependent variables to the independent variables. For example, the model to study the effect of a 5% change in interest rates would be different from the financial model that would be used to study the effect of a 20% change in interest rates.
  2. Sensitivity analysis helps one make informed choices. Decision-makers use the model to understand how responsive the output is to changes in certain variables. This relationship can help a business in deriving tangible conclusions and be instrumental in making optimal decisions.

You’ll then implement the best option and closely monitor the impact by regularly reviewing the results and comparing them to the forecasts made. You can then adjust plans as and when required (variance analysis of actual versus forecast cashflows should be carried out with variances robustly challenged).

Please read part two for Eric’s top 10 tips on setting up a three-way cash flow forecast model in Microsoft Excel.


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