Page 148 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 9: Cash Flows Forecasting and Treasury Management

3. Administrative Costs Benefits: Forecasting may require extensive administrative efforts Notes
to collect and digest data. On the other hand, forecasting may provide administrative
benefits in the form of better planning and more timely management reports.
4. Control: Daily cash budgets often provide a standard against which deposit reports from
the field can be compared. If actual deposit varies from project deposits, inquiries may be
warranted.
5. Forecast System Costs: There costs are associated directly with developing, maintaining,
and running the forecasting model and associated data bases. Some forecast systems require
extensive computer time and information. Others are simple and inexpensive.
Designing forecasting systems requires that management make trade off among these five cost
factors.

Example: An extensive, accurate forecasting system may be costly to build and maintain
and may require strong administrative effort. But such a system may enable the firm to achieve
better returns on its short-term investments, reduce borrowing costs, and exert better control
over cash flows.

9.2 Cash Forecasting Horizons

Cash forecasting may be divided into roughly three sub problems. Depending on the horizon
the forecaster wishes to consider. Different techniques and purposes are associated with each
horizon.

9.2.1 Long-range Forecasts

Cash forecasts of one or more years into the future are needed primarily to assess the viability
of the firm’s long-range financing and operating policies. Long-range forecasts give planners an
idea of how much cash the firm needs to raise through debt or equity issues, internally generated
cash, or other cash sources. These forecasts also assist managers in establishing dividend policies,
determining capital investments, and planning a mergers and acquisitions (or divestitures)
programme. It is typical for a firm to have a 5 or 10-year forecast that is updated annually.
Long-range forecasts are generally based on accounting projections and typically involved the
generation of various scenarios for future economic and technological environments. Such
forecasts are considered strategic in the sense that possible major changes are examined.

9.2.2 Medium-range Forecasts

We consider medium-range forecasts to be those that cover cash flows during the next 12 months.
A firm may have, for example, a forecast of quarterly cash flows over the next 4 quarters, with
monthly detail over the next 3 months. Medium-range cash forecasting usually takes the firm’s
existing technology and long-range financing as given. Hence, this kind of forecast is considered
tactical rather than strategic. Although it can be accounting based, adjustments are made to focus
on cash flows rather than earnings. It is sometimes called cash budgeting.

Did u know? What is the purpose of medium-range forecasting?
The purpose of medium-range forecasting is to determine the firms need for short-term
cash from credit lines, commercial paper sales, or credit and payables policies. It also

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