Cash flow modelling
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Cash flow modelling

Jun 10, 2013 · 2 min read

What is it?


Cash is king. Most businesses fail not because they don’t make a profit but because they run out of cash.

Cash is the lifeblood of any business. Cash flow modelling is the practice of planning and forecasting the sources and uses of cash. Its ultimate objective is to provide a framework that enables the most effective, efficient and economic use of available cash and the maximisation of free cash flow (the cash generated by operating cash flow less capital expenditure), which is important as it enables a business to invest in growth-generating options.

What benefits does cash flow modelling provide?

Cash flow modelling enables companies to manage solvency more proactively. It improves the sustainability of the organisation and it improves the understanding of the impact of drivers on cash flow, leading to better decisions. Modelling facilitates cash driver target setting, and it provides a basis for enhanced analysis and reporting of cash flow performance against targets as well as earlier indicators of expected future cash flows. Cash flow modelling also improves understanding of the cash impact of investment decisions, and it improves access to capital, as capital providers have more confidence.

Questions to consider when implementing cash flow modelling

  • Do we plan scenarios to cater for a range of risks?

  • Does liquidity at times constrain strategy execution?

  • Do we have a cash flow or liquid reserves policy?

  • How well does my organisation’s cash generation compare to others in the sector?

  • Does management have a clear understanding of the organisation’s working capital structure?

  • Does the quantity of data from the ERP system overwhelm our ability to structure it in a way that could support a model?

  • What are the key drivers of cash flow in the business; where can we source the required data to support the forecast?

  • Do we have the expertise and capacity to create and maintain a cash flow model?

Actions required

Actions to take / Dos

  • Develop a model that facilitates analysis and reporting

  • Develop a driver-based model and assign accountability for driver targets, to encourage the right behaviours across the organisation

  • Create policies, processes and procedures that support sound cash awareness, stewardship and targets.

  • Reconcile long- and short-term cash flows

  • Communicate regularly with the treasury function, to ensure cash availability.

  • Keep a history of driver actuals to ensure patterns and trends are understood

  • Maintain a rolling forecast, updating period opening positions with actuals to improve short-term forecasting accuracy

  • Regularly share cash forecasts and performance information with lenders, to encourage their support in lean times

  • Report, in MI, on the security of, and risks associated with, sources of funding. Monitor the creditworthiness of key (or new) customers, taking action if credit risk increases If the organisation is planning a fundamental change, eg a restructure, merger or acquisition, get involved from the start, focusing on cash model impact

Actions to Avoid / Don'ts

  • Avoid blind faith and optimism – don’t rely on modelling only one scenario

  • Don’t rule out the effect of environmental factors such as inflation and currency exchange rates

  • Avoid developing a cash flow model in isolation of the balance sheet and P&L. The rigour of balancing the balance sheet increases assurance that the cash forecast is realistic

  • Don’t make cash flow management a purely financial function. Communicate with wider management to avoid a culture focused on the top and bottom lines of the P&L

  • Avoid regularly exceeding creditor settlement terms – credit ratings will reflect this to the possible detriment of the organisation’s cost of capital and ability to attract new capital. If necessary, formally agree longer settlement terms with creditors

  • Avoid taking an optimistic view when forecasting drivers; instead, form an independent view and ensure expenditure is aligned to this

  • Don’t assume that the credit rating of your organisation or group is accurate – proactively manage your organisation’s ratings with the ratings agencies

In practice:

Cash Flow Modelling

Helping Marks & Spencer deliver £185m in cash flow between 2007 and 2010

Working with other parts of the business, the business service centre helped to deliver incremental cash flows of £185m over this critical period. Gary Critchley,

Head of business services and information, says, ‘It is really a team game in terms of how we partner with our colleagues in finance and other parts of the business. That could be sourcing, treasury, logistics, or on projects, so that, when we are implementing business changes, we are always cognisant of how we can make this work for us both practically and financial.’

One of the ways that cash flow was delivered was through improved cash management. Managing net debt over the period helped Marks & Spencer to sustain its credit rating, cost of borrowing and – ultimately – its profits. ‘We were able to sustain the debt during the credit crunch when credit markets tightened significantly. If we had needed to renegotiate any of our facilities, then that would have been difficult and potentially expensive. You needed to conserve as much cash as you could during that time. We have to make sure that we create commercial value – value in understanding the connection between the business behaviour, the commercial driver, the business project and the financial ledger.’

Related and similar practices

  • Internal rate of return (IRR)

  • Discounted cash flow (DCF)

  • Net present value (NPV)

  • Capital ratios

  • Investor ratios

  • Weighted average cost of capital (WACC)

  • Capital asset pricing model (CAPM)

  • Cash flow return on investment (CFROI)

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