Central banks have been raising interest rates across the world over the past year.  This significantly impacts the cost of funding and/or the cost of capital for all types of commercial decisions across the company.

According to the 2024 FP&A Trends Survey, only 21% of organisations report using a fully integrated model that combines the profit and loss (P&L) statement, balance sheet and cash flow statement — enabling comprehensive financial oversight. Meanwhile, a significant portion of organisations (over 53%) still plan their cash flow either separately from the rest of the financial model or with only limited integration.

In fact, cash flow forecasting ranks just 7th among FP&A transformation priorities, with only 6% of respondents identifying it as a current area of investment focus.

These results are stark, especially in the context of global market volatility and rising interest rate sensitivity. But they also reveal a clear opportunity: to shift from fragmented forecasting to a driver-based, integrated approach where cash flow planning is not an afterthought, but a core element of business agility and strategic decision-making.

Driver-Based Forecasting

Driver-based forecasting is not commonly used for cash flow management, although cash flow forecasts are essentially derived by adjusting P&L and balance sheet projections. Often the data is already there, and large amounts of efforts has gone into developing driver-based P&L forecasting. So why would this data not be leveraged for cash flow management?

Integrated planning tools provide the flexibility to utilise the same data source to generate scenarios within different business models for different purposes. By changing a driver or a variable, different possible outcomes can be evaluated, and the models can form a holistic view, providing relevant insights for various stakeholder conversations. Scenario analysis enables the Board and the Executive Committee to evaluate options, improve agility, cater to risk management and even mitigate the risks of a liquidity event.

For example, if the company forecast includes an expected set-up of a new business division or product, there will be an associated expectation that it will generate X amount of income and Y amount of costs over several years. Cash flow requirements will be impacted, depending on whether the set-up progresses as planned, and the timing of associated investment, funding, and deposit will be affected. Setting up driver-based forecasts to adjust the timing and/or growth rates of the division set-up would help inform the magnitude of the difference between various scenarios. Without an effective cash flow forecast process, cash management can often be passive and reactive.

Cash flow constraints may often require further rationalisation of investments, especially when future interest rates remain uncertain. For example, a higher cost of capital may mean some projects cannot generate a net positive return and, therefore, be cancelled when funding costs increase. The commercial impact of current changing interest rates is driving a greater need for insight and understanding of cash flow management and its impact on operational and strategic plans.  

Technological Capabilities

According to the latest FP&A Trends Survey, Excel remains the dominant system for planning and forecasting, with 52% of users relying on it as their main tool. The survey also revealed that approximately one-third of an FP&A team's time is spent on non-value-adding activities.

The inefficiency and inflexibility of processes can be demoralising to staff when much of their time is spent dealing with risks such as file corruption, version control and interdependencies between increasingly complex models. The lack of a single source of truth can also undermine data integrity which is fundamental to building trust with business stakeholders.

FP&A technology continues to develop rapidly, and models can be set up and adapted with speed and ease to cater for different business requirements. For example, planning tools can integrate data from different system sources. From a cash perspective, this would enable data to be captured from both accounts receivable (AR) and accounts payable (AP), including credit terms, to generate cash flow forecasts with appropriate time lags. Adjustments can be made to different data variables simply by selecting or deselecting sales or expenses to be included in the forecast.

Building capabilities to handle complexities is an important part of cash flow transformation, especially for companies with multiple entity structures, currencies and regulatory or compliance requirements.

Predictive analytics is also a useful tool, where inbuilt algorithms can generate cash flow forecasts based on historical data captured within the system.

Effective cash flow management can mitigate liquidity risk, minimise the cost of funding unexpected cash shortfalls and avoid the opportunity cost of losing interest income if significant cash surpluses are not deposited or invested efficiently. The business case to support investment into systems and processes that allow for cash flow transformation is further strengthened when interest rates rise.

Collaboration and Accountability

Greater collaboration between the FP&A team and the treasury team is essential for any cash flow transformation. For example, the treasury team can help identify relevant cash flow drivers that can be integrated into a 3-way model.  These are some practical ways to be innovative, enhance collaboration and bring real commercial value.

1. Inclusion of cash flow analysis to departmental decision-making

An integrated driver-based 3-way model will enable cash flow analysis to become a more holistic budget and investment appraisal process for many business divisions. For example, company cost of capital considerations based on different funding options and updated discount rates can impact departmental investment decisions, including the timing and size of potential returns. The detailed work usually carried out in the background by the treasury team can be brought to the forefront.

2. Extension of treasury cash flow forecasting and scenario planning to multi-year models

FP&A can also support the development of long-term cash flow forecasting and scenario analysis to assist the treasury team in planning long-term cash flow requirements. Providing insights on any driver changes in the P&L and balance sheet can help inform discussions and allow for dynamic planning across all financial moving parts.

For example, if a significant shortfall or surplus is expected to arise within 12 to 24 months, the treasury team will have ample time to explore options for competitive interest rates. In fact, where necessary, they will have time to establish contracts with new providers for greater diversification, rather than simply resorting to existing providers when time is limited.  

Enhancing the visibility of the performance and effectiveness of treasury activities may also encourage other divisions to be accountable when developing P&L forecasts and budgets. They will be able to view and consider how their plans may impact cash flow management and, in turn, return on investment, cost of capital, or debt.

Conclusion

Cash flow transformation that is driver-based, collaborative and embraces the use of technology can streamline the planning process, encourage greater transparency, demand greater accountability and enable greater agility to respond quickly to a rapidly changing environment.

In a higher interest rate environment, a collaboration between the FP&A team, the treasury department and the broader business is essential to ensuring future cash flows are carefully planned, and competitive interest rates on both cash receivable and payable are achieved. An integrated driver-based 3-way model can enable scenario analysis to inform decision-making, provide valuable insights to the Board and Executive Committee and ensure liquidity and credit risk are managed effectively.

This article was first published on the SAP Blog.