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Cash Flow Planning

Cash Flow Planning


What is Cash Flow Planning and how is it different from profit planning?


Cash flow planning is the process of ascertaining and managing the cash inflows and cash outflows from a business, and how the surplus or shortfall between them are managed.  Cash flow reflects the change in the cash balances over a period of time.The cash inflows are typically realized through realization from customers and the cash outflows primarily are for payments to suppliers or employees in the business. The primary difference between cash flow planning and profit planning is with respect to the timing of the money flows. The cash does not coincide with the realization of the profits and therefore this result in having to plan for funding from banks or financial institutions for the shortfall.


Why is Cash flow planning important?


Any business may look very profitable but still there may be difficulty in managing payments to various stakeholders such as employees, suppliers. This is because of inadequate cash flow planning. The timing of receipts would not coincide with timing of payments. So it is very important to plan the cash flows and make provisions to get the shortfall funded. In certain businesses, there could be surplus cash which needs to be appropriately utilized.


Best Practices in Cash Flow Planning


Based on my experience working for companies such as Pepsi, Ford in their FP&A and Treasury groups, I have laid out some of the best practices that could be very useful in building cash flow planning:


Split Long term and Short term cash flow planning:


It is important for every business to build separate cash flow plans from a long term perspective and a short term perspective. The long term planning would be built for 3-5 years. This would be derived from the long range income and expense planning that would have an effect on the cash flows. But the most important aspect of the long range planning would be with respect to cash outflows on account of capital expenditure and the means to fund the same. This would include examples such as setting up a new facility to make a new product and building the plan to fund the new facility. Therefore the long term cash planning focuses on more strategic aspects of the business and adequate planning would help negotiate better funding with financial institutions for the shortfall. Another important aspect of long range cash flow planning is the ability to incorporate concepts of discounted cash flow. The discounting allows for adjusting the time value of money into the cash flows to make right investment decisions. Euro 1 Million spent today may not have the same purchasing power in 3 years from now since the money value is going down.

Short term planning would be more focused on ascertaining the near time differences of the cash surplus and deficit. It is best practice to have 25% of your short term deficit funded through your long term sources.


Separate cash streams for receipts and payments


One of the best practice around cash flow planning is to build separate cash streams for receipts and payments. Normally each of these cash streams is represented by different bank accounts. The receipt stream allow for pooling of the funds from different receipt points. The payment streams allocates funds to fulfill the cash outflow commitments. This best practice eliminates confusions that may arise when receipts are directly channelized for payments without appropriate consolidation. This also allows better negotiations with banks and financial institutions for shortfall funding.


As an example, the regions generate the cash receipts from sales. The regions would have payments for salaries, sales office rent etc. There should be separate streams to collect the sales receipts and separate stream to make payments for the expenses for better cash planning and management.


Driver based cash flow planning


In our earlier blog, we did cover the best practice around driver based planning. This best practice is very important in the context of cash flow planning. Cash flow planning is always derived based on other drivers and assumptions. Cash inflow is derived based on the revenue and the average days realization drivers. Cash outflows are derived based on the expenses and the average days payment drivers for each category of expenses. To get the best results, it would be good to build a driver based cash flow planning model where the cash flows are derived based on the different drivers and assumptions provided collaboratively by the various experts in the organization. By building a driver based model, the users also get great insights into how different groups are realizing the money and this becomes a key metric in managing the cash more effectively across the organization.


Rolling forecasts


It is very necessary that the cash flow planning is revisited every month for the next quarter, especially with respect to the short term cash flow planning. This will allow for adjustments in assumptions to accommodate changes in the business scenario. Also since the cash flow is a function of the past events, incorporating the actual data into the plan could result in more accurate forecasts. For example, if the actual sales increased by 10% over the budget, for which the realization happens with one month credit, the cash flow that would be realized will also increase by 10% in the next month, and this could be leveraged very effectively to pay off some supplier bills to gain cash discounts.


Forecast vs Actual analysis, for better predictability


Extending the above best practice on rolling forecast, it is important to do forecast vs actual analysis every month. This will throw variances and possible inconsistencies in the way the assumptions were built to derive the cash flow plans. Over a period the cash flow planning can become better predictable through such reviews and comparisons.


In addition to the above, the general Budgeting Best Practices with SAP Business Planning – Part IV can also be applied with respect to cash flow planning.


Cash Flow Planning with SAP Business Planning and CPM


SAP Corporate Performance Management products allows a set of solutions that cater to different aspects of the cash flow planning.


The SAP Strategy Management product would facilitate in identifying the business objectives, the initiatives around the objectives and the Key performance indicators to track those objectives. So extending the above example where we explained the launch of new product and setting up of a facility to produce the new product, the same could be setup in the SAP Strategy Management product as objective of increasing sales by x%, and the initiative would be to setup a new facility. One of the milestone for the setup of new facility would be to determine the cash flow requirements and the funding for the same.


The SAP Business Planning product would take this further where a driver based multi hierarchical model can be built to support the cash flow planning process. The power of this would be realized by having it integrated into other facets of income, expense and capital expenditure planning, where the cash flow is a derivative of the other planning models. The best practices for cash flow planning is well realized in a multi dimension hierarchical planning product since the cash inflows and outflows can be aggregated and planned across different departments, regions and cost centers in a business. Also features such as P Square with SAP CPM facilitate building the cash flow planning process alongwith workflows for requests and approvals to realize the best results. With the theme of Finance Owned and Managed SAP CPM – Part V application, modeling of cash flow planning and most importantly modification is best realized through SAP Business Planning product.  Capabilities such as predictive analytics and Leveraging Variance Analysis in CPM can be leveraged in the context of cash flow planning. And above all since the product provides the user with familiar How are EPM solutions better than spreadsheets? interface with very intuitive planning capability, users acceptance is best realized through this products.

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      Author's profile photo Ramesh Iyanswamy
      Ramesh Iyanswamy
      this is really damn good article.
      but my question is how do we realize this cash flow planning ?
      I feel this can be acheived using BI - IP , but the question lies what could be the possible KPI's for this ?
      e.g on what keyfigure would we plan upon ?

      If we segregate some GL account to cash inflow & some to cash outflow accounts , then at one point of time , how is the current cash in hand  estimated ?


      Author's profile photo Former Member
      Former Member
      I think this is a good intro on cash flow planning , the subject is a bit confusing.

      At a short term  it is more like  working capital management and in the long term it is like  capital  investment  management.

      Author's profile photo Former Member
      Former Member
      Does SAP have the capabilities, without other 3rd party applications, to perform the typical DCF models that are done in an "Argus" type of software package?