Optimizing funds with cash flow forecasting: by involving operating departments in planning and prioritizing organization-wide s

In a study published in the August 2003 issue of Government Finance Review, 51 percent of the government finance professionals surveyed indicated a need for further developing their forecasting skills. Among the most important applications of forecasting skills is estimating cash receipts and disbursements for one or more periods. Cash flow forecasting is a tool used by local governments to avoid problem situations and otherwise enhance the responsible stewardship of the public's resources. GFOA offers practical guidance on cash flow forecasting in a newly adopted recommended practice--Use of Cash Flow Forecasts in Operations.

ENSURING LIQUIDITY, MAXIMIZING INVESTMENTS

Cash flow forecasting is important for local governments on two fronts: (1) to ensure proper liquidity levels are available to meet liabilities and (2) to maximize dollars available for investment. Without a picture of its expected cash flow position, a government may fall into the trap of blind spending. By blind spending, I refer to the practice of spending without regard for the drain on cash flow. Blind spending often leads to cash shortfalls and increased costs, either from having to borrow money to pay bills or from foregone interest earnings. Missing payroll in one month because of the purchase of a few squad cars in the previous month happens. It happens because the government did not have a handle on its cash flows. But even the most accurate cash flow forecast is worthless if the organizational units are not willing to adhere to established parameters on the timing of expenditures.

It was in this light that GFOA's Committee on Cash Management took on the task of developing a recommended practice on cash flow forecasting. Given the wide variety of organizations GFOA serves, it is possible that smaller units of government will benefit most from guidance in this area. Some organizations cite complexity as a reason for avoiding cash flow forecasting, along with being overwhelmed by day-today operations and the sheer volume of financial data. The recommended practice sets forth concrete measures that allow an organization to frame how a forecast is developed and used, thus allaying barriers such as complexity, data overload, and relevance. The following is a snapshot of the guidance in the recommended practice:

* Forecasting cash flow must be done on an organization-wide level

* The prioritization of expenditures is a function of the organization's goals

* Forecast timeframes need to accurately reflect the receipts of the organization

* Use historical data to measure activity of a cyclical nature, both for receipts and disbursement

* The forecast of receipts should include cash and both short- and long-term investments

* The forecast of disbursements should recognize the organization's priorities in light of statutory regulations on prompt payment

* Cash forecasters should recognize the items and controls that influence the organization's float, and develop strategies that favor the collection of receipts as soon as possible and the delay of disbursements for as long as possible

* Forecasts should leave room for error

CASH FORECASTING IN WARRENVILLE, ILLINOIS

For the City of Warrenville, Illinois (population 13,363), the use of cash flow forecasting has had concrete and demonstrable benefits. In the past, departments would aggressively pursue their spending plans as soon as the budget year began. This meant that the departments were submitting purchase orders for large capital items like police cars, computer systems, and public works vehicles at precisely the same time the city was being invoiced for summer roadwork and construction improvements. The strain on the city's concentration account was acute, and could only be relieved by pulling resources out of investments to meet the cash demand.

A similar cash drain would occur at the end of the fiscal year. Recognizing that budgeted funds would soon go unspent, the departments would start filling orders for items delayed as budgetary performance was measured. The result of both cycles was a frustrating lack of consistency for investment managers during the three to four month period around the beginning and end of each fiscal year. This not only hurt investment earnings, but it also increased costs.

To remedy this problem, the Finance Department organized a series of meetings and education efforts with the operating departments. Since operating departments were not aware of the city's overall cash flow situation, education was crucial to establishing the need for smoother spending. Likewise, the buy-in of the operating departments was crucial to establishing organization-wide spending priorities. The Police Department had to willingly take second priority to the Public Works Department in the May-June construction season. Public Works had to step back and allow Police to purchase new squad cars in July and August for delivery later that year. Coordination of all projects with receipts of property tax revenues is imperative.

After organizational spending had been established and prioritized, Finance identified a series of time periods for which knowledge of the city's cash position was crucial. The construction season was particularly important, given the high demands on the city's cash during that period and the need to coordinate construction expenditures with property tax receipts. Likewise, the city had to ensure that it had sufficient cash to meet debt service payments and other recurring expenses like payroll, insurance, and utilities. The city established single-month bookends for these periods, thus creating two separate cash flow timeframes.

Finance then pulled historical data on like expenses and established revenues for these same periods in previous fiscal years. The city analyzed growth rates for major sources of revenues and made assumptions about external influences on these revenues going forward to arrive at revenue estimates for the forecasting period. From there, it was simply a matter of plugging in the estimates of expenses to arrive at an optimal spending pattern in light of available resources. The city has not been forced to pull money out of an investment in more than four years.

Cash receipts and disbursements, available balances, and short-term investments are folded up into a graphic representation of the city's actual cash flow. Exhibit 1 is an example of what this looks like. In this example, the hypothetical organization has a serious cash flow problem in August. By forecasting cash flows in this manner, however, the government can take action now to smooth out its cash flow and avoid unnecessary costs.

ERIK W. BUSH is director of finance and information services for the City of Warrenville, Illinois, and a member of GFOA's Committee on Cash Management.

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