Cash flow forecasting: identifying cyclical shortfalls

Alan Kuhnell has over 30 years experience advising boards of directors and financial stakeholders of multi-nationals; the last 16 years were spent at PwC in London. More recently, he’s been advising independent schools. Here, he shares his advice when it comes to cash flow forecasting.

The day to day management of a school is an onerous (but ultimately rewarding!) task which requires dedication and passion. With the time and effort required to manage the staff, the pupils, the curriculum and any other day to day business of the school, it’s not always easy to find the time and resource to devote to the detailed forecasting necessary to understand where the school’s finances are heading, and in particular, identifying any cyclical or structural funding shortfalls.

“The earlier such cash shortfalls are identified, the more options there are available to successfully address them.”

Ideally, detailed profit or loss and cash flow forecasts for the academic year ahead will have been prepared by the Spring. Then, they will be subsequently revised in the Summer as final pupil numbers and the mix are known. This is so that expected revenue can be accurately determined. Summary forecasts for, say, three years ahead should also have been prepared to give a more strategic insight as to where the school’s finances may be heading with the existing business model, and to facilitate assessment of the financial effects of alternative strategies.

Assuming that the school invoices a select group of parents on an annual basis and the rest termly, then it will have peak cash at the start of each term and low cash at the end of term before next term’s fees are received. If the school has historic cash reserves or it is generating significant surpluses of income over expenditure (including capital expenditure), then the low points in the cash cycle should be able to be readily managed. However, if the school is only marginally profitable and does not have historic cash reserves to call upon, it will very likely face cyclical cash deficits at the end of each term. This will be particularly prominent during the long summer break, which will require very careful planning to manage. Where the school is not profitable, besides the cyclical cash shortfall, there will be a structural cash shortfall likely to be highlighted in the cash forecast as an ‘ever increasing deficit’ at the end of each term.

How a forecast cash deficit should be manged will primarily depend upon whether it is cyclical or structural. If cyclical, the most cost-effective way to address it may be to temporarily defer any planned capital expenditure or improve the efficiency of working capital management. For example, the processes of invoicing and collecting fees from parents, looking at the credit terms agreed with suppliers and not holding excessive inventories. Alternative but more expensive ways to manage cyclical cash shortfalls include arranging an overdraft facility or perhaps leasing rather than purchasing new equipment and vehicles.

However, if any part of the forecast deficit is structural because the school is making a loss, then a different approach is required. Whilst deferring capital expenditure and improving working capital management may help in the short term, unless the structural deficit is eliminated this will only be a sticking plaster. And in a loss-making scenario, a bank will be reluctant to provide an overdraft facility unless it is offered both assets as security and it is provided with a realistic plan as to how the school intends to turn around its finances during a timeframe considered as acceptable.

If the identified structural deficit is forecast to become severe, then the solution may require a fundamental reassessment of the school’s business model. Such a course of action requires significant time and resource, so the first step will be to consider how to fund the cash deficit in the interim. This might be by the sale of surplus assets, interim bank funding (with security etc. as above), a loan from an interested party or identifying a new investor; but all of these options require time to arrange and hence the early identification of when a structural cash deficit is expected to arise, and the likely size of it is key.

Many finance functions will not have sufficient resources to provide the detailed financial information needed to help plan and implement a major strategic shift. In these cases, outside help will certainly be required. The first priority should be to ensure that there is timely and robust profit and loss and cash flow forecasting, enabling the anticipation of financial problems. Then, a third party could be used to set up a suitable forecasting model, and train personnel to use it successfully.

In summary, for the long-term health of the school, it is important to have good profit versus loss and cash flow forecasting models, in particular to identify any cyclical or structural cash flow shortages as early as possible in order to improve the chance of finding successful solutions and ensuring the successful future of the school.