The accounting staff is frequently responsible for creating the cash forecast. Accountants can usually create reasonably accurate estimates of the amounts and timing of incoming payments from customers and outgoing ones to suppliers. However, the inventory component of the forecast can be downright befuddling. Inventory levels may rise or fall so sporadically that it appears impossible to forecast accurate payables.
One element of inventory forecasting that causes so much heartburn for the accountant is the bullwhip effect. This is when the company runs into a materials or capacity shortage, and informs its customers that they are being put on an allocation basis. The customers immediately ramp up their order quantities so they can lock in a greater proportion of the company’s output over a longer time horizon, which forces the company to increase its capacity to meet the unexpected demand; once the company starts meeting the larger orders and eliminates its shipment allocations, customers promptly shrink their planning horizons, find that they now have plenty of inventory for their immediate needs, and rescind most outstanding orders. The company has just been the victim of the bullwhip effect. The accountant’s cash forecast has also been bullwhipped, as the payables line item alternatively skyrockets and dives. How to avoid this problem?
The controller should monitor the issuance of any order allocation notices to customers, and see if there is a sudden order increase that occurs subsequent to the notice. If so, the controller should work with the materials manager to estimate “real” order volumes based on the historical order volumes of each customer, adjusted for any seasonal effects. Inventory planning should incorporate these historical values, rather than the incremental jump in orders, until such time as the allocation notice is rescinded and order volumes return to their normal levels. This kind of proactive planning will result in a much more accurate cash forecast, and will also keep a company from suffering through the inventory and production gyrations of the bullwhip effect.