One of the most difficult aspects of the budgeting process for any financial institution is for management to decide the optimal trade-off between expediency and accuracy. This is most evident when choosing how to plan balance sheet items and their net interest margin.

“Expediency” and the Average Balance-Average Rate Approach

If management decides to go the “expedient way,” the institution will choose an “average balance-average rate approach,” in which budget inputs are based on where the department manager believes their volumes and rates will be with no regard to what current volumes (and their runoffs) have on their position.

“Accuracy” and the Cash Flow Approach

If management decides to use a more “accurate” approach, they will use a “cash flow” method, where the current balance sheet position runs off over the budgeting time horizon based on the account’s characteristics. A variation of this method is to download results from an Asset/Liability system, and although very accurate, this method also has its challenges.

Why Traditional Approaches Fail:
Shortcomings of traditional approaches to projections

There are numerous approaches that institutions have traditionally employed to produce net interest income/margin and balance sheet projections for the annual plan or periodic forecast. These approaches include:

  • Planning for volumes only, not pricing or rate changes – This method omits any realistic margin calculations.
  • Using the ALM forecast generated for the consolidated institution – Not typically calculated at the individual business unit level, therefore this method does not show a realistic view of individual unit contributions to budget results.
  • Leveraging an ALM projection and allocate the margin to the associated units within the organization – Although a more accurate indication of the business unit, the allocation methodology can be difficult and lend itself to misleading results.
  • Planning at the profit center level with ‘simple rate times balance’ math – This common methodology lends little accuracy in the resulting margin calculation.

Why Institutions Choose Collaborative Cash Flow Margin Planning:
Benefits of cash flow planning

Collaborative cash flow margin planning (CCFMP) is a marriage between ALM and traditional financial planning approaches. More and more institutions are turning to this approach because of its many benefits, including:

  • Greater precision with regard to balances, net interest income and margin projections
  • Increased accountability – line of business stakeholders own the plan
  • Provides better focus on incremental new business – both volume and spread
  • Inclusion of forward-rate funds transfer pricing, so that business units can plan the margin contribution through time
  • Stronger modeling capabilities such as the ability to process meaningful “what if” scenarios
  • Greater insight into balance sheet and margin performance


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Critical Steps to Successful Cash Flow Planning

Instead of modeling one enterprise balance sheet as ALM typically does, CCFMP creates tens, hundreds, or even thousands of planning unit balance sheets – each reflective of the product mix, pricing and other nuances of the local markets they serve. With the incorporation of forward funds transfer pricing (FTP), CCFMP is positioned to include economic capital allocations, service transfer costs and other features that allow each planning unit to be measured on a risk-adjusted return basis. Using CCFMP, organizational profitability can be merged with the planning process, thereby applying a consistent view of the business regardless of whether it is forward or backward looking. The absence of forward rate FTP and a cash-flow based planning methodology suchas  CCFMP negates any ability to merge these views.

three critical steps for cash flow planning

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3 critical steps to successful cash flow planning