Forecasting Accounts Receivable

Forecasting accounts receivable helps businesses predict the cash they expect to collect from customers within a given period. When businesses estimate future payments, they can better manage cash flow, plan expenses, and make informed decisions to maintain financial stability. Accurate forecasting also supports effective credit management and reduces the risk of overdue payments.

What Is Accounts Receivable Forecasting

Accounts receivable forecasting is the process of estimating the amount of money a business expects to receive from its customers for goods or services sold on credit over a specific future period. 

This forecasting helps companies anticipate incoming payments and plan their financial operations accordingly. When businesses analyze historical payment patterns, customer behavior, and current outstanding invoices, they can predict when and how much cash will be collected. 

Accurate accounts receivable forecasting enables organizations to identify potential cash shortfalls in advance, optimize working capital, and make strategic decisions such as managing credit terms, adjusting budgets, or securing short-term financing. 

Why Is Accounts Receivable Forecasting Important

Accounts receivable forecasting provides insight into expected cash inflows. This foresight allows businesses to plan more effectively and avoid cash flow surprises. The benefits are:

• Improved Cash Flow Management: Helps ensure there is enough cash on hand to cover daily operations and expenses.
• Better Budgeting and Financial Planning: Enables more accurate forecasting of revenues and expenditures.
• Early Identification of Payment Risks: Highlights potential late payments or defaults so corrective action can be taken.
• Optimized Credit Policies: Assists in adjusting credit terms to encourage timely payments.
• Reduced Need for Short-Term Borrowing: Minimizes reliance on loans or credit lines and forecasts incoming funds.
• Enhanced Business Stability and Growth: Supports informed decision-making and long-term strategic planning.

Forecasting Accounts Receivable Using Days Sales Outstanding (DSO)

When it comes to forecasting your accounts receivable (A/R), there are multiple techniques you can use. Since predictions always carry some uncertainty, it’s smart to compare different models before making any major financial decisions. Common forecasting methods include:

• Historical averaging: Using past financial data from a specific period to estimate future figures
• Market-based adjustments: Starting with historical data but factoring in external influences like inflation or seasonal sales trends
• Rolling forecasts: Continuously updating projections and moving the historical data window forward as time progresses
• Days Sales Outstanding (DSO): A key performance indicator that calculates how many days it takes to collect payment after a sale

Of these, the DSO method is often the simplest to apply manually for forecasting accounts receivable. Here’s a step-by-step approach:

1. Prepare a Sales Forecast

Before estimating your A/R, you need to project your sales for the target period. Various strategies exist depending on the quality and quantity of your available data. It’s best to collect accurate, up-to-date sales and procurement records at both the individual account and overall company levels.

One straightforward way is to use last year’s sales data for the same timeframe as a baseline. More sophisticated approaches adjust this data to incorporate external factors like:

• Changes in the market, such as inflation or supply chain issues
• Growth trends in sales volume
• Adjustments in pricing of products or raw materials
• Customer retention and loss rates
• Shifts in market share
• New regulations impacting business

Some formulas for sales forecasting include:

• Sales Forecast = Last Year’s Total Sales + (Average Monthly Sales × Number of Months Remaining)
• Sales Forecast = Last Year’s Total Sales + (Last Year’s Sales × Inflation Rate)
• Sales Forecast = Last Year’s Total Sales + Projected Growth – Expected Customer Churn

2. Determine Days Sales Outstanding (DSO)

Next, calculate your DSO, which represents the average time between invoicing and payment collection. Generally, keeping DSO below 45 days is advisable, though acceptable values vary by sector and region.

DSO is calculated as:

DSO = (Accounts Receivable ÷ Net Credit Sales) × Number of Days

3. Forecast Your Accounts Receivable

Finally, use your sales forecast and calculated DSO to estimate the accounts receivable for your forecast period.

Accounts Receivable Forecast formula:

Accounts Receivable Forecast = DSO × (Sales Forecast ÷ Number of Days in the Forecast Period)