Wouldn’t it be nice to be able to predict your future cash flow? You could better allocate funds and make more informed business decisions. Luckily, you can with accounts receivable forecasting.
Accounts receivable forecasting is like having a financial crystal ball. While it might be a challenge, depending on how you manage your accounts receivable, forecasting is a powerful tool to help you grow your business. Here’s how to forecast accounts receivable to quickly and reliably predict your future cash flow.
What Is Collections Forecasting?
Accounts receivable forecasting is a way to measure and track payment history and can also be used to predict future payments. It relies on clients’ payment histories to determine what your cash flow will look like in the future.
Why Is Forecasting Accounts Receivable Collections Important?
Cash flow is essential for business. It allows you to pay for monthly operating expenses like supplies, vendors, or even investments into new projects. If you’re not sure what your cash flow will look like in the future, you won’t be able to make effective business decisions.
Accounts receivable forecasting can provide you with an accurate and reliable balance sheet forecast, which can profoundly impact your working capital. Knowing what your A/R will look like in the future, you won’t have to rely on external financing options to boost your cash flow. And if you still need to utilize financing facilities, you’ll be able to make more informed decisions about how much you’ll need and how long it’ll take to pay it back.
An accounts payable projection simply gives you the tools and knowledge to help you make better, more effective decisions for almost all business aspects.
How to Forecast Accounts Receivable Collections Using DSO
The easiest and most accurate way to forecast your accounts receivable is using days sales outstanding (DSO). Here are the steps to calculate an accounts payable projection using DSO.
Step 1: Sales Forecast
The next step to predicting your accounts receivable is to determine a sales forecast. A sales forecast is simply the number of sales you expect to make over a certain period.
The easiest way to create an accurate sales forecast is to look at historical data. Most business is cyclical. If you made $300,000 for a certain month last year, there’s a good chance you’ll make something similar this year.
Don’t forget to account for any changes that may have occurred over the past year:
- Price changes
- Customer or account acquisitions
- Changes in payment terms
- Market growth
It might take some time to research all the data, but an accurate sales forecast is essential for predicting accounts receivable.
Step 2: Calculate Days Sales Outstanding
DSO stands for days sales outstanding, and it’s an important key performance indicator (KPI) used to determine your business’s financial health. It measures how long it takes customers to pay invoices on average, which directly impacts future cash flow.
Here’s the DSO calculation formula:
Days Sales Outstanding = (Accounts Receivable / Total Sales) x Number of Days
Once you know your average DSO, you can use that information to forecast your future accounts receivable.
Step 3: Calculate Accounts Receivable Forecast
Once you have your DSO and sales forecast, you use them to determine your accounts receivable forecast.
Accounts Receivable Forecast = Days Sales Outstanding x (Sales Forecast / Time Period)
Understanding your average DSO and sales forecast gives you a great base perspective, but it’s important to remember that reality is unexpected and you cannot always expect an average outcome. There will always be those clients that are either overdue or prepaid in invoices. And it’s crucial to keep those possibilities in mind.
Start with the data you have, and then identify which clients tend to deviate from an average payment cycle and take those into consideration. The final calculation will give you an accurate estimate of the cash you can expect to receive in the upcoming period—not just the sales. You can forecast accounts receivable for any time period. Most businesses choose either monthly or annual forecasts.
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Tips to Increase Accounts Receivable Forecasting Accuracy
Predicting the future is never foolproof. That’s why accuracy is key when you calculate your A/R forecast. Here are a few tips to help you increase your prediction accuracy:
- Split accounts receivable into subcategories – As you’re looking through historic data, separate your customer accounts based on specific criteria like customer size.
- Monitor and adjust assumptions – Things change. Don’t just run the same forecasting calculations over and over. Every time you predict your A/R, adjust your assumptions based on all available data.
- Use an automated A/R platform – Manually managing your A/R is time-consuming and leaves room for human error. The more potential for error, the less accurate your forecasting will be. Switch to an automated A/R platform like Gaviti to streamline your calculations and increase prediction accuracy.
With an accurate A/R forecast, you’re ready to predict future cash flow to make better, more effective decisions for your business. If you want to simplify your A/R management and make more accurate forecasts, contact us to learn more about Gaviti automated A/R collections solution. We’ll help you save time, reduce errors and make more accurate cash flow predictions to better manage your growing business.