How to Improve Short-Term Accounts Receivable Collections Forecasting

No modern business can hope to thrive without the ability to predict the future. This may sound impossible, but forecasting is a skill. It is also a science that artificial intelligence has mastered.

Short-term accounts receivable forecasting is especially difficult because it involves digging beyond general patterns. Regardless of the deadline on the invoice, you must determine when and if clients might pay.

What Is Short-Term Accounts Receivable Collections Forecasting?

“Short-term accounts receivable collections forecasting” refers to the process of projecting payments the company will receive within a short period of time. For example, Company A has $500,000 in unpaid invoices from clients. All of these payments are due within the next two weeks. Company A also has outstanding costs, which amount to $450,000 and are due in 3 weeks. Company A recently bought new equipment and only has $25,000 cash in hand.

At first glance, it may appear that Company A will have enough money to cover the costs. However, Customer B owes $100,000 of that total and has occasionally paid invoices late or in installments. The process by which Company A determines whether clients will pay enough of their invoices so it can cover its own costs is known as short-term forecasting for accounts receivables.

Why Short-Term Accounts Payable Projections are More Difficult?

Using the example above, determining whether Customer B will pay its invoice within two weeks is a lot more difficult than estimating payment for a month. This is because, with short-term projections, there’s less time to accommodate variables that may affect payment. 

For example, the more interconnected the industry is, the more likely different variables, such as market demand or interest rates can greatly impact your business. The more interconnected the industry is, the more likely high-impact variables become. Customers might delay because they have not received payments from their customers or because they need to retain extra cash for accounting purposes.

The Importance of Forecasting Accounts Receivable

Forecasting accounts receivable has a number of benefits. First, it enables companies to accurately predict the cash flow they will have and enable better planning and investment for the future. This in turn helps companies avoid short-term borrowing and the possibility of debt. It may also help identify short-term cash flow issues and develop alternative financial plans to mitigate against last-minute financial risks. Finally, it can ensure that any cash flow issues do not cause operational disruptions. 

For example, imagine what might happen to Company A if it only received $400,000 of the money it was owed. To pay its obligations for the month, it would need to empty its banking account and would still be $25,000 short. If Company A knows this ahead of time, it can plan by reducing other expenses or seeking short-term loans with favorable rates. It can also ensure that all critical suppliers and services are paid in advance. 

Without accurately forecasting accounts payable and receivable, Company A could discover it needs extra money just days before its payments are due. This significantly increases the need to rely on fast financing, which negatively impacts the bottom line.

Accounts Receivable Forecasting Models

If your A/R team is trying to determine how to project accounts receivable, there are a few models it can choose from:

• Historical averaging. This model uses historical data to identify patterns and predict future cash flow. 

• Market adjustments. This approach uses other methods but makes manual adjustments based on conditions such as: sudden industry growth, emerging technology or a global economic recession. 

• Rolling forecasts. Rolling forecasts take the historical average, but over a changing time period. For example, instead of calculating a static 12-month period, it would take the average of 12 months from the current data. 

What Is the Forecasting Accounts Receivable Formula?

However, the simplest option for forecasting account receivable is by using DSO (days sales outstanding):

Accounts Receivable Forecast = DSO x 

(Sales Forecast ÷ Days in Forecast)

Where DSO = average accounts receivable ÷ (annual revenue ÷ 365)

You should also note the days in the forecast refers to the time period used for the projection. The sales forecast refers to the expected revenue from sales.

How CFOs and Finance Teams Can Improve Short-Term AR Collections Forecasting

Improving short-term AR collections is a never-ending process. These are some of the more successful methods CFOs and finance teams have used:

• Analysis: Paying keen attention to industry trends, seasonal trends, and client trends can better determine who will pay in full and when. There is no standard way to accomplish this, so it will take some trial and error.
• Contingency: Planning for the possibility of not receiving on-time payments by introducing variance can help. It can also help collections teams evaluate their own projection performance.
• Organization: Categorizing accounts receivables can make it easier to determine which customers pay more easily and quickly. You can either choose categories based on placement in the supply chain, payment history, or different industries.

Gaviti Helps Accurately Forecast Your Accounts Receivable

Knowing how to forecast cash cashflow is critical for cash flow management, but it is only one part of effective management of your accounts receivable. Gaviti’s A/R management and automation platform streamlines your entire A/R process, from credit management to cash application and credit monitoring and disputes and deductions. It also centralizes your data, including KPIs such as total A/R, DSO, collections rate, and customer risk so that you can track collections performance of both individual team members and your A/R team as a whole. Having the data in one place makes it easier to correlate payment history with customer risk to generate AI-driven insights that accurately forecast future payments.

Want to learn more about how Gavit can help you accurately forecast your accounts receivables? Speak to a specialist today to get started.