Forecasting Accounts Receivable: How Automation Can Improve the Process

What is accounts receivable forecasting? 

In more detail, A/R forecasting focuses on collecting and analyzing existing payment records — such as invoices, receipts, bad debt statements, and other financial reports — to identify behavior patterns within individual accounts and across the broader customer pool. Not only is this knowledge helpful in determining the probability of when or if current invoices will be paid, but it can also provide visibility into the likely behavior of new and future buyers.  

Why accounts receivable forecasting is important 

Alongside offering a clear picture of your company’s overall financial health, your A/R — and, by extension, your broader cash flow — also helps to identify what resources are available to support efforts beyond your day-to-day operations. Suppose you’re hoping to fund an equipment refresh, a significant marketing push, additional hires, or an expansion into a new territory. In that case, it’s critical that you have a solid understanding of what funds are and will be available to you in the future. The more accurate these predictions, the fewer last-minute changes or compromises your chief financial officer (CFO) and other vital decision-makers must make.

Alongside more efficient and effective planning, A/R forecasting can also help your business:

• Avoid unnecessary loans by better leveraging available funds
• Isolate and eliminate process bottlenecks to improve accounts receivable
• Limit the likelihood of bad debt being added to your financial records
• Broadcast a more accurate picture of company health to stakeholders and investors

How to forecast accounts receivable using DSO

You can use a few different methods to create your A/R forecast. Given the built-in uncertainty of any prediction effort, consider contrasting the results of a few other models before making a significant financial decision. Some common strategies include:

• Historical averaging that concludes existing records from a specific period
• Market adjustments that build off of captured performance data, modifying these figures to account for outside considerations like inflation or sales spikes
• Rolling forecasts that engage in an ongoing practice of historical averaging, shifting the examined period as time passes
• Days sales outstanding (DSO) — an A/R key performance indicator (KPI) —that measures how quickly your business can convert sales into cash

That said, the days sales outstanding strategy offers the most straightforward option if you manually build your forecast. For this process, you’ll need to:

Step 1: Create a sales forecast

Before making your A/R forecast, you must develop a sales forecast for the same targeted period. Similar to A/R forecasting, there are multiple strategies you can use to construct this projection, depending on what data you have available. Ideally, before running any calculations, you’ll first want to assemble accurate, up-to-date records and reports that catalog the entire procure-to-pay pipeline at the account and enterprise level.

The most straightforward forecasting option, the historical method, simply maps sales data for the same period from the previous year onto the projected window. Alternate options will also leverage historical sales data but at the same time attempt to compensate for outside factors, including:

• Market conditions (e.g., inflation, supply chain shortages)
• Sustained growth
• Pricing adjustments both in your products and raw materials
• Customer churn
• Market share
• New regulations

Forecasting sales formula

Just as there are many methods for generating a sales forecast, various formulas are also available. Some standard options include:

Sales Forecast = Total Sales Last Year + (Average Monthly Sales Rate x Months Remaining in the Year)

Or

Sales Forecast = Total Sales Last Year + (Total Sales Last Year x Inflation Rate)

Or

Sales Forecast = Total Sales Last Year + Expected Growth – Expected Churn

Forecasting sales example

To illustrate how forecasting sales works in practice, consider the following example:

Expanding the scope of what can be considered music, Twang n’ Clang Co. manufactures and sells rubber band-based musical instruments. Wanting to plan out some ambitious marketing campaigns for the rest of the year, the business needed to project its future sales for the second half of 2024.

Having assembled its sales records from 2023, the company identified that it had made $258,000 in sales during the third and fourth quarters of that year. At the same time, Twang n’ Clang’s accounting staff identified a steady growth trend of 12% each month over the first six months of 2024 and a corresponding average churn rate of 2%.

Given these figures, Twang n’ Clang projected sales of $283,800.

Sales Forecast = $258,000 + (.12 x $258,000) – (.02 x $258,000) = $283,800

Step 2: Calculate days sales outstanding 

With your sales forecast, you’ll next want to calculate your DSO. Fortunately, this metric is much more straightforward, capturing the average days between a business sending out an invoice and receiving the corresponding payment. You’ll typically want to target a DSO below 45 days to align with accounts receivable best practices. However, that goal may need to be adjusted depending on your industry, your region, or the comparable DSO of your competitors.

DSO formula 

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

Calculating DSO example

In the first six months — or 182 days — of 2024, Twang n’ Clang made $236,000 in sales, and its outstanding accounts receivable on June 30th was $49,000. As such, the company’s DSO for the first half of 2024 was 38.8, meaning the average delay between invoice date and payment was just under 39 days.

DSO = ($49,000 ÷ $236,000) x 182 days = 38.8

Step 3: Forecast accounts receivable 

At this stage, you have all the information you need to quickly and easily generate your A/R forecast for the given time. Simply plug your data into the following formula. 

Forecasting accounts receivable formula 

Accounts Receivable Forecast = Days Sales Outstanding x (Sales Forecast ÷ Time)

Forecasting accounts receivable example

Returning to Twang n’ Clang and its efforts to forecast A/R for the remaining 184 days of 2024, the business can expect a future A/R balance of $59,845 — plenty to help support its marketing plans.

Accounts Receivable Forecast = 38.8 days x ($283,800 ÷ 184 days) = $59,845

How automation can improve accounts receivable forecasting 

As mentioned, leveraging your DSO is likely the easiest way to generate a usable A/R forecast manually, but it still requires a fair amount of labor. However, with the right automation tools in place, you can streamline these calculations while boosting the accuracy of your predictions and simplifying your overall accounts receivable management.

You can avoid potential transcription or calculation errors by minimizing the direct human involvement in your forecasting efforts and instead relying on integrated data streams that feed real-time information into customizable reports and dashboards. Additionally, with software handling calculations, you can explore more complex forecasting methodologies, yielding potentially more accurate predictions while investing less time and effort into the process.  

Invoiced: Automated accounts receivable forecasting and more

Of course, not all automation platforms are the same, so you should consider Accounts Receivable Automation software that provides comprehensive access to pre-built, customizable report templates that actively monitor the A/R KPIs that matter. With Invoiced, our A/R software solution does all of this and more, such as an integrated cash collection forecasting function that helps remove the guesswork from your planning and budgeting efforts. 

Even better, automated workflows and our Smart Chasing technology can accelerate your collection timelines, strengthening your cash flow and giving your business more capital to work with now and in the future. But don’t take our word for it. Explore what our software can do for you first-hand by scheduling a demo today.