Accounts Receivable Forecasting

Properly forecasting cash flow is essential to managing a business successfully. Poor cash management can create serious and in some cases unsurvivable problems for companies.  For this reason, accurate cash flow forecasting is a critical success factor for almost every business.  Accurate cash flow forecasting depends in part on the availability of relevant and accurate information.  It also relies on the ability of the recipient of that data to create a model that aggregagates the information provided and formats it in a way that simplies the cash forecasting process.

Forecasting cash collection is a complex, difficult, and often misunderstood process.  Forecasting cash inflows from customers may be assigned to the credit department.  When it is, the cash forecasts generated are often so inaccurate as to be of little practical use to the creditor company.  For that reason, it is worth your time to examine some of the tools that can be used to improve forecasting cash inflows (payments) from customers.

Simply using last month's or last years collections as a benchmark when creating a forecast is generally not sophisticated or accurate enough to be of any benefit to the creditor company as a tool to manage cash inflows and outflows.  Efficient and accurate cash flow forecasting helps creditor companies make appropriate strategic and operational decisions involving investments and working capital. Forecasting requires establishing a disciplined process as well as establishing specific goals relating to the accuracy of cash forecasts and in particular cash inflows. 

Striving for perfection inorecasting cash inflows isnota fool's errand.  Here are some guidelines and thoughts about the process that include topics such as purpose, time periods, and formatting ideas

Purpose of the Forecast

There should be general acceptance as to why the forecast is being prepared. This included understanding: Who are the users of the forecast? Who is asking for the information? What will the forecast be used for? What is the purpose of each forecast?

Forecast Time Periods

The time horizon and the regular reporting periods are key decision items. For instance, if the forecast is to be prepared monthly, it is important that it be coordinated with regular accounts receivable reporting so it does not create extra work for everyone and so it takes the most updated information. It should tie in to reported figures. This means that there will probably be some time delay necessary after normal accounting closing to provide the data. The time horizon is an important factor, but it is usually set when the forecasting system is first designed. For instance, the forecast may be for daily collections for the next week, weekly collections for the next month, monthly collections for the next year, or quarterly collections for the next two to three years. Obviously, the length of the time horizon will have an influence on the desired accuracy of the forecast and the amount of work required to prepare the forecast regularly.

Responsible Departments and Staff

Establish a focal point for your forecasts: i.e., is it corporate treasury, or are you going to try to forecast for each major operating area? Who has the information needed to successfully complete the forecast?

Analysis of Current Process

Define the forecasting process for your company (if you already have not). Assess whether the process is sufficient. Have changes in your company's structure influenced the current forecasting process? Review major problems, shortcomings, and strengths of the current system, planning to keep the good and throw out the bad. Will the process need to be changed? What were the lessons learned from the last forecast? How will the lessons be incorporated?

Level of Detail and Accuracy

Can the forecast be produced regularly and reliably? What is the level of detail required? For example, does it need to be at the country, region, product, or company level? Are total amounts enough or will each number need to be broken out into more detail? How will the accuracy or lack of accuracy be accounted for? Shorter-term forecasts differ from longer ones in that they will usually require higher degrees of accuracy. This is because their time periods are smaller, which means that there is little time to recover from or accommodate widely inaccurate estimates that could have severely negative effects on the tactical decisions being made on the basis of the forecast. Longer-term estimates, on the other hand, may not need such accuracy as they are used to make more strategic decisions.

Forecast Data Format

The format of the forecast is the way in which the estimates are presented. For example, shorter-term forecasts including those up to one year, are often more meaningful if they are presented in a receipts and disbursements format, which shows the cash flows in common terms. The opposite of this type of format is a financial statement format, which may look like a statement of cash flows or extracted items from a balance sheet and/or income statement. This type of format is fine for longer-term forecasts, such as those for longer than a year, but it is very confusing and difficult to work with for shorter forecasts. Some senior managers may be accustomed to this format and may suggest using it for shorter forecasts, but it can provide estimates that are not understandable or that cannot be reconciled easily with actual data.

Summary

Once a process is in place to accurately forecast cash inflows, the company can focus on making cash management decisions based on sound information rather than on best guesses.

Edited by Michael C. Dennis.  Michael is the author of "1001 Collection Tools and Tips".  He can be reached at mcdennis13@yahoo.com