How to Improve the Accuracy of Accounts Payable Forecasting

17 April, 2023
Gerry Daly, AVP Product Strategy - Treasury

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Table of Content

Key Takeaways
Guide to accounts payable forecasting
Why is accounts payable forecasting so difficult?
How to improve accounts payable forecasting?
Benefits of accounts payable forecasting
What are the advantages of using the cash flow forecasting system?
Transformation stories of HighRadius’ cash flow forecasting system

Key Takeaways

  • Forecasting accounts payable helps prevent cash flow disruptions and provides information on liabilities for cash management, optimization of cash spending, and more.
  • Accounts Payable Days (DPO) is a metric that measures the average number of days a company takes to pay its invoices and bills. 
  • A higher DPO indicates better credit terms from suppliers, but a lower DPO may mean better vendor relationships.

Guide to accounts payable forecasting

Accounts payable forecasting is a process that helps a company plan for its production needs and avoid problems beforehand. To get into the nitty-gritty of getting it right, let’s first understand the importance of accounts payable. 

In this blog, we will discuss how to forecast AP, the challenges associated with it, and how you can overcome them.

What is accounts payable?

Accounts payable (AP) is the amount that a company owes to its creditors and suppliers against the purchases made. It is recorded on the balance sheet under current liabilities. Accounts payable is a leading indicator of the entire amount of upcoming liabilities, including supplier payments.

What is the role of forecasting accounts payable?

The main role of forecasting accounts payable is to prevent cash flow from unexpected disruptions. It also provides information on liabilities (costs and debts) that helps with cash management. Additionally, it helps to optimize the remaining cash to spend on growth and investment.

How to forecast accounts payable?

Accounts payable entries are directly connected to companies’ cash cycles. When creating a cash forecast, treasurers need to calculate it based on days outstanding or the average number of days required to get paid (accounts receivable), sell finished goods currently on hand (inventory), or pay companies short-term liabilities (accounts payable).

What is the significance of forecasting accounts payable?

Accounts payable forecasting assists to fine-tune your payment patterns. It captures essential incentives such as early payment discounts when desired. This leads to maintaining a healthy working capital ratio while preserving vendor relationships.

Forecasting accounts payable also helps a company plan for its production needs and avoid problems. Automating the process can provide fast financial information and help avoid delays and problems in the business.

What is Days Payable Outstanding (DPO)?

Accounts Payable Days, also referred to as Days Payable Outstanding (DPO), is a financial metric that measures the average number of days that a company takes to pay its invoices and bills. 

Days Payable Outstanding (DPO) Formula

Accounts Payable Days (DPO) Formula

For example – In a B2B scenario, let’s say Company ABC Corp has accounts payable of $50,000 and a cost of goods sold of $500,000 for the current quarter. The current quarter has 90 days.

To calculate DPO, you would use the following formula:

DPO = (Accounts Payable / Cost of Goods Sold) x Number of Days in Period

DPO = ($50,000 / $500,000) x 90

DPO = 0.1 x 90

DPO = 9

So, Company ABC Corp takes an average of 9 days to pay its accounts payable.

What is a good DPO? Is a higher or lower DPO better?

Days payable outstanding (DPO) determines the average number of days required to pay a company’s expenses and liabilities.

Calculating and monitoring DPO can help the AP teams find ways to streamline operations and improve cash flow.

A high DPO is usually better because it means the company is getting good credit terms from suppliers and can use cash for other expenses or short-term investments. A low DPO means the company pays bills faster but may not have good credit terms with suppliers. 

Sometimes a company chooses to pay quickly to improve vendor relationships or get early-payment incentives. However, higher DPO numbers, while desirable, may not always be favorable for the business since they can indicate a cash shortage and inability to pay.

Why is accounts payable forecasting so difficult?

Accounts payable forecasting is accurate in the short-term, up to the next 2 to 4 weeks. However, due to the uncertainty surrounding payments, accuracy suffers in the long run. With the limitation of spreadsheets, treasurers also have to deal with the unpredictability of accounts payables while creating a cash forecast.

Challenges in accounts payable forecasting

Here are the following barriers while creating account payable forecasts manually:

Challenges in accounts payable forecasting
  1. Sudden / Unexpected expenses
  2. Errors caused at record entries
  3. Lost open invoice data
  4. Increase in the cost of goods sold(COGS)
  5. Lack of granular visibility
  6. Difficulty in predicting payments

1. Sudden / Unexpected expenses:

Unexpected expenses such as breakdowns, an increase in inventory, and sudden payments may arise, which contribute to variance. As an impact, treasurers need to establish additional cash buffers. That helps to absorb the impact of unexpected expenses. Volatility in CAPEX project particulars such as payment dates and timings.

2. Errors caused at record entries:

Raising a purchase order to issue a vendor invoice is often a manual operation. That leads to errors such as record duplication and incorrect invoice amount capture. This inaccurate information also gets considered while building a forecast. As a result, there is an increase in the variance and cash buffers.

3. Lost open invoice data:

Most of the enterprise’s data (invoice data) related to accounts payables is in various systems such as ERPs, CRMs, and Billing Management Systems. Collecting those invoices manually is challenging and also time-taking. Sometimes few of these invoices miss getting considered. This leads to high variances, costs of payments, and an impact on an organization’s creditworthiness.

4. Increase in the cost of goods sold(COGS):

As spreadsheet is unable to capture market fluctuation such as:

  • Labor costs
  • Manufacturing costs
  • Raw materials cost
  • Increased variability during seasonal rebate programs

These certain expenses tend to increase, which affects the accuracy of the cash forecast.

5. Lack of granular visibility:

The possibility of negative variance is primarily due to the lack of granular visibility into inflows and outflows using spreadsheets.

6. Difficulty in predicting payments:

It is difficult to predict payments for which invoices haven’t arrived yet from suppliers. This unpredictability of cash flow categories negatively impacts other factors such as working capital management and long-term liquidity.

How to improve accounts payable forecasting?

Here are some best practices to improve accounts payable forecasting:

  • Analyze historical data by estimating which forecasting period had sudden expenses and high variance. Additionally, identify the reasons behind it.
  • Identify the categories of the payments that suddenly cropped up and the reasons behind them.
  • Determine instances of late payments and the penalty imposed.
  • Identify the payments made on time and the goods/services purchased on the purchase order.
  • Identify payment patterns of repayments related to debt.
  • Calculate the taxes paid during an accounting period.

Benefits of accounts payable forecasting

Forecasting accounts payable can help you prevent cash shortages, realise early payment discounts, and build good relationships with suppliers. An accurate AP forecast gives key insights into how much working capital will be available for innovation and growth once debts are paid.

Additional benefits of accounts payable forecasting

  • Helps to maintain strong relationships with suppliers. 
  • Gives appropriate forewarning about the amount of outgoings.
  • Reduces the chance of missing a payment deadline due to low cash availability.

Introducing automated cash forecasting systems can provide fast financial information and help avoid delays and challenges in the business.

What are the advantages of using the cash flow forecasting system?

Cash flow analysis tools assist in avoiding last-minute hurdles. Proper cash flow analysis tools help to stay financially stable by planning outlays on capital expenditure in advance.

Here are some key benefits of the HighRadius’ cash flow forecasting system:

  • Customized AI models designed for specific needs:

    Our data scientists analyze the company’s data to develop customized cash flow forecasting models that provide high accuracy in AP forecasts by being aware of your obligations and the DPO of your business.

    How to Improve the Accuracy of Accounts Payable Forecasting
  • Realistic cash predictions:

    An AI-based cash flow forecasting system would compare historical and recent data and run scenarios using different AI algorithms, selecting the most optimistic and realistic cash prediction to produce an accurate AP estimate. This allows the treasurer to anticipate expenses that may happen throughout the forecast period and cost fluctuations.

  • Integrates with all systems:

    HighRadius cash flow forecasting tool is designed to integrate effortlessly with any ERP, TMS, accounting solution, or other legacy systems through API or sFTP, preventing lost open invoice data for companies’ AP forecast.

  • Rational scenario planning through Excel-on-Web:

    Risk management becomes more accessible through AI-based scenario planning, which is done by tweaking minor data in a spreadsheet. This feature allows enterprises to incorporate sudden expenses into their accounts payable forecast.

  • Drill down into entity-level forecast:

    This feature of the cash flow software allows users to drill down into local-level cash flows and forecast data into categories such as geography, currency, and customer.

  • Easy collaboration:

    The Highsheets feature of the cash flow software allows tweaking of the forecasting models by enabling multiple users to collaborate and modify inputs on a know-how basis.

Transformation stories of HighRadius’ cash flow forecasting system

A leading global children’s entertainment company with a revenue of $155.3 crores was facing challenges in its account payable forecasting:

  • Pulled short-term 30 days for AP from SAP into spreadsheets.
  • Spent 4,300+ hours/year on data consolidation and lost details in consolidating data.
  • Data was spread across 25 different entities around the world. Performed variance analysis monthly for some of their entities.
  • They had a sweeping structure: 2-4 weeks is the time frame they conducted variance analysis for.

Advantages offered to them with HighRadius cash forecasting software:

  • Increased efficiency:
    • ≥ 92% automation rate
    • Elimination of ≥ 3,960 manual hours
    • Integration with SAP, FP&A & other sources
    • Ability to create manual adjustments/overrides
  • Increased forecast frequency (up to 12-month forecast duration).
  • Increased forecast accuracy (> 90% accuracy) globally, with better quarter-ending cash predictions.
  • Improved reliability with clear visualization of available cash.
  • Improved visibility with:

Related Resources

Cash Forecasting
Treasury & Risk
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