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.
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.
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).
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.
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.
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.
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.
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.
Here are the following barriers while creating account payable forecasts manually:
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.
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.
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.
As spreadsheet is unable to capture market fluctuation such as:
These certain expenses tend to increase, which affects the accuracy of the cash forecast.
The possibility of negative variance is primarily due to the lack of granular visibility into inflows and outflows using spreadsheets.
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.
Here are some best practices to improve 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.
Introducing automated cash forecasting systems can provide fast financial information and help avoid delays and challenges in the business.
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:
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.
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.
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.
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.
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.
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.
A leading global children’s entertainment company with a revenue of $155.3 crores was facing challenges in its account payable forecasting:
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