Managing your business finances demands knowing how much cash is flowing into and out of your business during any given period. And to manage cash flow effectively, you'll need to know how to forecast accounts payable. By forecasting accounts payable, you'll have a better understanding of your future expenses and be able to use this data for better cash flow management.
What is accounts payable forecasting?
Accounts payable forecasting helps you predict the timing and magnitude of your future debts so you can align your overhead expenses with your operating budget.
Financial teams therefore rely on historical data to predict the company's future expenses. Proper AP forecasting will prevent your business from being surprised by future costs, which in turn aids in your financial planning processes.
By implementing the best practices for forecasting accounts payable, you'll gain deeper insight into your company's financial health. You'll also improve the relationship you have with suppliers, who may award you with early payment discounts for making timely payments.
Benefits of forecasting accounts payable
Knowing how to forecast accounts payable can provide strategic value to your entire organization. Here are three important benefits of accounts payable forecasts.
Improve cash flow
Accounts payable forecasting can improve your cash flow. According to one study, 82% of businesses fail due to problems in cash flow management. While cash flow is also dependent on accounts receivable, AP forecasting can help businesses optimize their payment schedule to maintain consistent working capital.
Maintain vendor relationships
Cash flow forecasting can improve supplier relationships. Businesses will be better able to predict when they'll need to reorder inventory or supplies, and they can ensure that vendors receive timely payments. Not only will this avoid penalties due to late payments, but some suppliers may offer early payment discounts that can save you money on your next order.
Predict future cash flow
Accounts payable projections will also help you predict future cash balances. This data will provide you with a better picture of your working capital and what you can allocate toward future improvement projects and other business opportunities. And if you anticipate a disruption in your cash flow (e.g., a low period in your sales cycle), you can take steps to strategically improve your AP processes and maintain steady cash flow.
Ensure smooth operations
The more accurately you can project accounts payable costs, the more you'll be able to predict future cash flow. This ensures that you have the working capital to cover your short-term liabilities, such as payroll, and your most immediate financial obligations. Without a clear cash flow forecast, your business could be in danger of running out of money and becoming unable to cover your operating costs, which could result in a business interruption.
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Why forecasting accounts payable can be difficult
As you can see, accurate financial forecasting can play a strategic role in the operation of your business. Unfortunately, accounts payable forecasting isn't always easy. Business owners and financial teams face several critical challenges, including:
Unforeseen expenses
Financial forecasting typically relies on historical data. Last year's cash flow statement may not reflect upcoming expenses that you didn't expect — like needing to repair or replace business equipment.
Rising costs due to external economic conditions
While you may predict some costs, these costs can rise from year to year due to inflation. Unless you factor rising inflation costs into your financial projections, these increased expenses could impact the magnitude of your accounts payable expenses.
Errors in accounts payable data
Sometimes simple errors on your income statement or other documents can create inaccurate forecasts. For accounts payable forecasting, errors made in invoice processing could result in duplicate payments or paying the wrong balance — which could also add to costs through late fees.
Missing invoice data
What if an invoice is missing information about the number of goods or the vendor's payment terms? This missing data could lead to incorrect payments, which lead to false financial forecasts and an unclear expectation of cash flow.
Increase in the cost of goods sold (COGS)
Sometimes vendors will simply raise the price of their materials or supplies. This will also impact your cash flow forecasting since you'll have to account for the rise in costs — even though these price hikes aren't necessarily regular or predictable.
Lack of visibility into your financial data
Legacy accounts payable systems allow you to analyze historical data, but they don't always provide you with accurate accounts payable information or real-time visibility. As a result, you may not have direct insight into your financial performance, or you may fail to adapt to changes as they happen.
How to forecast accounts payable
There are several methods you can use when forecasting accounts payable. Here's an overview of each method and a description of the accounts payable forecast formula used by the days payable outstanding method.
Direct method
The most direct method simply involves calculating your future accounts payable based on invoices or bills that you expect in the immediate future.
For example, if you already plan on submitting purchase orders or receiving an inventory replenishment, you can calculate expected accounts payable costs based on known financial data. The only drawback is that this method doesn't account for unforeseen expenses or changes in the economy or cost of goods sold.
Indirect method
The indirect method relies on overall cash flow patterns to estimate your future accounts payable. Instead of using individual invoices, you'll simply look for broader patterns in your company's expenses. While this may sound imprecise, it can be surprisingly beneficial in predicting and responding to seasonal and cyclical sales trends, helping you align your forecast with your previous business trends.
Percent of sales method
Another key accounts payable forecasting method involves a percentage of projected sales. This, too, depends on historical accounts payable data. You can calculate your average accounts payable costs as a percentage of your total sales.
Then, you can take your projected sales figures and use this same percentage to calculate your accounts payable projections. Just remember that this method assumes that you have clear sales projections and that the percentage of sales will remain constant in the future.
Regression method
In the regression method, business leaders will look for relationships between accounts payable and other variables. For example, you may determine a relationship between your accounts payable costs and production levels. As production levels increase, so do the number of outgoing payments. You can use this data to estimate your accounts payable costs and form projections about the future.
Days payable outstanding (DPO)
Your company's days payable outstanding refers to the average number of days it takes your business to pay its vendors after receiving an invoice. You can calculate your DPO using the following formula:
DPO = (Average accounts payable) / (Cost of goods sold) x 365 days
So, imagine that a company has an average accounts payable of $75,000, with a total cost of goods sold of $165,000. Plugging these numbers into the formula above yields:
DPO = ($75,000) / ($165,000) x 365 days
DPO = 166 days
As a general rule, a higher DPO is good for your company's cash flow, since it means it takes a greater average number of days for money to leave your accounts. However, just make sure that a high DPO doesn't result in strained vendor relationships or cause you to incur late payment fees if you cross a payment deadline.
You may already be familiar with days sales outstanding, which refers to the number of days that it takes your company to collect payment from your debtors. Credit sales generally allow you to collect payment quickly, though you can also optimize your accounts receivable process to ensure early payments from your clients for strong future revenue.
Industry trends method
Historical patterns aren't always enough to create accurate cash flow forecasts. That's why business leaders should seek to pair the above methods with external data, such as observing industry trends.
For example, if production costs are rising in your industry, you may see a rise in the cost of goods sold through your business. Predicting these trends can help you account for rises in your outgoing expenses and create cash flow forecasts that reflect internal as well as external financial data.
Ready to streamline your accounts payable forecasting?
Fortunately, technology can be used to manage and forecast your accounts payable processes. Through innovative tools such as BILL, you'll be better equipped to handle your upcoming financial obligations and forecast for your company's future.
In the right hands, these tools can be used to contribute to your core financial strategies and aid in your financial planning. And instead of waiting to generate your financial statements on a summary basis, you'll have access to the most up-to-date data that can be used for cash management and ensuring strong vendor relationships.
Case study: JMA Ventures uses BILL to create cash forecasting model
Colin Casper, CFO of JMA Ventures, explains that BILL has completely changed the way this real estate investment and development firm looks to the future.
Casper notes that the combination of BILL and Microsoft Dynamics 365 "streamlines our entire AP process: from coding invoices and collecting approvals to making digital payments. This enables us to have real-time visibility and understanding of our cash position, both with the accounting team and at the asset management level. This integration eliminates duplication of work efforts and saves us tremendous time across the entire company."
Thanks to real-time data, JMA Ventures is better able to forecast its upcoming liabilities and even plan for the future with clear, accurate insights. And with BILL's mobile app, the team has been able to monitor their financial commitments with the swipe of a finger, giving them greater visibility and control over their most important processes.
Leveraging BILL Accounts Payable for forecasting AP
BILL can take your organization beyond the balance sheet and into accurate, real-time data. You'll achieve a superior view of your accounts receivable process and better identify payment patterns that could be affecting your company's cash flow. And with a better cash flow strategy, you'll be able to meet your commitments and avoid financial challenges.
Learn more by visiting BILL's accounts payable page today, and discover how BILL can help you say goodbye to inaccurate forecasts.
Forecasting accounts payable FAQ
How do you forecast accounts payable using DPO?
DPO, or days payable outstanding, is calculated by dividing your average accounts payable value by the cost of goods sold, then multiplying this number by 365. This will tell you how long it takes to pay your vendors and suppliers, and that information will reveal the pattern by which cash flows out of your company.
How do you forecast accounts payable on the balance sheet?
Your company's balance sheet will help you forecast accounts payable in a very direct way. Balance sheet line items include assets and liabilities, and by looking at upcoming liabilities (expenses that occur regularly, such as utilities or vendor payments), you'll be able to predict when you expect to pay for accounts payable expenses.
What questions should be asked about accounts payable when forecasting?
Business leaders should ask questions like: What financial obligations am I responsible for during this accounting period? Which invoices should I prioritize to ensure discounts and/or strong supplier relationships? How can I optimize my accounts payable process to avoid risk and low cash availability? These questions will help you streamline your processes while avoiding financial risk that could put your business in jeopardy.
