How to Project Accounts Receivable for Better Cash Flow

Accounts receivable (AR) represents money owed to a business by its customers for goods or services delivered on credit. Projecting accounts receivable is a forward-looking financial exercise that helps businesses anticipate these incoming funds. This foresight is valuable for maintaining healthy cash flow, developing accurate budgets, and guiding overall financial strategy, enabling informed decisions that support financial stability and growth.

Understanding Accounts Receivable Projection

Accounts receivable projection involves forecasting the cash a business expects to collect from its credit sales over a defined future period. Forecasting these collections helps businesses anticipate liquidity, ensuring sufficient funds to cover expenses, manage payroll, and invest in operations.

The projection process provides a realistic view of anticipated revenue, informing budgeting and financial planning. It allows businesses to assess working capital needs and make strategic decisions regarding credit policies and collection efforts. Understanding when payments are expected helps avoid cash shortages and supports precise financial decision-making.

Essential Data for Projection

Accounts receivable projection relies on historical data. Businesses need historical sales data, particularly distinguishing between cash and credit sales, to form a base for future estimates. Past accounts receivable balances are also important for understanding trends.

Information on historical collection patterns is necessary to determine how quickly customers typically pay. This includes the average time customers take to settle invoices and the percentage of receivables collected within various periods. Details on existing credit policies and payment terms offered to customers, such as Net 30 or Net 60, also inform these patterns. This data is commonly found in accounting software, sales records, and bank statements, providing the foundation for accurate forecasts.

Key Projection Methods

Several common methods are used for accounts receivable projection. The Percentage of Sales Method assumes a consistent relationship between credit sales and accounts receivable balances based on past trends. This approach suggests that if historical AR has typically been a certain percentage of credit sales, this percentage will likely hold true for future sales.

Another approach is the Days Sales Outstanding (DSO) Method, which measures the average number of days it takes a company to collect its receivables. This method uses the historical DSO figure to forecast future accounts receivable. A lower DSO generally indicates more efficient collections.

The Aging Schedule Method, also known as the roll-forward method, involves categorizing existing accounts receivable by how long they have been outstanding. This method then applies historical collection percentages to each age category, or “bucket,” to estimate future collections. This allows for a more nuanced forecast, as older receivables typically have a lower probability of collection.

Calculating Accounts Receivable Projections

For the Percentage of Sales Method, businesses first calculate the historical percentage of accounts receivable to total credit sales. If, for instance, historical accounts receivable has consistently been 20% of credit sales, and projected credit sales for the next month are $100,000, then the projected accounts receivable would be $20,000 ($100,000 x 0.20).

With the Days Sales Outstanding (DSO) Method, the calculation begins by determining the historical DSO, which is generally (Accounts Receivable / Total Credit Sales) x Number of Days in the Period. If a business has a DSO of 45 days and anticipates average daily credit sales of $3,000, the projected accounts receivable would be $135,000 (45 days x $3,000/day). This method requires a sales forecast to project future daily sales.

The Aging Schedule Method requires categorizing current outstanding invoices into time buckets, such as 0-30 days, 31-60 days, and 61-90 days past due. Based on historical data, a collection percentage is assigned to each bucket; for example, 95% for 0-30 days, 70% for 31-60 days, and 40% for 61-90 days. The amount in each bucket is multiplied by its respective collection percentage to estimate expected collections from existing receivables. For new sales, a separate projection based on expected payment terms and historical collection rates for new invoices is added to this total.

Utilizing Your Projections

Accounts receivable projections improve cash flow management by providing insight into when funds will become available, enabling better liquidity planning. They also support the creation of more realistic budgets and financial targets, as companies can align spending with anticipated cash inflows.

Projections help identify potential cash shortages or surpluses in advance, allowing for proactive measures like securing short-term financing or planning for investments. They also offer a way to evaluate the effectiveness of current credit and collection policies. Regularly reviewing and updating these projections ensures that financial plans remain responsive to changes in market conditions or customer behavior.