Guide to accounts payable forecasting

Small businesses and multinational corporations alike rely on financial modelling tools and techniques to predict future cash flow. The insights gained from financial planning are invaluable – they help businesses to build a better understanding of the financial landscape that lays before them, protecting them from surprises that can harm operations. And, at least for the short to medium term, accounts payable is one area of the balance sheet for which forecasting can be particularly valuable.

Accounts payable is the term used for short term liabilities – costs and debts that are usually expected to be paid off within a year or less. Having a clear picture of what these liabilities are, how much they total, and when they must be settled by is a critical part of cash flow forecasting. In simple terms, knowing how much to pay means knowing how much remains to spend on growth and innovation.

Here’s everything you need to know about accounts payable forecasting.

The basics of financial modelling

Financial modelling often centers around analyzing three distinct major financial documents that are commonly used by businesses of all types – the income statement, cash flow statement, and balance sheet. This approach is called the three statement model and has a range of benefits that drive its popularity, including its relative simplicity and adaptability.

However, out of the three major documents, the balance sheet is particularly important in the financial modelling process, in part because it contains several items that have a direct impact on cash flow. Items on the balance sheet are generally split into three categories: assets (which include accounts receivable, inventory, current assets, and long-term assets), liabilities (including accounts payable, interest payments, and long-term debts), and equity (covering shareholder equity and retained earnings).

Within the balance sheet, accounts payable and accounts receivable are two items that have a particularly large impact on both current working capital levels and projected future cash availability. Accounts payable because it represents the short-term liabilities due to be paid and accounts receivable because it covers upcoming cash inflows. In other words, AP is money out, AR is money in.

Forecasting accounts payable

A balance sheet that’s maintained in an accurate and timely fashion will give valuable insights into upcoming liabilities that must be paid. However, you can also use a calculation to help forecast accounts payable in a given period in the future by determining days payable outstanding (DPO), using historical data.

DPO is a measure of how many days, on average, it takes to pay suppliers. It’s calculated using average accounts payable and cost of goods sold using the formula below:

DPO = average accounts payable x number of days/cost of goods sold

This formula can be used to generate a DPO figure for any given period. For example, if you wanted to know what your DPO was in a 365-day period, you would use the average accounts payable, and cost of goods sold figure from that period and 365 as the number of days. Understanding the DPO for a three-month period requires an adjustment of the figures accordingly.

Calculating DPO and using the resultant figure in accounts payable forecasts gives insights into how to manage working capital, and the more historical data to draw from, the more accurate future accounts payable forecasts will be. With these forecasts, trends can also be identified that can be used to optimize accounts payable and improve cash flow efficiency.

Benefits of accounts payable forecasting

As accounts payable reflects short-term liabilities, knowing how to forecast them can provide improved clarity over upcoming financial obligations, in turn enabling better cash management. These are three of the top benefits of being able to predict the future of accounts payable:

Make better use of working capital

The output of an accounts payable forecast is invaluable in broader cash flow forecasting – giving key insights into how much working capital will be available for innovation and growth once debts are paid. That means you’re able to reinvest in your own business with greater confidence that you’re not putting its fundamental health at risk.

Maintain strong supplier relationships

Forecasting accounts payable ahead of time also provides a leading indicator of how much the upcoming liabilities total, which includes payments due to suppliers. Clarity in this regard is hugely beneficial in helping maintain strong relationships with suppliers, ensuring appropriate forewarning about the amount of outgoings and minimizing the chance of missing a payment deadline due to low cash availability.

Mitigate potential disruptions or crises

Finally, having a clearer picture of upcoming accounts payable liabilities (as well as accounts receivable and other income) helps to plan for potential future disruptions more effectively. With an understanding of how much capital will be entering and leaving the business over a given time-frame, one can build a better understanding of how much reserve capital is needed to mitigate any potential supply chain risks or existential threats.