Forecasting accounts receivable (“A/R”) requires determining “average accounts receivable days” and “projected daily sales” and then multiplying average accounts receivable days by projected daily sales to figure forecasted accounts receivable.
That is a mouthful, so let’s break out the above formula in more detail.
Step 1 – Understanding the Formula’s Concept
To understand the concept, you need to know that when a business makes a sell on credit, revenue is recorded and accounts receivable is increased. Therefore, there are always a certain amount of “sales on the balance sheet”
This means another way to think about how to forecast accounts receivable for small business, is to think: “How much sales will I have in accounts receivable at the end of year or forecast period?”. This leads us to step 2 –
Step 2 – Determine Average Accounts Receivable Days (With Example)
Please keep the above concept in mind during this step. What we are trying to do here is to find out what percentage of sales are on the balance sheet and then to express that in days.
Accordingly, we can do that by dividing Average Accounts Receivable by sales to determine A/R turnover. See https://www.investopedia.com/terms/r/receivableturnoverratio.asp for a more detailed analysis.
This will produce a ratio or you can think of it as a percentage expressing the percentage of sales that are in accounts receivable.
After this, you need to express this in days in a year by taking this ratio and multiplying it by 365.
ABC Company’s annual revenue is $1,000,000 for the year ending 12/31/2022.
Their ending A/R for the year ending 12/31/2021 was $120,000
Their ending A/R for the year ending 12/31/2022 was $96,000.
Therefore, their average A/R for the time periods mentioned is $108,000 ($120,000 / $96,0000).
And their A/R turnover equals .108 ($108,000 / $1,000,000).
Finally their Average A/R days is approximately 39 (365 * .108)
Step 3 – Determine Projected Daily Sales
Now, that you have the “average accounts receivable days” you need to have an estimated average daily sales. There are several methods that you can use to determine projected daily sales. I will briefly discuss my favorite –
Method 1 – Using Annual Forecasted Sales
This method uses what you have for an annual projected sales and divides by 365 to get daily sales. For example, if you are projecting $1,000,000 in annual sales, then your average daily sales would be approximately $2,740. Then you could multiply this figure by its “Average A/R days”. Using the example in Step 2 of 39, this means projected A/R would be $106,860 ($2,740 X 39).
Method 1 – Using Year To Date Actual Sales
This method takes average daily sales incurred year to date and uses this figure to project ending A/R. For example, let’s assume on January 31st, the company had made $95,000 in sales. Therefore, the average daily sales for the year would be approximately $3,065 ($95,000 / 31 days). Thus projected A/R using the figure from the Step 2 example would be $119,535 ($3,065 * 39).
Wrapping it all up
In conclusion, forecasting accounts receivable for small business requires knowing average accounts receivable days and then multiplying that figure by projected daily sales to end up with an estimated accounts receivable.