How to Accurately Forecast Cash Flow When Late Payments are a Reality

Finances are crucial for any business, and these need to be managed properly for the company to be successful. Cash flow needs to be consistent without any hurdles so that everything can operate smoothly, but there can be trouble with this due to the world becoming a cashless society. Missed customer payments can get in the way of this and cause disturbances to the business's finances.

An accurate cash flow forecast is critical for operational stability, but traditional models that assume prompt payment often lead to nasty surprises that can stun businesses. To create a robust forecast that accounts for the reality of late payments, you need to shift your focus from when an invoice is due to when the cash is historically received. We’ll explore this throughout the article, so continue reading to find out more.

Forecasting Cash Flow

Analyse Your Historical Collection Behaviour

An accurate cash flow needs a shift in focus from an invoice's contractual due date to the historical reality of customer payment behaviour. The most basic analytical tool for this is the Days Sales Outstanding (DSO), which reveals the average number of days your company takes to collect payment after a sale. Calculating your DSO over the last 6 to 12 months gives you a critical correction factor. For example, if your standard payment term is 30 days but your average DSO is 45 days, you must project the realistic collection date for future invoices at 45 days.

For a more granular and powerful projection, businesses should conduct a payment pattern analysis. This involves analysing past data to determine the specific percentage of total invoice value collected in the month the invoice is due.

Segment Your Customers

Segmenting your customers into different tiers will give you a clearer picture of who is most and least likely to miss payments, as it gives you a collection pattern for each group. Your reliable payers are customers who always pay on time, so you can forecast their payments close to the due date, as you know you can trust them. Then, you’ll have the average payers who consistently pay a week or so after the payment date. This is where you’ll apply your DSO or the delayed collection pattern to give you some wiggle room for these late payments.

You also have to deal with the problematic payers. These are customers who often pay over 60 days late or require a lot of chasing for them to complete a payment. You should forecast these amounts with a significant delay or flag them as uncertain, so you won’t expect that money to enter your cash flow any time soon.

Scenario Planning

The best-case scenario planning assumes optimistic sales and that customers adhere strictly to the current DSO, which helps to identify any extra cash that can be used for strategic investments. The most likely scenario relies on realistic assumptions, using the payment pattern analysis and conservative sales projections to guide daily operational decisions. 

The worst-case scenario assumes significant delays and higher bad debt assumptions, which focuses on this scenario's lowest cash point, allowing the business to proactively secure necessary financing or implement cost-cutting measures before a potential cash crisis hits.

Best Practices for Maintenance

Rolling Forecast

Do not create a forecast for just a single month, as you’ll need a long-term plan to better balance your finances when you’re receiving missed payments. Use a 90-day rolling forecast that you update every week to give you the most realistic expectations. As the current week ends, you add a new week to the end of the projection. This keeps you constantly looking forward and planning for the future.

Actual vs. Forecast Analysis

At the end of every month, compare your actual cash flow with your forecasted flow to see if it matches or differs. This will allow you to analyse the reasons for the difference, so you can get a better understanding of where your money is going. This feedback loop is essential for improving the accuracy of future predictions.

Incentives and Penalties

Factor the impact of any credit control measures into your forecast. If you implement a late fee, forecast that some late payers will pay slightly sooner to avoid the penalty. This will also deter customers from making late payments in the first place, as they won’t want to receive any penalties for it.

Final Thoughts

While credit insurance is still the biggest protection against customer missed payments, consider integrating specialised accounting software that can automate DSO calculations. This will free up your finance team to focus on analysis rather than manual data entry. This tool converts uncertain future payments into a guaranteed recovery rate, adding more security that stabilises your balance sheet and ensures that even the most unpredictable customer behaviour does not ruin your operations.

You should combine a few different methods, using technology, risk mitigation and continuous analysis to forecast reality while future-proofing your business against the volatility of the collections process.