Accounts payable vs accounts receivable
Accounts payable and accounts receivable are two opposite concepts of business accounting. Accounts receivable is the money a company is entitled to get from its customers for the goods or services it has provided them whereas accounts payable is the money a company owes to its suppliers or vendors.
For bookkeeping and accounting purposes, it is essential to differentiate between accounts payable and accounts receivable as the former is a liability and the latter is an asset of the company. These both are often confused with each other. This happens because both these types of accounts are recorded in closely similar ways in the general ledger.
Accounts payable is a liability account for a company as it tracks all the funds that a business owes while transacting with a third party. A company records all the money it has to pay its vendors and suppliers for the goods and services the company has taken from them.
Accounts payable includes accrued expenses like logistics, licensing, raw material procurement, leasing, and job work.
Accounts payable are recorded on the basis of the receipt of an invoice that states the payment terms that both your company and the vendor have agreed upon. When the team gets a bill payable for the goods and services the company has purchased, it is recorded as a journal entry and written under expense in the general ledger. The balance sheet will display the total Bill Payables and not individual transactions. After the expense, if approved and the payment is initiated under the terms and conditions of the contract, such as net-30 days, the accounting team members record it as an expense paid.
The AP department members are entrusted with the responsibility to process expense reports and invoices, along with this they also have to ensure that all the payments are accurately made. Maintaining a good supplier relationship by ensuring that all vendor information is correct and precise and all the bills are paid on time is also the job of the AP team members. A firm and structured AP practice reap immense advantages for a business like a team can help the company enjoy all the benefits of favorable payment terms and payment discounts. They also ensure error-free cash forecasts, minimal mistakes, and take preventive measures to stay secure from any fraud.
The accounts payable process has five major steps:
After the purchase of the required goods and services a business receives an invoice for the payment.
The invoice received is then recorded in the accounts payable ledger. However, if your company uses accounting software this recording process is done automatically by scanning the invoice.
The invoice recorded is then matched with purchase order details, shipping receipts, and inspection reports.
Before making the payment, the invoice has to go through a set of approvals to make sure payments are warranted.
The last and final step is to see that the payment is made on time and the correct amount is paid.
Accounts receivable are the payments the customer has to make to your company for the goods or service they have purchased and the invoices are created on those purchases.
The total amount of all accounts receivable are recorded on the balance sheet as current assets. This consists of invoices that the clients have to pay for the purchase they made on credit.
Usually, the customers are billed after the goods or services have been provided upon the agreed terms and conditions mentioned on the contract signed by both parties. The terms of payment are generally, net 30,60 or 90 — meaning that the customer agrees to pay within 30,60 or 90 days respectively. Though when dealing with large orders companies ask for a deposit before fulfilling the requirement. After the order is complete, the AR team members process invoices for the customers and record the invoice amount as an account receivable.
If the payment is received from the client’s side on time, the team records it as a deposit and the account is not receivables anymore. However, if the customer fails to make the payment on time, the AR team will send a solicitation letter, which has a copy of the invoice attached to it and a late fees receipt.
The AR process is easier than the AP process consisting of three main steps:
Once all the goods and services have been provided, the invoice must be sent immediately.
The invoices sent are regularly tracked. If the payment is not received, reminder emails are sent out and some additional measures are taken like phone calls
After the payment is received, the AR department makes sure that the correct amount has been received and is recorded in the ledger as “paid.”
After being well-versed with the basics of accounts payable and accounts receivable and also understanding the differences between both, you also need to consider the reasons why these accounting terms or processes are important.
Late payments are a serious problem for many small businesses. This is because late payments cause cash flow issues which tie up the working capital on the balance sheet. According to a survey, almost half of the medium-sized businesses are been given their payments late. Those companies are spending about 4 hours every week chasing behind clients for payments. This is a major problem, considering that the money could be used in other beneficial ways like funding new products, investing heavily in the growth of the company, giving the shareholder a greater payout, etc.
Maintaining a good accounts receivable process, you can guarantee that your business has a healthy cash flow. This means there will be more than the required cash flowing in for your business expenses. Plus, you can easily ensure the long-term stability of your company.
Your business either issues or receives an invoice for every sale or purchase. If you have sold your goods or services, the finance team will record the amount of the sales under accounts receivable. However, if you have purchased any goods or used any services from another company, that amount will be entered in bills payable.
Accounts payable is considered as a liability as you have to pay an amount for your purchase within a certain time limit. On the other hand, bills receivable are considered as an asset because you will receive money for the sales within a definite timeline.
These two accounting functions are often confused with each other and should be strictly separated into separate departments. Dividing accounting principles or segregation of duties is a fundamental task of any business owner, majorly to reduce vulnerability towards fraud.
When it comes to auditing accounts payable and accounts receivable different methods are used. While testing AP, the auditor mainly looks for unethical behavior from the vendor or any quality errors. Whereas for AR, the auditor looks for accounts that are due for more than the time limit agreed. In some instances, companies do have to adjust their expectations and work accordingly.
Faster payments, employee retention, and improved cash flow, are some of the benefits of automating your accounts receivable.
Businesses can manage and pay their vendors on time without missing a due date with the accounts payable software.