Accounts payable vs accounts receivable - Key differences
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 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.
Accounts payable and accounts receivable share an interdependent relationship. When a company extends credit to its customers (accounts receivable), it essentially becomes the accounts payable for the customers.
In other words, accounts payable for one company may often be the accounts receivable for another. This relationship highlights the interconnections of the two financial processes.
Establishing a clear and standardized approval process for both payables and receivables helps maintain consistency and ensures proper oversight of financial transactions.
Approval workflows should be set up in such a way that all payments are to be verified but at the same time should not disrupt the work and productivity of senior executives.
You can do this by using an expense management platform that is capable of creating multilevel approval workflows. This will let you set multiple approvals for a payment depending on the volume of payment.
Utilize accounting software and automation tools to streamline and expedite the accounts payable and receivable processes, reducing errors and improving efficiency.
Many tools have the ability to automatically source an invoice so that you don’t miss out on making a payment because you missed the invoice in your email.
As the business that has to make a payment, you can also schedule or create recurring payments with the help of automation technology for your accounts payable.
Define credit terms and conditions for customers to mitigate the risk of late or non-payment. Conduct credit checks on new customers and set credit limits based on their creditworthiness.
Send invoices promptly and ensure accuracy to avoid delays in payments and confusion for customers. Include detailed information about products or services, payment terms, and contact details for inquiries.
You can also use automation software to match invoices with relevant documents to verify their legitimacy.
Regularly track and follow up on outstanding receivables to minimize the risk of bad debts. Implement aging reports to identify overdue accounts and take necessary actions for collection.
You can also use tools to automatically send your customers reminders to pay on time.
Provide multiple payment methods to customers, such as online payments, credit card options, and electronic fund transfers, to facilitate prompt payments and improve cash flow.
A rigid way of letting your customer make payments can delay and put stress on your company’s finances.
Perform regular reconciliations to ensure accounts payable and receivable records align with financial statements, uncover discrepancies, and maintain accurate financial records.
Maintaining a strong cash flow is crucial for the financial health of any business. Keep a close eye on cash flow patterns and projections to manage working capital effectively and make informed decisions.
Maintaining a balance between accounts payable and accounts receivable is vital for several reasons:
Balancing payables and receivables helps ensure a steady inflow and outflow of cash, preventing liquidity issues and enabling the business to meet its financial obligations. If the volume of payments keeps increasing as compared to accounts receivable, then you might face a cash crunch.
On the other hand, if your receivables are more than payables by a certain margin consistently without significant growth, then you might be underutilizing your resources.
While you need to have a balance, having more accounts receivable as compared to your accounts payable is always a good sign.
By managing payables and receivables effectively, a company can optimize its working capital, ensuring it has sufficient funds for day-to-day operations, growth initiatives, and unforeseen expenses.
Maintaining a balance fosters positive relationships with suppliers and customers. Timely payments to suppliers enhance trust while managing receivables well will strengthen customer relationships.
It is almost like a never-ending cycle where paying and receiving payments help in building your business relationships.
Maintaining a healthy balance between payables and receivables demonstrates financial stability and improves the business's creditworthiness, enabling access to favorable financing options and terms.
In the future, if you ever plan to take a business loan, the institution offering you the loan or credit will look at your bank statements in order to determine your creditworthiness and the amount of loan that they can give you based on your financial activity.
It’s not only important to track all your accounts payables and accounts receivables but also to analyze this data. Monitoring the ratio between payables and receivables provides valuable insights into a company's financial performance, operational efficiency, and cash management practices.
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.