As a business owner, keeping track of money coming in and money going out is crucial. However the accounting terms used to describe these money flows can be confusing. Accounts payable and accounts receivable sound similar but they are distinctly different. This article will explain the key differences between accounts payable and accounts receivable in simple terms.
What is Accounts Payable?
Accounts payable refers to the money your business owes to suppliers and vendors It represents short-term debts that need to be paid off within a year Some common examples of accounts payable include
- Raw materials purchased from a supplier
- Inventory bought on credit
- Utility bills
- Rent
- Shipping and transportation costs
Essentially, accounts payable covers any expenses your business accrues through purchasing goods or services on credit. Suppliers and vendors issue invoices with due dates specifying when the payment is expected. As a business, you must pay off these debts on time to maintain good relationships with suppliers.
Recording accounts payable properly is also important for accurate financial reporting. When you receive an invoice, you make a journal entry debiting the relevant expense account and crediting accounts payable. This increases the accounts payable balance on your balance sheet. Then, when you pay off the amount owed, you debit accounts payable and credit your cash account. This reduces the liability.
What is Accounts Receivable?
Accounts receivable represents the opposite side of the coin – money owed to your business by customers It covers any sales made on credit terms The process begins when you issue an invoice to a customer who purchases your products or services. The amount they owe you gets added to accounts receivable through a journal entry that debits accounts receivable and credits revenue.
Accounts receivable is considered an asset, since it represents future cash that will be coming into your business. Having a healthy accounts receivable balance indicates you have a solid customer base and cash flow. However, accounts receivable can also pose risks if customers default on payments. Businesses must balance credit policies and collection procedures carefully to optimize accounts receivable.
Key Differences Between Accounts Payable and Accounts Receivable
While accounts payable and accounts receivable may sound similar, there are some important distinctions:
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Balance sheet classification – Accounts payable is a liability, while accounts receivable is an asset. Liabilities represent debts owed by a company, while assets represent value owned.
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Cash flow impact – Accounts payable represents cash leaving the business to pay expenses. Accounts receivable represents cash coming into the business from customers.
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Journal entry treatment – Accounts payable is credited on journal entries, increasing the liability balance. Accounts receivable is debited, increasing the asset.
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Risk factors – With accounts payable, the risks relate to damaging supplier relationships by paying late. With accounts receivable, risks relate to customers defaulting on payments owed.
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Accounting methods – Accounts payable arises under accrual accounting when expenses are incurred. Accounts receivable arises under accrual accounting when revenue is earned.
Real World Examples
Let’s look at some real world examples to better understand the difference between accounts payable and accounts receivable:
Accounts Payable Example
- On June 1, your business orders $5,000 of electronics parts from a supplier on credit terms of net 30 days.
- On June 2, you receive an invoice from the supplier for $5,000 due on July 1.
- You record this in your books by debiting Purchases Expense $5,000 and crediting Accounts Payable $5,000.
- On July 1, you pay the supplier’s invoice. You debit Accounts Payable $5,000 and credit Cash $5,000.
Accounts Receivable Example
- On June 1, you sell $10,000 of your products to a customer on credit terms of net 45 days.
- On June 2, you issue an invoice to the customer for $10,000 due on July 15.
- You record this in your books by debiting Accounts Receivable $10,000 and crediting Revenue $10,000.
- On July 10, the customer pays your invoice. You debit Cash $10,000 and credit Accounts Receivable $10,000.
As you can see, the accounting works opposite for accounts payable vs accounts receivable – but both are critical for tracking cash flow.
Importance for Small Businesses
Careful management of accounts payable and accounts receivable takes on increased importance for small businesses. Many small businesses face more restrictions in accessing credit and loans compared to large corporations. They can’t afford high bad debt expenses from uncollected accounts receivable either.
By optimizing their accounts payable process, small businesses can build goodwill and stronger relationships with their suppliers. This can provide flexibility if short on cash occasionally. Careful credit policies and collections procedures for accounts receivable also ensure they have reliable cash flow to meet immediate obligations.
Having good insight into accounts payable and receivable positions is also extremely helpful for small business forecasting and budgeting. The owner has increased visibility into upcoming cash commitments as well as forecasts of cash availability. Overall, diligence in managing these areas makes a big difference in keeping small business finances healthy.
Best Practices
Here are some top tips small businesses can follow to master their accounts payable and accounts receivable:
Accounts Payable
- Pay invoices on time to take advantage of any early payment discounts and avoid late fees
- Leverage technology like online billing and payments to automate the AP process
- Maintain good communication and relationships with key suppliers and vendors
- Review supplier contracts and negotiate optimal terms
Accounts Receivable
- Institute appropriate credit policies aligned to customer risk profiles
- Send invoices promptly and follow up on past due amounts
- Consider having credit insurance to mitigate nonpayment risks
- Automate payment reminders and follow standardized collections procedures
- Offer early payment discounts to incentivize faster customer payments
The Bottom Line
While they may sound similar, accounts payable and accounts receivable are distinctly different. Accounts payable represents liabilities or expenses owed, while accounts receivable represents assets or revenues owed to a business. Mastering these areas is critical for cash flow management, especially for small businesses with more limited resources. Following best practices and using technology can go a long way in optimizing these financial processes.
What is Accounts Receivable?
Accounts receivable (AR) is a current asset account in which a business records the amounts it has a legal right to collect from customers who received services or goods on credit. It’s an income statement that keeps track of all the money third parties owe you and the inflow of cash to the business. This can be any entity including banks, companies, and individuals who owe you money.
A common example of an accounts receivable transaction is interest receivable, which you get from making investments or keeping money in an interest-bearing account.
The Accounts Payable Process
There are five key steps associated with the AP process. For a larger business, a significant amount of time may lapse between these five tasks:
- Receival – After goods or services are purchased from another business, a company will receive an invoice requesting payment.
- Record – The next step is recording the invoice into the accounts payable ledger. If you have accounting software, this process should be automatic through technology like invoice scanning and optical character recognition (OCR).
- Match – Depending on your process, the invoice may need to be matched with a purchase order, shipping receipts, and/or inspection report.
- Approval – The invoice must go through a set of controls and an approval process to ensure the payment is warranted and accepted as a debt.
- Payment – The final step is to ensure the invoice gets paid, on time, and in the correct amount. Once payment is made, the entry should be removed from the account.
Accounts Payable (AP) vs Accounts Receivable (AR): What’s the Difference?
What is the difference between accounts payable and accounts receivable?
In short, accounts payable is the money you owe, whereas accounts receivable is the money others owe you. We’ve prepared an in-depth guide to compare accounts payable vs. accounts receivable to help you gain a better understanding of these two bookkeeping basics. Accounts payable (AP): The money a company owes to vendors and suppliers.
What is accounts payable on a balance sheet?
A company’s short-term debt or money owed to suppliers, vendors and creditors is an Accounts Payable. On a balance sheet, Accounts Payable is shown as a Current Liability. It is referred to as “current” because these debts are due within a year or less. What Kind of Account Is Accounts Receivable?
What is accounts receivable in accounting?
Accounts receivable is the other end of the accounting spectrum. Accounts receivable (AR) represents the money owed to a company for sales made on credit. Accounts receivable is part of the business life cycle between the delivery of goods or services and the payment for those by customers.
What is the difference between invoices and accounts payable?
Invoices collect payment after a company delivers goods or services to its customers. The accounts payable balance includes all invoices that are due to be paid to vendors or suppliers for goods or services. It is reflected in the balance sheet under current liabilities.
