Accounts Payable Vs Accounts Receivable: What's the Difference

Accounts Payable vs Accounts Receivable

Accounts Payable (AP) and Accounts Receivable (AR) are fundamental aspects of a company's financial operations.

Accounts Payable (AP): This is like the company's financial obligations. It represents the money your business owes to creditors or suppliers. In simpler terms, it's the outstanding bills that need to be paid. AP is recorded as a current liability on your company's balance sheet because it's money your business has to pay back.

Accounts Receivable (AR): On the other hand, AR is the money that's owed to your company by customers. It's like an IOU from your clients for goods or services they've received but haven't paid for yet. AR is considered a current asset because it represents future cash inflow when customers settle their outstanding invoices.

In summary, Accounts Payable is what your business owes, while Accounts Receivable is what others owe to your business. Managing both effectively is crucial for your company's financial health and cash flow.

What are Accounts Payable?

Accounts Payable are essentially short-term debts that your company owes to vendors and suppliers. These debts can include expenses related to products, travel, raw materials, and transportation, among others. However, it's important to note that accounts payable typically do not cover long-term debts like mortgages, nor do they include payroll expenses, which are usually handled separately in your company's payroll system.

Accounts Payable Example

Imagine you run a bakery and receive a $500 invoice for flour from your supplier. This $500 represents an account payable, a short-term debt owed to the supplier. Your finance team records it as a liability and ensures payment is made before the due date to settle the debt.

How to Record Accounts Payable?

Companies have two common methods for recording accounts payable (AP): accrual accounting and cash-basis accounting.

• In accrual accounting, companies record unpaid expenses as placeholders for cash event
• In cash-basis accounting, expenses are recorded when actual payments are made to suppliers. 

A useful metric for finance teams to monitor is days payable outstanding (DPO), which indicates how long it takes the company to pay its creditors and suppliers. To calculate DPO, start with the average accounts payable over a specific period, often a month or quarter. This metric helps assess cash flow management and supplier relationships.

What are Accounts Receivable?

Accounts receivable refers to the money that customers owe your business, and it's considered an asset. This can include outstanding bills or payments that clients or consumers owe for services your company has provided.

Payment terms for accounts receivable can vary, often with designations like net-30, net-60, or net-90, indicating the number of days customers have to make their payment. Sometimes, for larger orders, an upfront payment may be required. Invoices typically include details such as the amount due, the payment deadline, and any applicable sales tax.

Managing accounts receivable involves sending invoices on time and following up with customers to ensure timely payments. This helps prevent late payments and ensures a smooth financial flow for your business.

Accounts Receivable Example

In this example of accounts receivable, imagine you're a graphic designer who completed a $1,000 logo project for a client. You send them an invoice with a 30-day payment deadline. The $1,000 is now your accounts receivable, representing what the client owes you. If they pay within 30 days, the accounts receivable is cleared. But if they delay, it remains until they settle the bill, emphasizing the importance of managing accounts receivable for cash flow.

How to Record Accounts Receivable?

To record accounts receivable in accrual accounting, you list the receivable balance in the general ledger under current assets. When customers pay their invoices, your finance department credits the appropriate liabilities account and debits accounts receivable to show the payment, including any late fees.

There are key financial ratios that depend on accounts receivable, such as the accounts receivable turnover ratio, current ratio, and days sales outstanding (DSO), which provide insights into a company's financial health and efficiency in collecting receivables.

Comparing Accounts Payable and Accounts Receivable

Accounts Payable (AP) and Accounts Receivable (AR) are fundamental aspects of a company's financial management. AP represents the money a company owes to its suppliers, while AR signifies the money owed to the company by its customers. This comparison explores the key differences between these two critical accounting components.

What is Receivable Turnover?

Receivable turnover, also called the accounts receivable turnover ratio, is a measure that helps a company understand how quickly it turns its accounts receivable (money customers owe) into cash during a specific time, usually a year.

To calculate it, you divide the net annual credit sales (total sales on credit) by the average accounts receivable (the average amount of money customers owe) during that year. This ratio shows how efficiently a company collects money from its customers. A higher turnover ratio typically indicates better efficiency in collecting payments.

Can Accounts Payable and Accounts Receivable be the Same Person?

Yes, Accounts Payable (AP) and Accounts Receivable (AR) can be handled by the same person, especially in small companies. In many cases, when businesses are just starting out or are relatively small, one person may be responsible for managing both AR and AP.

This arrangement allows for better communication and coordination between the two functions because the same individual has access to all the necessary information for making decisions related to collections and payments. It makes the financial processes more agile and efficient within small companies. However, as companies grow, they may separate these functions into distinct roles to handle the increased workload and complexity associated with AR and AP