Many business owners don’t understand the difference between accounts payable and accounts receivable, but these are key terms related to your company’s finances. Despite their importance, accounts payable vs. receivable still becomes a source of accounting confusion for some.
Although both accounts receivable and accounts payable are items on your balance sheet that are crucial for business operations, it’s essential to differentiate between accounts receivable vs. payable. You must know which of these accounts is for assets and which deals with liabilities, or your business could end up in debt and overextended.
In this post, we’ll answer the question, ‘what are accounts payable and accounts receivable?’, discuss accounts payable vs. accounts receivable, and explain the importance of receivables and payables.
What are Accounts Payable?
Accounts payable (AP) refers to the amount of money a company owes to its suppliers and creditors. This current liability account is documented on the balance sheet beneath ‘current liabilities.’
When a company buys goods or services from a supplier on credit, the company sends a purchase order to the supplier. Once the supplier receives the order, it provides the purchased items alongside an invoice that outlines payment terms. Typically, companies must provide payment within 30 to 60 days, but sometimes this due date is even longer.
If the payments owed to suppliers and other third parties are not paid in full within the agreed time frame, the company suffers defaults or late payments. While unfulfilled invoices are usually due to inefficient accounting methods., such problems can also occur because of challenges within the supply chain.
What are Accounts Receivable?
Accounts receivable (AR) is a term that refers to any money your customers owe you for services or goods they have previously purchased. This money is generally collected after several weeks and is recorded on your company’s balance sheet as an ‘asset.’ The reason accounts receivable is classed as an asset is because they provide value to your business.
Accounts receivable are typically used as part of ‘accrual basis’ accounting.
Accounts Payable vs. Accounts Receivable
In corporate finance and small business operations, AR and AP both functions are both required for a complete transaction.
What is the Difference Between Accounts Receivable and Accounts Payable?
Let’s take a deeper look at receivables vs. payables:
Accounts payable are liability accounts; they represent money that you owe to another company.
Accounts receivable are asset accounts; they represent money that your customers owe to your business.
For example, let’s imagine you design a website for your friend Thomas’s business, Thomas’s Bookstore Inc., and send him an invoice for $1000.
When Thomas receives your invoice, he should record it as ‘accounts payable,’ as the balance is money that he owes to somebody else.
You should record this transaction as an ‘account receivable’ because it represents the cash you will receive from Thomas.
When we consider accounts payable vs. accounts receivable, they’re two sides of the same coin. The most important information to remember is that accounts payable represents money that your business must pay to suppliers. On the other hand, accounts receivable refers to money owed to your business by your customers.
Additionally, accounts payable is considered a current liability, whereas accounts receivable is regarded as a current asset. This is because, typically, accounts receivable will be converted into cash within 12 months. Although, some businesses deal with cases where longer-term credit periods are agreed upon with the customer. In those instances, accounts receivable should be recorded as a long-term asset.
The Importance of Accounts Payable and Receivable
Now that we’ve covered the basics of accounts payable vs. accounts receivable, as well as explaining their differences, it’s time to consider why these accounting processes are important.
Late payments can cause considerable issues for small businesses across the globe. In fact, they are a significant problem. This is because overdue payments lead to serious cash flow problems, causing working capital to become tied up on your business balance sheet.
Accounts payable and receivable are the core payment and invoicing processes of any business. They help organizations track income and expenditure, ensuring that they pay all the money they owe and receive all the money they are owed.
Both of these processes are crucial to any business’s success because they ensure that money is coming into the business and that the company finances are accurately recorded.
If you optimize your accounts receivable process, you can make sure that your business survives with a healthy cash flow. This means that you’ll be receiving enough cash to cover all of your business expenses. Additionally, you won’t have to struggle day-to-day and can take a long-term approach to business development and growth.
L3 Funding Solutions
Running a small business can be difficult, and sometimes it’s hard to find financial support. Luckily, that’s where our financial experts can help you. If you require small business working capital or some accounts receivable financing contact us to schedule a one-on-one business cash advance consultation today.