Let’s talk about two key parts of any business’s finances: Accounts Receivable vs Payable. Imagine your business is like a piggy bank. Accounts Payable is the money going out—you’re breaking open the piggy bank to pay for things you need or have used. Accounts Receivable is the money coming in—the cash you’re collecting for work you’ve done or goods you’ve sold. They’re pretty straightforward, but mixing them up can make a mess of your money. So, let’s clear things up.
Key takeaways:
- Accounts Payable (AP) is the money a business owes for purchases made on credit, recorded as a liability.
- Accounts Receivable (AR) is the money owed to a business by its customers for sales made on credit, recorded as an asset.
- Regular review of AP and AR is essential for maintaining a healthy cash flow, typically done monthly.
- Aging reports for AP and AR categorize unpaid invoices by the due date, crucial for cash flow management.
What Are Accounts Payable?
How do accounts payable and receivable differ from each other? Accounts payable comprise the amounts a company owes to suppliers and creditors for items or services purchased on credit. AP is recorded as a liability and does not include payroll or long-term debt but may include payments toward long-term obligations. The process involves recording an invoice upon receipt based on agreed payment terms and managing the payment process to maintain positive supplier relationships and accurate cash forecasts.
Example of Accounts Payable
- A merchant specializing in jewelry secures a large shipment of beads and precious stones on a credit agreement, with a 60-day term for payment. These materials are recorded as accounts payable, reflecting the merchant’s obligation to pay the supplier within the specified period.
- A company in the tech industry outsources the assembly of its laptops and smartphones to factories located in Taiwan and Vietnam. The payment for these assembly services is due after the work is completed, and until then, the owed amounts are categorized as accounts payable on the company’s balance sheet.
- An e-commerce retailer utilizes third-party transportation and logistics services to deliver goods to customers and also rents space in a warehouse for storing its inventory. The fees for these services, which are to be paid post-delivery, are recorded as accounts payable, representing the retailer’s current liabilities for these operational costs.
Guide to Record Accounts Payable
Businesses can record accounts payable using either accrual or cash-basis accounting.
In accrual accounting, expenses are recorded when incurred, not when paid. For example, if a company orders $1,000 worth of goods and pays half upfront, the full amount is recorded as an expense when the invoice arrives, assuming delivery has occurred.
With cash-basis accounting, expenses are recorded only when the payment is made. So, a $500 payment is logged at the time of the transaction, and the remaining $500 when the goods are received and paid for.
Monitoring the Days Payable Outstanding (DPO) is essential, as it indicates the average time taken to pay off suppliers, reflecting cash flow and supplier relationship management. Calculate DPO using the average accounts payable over a set period, like a month or quarter.
What Are Accounts Receivable?
How do accounts receivable and payable differ from each other? Accounts receivable are funds that customers owe a company for products or services that have been invoiced.
What is accounts receivable on a balance sheet? AR is listed as a current asset on the balance sheet and includes all invoiced amounts due from clients. The terms of payment are agreed upon at the time of sale, and companies may require deposits for large orders or services billed in advance.
Example of Accounts Receivable
- A merchant sells 1,000 candles at $10 each to Company A, amounting to a total sale of $10,000. Company A makes an initial payment of $3,000 and agrees to settle the remaining $7,000 over the next three months. The outstanding amount is recorded as accounts receivable, reflecting the merchant’s anticipation of receiving the balance.
- Stephanie subscribes to a monthly beauty box service, agreeing to pay the subscription fee each month for a year. The service provider records the expected payments as accounts receivable under “deferred revenue,” since the payment is for future goods and services to be provided.
- A roofing company enters into a $10,000 contract with homeowners for various roofing services. After receiving two out of five scheduled payments, the company also incurs $5,000 in expenses for roofing materials. The company must record the remaining contract balance, minus the payments received and including the additional material costs, as accounts receivable, indicating the total amount expected to be collected from the homeowners.
Guide to Record Accounts Receivable
Is accounts receivable an asset? In accrual accounting, accounts receivable (AR) are recorded as current assets. When payments come in, the finance team decreases the AR balance and increases the cash or equivalent account. If there are late fees, these too are added to the AR.
Key financial ratios involving AR include:
AR Turnover Ratio: This ratio assesses how quickly a company collects cash from credit sales. It’s calculated annually as follows:
| Net Credit Sales / Average Accounts Receivable |
Current Ratio: This liquidity ratio checks if a company can cover its short-term debts with its short-term assets.
| Current Assets / Current Liabilities |
Days Sales Outstanding (DSO): This measures the average time it takes to collect payment after a sale.
| (Accounts Receivable / Total Credit Sales) x Number of Days in Period |
What are “aging reports” for receivables and payables?
Aging reports for receivables and payables are summaries that show how long invoices have been unpaid. They list invoices in categories based on their due date, such as 0-30 days, 31-60 days, and so on. For receivables, they help track which customers owe money and for how long. For payables, they show what the company owes to suppliers and when it’s due. These reports are crucial for managing cash flow and ensuring timely collections and payments.
The bottom line
And there you have it – Accounts Receivable vs Payable are no longer a jumble of accounting jargon. They’re as simple as this: what your business owes and what it’s owed. Keeping these two straight helps make sure that your business isn’t spending money it doesn’t have and is getting paid for what it does. It’s like keeping your wallet organized with bills to pay on one side and money you’re waiting to collect on the other. Stay on top of these, and your business is set to keep ticking along just fine.
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FAQ
Are accounts payable debits or credits?
Accounts payable are recorded as credits in the general ledger. When a company receives an invoice, the accounts payable account is credited, indicating an increase in the company’s liabilities. When the invoice is paid, the accounts payable account is debited, and the cash account is credited, showing a decrease in liabilities and cash respectively.
How often should a company review its accounts receivable and payable?
A company should review its accounts receivable and payable regularly to maintain a healthy cash flow. This is typically done on a monthly basis, but some businesses may do it more frequently, such as weekly, to ensure they are on top of their cash management and to identify any issues early on.
How can a company improve its accounts receivable turnover?
A company can improve its accounts receivable turnover by:
- Implementing stricter credit policies to ensure that credit is extended only to customers with a good payment history.
- Offering discounts for early payments to encourage customers to pay sooner.
- Using automated reminder systems to follow up with customers on upcoming and overdue invoices.
- Regularly reviewing the accounts receivable aging report to manage and prioritize collection efforts.
- Considering invoice factoring or financing options to accelerate cash flow from receivables.
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