Accounts receivables and accounts payables are two sides of the same cash flow coin. On the one side, your accounts receivable is a current asset on your balance sheet because it’s money you’ll soon be receiving from customers or clients. On the other side, your accounts payable is a short-term liability on your balance sheet because it’s money you owe to vendors and creditors.
When both sides of your accounts payable and accounts receivable are well managed, your cash flow is healthy and your business has the space it needs to grow.
Keep reading to learn more about the difference between accounts payables and accounts receivables — and how both processes can help you grow your business.
Table of Contents
- What are accounts receivables?
- What are accounts payables?
- What is the difference between accounts receivables and accounts payables?
- Why are accounts receivables and accounts payables important?
- What is common between accounts receivables and accounts payables?
- What are examples of accounts receivables?
- How to calculate accounts receivables
- What are examples of accounts payables?
What are accounts receivables?
Accounts receivable is the balance owed to your company for any goods or services you provided to customers on credit. Your total accounts receivables are the sum of your invoices sent to clients.
On your balance sheet, accounts receivable is listed as an asset because it’s money your company will have in the bank within a certain period of time, depending on your payment terms with customers.
In the event your company can’t collect some accounts receivables, that amount becomes what’s called “bad debt.” You can eventually use bad debt trends to anticipate your “allowance for uncollectible accounts” on your general ledger and better plan your company’s financial strategy.
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What are accounts payables?
Accounts payable is the amount your company owes to vendors or creditors. Your total accounts payables are the sum of your short-term debt to creditors and invoices you received from suppliers who have provided your company with goods or services.
On your balance sheet, accounts payable is listed as a liability because it’s money that will soon flow out of your business within a certain period of time, depending on your payment terms with creditors and vendors.
Some companies choose to make payments on their accounts payables as close to their due date as possible to better manage cash flow.
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What is the difference between accounts receivables and accounts payables?
Accounts receivables are the revenues that flow into your company from clients who have received goods or services on credit, usually within a 30, 60, or 90-day window.
Accounts payables are the payments that flow out of your company to your vendors and creditors. Some small and mid-sized businesses (SMBs) also have what’s called an “accounts payable” department, which is responsible for making payments.
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Why are accounts receivables and accounts payables important?
Accounts payable and accounts receivable are important because they help businesses improve their ongoing cash flow.
According to brodmin, an independent late payment reporting directory, small businesses are experiencing cash flow problems after the pandemic because more than 10% of late invoice payments are written off as bad debt. That means SMBs are unable to collect 10% of their total accounts receivables.
To make matters worse, small businesses are losing 15 days every year chasing late invoice payments.
Tracking your accounts receivables is important because late payments to your business can affect your cash flow. If customers aren’t paying on time, you’ll need to follow up quickly and perhaps modify your business strategy if the problem is severe enough.
An automated accounts receivables process unlocks accurate tracking, so you can make informed decisions about your business.
On the accounts payables side, late payments to creditors and suppliers can result in two things:
- Additional interest and fees that your business wouldn’t have otherwise incurred
- Bad relationships with vendors who may not want to work with you again — and definitely won’t give you any discounts in the future
Accounts payable also makes sure your financial projections are accurate and not too optimistic. Unrealistic cash flow and revenue projections can cause you to make bad business decisions, and a functional accounts payable process can help you avoid mistakes.
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What is common between accounts receivables and accounts payables?
Accounts payables and accounts receivables may seem like opposing teams, but together they accomplish many of the same things for your business.
1. Accounts payable and accounts receivable manage your cash flow (short-term financials).
Accounts payable and accounts receivable answer the same question: At what rate is cash flowing in and out of my business?
Your business doesn’t run on hopes and dreams — it runs on cash. Your accounts receivable and accounts payable processes are tied to your cash flow and allow you to spot problems before they become problems.
2. Accounts payable and accounts receivable inform accurate financial projections (long-term financials).
After adopting accounts receivable and accounts payable automation processes, you’ll be able to anticipate cash flow trends and incorporate them into your financial projections.
For example, an accounts receivable process will allow you to anticipate bad debt (unpaid invoices) for the next year based on what happened in previous years. Without an ongoing, accurate view of your accounts receivable over a long period of time, your revenue projections are an uninformed guess.
3. Accounts payable and accounts receivable ensure good audit trails.
Every company in the U.S. and Canada is required to keep an audit trail, which is made up of documents and records that demonstrate the financial activity of your company.
Accounts payable and accounts receivable are both forms of comprehensive documentation on the cash flow of your business.
No one wants to get audited, but unfortunately it’s a risk of owning an SMB. Ongoing AR and AP processes can make the audit process less painful.
4. Accounts payable and accounts receivable can both be automated.
Additional payment integrations like Plooto can help you make and receive payments much faster while information flows back to your accounting software for automatic reconciliation. That means no more manually entering your accounts receivable or accounts payable into your general ledger once you get paid or pay someone else.
Technology has come a long way since the days of physical ledgers and checks. Software like Xero and Quickbooks can help you automate invoicing, bookkeeping, and accounting.
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What are examples of accounts receivables?
Let’s say you own a small business — Design Toro — that sells graphic design services to nonprofit organizations. To attract a new customer, High Climate, your design agency offers net-60 payment terms on a monthly retainer of $5,000 for six months, invoiced on a monthly basis.
With an accounts receivable process, the money High Climate owes Design Toro during that 60-day invoice period is listed on a ledger under current assets. When High Climate pays their first invoice within that 60 days, Design Toro credits their liabilities account and debits their accounts receivable to record the payment.
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How to calculate accounts receivable
- Identify how much each customer owes you
For all goods and services you’ve sold on credit and have not received payment yet, note the outstanding balance for each vendor.
- Mark when each payment is due to you
On a calendar, or within your accounts receivable software, mark when each balance is due chronologically in order of due date.
- Add up the balances owed each month
Tally up all the outstanding invoices in a given month and note the totals owed for each month.
- Create monthly financial projections
Now that you know how much is owed to you each month in the foreseeable future, you can make educated decisions about how to manage your cash flow.
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What are examples of accounts payables?
Let’s say the same design agency, Design Toro, purchases ten iPads on credit from a third-party Apple vendor for a batch of new hires. The iPads are worth $5,000 with a net-30 payment, and the invoice is sent on July 9.
Design Toro would create an accounts payable entry in their accounting software, and credit the Apple vendor’s account $5,000 by August 15. When the payment is made, Design Toro debits $5,000 from their asset account.
How to record accounts payable
Inaccurate financial reporting can cause problems for companies, especially when it comes to taxes. Accounting methods can affect how much tax you owe, and what deductions you take against income. If you’re unsure about which accounting method to choose, here are some things to consider:
Accrual vs Cash Basis
The accrual basis of accounting records expenses immediately upon incurring them. This method requires businesses to report expenses as soon as possible, even if payment isn’t due for several months. However, the cash basis of accounting records expenses when the related invoices are paid. Under this method, expenses aren’t reported until the related payments are actually made.
Cash Flow Reporting
Companies that follow the cash flow method of accounting must track cash inflows and outflows over a period of time. They do this by creating a balance sheet at the beginning and end of each month. When the cash flows are balanced at the end of the month, the books are closed. A company following the cash-flow method doesn’t prepare a monthly profit/loss statement because there won’t be one. Instead, the company prepares a quarterly statement showing net sales, operating costs, and other information.
Taxes
Accounting methods can impact how much tax you owe. Depending on whether the company uses the accrual or the cash basis, the company may be able to deduct certain expenses. These include interest expenses, depreciation expenses, and insurance premiums.
Accounts payable reporting
Companies generally report AP in two ways:
Accrual accounting
This type of reporting requires tracking each transaction individually. If an item costs $10,000 and takes three months to deliver, you must recognize the entire $10,000 as an expense when the bill is delivered.
Cash basis accounting
With this method, companies do not record expenses until they are paid. So, if an item costs $10K and takes three months to complete, you would only recognize the $3,333 remaining balance as an expense.
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How to record accounts receivable
Accounts receivable represent money owed to you by customers. You must record each customer’s invoice and collect payments. If you don’t, you could face penalties such as interest charges and late fees. Here’s how to track your receivables accurately.
In accrual accounting, you record sales revenue as soon as it becomes certain that the customer will pay. This is called “accruing” the sale. You record expenses as soon as they become fixed and certain. This is called ‘allowing’ the expense. If you sell products at $1,000 each, you earn $10,000 in gross profit. Your cost of goods sold is $5,000 because your inventory costs $2,500. To calculate your net income, subtract your total expenses from your gross profit.
Your accounts payable balance is calculated the same way. You record sales revenue as soon you receive the invoice. You record expenses as you incur them. If you owe $7,000 for office supplies, you don't wait until the end of the month to write off the office supply expense; you do it immediately.
When you collect money from customers, you credit accounts receivable and debit accounts payable.
The formulas for calculating the AR turnover rates for shorter periods look similar, but there are some key differences. For example, you cannot use the same formula for calculating the AR Turnover Rate for a monthly basis because it assumes that each month’s revenue equals the previous month’s total sales. Instead, you must calculate the AR turnover rate for each month separately.
In addition, the formulas for calculating the AR Turnaround Ratio for quarterly and annual periods differ slightly. These formulas assume that the average number of days required to collect outstanding balances is 30 days, regardless of whether the invoice is due on a weekly, biweekly, or monthly basis.
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Important metrics for accounts receivable and payable
Accounts receivable and payable are often combined into one category called cash flow statements. These statements show how much money the company has coming in versus what it owes out. They provide information about whether the company has enough cash to cover bills and make payroll. In addition to comparing current ratios, you might want to look at the following metrics:
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Current ratio
A measure of whether the company has enough operating capital to meet short term obligations.
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Quick ratio
An estimate of whether the company has sufficient working capital to operate.
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Working capital
The amount of cash, inventory, and accounts receivable minus accounts payable. -
Days sales outstanding
The number of days it takes to collect invoices. -
Days Inventory
The number of days' worth of goods it takes to sell.
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Days Payable
The number of days payments are due.
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Comparing accounts receivable and accounts payable
Accounts receivable and payable are both assets and liabilities that must be managed, but they differ in important ways. When you compare accounts receivable and payable, you are looking at how much cash flow each one provides based on what is owed to it. You want to make sure that you aren't overpaying for something because you're paying too little attention to the other side of the balance sheet. Here are some things to keep in mind when comparing accounts receivable and payable.
The current ratio
A common way to analyze liquidity is to look at the relationship between accounts receivable and accounts payable. If you divide the total amount of accounts payable by the total amount of accounts receivable, you'll find out the current ratio. In general, the lower the number, the better off your organization is financially. However, this ratio doesn't always tell the whole story.
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Accounts receivable and payable are two important financial measurements used to determine a company’s overall liquidity. They are often compared together, as well as against each other, to determine whether there are enough funds coming into the company to cover the bills it owes.
The amount of accounts receivable minus the amount of accounts payable equals the current ratio. A value greater than one indicates that there are more receivables than payables. Conversely, a value less than one indicates that there is more payables than receivables.
Other differences between accounts receivable versus payable include how they are classified, what types of accounts make up each balance sheet category, and how they are managed. Accounts receivable and payable are often compared together during a liquidity analysis, to determine whether there are sufficient funds coming into the business to cover the amount owed to vendors. The current ratio measures how much cash flow is being generated by the business, while the quick ratio measures how quickly cash flows could be spent. Both ratios compare current assets against current liabilities.
The difference between accounts receivable and payables is that receivables are considered current assets, while payables are considered current liabilities. However, both types of accounts are still included in the same balance sheet category, since it’s impossible to know what future payments might come due.
Another difference between accounts receivable/payables is that receivables are typically calculated for one specific type of transaction – either trade or non-trade receivables – while payables can include multiple accounts, each of which must be separately tracked. For example, a business may owe money to suppliers and customers, and those debts may be paid off over different periods of time. A business may also owe money to state and local governments, and those obligations may be paid off over varying lengths of time.
The quick ratio
In addition to calculating the current ratio, businesses may calculate the quick ratio. The quick ratio compares the current value of current assets to the current portion of current liabilities. If the current ratio is greater than 1, the quick ratio will also be greater than 1. When the quick ratio is less than 1, the business is incurring larger expenses faster than it is generating revenue.
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What do accounts payable and accounts receivable have in common?
Accounts payable (AP) and accounts receivable (AR) are two sides of the same coin. They're both liabilities and assets. But what do you know about each side individually?
The balance sheet provides a snapshot of where a company stands financially. You'll find it at the end of the financial statements. A simple summary of the information found there gives you an overall view of how much money your company owes and how much cash it has on hand.
But the accounting equation isn't just about numbers. It's about relationships too. So, while you might think of AP as being a "cost center," it's actually a source of revenue. And similarly, AR is a source of income.
So, don't see either side as a drain on resources. Instead, look at them as sources of revenue. Focus on what each side brings to the table. If you can add value to each side, you'll improve your bottom line.
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How to manage accounts payables and accounts receivables
You can learn more about the complete accounts receivable process here, but for now here are our top tips for SMBs on how to best manage AR and AP:
1. Automate payments that auto-reconcile with your accounting software.
Accounting software doesn’t take care of receiving and making payments, but using a payments integration like Plooto will save a ton of time on manual entry once payments are made and received.
An automated payment platform that auto-reconciles the books in your accounting software is worth its weight in gold, because it means all relevant accounts payable and accounts receivable entries in your ledger — current assets and liabilities — will be kept up to date the moment payments are made.
2. Negotiate long payment terms with creditors and vendors.
Many small businesses are reluctant to negotiate longer payment terms because they may be afraid to inconvenience suppliers. But longer payment terms can free up more cash to run your business, which can make a difference if you’ve hit a bad snag.
3. Use accounting software.
Accounting software like Quickbooks and Xero can help keep your balance sheet accurate and automate follow up on any late invoices.
Remember how small businesses lose 15 days every year to chasing late payments? Most accounting software solutions let you write and schedule automated follow ups when invoices are due and when they’re three, seven, and fourteen days late.
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CHAPTERS
00 A Complete Guide to Invoice Management for Accounts Payable
01 Is accounts payable an asset or liability?
02 Accounts Receivables vs. Accounts Payables: What’s the Difference?
03 How to Set Up a Full Cycle Accounts Payable Process and Workflow
04 How can accounts payable automation help your small business
