A key component to a small business’s success is knowing the difference between Account receivable vs. payable as this helps you to understand your business’s accounting process better.
Often when business owners are trying to understand bookkeeping and other accounting details of their business, they confuse Accounts Payable vs. accounts receivable as both are quite similar in the way they are recorded.
If mixed up, you’re going to see a lack of balance in your calculations, which will carry forward in your financial statements. Ensuring that your business runs smoothly means depending on the effective management of operating cash, i.e. the cash you have on hand.
Calculating both accounts receivable and payable helps business owners know how much the business needs to pay off and how much it will receive.
This article walks you through the differences between both and why is it important to have a balanced A/P and A/R for a smooth-sailing business.
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What is Accounts Payable?
Simply put, this is money that you owe to your lender or a creditor. Accounts payable is a current liability account that keeps track of money that you owe to a creditor for services availed. A popular example of this is purchases made for services and goods from other companies. You’re either required to pay the company as soon as possible or according to a predetermined date and time that lasts anywhere between 30 days to a few months.
What is Accounts Receivable?
Similarly, accounts receivable is a current asset account that keeps track of money that is owed to you by a debtor. These can be companies, banks, or people who have borrowed from you or availed services but haven’t settled their payments yet.
Examples of accounts receivable are of people or companies that have availed your services or ordered goods from you that generate revenue as a result of what your business offers.
How to Record Accounts Payable?
Companies often purchase goods on “accounts”. This type of transaction does not result in cash transfers. Rather the word “account” signifies that there was no cash involved in the purchase. For example, your company purchased electronic goods worth $3,000 on account of a retailer. This means your asset account, and electronic equipment, increased, and your liability account and accounts payable also increased by $3,000.
How to Record Accounts Receivable?
Inversely, when a company sells goods or services “on account”, this means there is a transaction occurring and cash is not involved. For example, if your business sold $3,000 worth of goods on account to a buyer, your accounts receivable will increase by $3,000 and the goods accounts will decrease by $3,000.
Accounts Receivable vs. Accounts Payable
Essentially, both are two sides of the same coin, where one represents money owed to your business and the other is money that your business owes to vendors and suppliers. Here are key differences you ought to know when understanding accounts payable vs. accounts receivable.
When talking about accounts receivable vs. accounts payable, the former is the amount that the customers of a company owe to it, while the latter is what the company owes to its suppliers.
- Both are included in your company’s financial statements and balance sheets. However, they are classified differently, where account payable falls under liabilities, and receivable falls under the current assets section.
- Account receivables are created when your company sells goods and services, while payables are created because you purchase some service or raw materials on credit.
- You can offset receivables with an allowance of doubtful debts, while payables have no offset.
- Accounts receivable leads to an increased cash flow for the company.
- Accounts payable will decrease the company’s cash.
- An invoice is generated for money to go under accounts receivable and delivered to the company that owes you, with payment expected within the agreed timeframe and terms.
- Accounts payable appears on business ledgers when an invoice is approved for payments.
- When calculating accounts receivables, you consider the total sales and subtract the returns and all the allowances as well as the discount given to the customers. The average receivables are calculated by adding the balance at the beginning and the end, then dividing it by two. While accounts payable is simply the total cost of purchases.
- The accountability for accounts payables lies on the business, while for accounts receivables the accountability lies on the debtors.
Why Should You Have a Balanced Accounts Payable and Receivable?
When managed effectively, accounts payable and receivables have a major impact on the cash flow of your business. This translates to the liquidity of a business while referring to a positive networking capital, i.e. having enough cash on hand for the daily operations of your company. This working capital is the difference between the current assets and current liabilities.
To ensure that you have a healthy and positive networking capital, there needs to be a collection of assets and a balanced settlement of liabilities. Hiring a professional who has a better understanding of accounting can help you with viable solutions and effective bookkeeping.
Understanding accounts payable vs. accounts receivable, helps you manage your company’s cash flows and late payments that can negatively affect daily operations.
Similarly, it is important to properly manage your accounts payable process. If you’re unaware of what and whom your business owes, you’re likely to end up in a financial mess that can take days to solve. Managing what you owe will help you determine the financial health of your business with some degree of accuracy and you will get out of reimbursing late payment interest.
Optimizing your accounts payable and receivable process is a great way to improve your company’s cash flow and financial health. If you find it hard to do so yourself, hire professional accounting services to help you manage your accounts.
Takeaway
Managing your business’s finance and accounting processes will mean understanding accounts payable vs. accounts receivable. However, accounting on your own can be taxing and might not result in favorable results.
Check out Monily for customized solutions to your accounting problems, and to ensure you’re running your business smoothly. Monily’s financial experts offer professional accounting solutions for startups, freelancers, truckers, the healthcare sector, as well as white label services and more. To understand how to manage your accounts payable and account receivables, contact our experts today!
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