Accounts Payable Vs. Accounts Receivable

By Sean Stevenson – Latest Revision January 3rd, 2021

Understanding the differences between accounts payable and accounts receivable is integral for small business owners. 

For enterprising business leaders too, the uses and contrast of these two terms can be staggering.

In this article, I will tell you everything you need to know about accounts payable vs. accounts receivable.  This includes:

  • The imperative definition for each term
  • Their key differences
  • Why they matter for any business model
  • How to make optimal use of each
  • How to record them
  • The use of discounts and why it is advisable for any business
accounts payable vs. accounts receivable
accounts payable vs. accounts receivable

Accounts Payable

Example:  Your business purchases something

Accounts Receivable

Example:  Your business receives payment

Accounts Payable Definition

Accounts payable (AP for short) is the amount that must be paid off by a business.  This means that AP represents a liability that is owed to a debtor, creditor, supplier, or some other involved party. 

Often, an accounts payable amount is recorded on a company’s general ledger for reference and planning.

For your own purposes, accounts payable would be an amount that your business must pay off in order to continue operating. 

The timeframe in which you have to pay off said amount, is something you must always consider carefully before taking on any form of debt.

Example

A small convenience store has taken on a loan to help it operate smoothly.  This debt allows the owner to buy some new equipment for his store. 

This would be an account payable, a liability, which must be paid by the business owner in due time.

Key Takeaways

  • Accounts payable represents outstanding liabilities that are owed by your business to a debtor
  • Any debt, invoice, or payment owed to suppliers, would represent an account payable
  • For easy reference, think of accounts payable to be just as its name implies; it is a payable amount that you owe, not something you are receiving

Accounts Receivable Definition

Accounts payable (AR for short) is the opposite of accounts receivable.  Accounts receivable represents an outstanding amount that is owed to your business. 

This owed amount can be considered as a line of credit.  Whether this is extended to customers, business affiliates, or otherwise, the principal remains exactly the same. 

The outstanding invoices that are owed to your business are all considered to be accounts receivable.

Example

The same business owner we mentioned before has extended a credit to a few of his more prominent customers.  They owe him on some additional goods he supplied for a large wedding.

The amount they will pay him is defined as an account receivable.

Key Takeaways

  • Accounts receivable represent outstanding invoices that are owed to you and your company
  • Any amount that you are due in your profession, or for your immediate business, would represent an account receivable
  • For easy reference, think of accounts receivable to be just as its name implies; it is a payable amount that you are to receive, not something you are paying

Key Accounting Differences Of Payable vs Receivable

In terms of accounts payable vs. accounts receivable, the two contrasts are opposite of one another.

They represent money that is either owed by your business to a third party, or owed by others to your business.

Essentially, accounts payable is you owing money, whereas accounts receivable is you gaining money.

In both cases, you are dealing with third parties.  It is because of this that accounting for your amounts owed and gained is very important.  A detailed business ledger will help you keep track of both gains and debts as you navigate your business affairs.

Example

On his business ledger, Tommy notices that he has more accounts receivable than he does payable for the coming month.  This means that Tommy will make money in the coming month, once all accounts have been fully paid for.

Key Takeaways

  • Payable is owing money, whereas receivable is being owed
  • Keeping track of these amounts with a detailed accounting ledger, is integral to good business practice
accounts payable vs. accounts receivable

"Capital is that part of wealth which is devoted to obtaining further wealth."

-Alfred Marshall

Why They Matter To A Business Model

Now that we have explored the definitions and differences of accounts payable vs. accounts receivable, we can consider their merit.

Most small businesses deal with payments of all kinds.  Whether they are owed, or owing, it is vital for them to maintain a tidy balance sheet.   

To ensure a tidy balance sheet for your own small business:

  • Always strive to remain accountable to what your business finances are telling you 
  • If it’s time to save, then be prudent 
  • If you have the ability and room to expand, then it may be time to explore options for growth
  • Be sure to carefully monitor your accounts payable and receivable, to keep debt levels low

Why Accounts Receivable Might Not Always Be As Secure As You Think

In a devastating article by Forbes, a troubling study has indicated that “large companies are systematically paying their smallest suppliers more slowly than their bigger counterparts.  Previse, a fintech business specializing in the payments sector, says that on average, businesses pay their smallest suppliers 30 days later than bigger firms.” 

A similar sentiment was echoed by Floatapp.com in their article “Late Payment of Invoices is Crushing Small Businesses.”

From these articles alone we can deduce that small businesses are facing significant issues with late or stalled payments.  This has a severe impact the bottom line of any enterprise.  A single significant late payment can cause crippling financial issues. 

Working capital that goes unrealized for longer periods of time can mean payment obligations go unfulfilled.  Worse still is the possibility that the funding of new projects, products, investments, or even research can be halted indefinitely.  This can be a death sentence for smaller enterprises, which rely on accounts receivable being honored in a timely manner.

By carefully reviewing and refining your accounts receivable process, you can meticulously mold your own business finances.  This means being careful about your selection of customers and business associates.  Moreover, you should always keep an emergency fund on hand.  In case you must cover any additional expenses on your own, you will at least be well prepared. 

Use this careful mindset to your own advantage.  It is imperative for any business owner to prepare for all financial eventualities.  This will also assist you in creating long-term growth strategies. 

Key Takeaways

  • It is vital for any small business to maintain a detailed ledger of accounts owed and received
  • Nearly half of small businesses in many countries are facing routine late payments
  • Refine your accounts receivable process by careful selection of those you do business with
  • Carefully monitor your accounts payable and consider ways of cutting down on debt
  • Always keep an emergency fund on hand for unforeseen events that might impact your business

Making Optimal Use of Accounts Payable Vs. Accounts Receivable

Accounts payable vs. accounts receivable are two sides of the same coin.  They represent the overall flow of cash into or out of, a business.

Avoiding cash flow problems is a key aspect of any business success.  Inefficiency in accounts or accounting practices are what often hinder economic growth.

In any business model, it is always ideal to optimize both aspects of accounts payable and accounts receivable.  To accomplish this, consider the following tips:

1. Streamline Your Invoices

Human errors introduced during an invoice process can stop important payments from ever reaching your business. 

Counter this by having a template for each individual customer in place.  This will ensure their information is already correct and on hand before the payment has even reached the bank. 

Moreover, remember to issue your invoice immediately upon work completion!

2. Automate Your Accounts Receivable

With so much technology designed specifically for small businesses and business owners the world over, there are quite a few options to choose from.  From a standpoint of automating your accounts receivable, we recommend QuickBooks

I should of course note that we are not affiliated with Quickbooks in any way.  This is simply the most reliable accounting software we’ve come across for small business owners. 

If Quickbooks isn’t for you, here is a list of accounting software to choose from proided by Fundera.

3. Always Negotiate Payment Terms

Negotiating payment terms that make the most sense for your business is a must.  For receivables, try to get your payments as fast as possible.  For payables, try to ensure a longer payment term as necessary to free up additional cash. 

Optimizing both of these will grant you greater flexibility in seeking out new projects.  It will also ensure you keep a healthy batch of working capital in the background, for whatever need arises.

accounts payable vs. accounts receivable
accounts payable vs. accounts receivable

"A debt problem is, at its core, a budgeting problem."

-Natalie Pace

How to Record Accounts Payable and Accounts Receivable

There is often some confusion as to what accounts payable and receivable actually look like on paper.

Despite the fact that the two are similar in the way they are represented on forms and accounts, it bears mentioning. 

Being able to differentiate easily between the two will serve you well in your business ventures.

How To Accurately Record Accounts Payable

Whenever your company purchases items on an account (without cash), your account payable will look like the example below. 

Bear in mind, this is a simple “journal entry” that helps to keep track of accounts payable within a business ledger.

Example

Date

Accounts / Explanation

Reference

Debit

Credit

08-Jul-2020

Machinery and Equipment

 

$3,000

 
 

Accounts Payable –  ILC Co.

  

$3,000

 

Purchased Forklift on Account

   

Above we can see that the company’s ledger details both an asset gained, and an amount owed.  This principal helps reinforce the existence of the agreement as it was acted upon by both parties.

Key Takeaways

  • The company in the figure above purchased machinery and equipment, worth $3,000
  • This makes the asset “Machinery and Equipment” a verifiable $3,000 under the “Debit” category
  • This also has the effect of making the extended credit “Accounts Payable – ILC Co.” worth another $3,000 in unrealized payables that are still outstanding

How To Accurately Record Accounts Receivable

In the opposite scenario of accounts receivable, there are time when a small business might sell its goods or services on account (again, without cash immediately involved).  The entry into the business ledger would look like the figure below.

Example

Date

Accounts / Explanation

Reference

Debit

Credit

15-Aug-2020

Accounts Receivable- William & Co.

 

$2,500

 

 

Office Furniture

 

 

$2,500

 

Sold Office Furniture on Account

 

 

 

Again, above we can see the details of the amount receivable by the company known as “William & Co.”  This company sold $2,500 worth of office furniture.  This means that the accounts receivable has increased by $2,500.  Whereas, the outstanding amount of our office furniture account has decreased by $2,500 in value. 

These are important abstracts to understand.  On a larger scale, they will help you track your own inventory, along with the amounts you are being paid for that inventory.

Key Takeaways

  • The company in the figure above sold office furniture to a customer worth $2,500
  • This makes the asset “office furniture” a verifiable $2,500 under the “Debit” category of accounts receivable
  • This also has the effect of making the credit for inventory under “office furniture” worth $2,500 in inventory that no longer exists
  • This method of tracking ingoing payments and outgoing inventory can be very useful for a business of any size

Why Using Discounts is a Smart Business Move

Every highly successful business model I have ever seen or been a part of, have all used discounts.  The reasoning behind this is simple.  A cleverly placed discount can incentivize both a buyer and a seller to conclude their business faster. 

As noted by nickkolenda.com in their impressive “Pricing Psychology” list, there is an extensive science behind the business art of pricing products attractively.

In short, a slightly smaller amount to be paid can have a huge impact on what a customer is willing to buy.

Considering the merits of a discount carefully, you can not only get paid faster, but you can also attract more customers.  No matter your industry, this is a huge asset that should be fully explored.

Your Leadership Coaching Story

Take Action

With this new information in mind, take a brief moment or two to write your own ideas about leadership in finance

In this simple activity, you can define your own definition of what it means to be a great coach for a leader you know. 

Ask yourself:

  • What insight do they need to reach the next level of their business practice? 
  • What ideas can help them to better manage the people who work for them?

If you need help to develop your own ideas, use this question:

  • What are these businesses missing that I can provide?  What can I do to make their future better?

You can also subscribe for more information, resources, and tools to help you on your professional journey!

Subscribe
Notify of
guest
0 Comments
Inline Feedbacks
View all comments

Related Articles

Attitude is Everything

Attitude is the basis of everything that exists in our lives. Without the right attitude in place, we are unable to overcome adversity in all its forms.

Attaining flexibility In Leadership

Today’s business environment is in a constant state of flux. Adapting to an ever-changing business landscape is critical to modern leadership.

Leadership Exercises

To be the best, you must practice consistently. Leadership exercises are a highly actionable means of improving your organization’s capabilities. Think of them as a series of drills, or a form of training.

Several Essential Elements Of Leading Others

The ability to delegate effectively and influence the outcome is a prerequisite for managing others in a meaningful way. Elements of leading are not complicated, though they are a skill that requires practice like any other.

Copyright © 2020 leadershipdean.com. All rights Reserved.

leadershipdean.com
0
Would love your thoughts, please comment.x
()
x