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If you’re trying to get a handle on your business’s accounting strategy, it’s important to understand accounts payable vs accounts receivable. While these two terms may sound similar, they are quite different. One is an asset to the business while the other is a liability. In essence, accounts payable vs accounts receivable are opposites of one another. One defines an amount owed to the business and the other refers to a sum of money the business owes to a third party. Read on to learn everything you need to know about accounts receivable vs accounts payable.
What are Accounts Payable?
Accounts payable are current liability accounts that track money, goods, or services that the business owes to a third party. These third parties may be a bank, another company, or even an individual the business has borrowed money from. A common example of accounts payable is a bill for goods or services from another company that’s unpaid. The bill terms may require immediate payment or delayed payment within a short period.
Examples of payables
Any time money is owed by the business to another entity it becomes an account payable. Examples of this would be any:
- Purchase made to vendors on credit
- Subscription or installment based payments for goods or services that the business has already received
- Deferred payments that do not accrue interest unless the repayment is late
Accounts payables do not refer to any routine expense the business might incur for regular operations.
What are Accounts Receivable?
When it comes to accounts receivable vs accounts payable, accounts receivable are current asset accounts that track money, goods, or services owed to the business from a third party. Just like with accounts payable, these third parties may be banks, other companies, or an individual who has borrowed money from the business. A common account receivable would be an unpaid bill for goods or services provided by the business. Most business owners will be familiar with pending invoices, these are considered accounts receivable.
Differences Between Accounts Payable and Accounts Receivable
As you’ve read, accounts receivable refer to an inflow of cash, while accounts payable refer to an outflow of cash. Accounts payable are accounts on the business’s general ledger representing an amount owed to creditors or suppliers. On the other hand, accounts receivable indicate outstanding invoices for credit, goods, or services owed to the business. They’re essentially a line of credit from the business to a third party whether that be a bank, customer, or another business.
Bills do not have to be complete right when the transaction occurs. Instead, a business might send an invoice for you to pay at a later date. Transactions with delayed payment still need to reflect on a business’s balance sheet. If the debt is owed to the business, it goes on the balance sheet as an account receivable. However, if the business owes the debt to a third party, it is an account payable.
How does accounts payable payment processing work?
It’s important to closely monitor the accounts payable payment process. To keep track of accounts payable, a business should record what is ordered, what is received, and the appropriate costs. The business should be provided with a purchase order before the invoice. The company should verify that both the purchase order and invoice are correct. The business should then record the transaction as an account payable and scheduled payment before the due date.
How This Affects Your Balance Sheet
Mixing up accounts payable and accounts receivable can throw off the business’s balance sheet and wreak havoc on basic financial statements. In the case of small businesses, late payments can cause the company serious issues. Outstanding invoices cause business cash flow problems leading to operational issues as well as improperly calculated balance sheets. Recording accounts receivable helps to balance the business’s accounts as well as maintain outstanding bills and prompt payment from customers. Keeping a record of accounts payable helps the business to manage its debt. Using accounts receivable also helps small businesses with cash flow if they can negotiate favorable payment terms.
Accounts receivable should be located in the assets section of a business’s balance sheet. They’re either a current or long-term asset depending on the repayment terms. Accounts payable should go under current liabilities on the business’s balance sheet. Accounts receivable and accounts payable are both ‘current’ (with receivable being an asset and payable being a liability) because they both have term limits of one year. In certain situations where the business is working under longer credit terms, accounts receivable may qualify as long-term assets instead of current ones.
Depending on how a business organizes its balance sheet, accounts receivable may be considered revenue. If a business is using cash-based accounting, then account receivable should not contribute total revenue. However, if a business is using accrual-based accounting, then accounts receivable can qualify as revenue once the transactions are complete.
It’s quite popular for companies to purchase items “on account” (i.e., not for cash). You still need to monitor and record these business transactions. Recording these payments helps businesses keep track of outstanding bills. It can let the business know who owes them and how much or who the business owes and how much. Tracking these accounts also provides the business a full outlook on its profits, debts, and overall financial status of the business.
If a business does not record accounts receivable the business may end up providing goods or services for free. If you do not record accounts payable, your business may end up losing track of debts. This may cause you to accumulate interest or the bills being sent to a debt collector. Recording accounts receivable can also work as proof of income which is vital for tax purposes.