Updated: 30 October 2023
The term ‘accounts payable’ refers to money owed by a company to other parties (e.g. suppliers). By contrast, the term ‘accounts receivable’ refers to money owed to the company by other parties (e.g. customers). Understanding accounts payable vs. accounts receivable is crucial for effective accounting and financial reporting. In particular, it is fundamental for robust cash-flow management.
Accounts receivable and accounts payable are both shown on a company’s balance sheet. They are, however, in different sections. Accounts receivable is listed as an asset and accounts payable is listed as a liability. Here is some more detail on both accounts receivable and accounts payable.
Accounts receivable, meaning funds that are due to a company, usually relate to purchases made on some form of credit provided by the company. This can mean anything from invoicing in arrears to offering instalment payments. As a result, they are generally categorised as short-term assets. This means that they are expected to be monetised within a year at most.
Managing accounts receivable starts with making sure that you always have a clear overview of what you are due. Small businesses may be able to achieve this by using free software, or even spreadsheets.
These types of solutions are, however, very easy to outgrow, and you may find it best to invest in a proper accounting software, or to use an accountant. There are options for all price points and also numerous cloud-based options.
Additionally, you need processes for ensuring that the relevant people are sent the relevant information about accounts receivable at an appropriate time. For example:
If you use a robust accounting package, a lot of these activities can be automated. If your accounting package links to payment solutions (as many do), then even more can be automated. For example, a customer could be sent an invoice automatically. Their payment could be collected automatically on its due date or paid manually. In either case, the payment could be automatically reconciled.
Credit control starts by making sure that you only extend credit to customers who can actually afford to pay it back. Given that a customer’s situation can change over time (for better as well as for worse), it’s advisable to make periodic checks on a customer’s financial standing.
Similarly, it’s vital to keep track of payments as they are made or not made. Dealing with the latter is an almost inevitable part of managing accounts receivable. Failed and late payments should both be addressed promptly and fairly, with a set process.
Accounts payable, meaning funds that a company must pay to other people, usually relate to payments to suppliers. They are distinct from internal staffing costs (which are considered expenses rather than liabilities).
Managing accounts payable starts with your purchase process. Generally, once an agreement is made with a vendor, it will be expected to stand unless there is a compelling reason to change it.
Just as you should be careful of extending too much credit to a customer, you should also be careful of taking on too much credit yourself. Ideally, your accounts receivable will cover your accounts payable (with room to spare). Practically, the realities of cash flow may make it preferable for you to have access to some form of business credit.
Flexible business credit options can be great tools for managing everyday expenses such as paying your own invoices. For significant investments, such as capital expenses, a business loan may be a better choice.
Here is an overview of the key differences between accounts payable vs accounts receivable.
|Accounts Receivable||Accounts Payable|
|Definition||Money owed to the company by third parties.||Money owed by the company to third parties.|
|Role in Financial Statements||Current Asset||Current Liability|
|Key Metrics and Indicators for Monitoring||Accounts Receivable Turnover Ratio, Average Collection Period, Ageing of Receivables||Accounts Payable Turnover Ratio, Average Payment Period, Ageing of Payables|
|Challenges in Management||Late customer payments, potential bad debts, and maintaining efficient collection processes||Delayed payments, missed discounts, and accurate recording of payables|
|Strategies for Optimization||Clear credit policies, streamlined invoicing, active collection efforts, and customer credit analysis||Efficient payment processes, negotiating payment terms, early payment discounts, regular reconciliation, and vendor relationship management|
In many businesses, accounts receivable and accounts payable have an important relationship. In essence, accounts receivable (e.g. payments from customers), is needed to cover account payable (e.g. payments to suppliers).
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30/10/23: While we want to help as much as we can, the information found here is provided solely for informational purposes and should not be considered financial or legal advice. To the extent permitted by law, Funding Circle does not accept any liability for any loss or damage which may arise directly or indirectly from the use of, or reliance on, the information contained here. If you have any questions, please speak to your professional adviser or seek independent legal advice.