Accounts Payable Vs Accounts Receivable – The Yin & Yang Of Businesses
Buying or selling products and services on credit is a common practice in the world of business. That’s where the concept and practices for accounts payable and accounts receivable come into play.
If you have recently stepped into the arena of accounting and bookkeeping, the terms accounts payable and receivable may still be a source of confusion. Both activities are part of the accounting cycle, and businesses that use double-entry or accrual accounting usually perform both.
A lack of information in either of these accounts would impact your financial statements and lead to false accounting.
Hence, in this blog, we’ll cover all the information you need to know about accounts receivables and accounts payables, and the difference between the two.
What are Accounts Payable?
Of course, you’ll need a variety of different products and services to keep your business functioning, all of which will cost money. Accounts payable is a balance sheet liability, meaning that the money is in the bank, but the debt to the vendor or supplier is still owed at the end of the payment term.
In other words, accounts payable is a term that refers to the purchase of goods or services on credit from other companies.
This account will also hold your organization’s overhead operating expenses, such as salaries, taxes, advertising, utilities, insurance, etc.
Therefore, maintaining an objective stance on your company’s finances necessitates keeping a watchful eye on accounts payable. It becomes incredibly impossible to prepare your budgets and predict growth without this account. With accounts payable, you can start keeping track of who you owe, how much you owe, and when it’s due.
On the other hand, keeping a track on your accounts payable isn’t only about monetary benefits. It also entails establishing good credit and maintaining great vendor ties. To develop confidence with your vendors, you must settle payments on time (or well before the contract expires). You can then use this trust in the future if you ever need to work out an alternate repayment schedule.
How does accounts payable work?
Accounts payable has three essential processes, similar to accounts receivable payment processing, although it’s critical to note that for many larger organizations, a significant amount of time may lapse between these steps:
- Receive the invoice: After you’ve bought goods or services from another organization, you’ll receive an invoice containing payment instructions.
- Record the invoice: The invoice will then be entered into the accounts payable ledger as the next step.
- Send payment: Once payment is received, the record should be deleted from the account.
What is Accounts Receivable?
Accounts receivable is an asset account that tracks money owed to you by third parties. Third parties can include banks, companies, or people who have borrowed money from you. The sum owed to you for products sold or services provided to generate revenue is a common example.
All accounts receivable will reflect on a financial statement, even when the payment is outstanding and has not yet been received.
So, how then do you collect payments from your customers? What’s more, how can you convert your account receivable into cash flow?
This is where payment terms are crucial.
Let’s assume you’ve decided to offer your consumer 30 days to pay you back for the product or service you’ve offered. The payment term in this instance is 30 days. You’ve essentially granted credit (or a short-term loan) to your consumer from the date the product or service is delivered until payment has been made. The longer the payment period, the more credit you’re giving the customer.
Using a clear contract to define payment terms allows your customer to pay within a predefined period and assures you will be paid on time.
Lengthier credit terms mean an extended time for customers to pay, which lengthens your business cycle.
Although not all debtors prove to be a risk, some default on payments, leading to Bad Debts. Consequently, a contingency plan is always set aside by the company to deal with bad debts. This is called a Provision for Doubtful Debts.
Before permitting a customer to purchase goods or services on credit, a few factors are considered. They are as follows:
- Credit Policy: This covers decisions like credit period, discount rate, and early payment, among other factors.
- Credit Analysis: This involves specifying whether or not a particular consumer is qualified for a more extended credit period. The assessment of credit scores, previous credit history, and other approaches are employed in this regard.
- Collection Policy: Receivables that are collected on time have a lower risk of being lost.
- Receivables Control: This involves debtor follow-up and faster debt collection.
How does accounts receivable payment processing work?
The business process flow for accounts receivable is rather simple. When chasing a payment, the accounts receivable department will take three key steps:
- Send the invoice: As soon as the product or service has been delivered, the customer will receive an invoice.
- Track the invoice: The account receivable team will track invoices regularly, and if payment has not been received, they will also send reminders.
- Receive payment: The team will mark the payment as “paid” and enter it into the ledger when the payment arrives.
As we all know, every coin has two sides, and the same applies to accounts receivable and payable. If there are accounts receivable for one company, there will almost definitely be accounts payable for another. Both are crucial for a business’s survival and efficient operation.
Maintaining control over your accounts receivable and payable drives your company’s operations. Inconsistent or erratic focus on these accounts can hinder growth, whereas a consistent procedure leads to a business capable of reaching all of its objectives.
To find out more about how we can help you with accounts payable and accounts receivable, visit CharterCPA.