Accounts Payable vs Accounts Receivable

The perfect balance, does it ever happen in real life?

Well, as far as business is concerned, the answer is an absolute yes, and it comes with the names of accounts payable (AP) and accounts receivable (AR). 

One cannot exist without the other, and it makes sense. Liabilities and assets are essential parts of every business, large or small. 

But what are the differences between payables and receivables? And more importantly, how can you manage both to the maximum efficiency level? 

That’s what we’ll be focusing on today 

But first, let’s cover the basics. 

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What’s Accounts Payable?

A hardware company orders some materials to carry on with their production process, the supplier sends the goods over. However, according to the purchase agreement, the payment will be processed in two stages. One when the product is delivered, the other after 30 days after. The company’s accounting department needs to be aware of this so it’s recorded as a short-term liability or in other words as an accounts payable. 

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In other words, AP refers to the money a business owes to its suppliers or vendors when goods or services have been delivered but there’s still a pending payment. It’s registered on the general ledger and is clearly an obligation that needs to be fulfilled. 

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What’s Accounts Receivable?

Now, AR has reversed the situation 

That same company of the previous example is interested in strengthening its relationship with a specific customer, so it offers them the possibility of buying the products with a set-to-pay date in the near future. Usually, this is 30 days, but depending on the case it could be 60 or even 90 days after the purchase is processed.  The client agrees and the company register this as an asset that has yet to materialize. 

That’s what accounts receivable are all about. Money that’s recorded in the business’s balance sheet but has still to be paid by the clients. 

Okay, so hopefully now we have a clearer idea of what AP and AR are, let’s move onto the key similarities and differences.

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Differences between Accounts Payable and Accounts Receivable

Definition 

It’s probably the simplest way to distinguish AP from AR, as we have just seen accounts payable represent a liability (money owed by the company), while accounts receivable represent an asset (money owed to the company).

Recording 

Following that line of thought, it’s expected that there will be a difference in the way companies register their payables and receivables. AP are recorded as current liabilities in the general ledger. AR are recorded as current assets. 

Impact on operations 

Of course, your pending payments and assets on waiting are going to have an impact on your operations flow, a good management of accounts payable will mean that you are responsible for your debts and that your suppliers are happy, on the other hand, managing correctly accounts receivable keeps your cash flow on balance. 

How AP and AR are connected? 

This is really easy to understand, every invoice involves one party that needs to pay and another party that will receive the payment. To fully understand how well or not your company is faring it’s precise to consider both your accounts payable and receivable together.

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The Accounts Payable Process 

Invoice receipt

Consider this as the first step, a vendor sends an invoice to your business for the products or services provided. This invoice includes key information such as the invoice number, date, amount due, and payment terms. It’s with these details that the process starts with. 

Verification

Now that you have the invoice, it’s time to review that all the information provided there matches the purchase order (PO) and the goods received. You’ll need to pay close attention to this as it’ll guarantee that you are only paying for what was ordered and received. 

Approval

What happens after you have verified that the details are correct? Well, it’s the moment for approval. Ideally, the invoice is forwarded to the right department or person for approval and that’s it. Yet, it’s worth noting that in large companies or manual processes, this step can face a lot of back and forth. 

Payment

Once approved, the invoice is processed for payment. The method you’ll use to do that will depend on the payment terms agreed beforehand. 

Why AP management is important? 

We are sure that at this point you already have an idea of the importance of having a solid management of your company’s AP. Effective accounts payable management is the foundation for maintaining healthy cash flow, as it guarantees that a company can meet its obligations without impacting operations or incurring extra responsibilities. Think about it, by making timely payments, you can build strong relationships with suppliers, which can result in better terms, discounts, and positive arrangements. Additionally, well-managed AP contributes to accurate financial records, something that will come in handy when the moment of creating reports arrives. 

Alright, but how can you achieve all that? 

There are some practices that you could consider 

Best Practices for Accounts Payable Management 

Set clear policies 

This is a must in any process, but it carries special importance for AP management, you want your team to be fully aware of their responsibilities and establish a simple workflow. 

Choose automated solutions

Utilize accounting software to automate invoice processing, payment approvals, and record-keeping. Automation reduces errors and speeds up the AP process. It’s a complete win-win.

Negotiate payment terms

If you know the ins and outs of your finances, why not take advantage of them? Negotiate favorable payment terms with suppliers to improve cash flow and take advantage of early payment discounts.

Reconciliation

Make regular reconciliations of accounts payable a habit, this way you can ensure accuracy and address discrepancies before it’s too late. 

Good supplier relationships

Communicate effectively with suppliers and address any issues or disputes quickly to maintain positive relationships.

Time to move on the other side of the coin 

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The Accounts Receivable Process 

Issue the invoice

Right after delivering the product to the client, your accounting department will send an invoice to the customer. And yes, this invoice is composed of the same details we saw on the AP process. Number, date, and payment terms. 

Keep communication open 

Probably your customers have been already notified of the invoice but it’s not a bad idea to follow up to ensure that invoices are received, this is also a great opportunity to discuss any questions or possible concerns. 

Payment collection

As simple as customers making payments according to the agreed terms.

Recording Payments

But wait, there’s more than celebrating the payment. Once the money is received, the responsible department will record the transaction in the company’s accounting system, reducing the accounts receivable balance and reflecting the cash inflow.

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Why AR management is important?

Managing accounts receivable correctly is key to keeping cash flow positive and supporting your business operations. Running a business in our current ever-changing environment is not an easy task, so the last thing you want is to see your assets left forgotten in a record instead of getting the money for your services/products.  A well-planned accounts receivable process is how you keep cash coming in. 

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Best Practices for Accounts Receivable 

Set clear billing procedures 

Nothing good comes out of a messy process, at least not when businesses are involved, so you want to approach your billing procedure with uniform practices. Ensure you document the process so all team members adhere to the same standards. Your billing protocol should cover:

• Schedule for billing cycles and invoice issuance.
• Required details on invoices (such as Purchase Order numbers, addresses, etc.).
• Procedures for maintaining records.
• Regular reviews and follow-ups of accounts receivable processes.
• Steps for managing overdue payments and collections.

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Trust on automation 

Yes, manual handling of accounts receivable might work just fine, but hear us on this, without automation, your process is prone to mistakes something that in accounting could mean financial losses. With a digital solution, you can remove repetitive asks from your team workload, allowing them to be fully focused on what matters.

Make payment a simple step 

Provide customers with various payment options to make it easier for them to pay promptly.

Make the payment process as smooth as possible by eliminating any obstacles that might get in the way for your customers.

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