Have you ever seen a coin being flipped in the air? Yes? So you know that every coin has two sides, accounts payable (AP) and accounts receivables (AR) are exactly the same for a business. They are so well-linked that more often than not you’ll hear the terms used interchangeably, something that’s not advised as AP and AR are different concepts designed for opposite circumstances.
Feeling confused? Don’t worry, today we’ll be reviewing all the important topics to fully understand what payables and receivables are.
What are Payables and Receivables?
In simple words, accounts payable are liabilities, think about it like that pending payment you have to make in a month for the goods you just received. They are obligations, your business needs to respect,
Accounts receivable, on the other hand, inverts the story, and instead, it’s your company who’s expecting to be paid. They are an asset.
Let’s see it in more detail
Exploring Accounts Payable (AP) and Its Importance
Definition of Accounts Payable
When a company mentions its accounts payable, it’s referring to the specific amount owed to suppliers and creditors, generally AP are short-term debts, which don’t include regular expenses like payroll or mortgage payments.
The process to record an account payable starts when an invoice is sent and accounting and finance teams receive it to record it as a liability in a ledger.
Examples of Accounts Payable
- A tech company that develops smartphones orders lithium batteries from China on credit. The payment is due within 30 days, this means that the transaction is going to be registered as an account payable.
- An e-commerce brand that outsources its manufacturing to a third party and relies upon a shipping company to deliver its products needs to pay for those services. The due date to do that is after 25 days of using the service.
How to Record and Manage Accounts Payable
There are two methods to record and manage accounts payable:
- Accrual accounting
This is one of the most used accounting methods for businesses, and while the name might sound a bit complicated, it’s quite simple to understand. Basically what accrual accounting does is consider business revenue and expenses the moment they happen, in the case of accounts payable, for example, this means that the liability is registered as an expense right when it’s generated, not when the debt is paid.
- Cash-basis accounting
Here, the story is different, using a cash-basis accounting method, means that both, revenue and expenses are recorded only when the cash goes in or in the case of accounts payable, the cash goes out. While it’s a valid method, bear in mind that by choosing this, you won’t get a clear picture of the business’s financial health.
In order to keep numbers right, it’s a good idea to use some metrics like days payable outstanding (DPO) This metric allows financial professionals to discover the number of days between a debt is gendered and the date is finally paid. Something really helpful to unveil how well cash flow is managed.
Understanding Accounts Receivable (AR) and Its Significance
Definition of Accounts Receivable
Accounts receivable are the other side of the equation, here your company is waiting to receive funds/money from a customer. All accounts receivable are registered as assets, including the invoices clients owe for whatever service or product you have offered
Examples of Accounts Receivable
- An art gallery sells a piece of art in a recent open night event, the buyer made a pre-deposit of 30% of the total value, and the rest of it will be paid once the painting is delivered within 30 days.
- Company Z is interested in growing its partnership with Company A and keep buying supplies from them. To do this Company Z offers a 50%upfront payment to acquire a large amount of goods, the remaining 50% will be covered when the products arrive.
How to Record and Handle Accounts Receivable Efficientlyç
Accrual accounting is again the best method to handle accounts receivable. By doing this a receivable is recorded in the general ledger as current assets.
The Relationship Between Payables and Receivables
At the core of every transaction, there’s a side that’s bound to pay for something and a side that expects to receive a payment for something. In business finance, liabilities and assets are fundamental to understanding how well a company is faring. Financial professionals and business owners need to rely on both AP and AR to improve their accounting practices, manage cash flow effectively, and of course, drive upward revenue levels.
To achieve this, questions like how much credit is my company receiving? How sustainable is this in the long run? Are metrics going in the right direction?
Key Differences Between Accounts Payable and Accounts Receivable
If your company is performing a sale, the accounting department will issue an invoice, if by the contrary, the company is purchasing from someone else, you’ll receive an invoice. In the first scenario, that transaction will be registered as part of accounts receivable, in the second case, it’ll be part of accounts payable.
How Payables and Receivables Impact Cash Flow
Cash flow allows to measure the capacity of a business to face financial commitments.
- AP: As we have mentioned, accounts payable are considered a short-term liability having a natural impact on cash flow. Let’s say, that there’s an increase in payables. Would you say that this is positive or negative?
As strange as it might sound, an increase in payables positively affects cash flow because it shows that your company is making more purchases on credit and not heavily relying on cash.
Now, the other way around, if you are having a decrease in AP, this is bad news for the business, as it’s a sign that cash is spent to cover short-term debts.
- AR: At this point, we know that accounts receivables are regarded as an asset, however when it comes to its relationship with cash flow, precaution is required. Think about it, if there’s an increase in AR, it means that cash is not coming directly as expected, causing a problem for cash flow levels.
Strategies for Managing Payables and Receivables Together
- Define Clear Payment Policies: Nobody likes the back and forth of a dozen of emails and calls, this becomes more serious when money is involved. To avoid transactions that just don’t seem to end no matter what, establish clear credit policies to manage your payables and receivables. Defined timeframes are crucial to prevent any misunderstanding.
- Promote Open Communication: This applies to external parties, like vendors and customers, but it’s also important to your team. In large companies, payables and receivables are handled by two different groups of accountants and financial professionals, by fostering constant communication across departments, you can have a clearer picture of the performance of your business.
- Prioritize Invoice Issuance and Collection: Following the first point, issuing invoices at the right time helps to minimize delays in the billing cycle. The same goes for receivables, segment your clients based on their credit behavior, so you know beforehand when it’s critical to allocate more effort.
- Use automation: We’ll see more of this below, but considering how tedious is to keep track of every single detail involved in managing AP and AR, is highly advisable to count with the assistance of an accounts payable software.
Common Challenges and Solutions in Payables and Receivables Management
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Challenges in Payables Management:
Delayed Payments: Suppliers may not receive payments on time.
Solution: Implement automated payment systems. Negotiate payment terms with suppliers that align with cash flow projections.
Invoice Processing Delays: Manual invoice processing might delay transaction cycles and mistakes can happen.
Solution: Adopt electronic systems to streamline the invoice approval process to automate data entry and reduce errors.
Cash Flow Management: Making sure that outgoing payments match incoming cash flow can be challenging.
Solution: Negotiate payment terms with vendors to align with revenue cycles.
Challenges in Receivables Management:
Late Payments: Delays in payments hurt cash flow.
Solution: Set clear credit policies and terms beforehand so everything is clear for all the parties involved.
Disputed Invoices: Customers may dispute invoices due to discrepancies or dissatisfaction with services provided
Solution: Ensure accurate and transparent invoicing keeping always communication open.
Customer Relationships: Strained relationships can result from payment disputes or misunderstandings.
Solution: Maintain proactive communication with customers. Provide multiple payment options and flexibility where possible. Seek feedback to continuously improve invoicing and payment processes.
Automation for Payables and Receivables Processes
Let’s picture this for a second, some invoices must be created, receipts need to be collected, there’s a large list of orders to ship, another set of products to purchase, and on top of everything, financial reports waiting to be completed.
How tiring, right?
We don't blame you, making sure that payables and receivables are managed correctly is not a simple task and that can lead to mistakes.
There’s a solution and it’s called Control Hub.
By choosing an automated software like Control Hub’s Managing your accounts payable becomes a cakewalk. ControlHub offers you a complete view of your accounts, streamlining the payment process and reducing manual work.
Among the benefits of automating your payables and receivables process you’ll find that:
- It saves time and money, giving your business more freedom to invest in productivity tasks.
- Reduces human errors, with no manual data entry, the risk of human error is drastically removed, improving financial accuracy levels.
- Better cash flow management, having real-time visibility of due dates for payables and receivables, helps companies to manage better their cash flow.
- Faster approval cycles, integrating all the steps in a single process, reduce bottlenecks in the approval process.
Final Thoughts
If a business wants to keep its finances on a good track, it’s important to be aware of the distinctions of payables and receivables and how these affect the financial performance of the company. A business that’s aware of its payables knows with precision where the money is going and why. The same happens by understanding the receivables, as it allows business owners to comprehend how profitable the business is.
KEY TAKEAWAYS
- Account payables or AP and Account receivables AR are not the same.
- AP refers to those short-term financial commitments, debts, that companies owe to suppliers/vendors.
- AR refers to unpaid money from customers that will be paid in a settled timeframe.
- While different, payables and receivables are connected to the financial health of any business.
- Accrual accounting is the most effective method to record and manage AR and AP.
- Challenges for managing payables and receivables include Delayed payments, mistakes, manual data entry, cash flow, and misunderstanding.
- Automation of the processes is key to being more efficient and avoiding waste of resources.
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