Accounts Payable Vs. Accounts Receivable – Understanding the Difference
In the context of accounting, accounts payable and accounts receivable operations are often misunderstood – especially by non-accountants. This misunderstanding relates to the definition of the terms and their uses and implications in the business environment.
Accounts payable and accounts receivable are two different operations in the accrual accounting system. They also influence a business’s performance and results in their unique ways. Understanding the difference between the concepts helps enterprises navigate and use them in all aspects of their day-to-day operations.
Purpose
Accounts payable and accounts receivable processes vary in their purposes. But to understand the difference between their functionalities, we need to define each of them clearly.
Accounts payable is the amount of money a business owes its suppliers for the supplied commodities or services. This payment is usually due from around 30 to 90 days after the purchase. And companies will need to pay late fees when they delay the payment.
Accounts payable helps businesses procure the materials and equipment they need to run or process a sale without tampering with their capital. Companies can process their products before paying for these equipment or raw materials. The AP department captures suppliers’ invoices, routes the approval process, and ensures that you complete outstanding payments in due time.
Accounts payable is the amount of money a business owes its suppliers for the supplied commodities or services.
Contrary to accounts payable, accounts receivable is the money to be paid to a business by its customers. Since most buyers do not always have sufficient resources to cover their equipment and inventory requirements, accounts receivable ensures they are met as and when due. AR is also paid on invoices and can be harnessed to facilitate business relationships between buyers and sellers.
The accounts receivable department monitors accounts receivable operations in every business. They also follow up on these to ensure prompt payment from customers. AR is also responsible for maintaining good relationships with customers and ensuring early receipt of payments.
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Accounts payable constitute your company’s liabilities and are recorded as a current liability on your balance sheet. During balancing, your AP is featured on the right-hand side of your ledger, under ‘liabilities and equity. It is a current liability because your business has a short period of 30 to 90 days to pay it off. They are also referred to as short-term debts.
You must credit the AP with the invoice sum and then debit the purchases column by the same sum to record accounts payable.
On the other hand, accounts receivable a current asset and merits their position under the asset column of a balance sheet. It constitutes funds from your business and can be used as collateral for loans and as stocks in capital markets.
To record an accounts receivable transaction, debit the AR side by the transaction amount and then credit the income account by the same amount.
Key Documents
A voucher or a purchase document is the primary document used in accounts payable operations. Essentially, this document is a means through which businesses ensure that the commodities purchased are correctly received and payments (by the time they are made) are appropriately authorized. It is usually backed up by other documents that substantiate the purchase process. These documents include:
- The supplier’s invoice
- Your business’s purchase order
- A receipt acknowledging delivery of goods from the supplier
- Accounting general ledger
- Proof of invoice approvals
Accounts receivable documents are categorized as billing and include proofs of sales made to customers and their details and receipt information. Essentially, the billing on your AR has:
- The invoice you send to your customers
- Customer’s purchase order
- Receipt showing that your customer has received the commodity
- Ledger for accounting purposes.
accounts receivable is the money to be paid to a business by its customers.
The key documents in both processes are essential for accounting, auditing, reporting, and tax preparation purposes.
Cash Implications
The cash implications of AP and AR processes can be pretty mistakable. It is easy to assume that AP reduces available cash while AR increases available cash. But the reverse can be the case.
Accounts payable can be regarded as a source of funds for a business because it increases cash at hand for other investments. When you take advantage of an accounts payable agreement from your supplier, you’ll still have the transaction amount at your disposal for the duration of the deal. And if at any point, your supplier increases the period for which you can complete the payment, it means you’ll have more time to use the cash for other business purposes.
On the other hand, accounts receivable can be viewed as a use of funds that reduces the cash at hand for the period you agreed with your customers. Consequently, if your customer is to pay $100,000 for the commodities you delivered to them in 60 days, you will not be able to access that $100,000 until the payment is made – after 60 days.
Software Objectives
With the advent of AP and AR software, both operations’ efficiency has dramatically improved. However, in using either of the software, there are specific objectives businesses are to aim at to achieve optimal results.
While using accounts payable software, the aim is to prevent overpayment and maintain good business relationships with your suppliers. Preventing overpayments entails processing your supplier’s invoices and payments early enough without affecting your cash flow. However, since accounts payable is a cash source for your business, you wouldn’t want to pay your supplier too early, as you would lose access to the AP funds.
Your AP software objectives should also entail automatically matching the details on your purchase order with your vendors’ invoice data to avoid erroneous payments.
On the other hand, your AR software objectives should essentially include facilitating customer payments without distorting your relationship with them. Hence, your AR software should ideally provide a means by which customers process your invoices faster and make your payments on time.
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Software Costs
There is no laid-out difference between the costs of using AP software and AR software. The cost of each solution will depend on its developers, it’s subscription-based pricing, and additional AP/AR features (like vendor and customer management and integrations with other business tools) it offers.
While software like Bill.com and QuickBooks offer users accounts payable and accounts receivable features, software like Melio Payments and Square offer only accounts payables and accounts receivable features, respectively. Consequently, the cost of running either accounting operation will depend on each product’s subscription plan.
However, software that runs only accounts receivable operations is more expensive than those with only accounts payable options. This slight difference in cost stems from the fact that AR software may need built-in payment processors or integration with third-party processors to afford customers the flexibility of paying via diverse channels.
Key Skills Required
The critical skills required to manage AP and AR operations are similar and the general skills necessary to complete basic accounting actions. These general skills include:
- Accounting prowess to be able to balance both accounts for accurate reporting.
- Attention to detail to avoid and detect errors during billing, invoice capture, and order matching.
- Data management skills to actively manage both vendor and customer data.
- Financial intelligence to deduce the best times to pay vendors and receive customer payments.
- Interpersonal relationship skills to maintain good relationships with vendors and customers.
Cash Flow Management
Cash flow management is the lifeblood of every business operation. Suppose there is an imbalance between your inbound and outbound cash flows. In that case, your business will run out of cash, or you’ll suffer a loss from excess expenditure and overhead costs.
Your payable period shows how well you can manage your outbound cash flow. Without the advantage of accounts payable, you would have to pay for commodities at the instance of purchase. This will, in turn, affect how much capital your business can have handy for future investments.
On the other hand, increasing your inbound cash flow (receivables) keeps your business financially healthy. But when you fail to manage your inflow of money properly, you may begin to relax on your negotiation systems and start spending beyond acceptable limits.
Conclusion
As explained above, accounts payable and accounts receivable are two different operations within an accounting system. We have seen differences in their purposes, entry methods, document requirements, software costs, and objectives.
However, while both processes differ, they are both required for the smooth running of every business. If your accounts payable goes wrong, your accounts receivable will be shaky because you need payables to generate receivables. By purchasing (as accounts payable) and processing commodities, you can sell the same commodity (as accounts receivable). And if you cannot receive your AR on time, you may not be able to place orders to be accounted as payables.
