Accounts Payable vs. Accounts Receivable

Accounts payable and accounts receivable are polar opposites, with accounts payable representing money owing to suppliers and accounts receivable representing money owed to the business (typically by customers).

When it comes to bookkeeping and accounting, the functions of accounts receivable and accounts payable are frequently confused. The way the two types of accounts are kept in the general ledger is extremely similar.

However, on a company's balance sheet, it's critical to distinguish between the two since one is a liability account and the other is an asset account. When they are mixed, it can lead to a loss of balance, insufficient working capital, or, worse, bad debt.  

What is Accounts Payable?

Accounts payable (AP) is a liability account because it keeps track of all funds that a business owner is responsible for when doing business with a third party. A business keeps track of the money it owes to vendors and suppliers for goods and services received on credit.

A business loan is a common example of an accounts payable account. A contract is formed to repay a debt in instalments over a set period of time. Each month, payment conditions are created with a firm due date.

Early payment to a vendor can result in debt reduction in some situations. AP transactions can also include anything from office supplies to income taxes and any short-term debt.

The Accounts Payable Process

The AP process is comprised of five major steps. A significant amount of time may elapse between these five tasks in a larger business:

1. Receival – After purchasing goods or services from another company, a company will receive an invoice seeking payment.
2. Record – The invoice is then recorded in the accounts payable ledger. This process should be automated if you have accounting software, using technology such as invoice scanning and optical character recognition (OCR).
3. Match – The invoice may need to be matched with a purchase order, shipping records, and/or inspection report, depending on your process.
4. Approval – To ensure that the payment is warranted and acknowledged as a debt, the invoice must go through a series of controls and an approval process.
5. Payment – The final step is to ensure that the invoice is paid on time and in full. The entry should be erased from the account once payment is received.

What is Accounts Receivable?

Accounts receivable (AR) is a type of current asset account in which a company records the amounts it has a legal right to collect from customers who have received services or commodities on credit. It is an income statement that maintains track of all the money owed to you by third parties as well as the cash intake into the business. This can be any entity that owes you money, including banks, corporations, and individuals.

Interest receivable is a common example of an accounts receivable transaction, which you acquire from making investments or storing money in an interest-bearing account.

The Accounts Receivable Process

The AR process flow is quite simple. When looking for a payment, an AR team must go through three major processes. They are as follows:

1. Send - When all work is finished, an invoice is instantly issued to the customer.
2. Track – A trial balance is used to track invoices on a regular basis. When payment is not received, reminders are given, and further action may be taken (i.e. phone calls or collections).
3. Receival – When a payment has been received, the AR department will ensure it is the correct amount and record it in the ledger as“ paid.”

How to do Accounting of Accounts Payable and Accounts Receivable

Whether it’s a small business or corporate finance, AP and AR function the same way and both are required for a full transaction.

This is how it works…

Company A offers items on credit to Company B. (with payment terms of 30 days). The sum is subsequently recorded by Company A as a credit to sales and a debit to accounts receivable.

Company B records the purchase as an account payable credit. When the credit sale amount is remitted, they will debit the liability in the AP ledger and credit cash.

Company A will deduct cash and credit the current asset at this moment.

This demonstrates that every transaction has two sides, which is known as symmetry.

At the time of the sale:

Company A declares a sale as well as a current asset.

Company B declares a purchase as well as a current liability.

At the time of payment:

Company A reports an increase in cash and a drop in AR.

Company B reports a decline in cash and an increase in AP.

Every credit transaction must include an element of both accounts payable and receivable. In this scenario, because Company A sells to Company B on credit, they are the "creditor," and Company B is the" debtor." This means that AP and AR are always involved in every transaction.

Final Thoughts

Understanding these two ideas is essential in business. This is especially true if you are just starting out and conducting a lot of credit-based transactions (i.e. "on account"). To lessen stress in the long run, you must be able to detect both processes.

Accounts receivable and payable are critical components of a company's cash flow. Late payments should never be accepted as the usual. It's vital to understand exactly what you owe and to whom. Missed payments can result in penalties and broken relationships.

A balance sheet with too much cash does not leave a corporation with enough capital to reduce debt and invest in growth. As a result, optimizing both procedures can improve an organization's financial health, boost cash flow, and generate revenue.

About Jordensky

At Jordensky, we are committed to providing an experience of the highest caliber while specializing in accounting, taxes, MIS, and CFO services for startups and expanding businesses.

When you work with Jordensky, you get a team of finance experts who take the finance work off your plate– ”so you can focus on your business.

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