Accounts payable and accounts receivable: Key differences
It is important for businesses to understand what are accounts payable and accounts receivable to better understand and manage their finances.
Although they are accounting concepts that act as opposites to each other, these two processes are equally important and are connected, requiring both to be managed accordingly in order to get both aspects of business accounting to go smoothly.
Accounts payable traditionally involve suppliers, vendors, or creditors and are short-term debts that the business must pay off in exchange for goods or services they have purchased.
On the other hand, accounts receivable are pending payments or incoming assets from other parties, typically customers, who have purchased goods or services from the organization or owe the organization money. Both accounts payable and accounts receivable must be reflected in the general ledger and the company’s balance sheet.
What are accounts payable?
Put simply, accounts payable (AP) are short-term debts that a business owes its suppliers, vendors, or creditors. Often shortened and referred to as AP, these include money that a business has yet to pay for products or services that it has already received, such as invoice payments, utility bills, office rent, and more.
Any supplier that offers the business credit for its orders should be recorded accordingly as part of the business’ accounts payable process.
These amounts owed are recorded as liabilities in the organization’s balance sheet and are obligations that must be paid and settled by their due date. Each supplier, vendor, or creditor may have its own payment terms, which is why AP management is crucial to get right.
Businesses must have a clear understanding of what are accounts payable and accounts receivable, with accounts payable making up the portion that deals with debts, liabilities, and traditionally vendors or suppliers. Both accounts payable and accounts receivable are important business aspects.
Example of accounts payable
If a clothing retailer orders INR 40,000 worth of garments from its wholesaler and has agreed-upon payment terms of net-30 and the invoice is sent on November 11, that means that the deadline for the payment is 30 days after November 11. This is considered an accounts payable entry in the retailer’s ledger.
The invoice will also contain information such as early payment discount eligibility. Either way, the retailer should debit its account and send a payment of INR 40,000 to its wholesaler by December 11.
What are the steps in an accounts payable process?
1. Documenting purchase order
A purchase order must be generated when a business places an order with a vendor. This is a document that details what the business requires from the order, such as the name of the item(s), the quality, and the quantity.
For a smooth accounts payable process, the procurement team must make sure that the purchase order, or PO, is documented correctly.
2. Acquiring
Vendors from whom the company ordered goods or services will deliver the order. Those who know what are accounts payable and accounts receivable will know that delivering goods and services accurately is a necessary step for processing payments.
In the case of accounts payable, when an invoice is paid depends on the contract and the agreed-upon payment terms. Generally, however, the order must first satisfy the business.
3. Recording
Businesses don’t want to miss any incoming deliveries and invoices. This is why it’s important to maintain detailed and accurate accounts payable records during every step of the process.
To make this easier, companies should consider using accounts payable software that can help them automate manual administrative recording processes. Ensuring up-to-date and accurate records will take no time.
4. PO matching with invoice
During the recording process and before payments are made, invoice matching should not be neglected. The invoice sent by the vendor should match the purchase order that the company previously sent.
In both accounts payable and accounts receivable processes, 2-way invoice matching is key in ensuring that the data between POs and invoices match, especially to avoid future discrepancies after payments.
5. Approval
To avoid discrepancies, unauthorized payments, and other payment-related issues, businesses need to have a strong approval process. Before accounts payable payments are processed and settled, the right personnel must first approve the invoice.
During this step, managers and executives will review the invoice and AP records to ensure that a payment is warranted. Only approved entries can be moved forward.
6. Payment
Once an accounts payable entry has been approved, it can be processed for payment to finalize the transaction with the vendor. When planning payments, businesses should consider what are accounts payable and accounts receivable and how to line them best up.
Make sure that accounts payable payments are made on time while still ensuring that they line up with receiving customer payments.
7. Archiving transactions
Just because a payment has been settled, it does not mean that the accounts payable process ends there. Keep in mind that archiving the transactions is as important as making them, as this provides companies with detailed records.
This will prove to be valuable during tax filings, audits, and general month-to-month accounting. Archiving helps prevent mistakes such as duplicate payments.
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How to record accounts payable
Accounts payable are recorded as journal entries during or after the receipt of an invoice. The invoice should state the agreed-upon payment terms, signaling that these terms must be met accordingly.
Although the expense is yet to be paid, accounts payable entries would still be accounted as expenses in the general ledger. They are also listed as liabilities on the balance sheet, although only the total amount will be recorded instead of individual transactions. When the expense has been paid, it will then be recorded as such.
Accrual accounting method
Businesses that know what are accounts payable and accounts receivable may already know about the accrual accounting method. In AP, this means that businesses will record unpaid expenses, such as when invoices are received for a product already purchased and delivered but not yet settled.
For example, if a business has purchased equipment for the factory and paid 30% as a deposit, the 70% will still be included in the expense record when the invoice is received, as the full amount is recorded.
Cash basis accounting method
Unlike an accrual accounting method, a cash basis accounting method records expenses as they are paid and settled. This means that if the business is invoiced on November 11 but only a down payment is given on that date, the records will only show the down payment.
The 70% that the business owes the supplier for the equipment they purchased will only be recorded on the general ledger once it has been paid in full, though the team will still need to keep track of pending payments.
What are the types of accounts payable?
Trade payables
As the name suggests, trade payables include bills for items that are necessary for the business’ trade. In other words, inventory-related payables are considered trade payables. For a clothing retailer, for example, the money that the business owes its garment supplier would be part of its trade payables.
Non-trade payables
Inventory-related goods alone are not enough to keep a business running. In addition to trade payables, businesses will also have non-trade payables, which are money owed to vendors for costs that are not directly related to stock. These include bills, maintenance and service charges, office supplies, and more.
Accrued liabilities
As with accrual accounting, accrued liabilities refer to expenses that have been incurred but have not been paid for. Different from other types of AP, these liabilities include expenses like year-long subscriptions that are billed on a monthly basis, with the coming months’ bills considered accrued.
Loan payables
Not all payables are for tangible assets. When learning about what are accounts payable and accounts receivable, it’s important to note that loans also play a factor. Loan liabilities that need to be paid off will also be noted on the company’s balance sheet and are considered loan payables.
Rent payables
Rent payables are as straightforward as they sound. They refer to money that a business owes for rent, whether it be for an office space or something else. So long as the vendor or asset owner is providing rental facilities for the business, the money owed would be listed by the business as accounts payable and accounts receivable for the asset owner.
Taxes payable
The biggest accounts payable vs accounts receivable difference is that types of accounts receivable can be more straightforward. With accounts payable, however, businesses will have to deal with taxes payable, which may also need to be calculated from customer payments received. This is the amount that businesses owe in taxes, including when they receive income.
Employee wages payables
While traditionally accounts payable are thought of as money that a business owes its vendors, the unpaid sum that the business owes its employees also factors into its accounts payable. If an employee has earned wages for a set number of hours but has not been paid for them yet, that would be considered wage payables.
Legal settlement payables
Though not as common as other types of accounts payable, businesses may have to make legal settlements in agreement with other parties. Any amount that has yet to be settled should be recorded as the company’s accounts payable under the legal settlement type of AP entries, as these would be a liability until they are paid off.
What is the importance of accounts payable in a business?
Businesses of all sizes and industries will benefit from investing in accounts payable management, as it can impact different aspects of the business. From managing invoices to maintaining positive vendor relationships, knowing what is accounts payable and receivable is important to any business.
Cash flow management
Paying vendors and managing accounts payable account for a great deal of the business’s cash flow management. Businesses need to know how much they know vendors and when payments must be made in order to maintain positive cash flow at all times.
Properly managing accounts payable and accounts receivable will guarantee that the timing of cash inflows and outflows match up accordingly to fulfill the business needs.
Invoice management
Invoices and accounts payable go hand in hand. In order to ensure that every invoice payment is made on time and according to its contract, businesses need to invest in proper accounts payable management.
Although AP refers to just the money owed by the company, managing accounts payable properly also helps businesses keep track of orders, incoming invoices, and payments. It also becomes easier to prioritize invoices accordingly.
Enhanced vendor relationship
Ensuring that all vendor payments are made on time and there are no delays in the accounts payable process are key aspects to maintaining strong relationships with vendors.
Businesses that are on top of their accounts payable management are more likely to meet payment deadlines, which in turn boosts their reputation. Vendors will be more eager to work with businesses that are professional and reliably meet their payment terms.
Compliance and reporting
Having detailed records of accounts payable allows the finance and compliance teams to have an easier time compiling reports and ensuring that the business’ finances comply with company policies and local regulations.
Due to the amount of administrative work necessary to keep up with accounts payable vs receivable, however, many businesses will enlist the help of accounts payable management software to ensure compliance and efficiency at the same time.
Cost control and risk management
Businesses that keep a closer eye on their expenses and liabilities are more likely to do a better job at controlling costs. This is why recording and managing accounts payable is crucial, as it helps businesses keep track of how much money they owe.
With a clearer picture of the business’s finances, it also becomes easier to manage risks. Companies that have clearer and stricter accounts payable management processes are less likely to overspend.
Insight into spending patterns
Businesses that understand the accounts payable vs accounts receivable difference will know that keeping a close eye on both will provide them with better insights into the business spending patterns. In other words, whether the spending is proportionate with the business income.
With the help of modern tools that can easily analyze business accounts payable data for more detailed insights, businesses will have more information for budgeting and improving spend controls.
Strategic decision making
The best thing managers and executives can do when making decisions is to be informed of the choices and consequences. Knowing what are accounts payable and accounts receivable aids businesses and allows them to be more strategic with decision-making.
For instance, with clear records, the company will be able to prioritize which accounts payable payments to make first to take advantage of offers such as early payment discounts.
Efficient vendor dispute settlements
In the rare cases of vendor disputes occurring, businesses want to quickly and efficiently settle these disputes to not disrupt operations. Without the right records and processes, however, this will be a challenge.
This is why understanding what are accounts payable and accounts receivable is crucial, as it allows businesses to establish a process with accurate records to quickly compare and contrast information and identify discrepancies for settlement purposes.
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What are the main challenges in the accounts payable process?
When each invoice is unique to its particular vendors and has its own contract terms, staying accurately up-to-date with every invoice is not easy. While knowing what are accounts payable and accounts receivable might prepare the team for the complexities of invoice processing, it requires a lot of work to ensure that everything goes smoothly.
It’s important that the AP team understands intimately what is required to smoothly process and pay invoices.
Proper accounts payable management is necessary to ensure that invoices are not paid late, but late payments and cash flow issues are also challenges in the accounts payable process that can make managing AP tough.
The more late payments businesses have to settle, the higher the penalties and fees are. As a result, these may cause more cash flow problems for the business. Late customer payments will also impact the timeliness of invoice payments.
With manual data entry, time is not the only concern that businesses have. Another issue that they may run into is data entry errors, often caused by typos or a lack of double-checking. Even with the accounts payable vs accounts receivable difference, data entry errors also affect both processes.
During the AP process, errors can lead to wrong amounts being entered during payments, which will result in discrepancies. Entries that are duplicated can also breed confusion.
While one of the goals of efficient accounts payable management is to avoid vendor disputes, sometimes these disputes can be unavoidable. Accounts payable and accounts receivable both have multiple parties involved, which is why disputes may happen.
Discrepancies between receipts, purchase orders, and invoices will need to be settled, which is time-consuming for both the business and its vendors. Not only will this impact efficiency, but also relationships with vendors.
Managing invoices is a notoriously complex and time-consuming task, often requiring a lot of labor or the right tools to be able to handle the workload of the company’s invoices. Bigger companies may struggle with more complexities, especially with the number of invoices they have to process.
To avoid issues during the invoice management process, it’s best to streamline and centralize with a singular platform that minimizes hassle and confusion.
One issue that could arise during the accounts payable process if the team is not carefully checking and recording every payment is the potential for duplicate payments. This happens when the same invoice is paid twice.
At best, duplicate payments create noticeable discrepancies that consume the team’s time. At worst, duplicate payments that go unnoticed will result in a loss for the company. If multiple of these happen, they will easily add up over time.
Other than recording owed amounts and payments processed, another major part of the accounts payable process is ensuring that invoices are reviewed and approved before they are paid. With manual processes, however, approvals can be prone to delays.
If there is an approver who is not physically in the office, for example, the approval requests on their desk can get pushed aside. Employees will also have to spend more time chasing approvals from desk to desk.
A big bottleneck in the accounts payable process for a lot of businesses is how slow the manual administrative tasks are. With the fast pace of many industries in the current landscape, the best companies should be able to keep up with the demands.
Manual processes are no longer enough. Businesses need to start making the switch from manual to automated to half the time required to manage and process accounts payable.
Invoice data needs to be scanned or captured accordingly to ensure that no information is lost during the process. However, without the correct processes, inefficient invoice scanning can be time-consuming or lead to issues like errors. Modern accounts payable tools can help mitigate this.
Many software providers offer optical character recognition (OCR) technology to allow faster invoice scanning. All employees will have to do is snap a picture to scan information.
What are some of the best practices in accounts payable?
1. Implementation of AP automation
With many modern solutions for accounts payable available to businesses, one of the best things a company can do to increase the efficiency of its AP processes is to implement AP automation.
Introduce a platform that can centralize accounts payable tasks and automate manual administrative processes. Familiarizing employees with these tools will create a more efficient and effective workflow.
2. Automated approval workflows
One of the major processes that can be automated with accounts payable software is approval workflows. Traditionally, approvals in accounts payable and accounts receivable take time and require documents to cross from desk to desk.
With AP automation, businesses can route all invoices and payment requests through just one dashboard. Every approver in the workflow should be automatically notified when approval is needed.
3. Vendor data management
Centralize vendor management on a single platform and perform accounts payable-related tasks from the same place. No more going through stacks of paper contracts and struggling to find vendors’ bank accounts.
It’s crucial that companies manage their vendor data accordingly to ensure that the rest of the accounts payable process can go smoothly. Accuracy and timeliness are key in vendor data management.
4. Segregation of duties
Those who are familiar with the answer to what are accounts payable and accounts receivable may already know that the processes involve a lot of steps. To avoid confusion, it’s good practice to neatly segregate duties and assign responsibilities accordingly.
In the AP process, this avoids miscommunication and prevents issues like duplicate or missed payments from happening.
5. Regular reconciliation of payments
Make it a habit to regularly reconcile payments. While the reconciliation process can be challenging, businesses that perform accounts payable payment reconciliation on a regular basis will be more prepared for audits and tax filings.
With modern accounts payable tools, regular reconciliation can also be automated. It takes less time for businesses to maintain higher levels of accuracy.
6. Payment scheduling
Having to manually process payments every single day can get tedious. Rather than preventing the accounts payable team from tackling other tasks, allow the team to schedule payments in advance.
The key accounts payable vs accounts receivable difference is that while AR only requires the team to ensure that payments come in on time, AP requires proactively creating payments. Use tools that allow advanced scheduling to save time.
7. Screening for duplicate payments
Using accounts payable automation software makes it easier for businesses to avoid duplicate payments, as most software providers offer features that can automatically flag duplicates.
However, it’s important to proactively screen for duplicate payments and routinely check flagged entries to stay on top of all payments while accounting for them accurately without any duplicates. Make sure to regularly double-check payments.
What are accounts receivable?
By understanding what accounts payable are, businesses may also already have an inkling about what accounts receivable entail. However, there are some accounts payable vs accounts receivable difference, which makes it important for businesses to know and fully understand what accounts receivable are too.
Put simply, accounts receivable can be considered as the opposite of accounts payable. Whereas payables are money the company owes its creditors, in accounts receivable, the company acts as the creditor. They are owed funds by customers or other parties who have received products or services from the company.
In both accounts payable and receivable, there are multiple parties involved. In the case of accounts receivable, however, the other party involved will be someone who owes the company money, traditionally the company’s customers who have been offered a credit term on their invoices.
These transactions and pending funds are recorded as assets on the company’s balance sheet. Despite not having yet received the money, the company would already be entitled to it.
Example of accounts receivable
Company A is a software provider that offers its customers a subscription-based payment plan. Company B is one of the businesses that use Company A’s software, agreeing to a payment term where it is billed monthly for the year it is using these services.
This is both an accounts payable and accounts receivable transaction depending on the point of view, but Company A will view it as an AR transaction and may offer a net-30 term, meaning that Company B has to pay them in 30 days from when the invoice is issued.
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What are the steps in an accounts receivable process?
Order placement
The accounts receivable process starts when a customer places an order with the organization. This means that the business itself cannot be the one who initiates the process, as it is reliant on an order coming in.
However, businesses should be ready with a clear process and policy for when a purchase order comes through, ensuring prompt and efficient handling when the accounts receivable process starts.
Sales order processing
The company will need to approve the purchase order that a customer sends in. Once it has been approved, the purchase order will then be turned into a sales order, which details the specifications of the product that the customer will receive, including any special requirements or terms.
This includes the quantity, quality, and price of the product. A sales order also serves as an agreement between both parties.
Credit approval
Not every incoming order is creditworthy. Businesses must make sure that they incorporate a credit approval step in the accounts receivable process to ensure that they don’t run into delinquent customers.
Even existing clients still need to be reassessed for credit approval, maintaining that they are still creditworthy. Customers who do not pass the approval may be offered alternative payment methods.
Setting payment terms
Even with the accounts payable vs accounts receivable difference, similar to agreeing on payment terms with vendors in the accounts payable process, businesses must also set payment terms with their customers for an efficient accounts receivable process.
These terms must be discussed and agreed on by both parties, clearly outlining the billed amount, payment deadline, payment methods, and more.
Sending invoices
Once credit has been approved and the business has agreed on payment terms with its customers, it is the appropriate time to begin sending invoices.
The invoice should contain important details such as how much the customers need to pay the business, where to send the payment, and when the deadline is. Other information such as discount terms and late fees will also be listed.
AR monitoring
The accounts receivable team cannot just wipe their hands clean after sending invoices to customers. It’s important to closely monitor sent invoices and accounts receivable regularly.
This helps with ensuring that payments are collected on time. If there are invoices that are overdue, monitoring the process allows the organization to quickly pinpoint it and make more proactive attempts at collection.
Handling disputes
Between late or non-payments and other manual errors, there could be issues that lead to discrepancies in the accounts receivable process. If they are not nipped in the bud and quickly solved, businesses will have to handle disputes with customers efficiently.
Make sure that they are handled in a timely manner to avoid late accounts receivable collection or further complications. Customers may also pay the amount that is not disputed first.
Receiving payments
This step may seem straightforward in the AR process, as receiving rather than sending is a big accounts payable vs accounts receivable difference. However, businesses need to be well-prepared for receiving payments efficiently.
There are quite a few modern payment methods that are popular amongst businesses today. Offering a variety of methods can speed up the collection process, but businesses must have the right tools for them.
Reporting and analysis
Make sure that the accounts receivable team does not neglect reporting AR and payment collections. In both accounts payable and accounts receivable, reporting is crucial as the business will need this information for future use.
Other than for tax and audit purposes, accounts receivable reports also provide insights into the company’s finances. Allow the AR team to perform analytics based on the records they have.
How to record accounts receivable?
Accounts receivable and a company’s receivable balance are recorded in its general ledger when the company performs its accounting activities using the accrual method. When a customer of the company is provided with goods or services on credit, the amount that the customer must pay should be recorded immediately after the invoice is sent.
This is good practice as it ensures that all AR transactions are noted down accordingly. When the invoices have been paid, these need to be recorded as well, accounting for any potential late fees.
Accounts receivable turnover ratio
One of the common standardized ratios used in accounts receivable records is the receivable turnover ratio, used to measure on average, how efficient an organization is at turning its receivables into cash. This ratio follows the formula:
Net annual credit sales / average accounts receivable = accounts receivable turnover
If Business A has INR 4,000,000 in sales over the period of one year and it started and ended the year with 500,000 INR in AR each, the receivable turnover ratio is:
4,000,000 - 500,000 / (500,000 + 500,000)2 = 7
Working capital ratio
The working capital ratio, often referred to as the current ratio, involves both accounts payable and accounts receivable, despite the accounts payable vs accounts receivable difference. The working capital ratio is a simple formula:
Working capital ratio = current assets / current liabilities
This determines whether or not a business can pay its short-term debts and obligations. For example, a company with INR 6,000,000 in current assets and INR 3,000,000 in current liabilities will have a ratio of 2.
Days sales outstanding (DSO)
Days sales outstanding, or DSO, measures the average time it takes for an organization’s customers to pay them for the goods or services provided. The formula follows:
DSO = accounts receivable in the given period / total credit sales X the number of days in the period
To calculate Business A’s (in the example above) DSO for one year, the formula would be:
500,000 / 4,000,000 X 365 = 0.125 (12.5%) X 365 = 45.6 days
This means it takes the business an average of 45 to 46 days to get customers to pay it back.
What are the types of accounts receivable?
Vendor receivables
Vendors are usually a key part of accounts payable, vs receivable, which more often than not deal with customers. It is possible, however, for businesses to have vendor receivables. These could come in the form of discounts or promotions that the vendor has promised but has yet to provide to the business.
Notes receivables
The basic mechanics of notes receivables are similar to trade receivables or other more traditional accounts receivable types, but there is one key difference. Unlike traditional receivables that are short-term, notes receivables can be extended for even longer than a year. The caveat is that these types of receivables will also accrue interest.
Employee receivables
When considering the accounts payable vs accounts receivable difference, one key difference on the surface is that with employees, it is traditionally the business that has to pay them, therefore employee payables are more common. However, it is also possible to have employee receivables, which include personal expenses that the company initially paid and the employee must pay back these expenses.
Interest receivables
Basic research of what are accounts payable and accounts receivable will mention how these are forms of credit that the business owes or is owed, but equally important to mention is the possibility of interest involved. In the case of late customer payments, for example, the business may charge interest, which will be recorded as interest receivables, generating additional revenue for the company.
Trade receivables
As the name suggests, trade receivables are funds that the company is owed as a result of doing business with its customers. For example, an unpaid invoice would be considered a trade receivable. This is often a large source of the company’s working capital. Timely collection of these receivables is important for this reason.
Accrued receivables
Similar to its payables counterpart, accrued receivables refer to past purchases that have not been settled yet. If a customer purchased a year-long subscription, for example, each month’s subscription income could be accrued and paid on a monthly basis despite already having a deal to get the subscription for a year.
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What is the importance of accounts receivable in a business?
Businesses that understand what is accounts payable and receivable will undoubtedly understand that the accounts receivable process is as vital as accounts payable. Good AR management maintains a positive cash flow, improves working capital management, and increases business efficiency, all inspiring investor confidence.
Revenue generation
Businesses generate their revenue through customer payments. Any unexpected changes in that process, such as late or missed payments, will affect the business’ revenue. This is why it’s so important for businesses to ensure that accounts receivable collection is done smoothly.
Businesses that are not on top of their accounts receivable and collection may even have to contend with a sizeable amount of their customer base missing payments, reducing their revenue.
Cash inflow
Cash inflow and accounts receivable go hand in hand. To ensure that a business always has positive cash flow, it will need to manage its receivables accordingly. When late collection occurs, for example, the business’ cash inflow will be affected.
This is crucial to understand in accounts payable and accounts receivable. If the business has an invoice due but no cash inflow, it may struggle with meeting the invoice payment deadline.
Maintaining liquidity
Sometimes people mistake assets as the sole sign of a successful business. However, businesses need to keep in mind the liquidity of their assets and whether or not they have enough liquidity to ensure that day-to-day operations can go smoothly.
This also will impact the way the company manages its accounts payable vs receivable. The company will have to settle its accounts payable in a timely manner, which is only possible if they have cash or cash equivalents.
Improved customer relationships
No business wants to work with customers that don’t benefit them in one way or another. When customers pay their bills on time, businesses will automatically be happier to provide their services, maybe even giving customers who never miss payments special discounts or benefits.
With proper accounts receivable management, businesses can build better relationships with clients and ensure that they know when and how they’re getting paid.
Sales performance and growth
The better a business’ sales performance is, the more accounts receivable the business will have to manage. However, accounts receivable is also a measure of the business’ sales performance and growth.
Businesses that have more customers will have more receivables. It is a good idea for businesses to regularly analyze and gain insights from their accounts receivable to gauge how their sales performance and growth are looking. This also helps businesses plan their growth better.
Working capital management
Despite the accounts payable vs accounts receivable difference, the two processes are both necessary for any organization’s working capital management.
On the receivables side, timely and accurate collection is a must to maintain the organization’s assets and ensure that the company can pay off its short-term obligations.
The more efficient businesses are at managing their accounts receivable and assets, the easier managing debts and accounts payable will be too.
Investor and shareholder confidence
Businesses with good accounts receivable management will inspire a higher level of confidence. Investors and shareholders are more likely to work with businesses with a steady income stream and know how to manage their collections.
Conversely, businesses that are unaware of what are accounts payable and accounts receivable as well as their importance will worry investors. As these are the building blocks of a successful business, accounts receivable management is a measure for investors to gauge the business' profitability.
What are the main challenges in the accounts receivable process?
Even with the most clear and concise policies, the accounts receivable team may still run into challenges that they will have to know how to deal with in order to achieve a more efficient process. These are some common accounts receivable challenges businesses face.
Delayed payments
Even with meticulous plans and controlled accounts receivable management, these do not entirely eliminate the risk of delayed customer payments. When customers are unable to pay their bills on time, this could throw a wrench in the company’s accounts receivable timeline and cash inflows.
Businesses will want to mitigate this by making sure that they stay up to date with their customers’ timelines. It’s good practice to regularly check in with customers to ensure timely payments.
Bad debt losses
Even with the best accounts receivable team, sometimes delinquent customers and bad debt can be inevitable. Unfortunately, this will lead to losses, as there are costs associated with the product or service that the company is offering to its customers.
Bad debt losses are challenges that businesses must know how to face and create contingency plans for. Forecasting the risk of losses and creating appropriate profit margins are crucial in offsetting bad debt.
Increased overdue receivables count
The more businesses have to contend with delayed payments, the more overdue receivables they will have to manage. This can spiral into a lot of different issues that no organization will enjoy dealing with.
Starting from cash inflow problems to an increase of administrative costs, an increased overdue receivables count needs to be nipped in the bud as soon as possible. It is important to prioritize accordingly and tackle late collection.
Ineffective collection practices
Those who know what are accounts payable and accounts receivable may already know how time-consuming collecting payments can be, especially when not performed efficiently and effectively.
These ineffective collection practices will cost the business not only just time but also money, as administrative tasks can be costly when they are not optimized accordingly. It could also cause more problems down the road, such as delays in receiving payments or mistakes in the recording process.
Inaccurate invoicing
If the accounts receivable team is not meticulous in double-checking invoice details before sending invoices out to customers, the company could run into the risk of inaccurate invoicing, which can affect cash flow and customer relationships.
Even if these invoices are then checked by the customers before they are paid, there is still some additional back and forth that must be completed before payment, which could result in delays. Paid inaccurate invoices can lead to disputes, requiring additional time and resources to resolve.
Disputes and discrepancies
Despite the accounts payable vs accounts receivable difference, one common challenge that businesses will face in both AP and AR processes is dealing with disputes and discrepancies. If a payment does not match its invoice, for example, that discrepancy will have to be examined and settled.
This not only takes time for both parties but can also sour relationships with customers. While they are important to settle, ideally businesses don’t want to run into them.
High administrative cost
There is a lot of admin work that must be done in the accounts receivable process, especially if an organization wants to stay on top of its collection. However, achieving timeliness and accuracy can come with high administrative costs.
Despite accounts payable vs receivable having differences, admin work is just as important for accounts receivable as it is for accounts payable. Some businesses may want to reduce their costs by implementing automation solutions.
Fraud risks
Businesses of all sectors need to be careful of fraud attempts when transacting with customers. It’s important to implement measures that double-check the legitimacy of customer payments.
Even with attachments of payment receipts, businesses still need to be aware that receipts can be doctored. Ensure that the AR team is checking that payments are received correctly in the account before clearing the invoice and marking it as settled.
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What are some of the best practices in accounts receivable?
1. Implementing AR automation
Those who know what are accounts payable and accounts receivable may already be aware that just like with accounts payable, accounts receivable processes are also much faster and easier with the help of automation. With the number of software providers on the market, finding one that suits any particular business is a manageable task.
However, businesses should keep in mind that every organization has different requirements. This means that thorough research is important, as it will help determine which AR automation tool is the best for the organization.
2. Timely invoicing
To ensure that the accounts receivable process goes smoothly, businesses must ensure that they send out invoices in a timely manner. This allows the customer to have ample time to plan the payment.
Customers are more likely to pay invoices on time without complaints if invoices are sent in advance. Most companies will also have their own set of accounts payable policies, which will require some time before invoices can be paid. Delays on the vendors’ part will create payment delays.
3. Set clear policies
Avoid confusion during accounts receivable management. It’s important that companies set clear policies and outline what is expected from employees during the AR process. Processes, deadlines, and duty segregations need to be mentioned clearly.
Make sure that all employees involved in the process know the company’s accounts receivable policies intimately. This helps in invoicing, collecting, and recording payments, minimizing the chances of delays and misunderstandings. Any issues with the policy should quickly be addressed accordingly.
4. Regular reconciliation
Both accounts payable and accounts receivable require regular reconciliation for businesses to properly maintain and manage their financial records. It is good practice to schedule routine reconciliation as part of the business’ accounting process.
Ensure that employees understand that reconciliation is vital for accounting, audits, and tax filings. The more organized a company’s account reconciliation process is, the easier it will be to manage its finances. Employees won’t have to go through a backlog of unreconciled records and can easily spot any discrepancies.
5. Invoice validation
Before invoices are sent out to customers, make sure that they are first validated and checked for accuracy. Every company should have policies that outline what the invoice validation process is like. This avoids confusion for employees.
With a clear and concise invoice validation process, businesses can efficiently and accurately send invoices to customers. This avoids future issues such as disputes and discrepancies, allowing businesses to achieve faster collection and better relationships with their customers.
6. Monitoring and reporting
Timely collection alone is not enough for good accounts receivable management. Each step in the process needs to be carefully monitored to ensure that there are no mistakes and delays. Even after money is collected from customers, it is important that the accounts receivable team record the process and transaction accordingly.
This allows the organization to have detailed records that the team can later refer back to for tax or audit purposes. Despite the accounts payable vs accounts receivable difference, this step is key in both processes.
Difference between accounts payable and accounts receivable?
Although it’s clear that accounts payable vs receivable both need to be managed in tandem, the processes due have some key differences that set them apart. Understanding these differences can help create more efficient processes as the teams will know what is exactly necessary for accounts payable and receivable.
Definition
● Accounts payable
As their names suggest, accounts payable and accounts receivable are two processes that are polar opposites, despite both working together to achieve stronger financial stability. Accounts payable refers to the money owed by the business to its suppliers, vendors, or other creditors for products or services that they have purchased.
● Accounts receivable
On the other hand, accounts receivable is a process that manages money collection from customers that businesses sell their products or services to. The accounts receivable team is separate from the accounts payable team and is responsible for sending out invoices and receiving payments.
Position on the balance sheet
● Accounts payable
Those who know what are accounts payable and accounts receivable will already be familiar with the fact that accounts payable are essentially the company’s short-term debts. For this reason, AP is considered a liability and will be listed as such on the company’s balance sheet.
● Accounts receivable
As accounts receivable are money that the company is waiting to collect from customers, they are counted as assets even though the company has yet to receive the funds. This is because, by the agreed-upon deadline, the company will have liquid assets from the sale.
Direction of cash flow
● Accounts payable
Entries that are recorded as accounts payable are associated with cash outflow, as money must go out of the organization for it to pay for the debt that they owe. When accounting for AP, businesses must ensure that they have enough cash so that even with the outflow, the business’s overall cash flow won’t go into the negatives.
● Accounts receivable
Accounts receivable indicate that there is cash flowing into the organization, even if it has not happened yet. Knowing what are accounts payable and accounts receivable makes it easier to understand the direction of cash flow of both processes.
Parties accountable
● Accounts payable
The two parties involved in an accounts payable entry would be the business and its corresponding supplier, vendor, or creditor. The business is accountable for the money that it owes the debt to and must settle that payment according to the terms.
● Accounts receivable
In an accounts receivable transaction, it is the business that is owed money by another party. Therefore, the parties involved are the business organization and its customers, clients, or any other parties that are liable for settling the debt. In this case, the business is the creditor.
Purpose of the payment
● Accounts payable
The primary purpose of accounts payable transactions is to settle debts that the business has. These are traditionally with suppliers or vendors, but can also be with other creditors. Managing accounts payable properly ensures that the business has no late outstanding payments.
● Accounts receivable
Accounts receivable payments are not made by the business itself. Instead, AR collection is about customers or other parties involved sending money in exchange for goods or service provided by the business. The AR team’s job is to ensure that these payments are reserved quickly.
Impact on cash flow
● Accounts payable
Given the nature of accounts payable, the company’s cash will decrease when AP payments are made. These payments are considered cash outflow. Businesses that aren’t careful with their accounts payable management could end up with a negative cash flow.
● Accounts receivable
While AP is about cash outflow, accounts receivable is a way to increase a company’s cash. They are considered as cash inflow and payments that have been received contribute to a positive cash flow for the organization. It ensures that the company has cash for its AP payments.
Risks involved
● Accounts payable
Accounts payable that are not properly managed can lead to late payments, which will breed problems like strained relationships with vendors and creditors, late payment fees, interrupted operations, and even an increase of admin costs. Vendors may not want to provide goods or services to default accounts, interrupting the production flow.
● Accounts receivable
Late accounts receivable collection can lead to cash flow problems. Businesses also run into the risk of bad debts with AR, which could lead to further complex disputes with their customers.
Impact on financial statements
● Accounts payable
On the company’s balance sheet, accounts payable are considered liabilities. As short-term debts, unsettled AP transactions reduce the business’ equity. This is why it’s important to not let invoice payments build up, especially past their due.
● Accounts receivable
Accounts receivable are considered assets, but it is important to note when recording them that they can be current assets or non-current assets on the balance sheet. The distinction is crucial as uncollected AR may term into liabilities in the form of bad debts.
Automation
● Accounts payable
Both accounts payable and accounts receivable processes will benefit from automation, but there are different approaches to them. For AP, tools that can help with scheduling payments and approval workflows are key. Invoice management automation will allow the business to process its payables faster.
● Accounts receivable
Businesses will want tools that can help them send invoices faster. There are many software providers that offer invoice generation automation, allowing businesses to simply input basic customer information to generate invoices based on their orders. Tools that can automatically record incoming payments are also useful for AR.
Streamline your accounts payable process for enhanced efficiency
What do accounts payable and accounts receivable have in common?
With a close understanding of what are accounts payable and accounts receivable, businesses can easily discern that both must be recorded accordingly in the general ledger. They are also reflected on the company’s balance sheet, with AP reflected as liabilities and AR as assets. It is important to maintain both in the financial management process.
As both accounts payable and accounts receivable involve multiple parties in the process, every accounts payable transaction is considered an accounts receivable transaction by the other party. The same is also true in reverse.
For example, if Company A sells its products to Company B on credit with payment terms of 60 days after the invoice is issued, this process will be recorded as accounts receivable for Company A. Company A’s goal is to collect funds from Company B by the payment deadline.
On the other hand, Company B will record this transaction as accounts payable, as the purchase is made on credit and it has an obligation to pay Company A for the order. For Company B, the objective is to have enough funds to ensure that it can fulfill this obligation and settle its debt.
In summary, AP and AR transactions can be the exact same, just viewed from two differing perspectives.
What is the importance of maintaining a balance between accounts payable and accounts receivable?
A negative cash flow is fatal for any business. It’s important to ensure that accounts payable and accounts receivable are managed accordingly so that the cash outflow is never larger than the cash inflow.
Businesses need to consider their accounts receivable and calculate how much income they can collect when planning expenses. This ensures that there is enough cash available to meet obligations on time. It is also good practice to sync up the timings so that the business’ cash flow remains strong.
The most successful businesses are able to maintain great relationships with not only their customers but also their vendors and suppliers. This is important as it ensures that they are able to smoothly perform necessary business operations, starting from gathering supplies to selling products to their customers.
It’s not enough to just have strong relationships with one category over the other. In order to generate revenue, businesses need to pay attention to both payables and receivables.
Those who know what are accounts payable and accounts receivable will already understand that to optimize a business’ working capital, both finance processes need to be managed accordingly.
Although accounts receivable is key to generating working capital and ensuring that the business has enough, the act of managing short-term debts goes hand in hand with overseeing accounts payable. It is necessary that the finance team understands how much money is owed.
Businesses that have a good grasp on their accounts payable and accounts receivable complete with detailed records have the resources to gain more insights and analyze their performance better.
It should be noted that planning and budgeting are crucial aspects of business finances, meaning that good accounts payable and receivable management can go a long way. The records can help with forecasting, cashflow management, risk assessment, growth planning, and many more.
No business wants to face financial instability or run into heavy-hitting risks. Fortunately, understanding accounts payable vs receivable and managing them appropriately can help mitigate these issues.
The ability to manage debts and income is guaranteed to allow businesses to have an easier time forecasting, which means that they are more prepared to achieve stability. Stable finances are also often associated with creditworthiness, with stable businesses having more doors open with credit.
Growth opportunities are often time-sensitive, which means that businesses that want to take advantage of these opportunities need to have the resources to react to them quickly. One of the best ways to ensure that these requirements are met is by having enough liquidity.
Make sure that the accounts payable vs accounts receivable difference does not see a higher amount of debt, as this will mean the business has a liquid cash inflow that can be used for growth opportunities.
Automate your accounts payable with Volopay!
Knowing what are accounts payable and accounts receivable will give your company a better understanding of why these processes are key for business finances, as well as what you need to execute them effectively. Automation is crucial, but you’ll want the right tool to help you perform every step in just a single platform.
Allow your business to improve the way you manage your finances and increase your overall efficiency by automating your processes with Volopay. With an intuitive dashboard and user-friendly interface, Volopay’s accounts payable module helps businesses centralize every step of the process from start to finish.
Get invoices sent directly to your Volopay dashboard and manage all your vendor information in one place. From contracts to bank details, you won’t have to look too far to sort out your invoices. Quickly find out when your invoice deadlines are and plan your accounts payable payments, complete with the ability to schedule payments in advance to make sure that you never miss an invoice.
You’ll have access to analytics and insights automatically formulated based on your accounts payable data. When your teams are busy recording accounts payable and accounts receivable transactions, you want to make the most of your records and make them easy to access for tax and audit seasons.
FAQs
Technically speaking, accounts payable are liabilities. However, when they are processed for payments, they do become business expenses. As accounts payable, they are accounted for in the balance sheet, and later recorded in the income statement when the corresponding expense is made.
Due to accounts payable being liabilities, they are also classified as credit entries rather than debit entries. It is only when the payment has been processed and debited from the business account that it becomes listed as a debit entry.
Although it is possible, it is generally recommended to have two separate teams. The accounts payable vs accounts receivable difference means that a segregation of duties can make managing them more efficient. However, it’s also important that the two teams communicate and work together.
As accounts payable are liabilities, on a business’s balance sheet they are listed as negative balances. This does not mean that they are bad, simply that they are liabilities that the business must pay back. Accounts payable are considered short-term debts.
Accounts receivable are considered assets. Those who know what are accounts payable and accounts receivable will know that accounts receivable are money owed to the company, therefore making it an asset. It becomes liquid when the customer payment comes through.
Accounts payable and trades payable are similar, given that trades payable are one type of AP. While all trades payable are considered accounts payable, not all accounts payable entries are trades payable. AP also includes debts that are not directly inventory-related.
Determining what is easier between accounts payable vs receivable depends on how effective the company’s processes for each one are. Generally, however, accounts receivable are considered easier and more straightforward to manage compared to accounts payable.
A company paying a monthly subscription fee for a sales management tool on a certain date each month would be an example of accounts payable. The same company selling its products to customers and invoicing them would be considered as accounts receivable.
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