Accounts Receivable vs Accounts Payable: What’s the Difference?

Effective finance management is key to the long-term survival and growth of any and every business out there. For money is what makes a business and what businesses are intended to make.

However, when it comes to handling finances, it is almost impossible to miss out on terms like accounts receivable and accounts payable. As vital aspects of accounting, these fall on the opposite ends of a business’ financial transactions and affect its cash flow differently.

Read on to know what they are and what sets them apart, so your business can achieve the financial stability it seeks and deserves to achieve….

What is Accounts Receivable?

Accounts receivable (AR), as the name suggests, is money that a business is owed for goods or services that it has provided to its customers but hasn’t received any payment for yet. It falls under outstanding payments that a business is expected to receive shortly.

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It thus gets recorded as an asset on the balance sheet, for once received, it can be invested into the business again, be it for paying existing bills or buying something new, to ensure continuity.

For instance, if, as a business owner, you sell goods or services to a customer on credit and the customer, in return, agrees to pay for them in, say, a month, the money that he owes you is what we call accounts receivable.

Now that you know what accounts receivables are, it is important you know how significant it is for a business to manage them. If a lot of accounts remain unpaid, a business’ liquidity is bound to suffer, which would make it difficult for them to cover their routine expenses and continue operating.

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The AR process typically includes the following stages…

Sharing Sales Quotation & Receiving the Order
Documenting the Sales Order
Delivering Goods or Services
Issuing Invoice
Recording Accounts Receivable
Receiving Payment
Settling Accounts Receivable

What is Accounts Payable?

Accounts payable (AP), on the contrary, is money that a business owes for goods or services that it has received from its vendors or creditors but hasn’t made any payment for yet. It falls under outstanding debts that a business is expected to pay in the near future. It thus gets recorded as a liability on the balance sheet.

For instance, if, as a business owner, you purchase goods or services from a supplier on credit and in return, agree to pay for them in, say, a month, the sum of money that you owe is what we refer to as accounts payable.

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Just like accounts receivables, it is important for businesses to effectively manage their accounts payables. For if left unpaid for a long time, these have the potential to severely damage a business’ relationship with its lenders or suppliers. Businesses can also incur late payment penalties for the same, which would hamper their ability to avail things on credit to continue operating in times of needs.

The AP process typically includes the following stages…

Sending a Purchase Order
Receiving Goods or Services
Reviewing Vendor Invoice
Recording Accounts Payable
Approving Payment
Making Payment
Settling Accounts Payable

Key Differences Between Accounts Receivable & Accounts Payable

While both accounts receivable and accounts payable play an important role in managing a business’s financial operations, they vary on several accounts. Some of the key differences between the two are listed below for your understanding…

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Nature of Transaction: While accounts receivable represents money owed to a business by its customers, accounts payable, on the other hand, is money a business owes to its suppliers or vendors.
Position on the Balance Sheet: Accounts receivable get recorded as an asset on the balance sheet, for it is money that a business is going to receive in future. Accounts payable, on the contrary, gets listed as a liability, for it is the sum of money a business has to pay to its vendors in the days to come
Impact on Cash Flow: Accounts receivable impacts the inflow of cash into a business if left unpaid for on the part of a customer for a long time. Accounts payable impacts the outflow of cash from a business, if left unpaid for on the part of the business owner for a long time.
Management Focus: Whilst managing, accounts receivable ensures that customers clear their dues on time, and accounts payable, conversely, ensures that businesses clear their debts on time. Both require routine reminders and follow-ups to attain the same. This, is so businesses get to maintain a healthy cash flow for operational efficiency and overall success.
Effect on Working Capital: Accounts receivable, as an asset, add on to a business’ working capital. Accounts payable, as a liability, decreases the working capital of a business.

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Factors to Consider Whilst Managing Accounts Receivable

When handling your business’ accounts receivables, it is important to keep the following factors in mind…

Credit Policy: A business must have a clear credit policy before lending goods or services to its customers on credit. By setting payment deadlines, late fees, etc., therein, they can minimize the possibility of deferred payments or bad debts
Invoicing & Follow-Up: Along with putting effective payment terms in place, businesses must indulge in prompt invoicing and routine follow-ups on outstanding accounts receivables. This, is so they can collect payments in a timely and effective manner. Automated tools like Melio, Sage Intacct etc., can help them attain the same in the best way possible and while at it, can significantly reduce the workload on the accounting team.
Bad Debt: Even after taking all the precautionary measures, businesses can come across bad debts. To prepare themselves for such situations, they should regularly monitor their accounts receivables to flag doubtful accounts and write off those that seem absolutely irrecoverable. This, so their cash flow does not get disrupted if and when their suspicions turn true.

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Factors to Consider While Managing Accounts Payable

When handling your business’ accounts payables, it is important to keep the following factors in mind…

Negotiating Payment Terms: Businesses, whilst purchasing goods or services on credit, should negotiate favourable payment terms. These can include anything from extended deadlines to early payment discounts. For, by availing these, they can manage their cash flow in an effective and flexible manner.
Avoiding Late Fees: Only if a business clears its accounts payables on time can it attain a good relationship with its creditors and avoid late fees. Automated tools like Tipalti, Stampli etc., can help businesses achieve the same through regular reminders and streamlined approval workflows.
Cash Flow Forecasting: Effective accounts payable management helps businesses forecast future payments. Using these forecasts, business owners can plan their cash flows, so they have enough cash on hand at all times.

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When To Choose Accounts Payable (AP) and Accounts Receivable (AR) Software?

For small businesses, you can consider using accounting software that provides basic automation features for both accounts payable (AP) and accounts receivable (AR). These solutions can streamline your financial processes without the complexity or cost of specialized tools. Examples include simple accounting platforms that offer invoicing, expense tracking, and financial reporting.

For mid to large-sized businesses, it’s often better to choose individual AR and AP automation software for advanced features and scalability. These solutions enhance efficiency and streamline financial operations.

AR automation solutions like Peakflo, Upflow, HappyAR, Kolleno, or Billtrust can automate accounts receivable, speeding up collections and improving cash flow.
AP automation tools such as Volopay, Sage Intacct, Highradius, and Newgen Finance & Accounting help manage supplier invoices, approvals, and payments.

Larger organizations may also benefit from integrating both AR and AP automation software to streamline their entire financial operations, making their processes more efficient and reducing manual tasks.

Conclusion

Though falling on the opposite ends of the spectrum, both accounts receivable and accounts payable thus are essential for businesses to maintain a healthy cash flow. only by managing them effectively can a business operate smoothly without any financial strain.

If you too are looking to optimize your business’ accounting processes, know what AR and AP are and let automated tools do the rest for you. If you still need assistance in selecting a tool that would meet the needs of your business in as effective a manner as possible, get in touch with the Techjockey team today.