The differences between accounts payable and accounts receivable

Modern accounting departments consist of two major concepts: double-entry bookkeeping and the professionals who manage those records—an evolution of accounting that spans thousands of years and was once tied to trade transactions in Mesopotamian temples. With the number and complexity of business transactions progressing exponentially over time, an accounting department is also usually broken down into two oversight divisions: One that tracks money flowing out of a business, and one that tracks the money flowing into a business—accounts payable and accounts receivable.

What are accounts payable (AP)?

Transactions that represent money owed by a business are tracked through accounts payable. When a vendor or supplier sends an invoice to a business, a process is initiated by an AP team to verify, approve, and reconcile the invoice. Accounts payable are recorded as current liabilities on a company’s balance sheet and an appropriate journal entry is recorded in the general ledger.

Best practices for the AP process involve either a two- or three-way invoice matching. In this process, additional documents—the purchase order (PO) and shipping or order receipt—are referenced to verify that the information provided in the invoice is accurate. Often, for invoices of higher amounts or if discrepancies in the matching process arise, approvals by relevant stakeholders are required before the payment can be reconciled.

An accounts payable team plays a crucial role in managing the cash flow and health of a business. They must be able to prioritize earning incentives offered by creditors and are evaluated on days payable outstanding (DPO). While some businesses maintain manual processes for AP, many are embracing automation to improve payment turnaround and taking advantage of early payment incentives, leading to improved vendor relationships and terms.

Examples of accounts payable

Accounts payable is a generic cash-flow into a business. Descriptive accounts payables provide insight to finance teams for determining where cashflow is going. Here are some examples of accounts payables:

Transportation and travel expenses

If your sales reps or R&D teams travel for their work or if your business provides mass transit cards to local employees.

Office supplies

Printing paper, break room supplies, and whiteboard markers that are ordered through a delivery service are all payables.

Vendor and independent contractor services

Hiring a freelancer for website management or copywriting services.

Leases and licensing

Rent that is paid for office space or software subscriptions.

What are accounts receivable (AR)?

Transactions that represent payments that have yet to be received for work already completed are accounts receivable. When your business completes work for a client or another business a process of capturing, notifying, and collecting a payment is initiated.

Accounts receivable are considered credit sales because they represent payments that have yet to be received. Your business has agreed to let the client or business pay at a later date than when the work was completed. However, accounts receivable are considered an asset account because your business is likely to be paid within a short window of time.

While these amounts are considered current assets on a balance sheet, they do carry risk. When you do business with clients who have poor credit, this impacts cash flow. It is important to know that any amounts currently in accounts receivable reflect money you have not yet been paid and will ultimately be deducted from net sales amounts if they remain unpaid.

AR teams are responsible for getting accounts receivable amounts to zero, directly impacting your company’s cash accounts. Accounts receivable processes include reporting through aging out sheets to determine how many days the invoice has remained unpaid, and are evaluated on the days sales outstanding (DSO) as well as a receivable turnover ratio determined by dividing net credit sales by average accounts receivables. They must be able to resolve payment issues with debtors in short periods of time—resulting in a high receivable turnover ratio—leveraging term discounts and penalties as a way to encourage timely and early payments from clients.

Examples of receivables

Similar to accounts payable, accounts receivable is not the only designation for incoming cash, and the more nuanced the categories, the more useful the reports are to finance teams. Here are a few examples of receivables categories:

Notes receivable

Promissory notes that indicate a time frame for multiple payments. For example, a client that originally agrees to pay a larger sum, but having fallen on hard times, agrees to pay off the debt in smaller sums in a set period of time.

Interest receivables

If a business expects to gain interest, but has not yet done so, these amounts are recorded in this way.

Vendor receivables

Discounts and incentives your business receives from your suppliers are considered a type of receivable.

What’s the difference between accounts payable and accounts receivable?

The short answer is that accounts payable represents money that a company owes to vendors and suppliers whereas accounts receivable represents money that a company is owed, in turn, by their clients. While the money that a company stands to gain is considered an asset, the money that a business owes is considered a current liability account.

For effective oversight and control of company finances, segregation of duties between AP and AR is considered a basic component. The person receiving and entering incoming invoices should not be the same person who is submitting and following up on unpaid invoices.

For audits, different approaches are taken to ensure the efficacy of each department. Whereas AP will be evaluated on incoming invoice accuracy for each vendor, AR invoices that are well-past due may need to be moved into a bad-debt account.

What do accounts payable and accounts receivable have in common?

For a full overview of a company’s cash flow both AR and AP need to be taken into account, and so in many ways the two exist in a kind of symbiotic relationship. And like any symbiotic relationship, one cannot function without the other. The symmetry of the two determines the financial health of your business’s net working capital.

For example, cash flow problems can be the result of a bottleneck in both AP and AR. If your business has given your clients terms of net60 or even net90, but agreed to net30 or net60 terms with your suppliers, you may find that being able to pay on time is difficult. In other words, if you bill a client $1000 and they have 60 days to pay, but you have just received a bill yourself of $500 and you have only 30 days to pay, you may not have the cash in time to meet the 30 day terms.

Improve accounting processes with Routable

Routable understands how important it is to pay—and get paid—in a timely manner, giving you the working capital to grow and your vendors the confidence that you mean business.

AR automation

Ensure correct client contacts receive invoices, reminders for prompt payments, and are offered flexible payment options. Your business benefits from being able to see right when a payment is made and that the payment is syncing with your accounting software.

Scalable mass payments for AP

Your accounting team’s ability to process myriad payments shouldn’t inhibit growth. CVS upload and API integration means that your software scales with you.

Reduce up to 80% of manual tasks

Manual tasks in accounting lead to overworked teams, inefficient processes, and harmful delays. Free up your finance team for strategic planning through automation.

Conclusion

Understanding the differences between AR and AP helps you make the best decisions for your business. Mismanaged accounting can lead to unhealthy cash flow and penalties. Accounting automation ensures fast, efficient processes and payments. Schedule a demo with Routable to learn how you can optimize your AP and AR processes.