In bookkeeping, Accounts Payable (AP) are the amounts you owe to your vendors and suppliers. Accounts Receivable (AR) are the amounts your customers owe to your business. For small business owners, it’s important to understand how these two are different and how you can automate them using accounting software.
Both accounts payable and accounts receivable appear as separate entities on your company’s general ledger. The difference between these categories comes down to cash flow.
When your company purchases from a supplier on credit, you record this transaction under accounts payable. Conversely, your supplier records the same transaction under their accounts receivable.
Accounts receivable represent future cash inflow from your clients to your business, considered a current asset. A current asset refers to amounts expected to convert to cash within 12 months. These transactions remain in your accounts receivable ledger until your customer pays their bill.
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After completing a transaction, you send your customer an invoice documenting the supply date, a unique invoice number, a description of goods and services, the total amount payable, credit terms, and how to pay.
Until your customer pays their bill, you can record this transaction under accounts receivable as debit and credit your sales account. Make a journal entry in your general ledger like this:
|Types of Accounts||Debit||Credit|
Accounts payable represent future cash outflow from your business to your suppliers and vendors. These short-term debts are considered current liabilities. A current liability refers to amounts due to your creditors within 12 months. These transactions remain in your accounts payable ledger until you pay your bill.
This method of collecting payments is known as accrual accounting. Rather than recognizing payments based on the time you receive or pay out cash, accrual accounting tracks incoming and outgoing cash before the transactions occur. As a result, you record expenses at the same time you record an account payable.
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After completing a transaction, you send your vendor a purchase order documenting the items requested, price per unit, quantity, payment terms, and delivery details. A purchase order allows the supplier to extend credit with the understanding you will pay upon receiving their goods or services.
Until you secure your order, you can record this transaction under accounts payable as credit. Let’s say that you order office supplies for your company. You can make a journal entry in your general ledger documenting that transaction:
|Date||Type of Accounts||Debit||Credit|
|21-Mar-22||Expenses - Office Supplies||$250||–|
|–||Accounts payable - Office Supply Store A||–||$250|
Knowing the difference between AP and AR is vital whether you’re a business owner or bookkeeping for a small business. The table below outlines these at a glance:
|Premise||Accounts Payable||Accounts Receivable|
|Definition||What you owe vendors/suppliers||What your customers owe you|
|Cause||Buying items on credit||Selling products/services on credit|
|Result||You pay your vendor/supplier||The customer pays off their debt|
|Responsibility||Lies with your business||Lies with your debtors|
|Balance Sheet Location||Current liability section||Current asset section|
|Cash Flow||Cash Outflow||Cash Inflow|
|Offset||None||Allowance for doubtful accounts|
Accounts payable allow you to track bills and measure the cost-effectiveness of your business. They also help you pay your invoices on time, prevent late payment fees, and avoid tying up working capital in your balance sheet. Working capital represents the operating liquidity of your business, calculated as current assets minus current liabilities.
To free up more working capital, check your suppliers’ payment terms. You can sometimes negotiate a discount for early payment on purchases.
Accounts receivable promote healthy cash flow management. This liability account tracks outstanding customer invoices, showing your credit sales and who to contact for payment. It also allows you to write off bad debts should a customer fail to pay and highlights the profitability of your business.
To calculate profitability, take the total of your accounts receivable and assets. Then, subtract the sum of your accounts payable. A positive number indicates that your business is profitable. A negative number is a warning to limit expenses and revisit your company’s balance sheet.
Where are accounts receivable and accounts payable on a balance sheet?
Are accounts receivable an asset or liability?
Are accounts payable an asset or liability?
Why should I automate accounts payable and accounts receivable reports?