Accounts payable and accounts receivable both represent the flow of cash in a business. However, they have distinct differences. Account receivable refers to money that is due to your company but not yet paid. Accounts payable, on the other hand, is the money your business owes its suppliers and vendors for goods or services received but not yet paid for.
Maintaining a healthy balance of cash inflows and outflows is essential for the financial health and stability of a business. It also allows your company to maintain positive relationships with customers and suppliers, and can improve your chances of getting a small business loan.
Here’s a closer look at how accounts payable and accounts receivable work, their similarities and differences, plus tips on how to monitor and manage your company’s cash flow.
Key Points
• Accounts payable (AP) represents a business’s obligations to pay its suppliers for goods or services, while accounts receivable (AR) refers to money owed to the business by customers for sales made on credit.
• AP is recorded as a liability on the balance sheet, reflecting outstanding debts, while AR is recorded as an asset, representing future cash inflows.
• AP reduces cash flow when payments are made, whereas AR boosts cash flow when customer payments are collected.
• AP typically has payment terms set by suppliers, such as 30 or 60 days, while AR involves terms extended to customers for payment after a sale.
• Lenders may look at both accounts receivable and accounts payable, along with other items on your balance sheet, to determine whether or not to extend financing to your business.
What Is Accounts Payable?
A company’s accounts payable are amounts it owes to suppliers and other creditors for products or services purchased and invoiced for but not yet paid for.
Whenever you buy a good or service on credit (meaning you don’t pay cash up front), you have created an accounts payable. For example, if you purchase materials for $1,050 from a supplier and ask that supplier to send you an invoice rather than paying immediately, you would list that $1,050 in accounts payable.
Accounts payable does not include payroll or long-term debt, but does include payments on that long-term debt.
A company’s total accounts payable balance at a specific point in time will appear on its balance sheet under the current (or short-term) liabilities section. Accounts payable must be settled relatively quickly to avoid default.
How Accounts Payable Works
The accounts payable (AP) department is responsible for processing expense reports and invoices, and making sure all payments are made.
When the AP team receives a bill for goods or services, they need to record it as a journal entry and post it to the general ledger as an expense.
Once the expense is signed off on by the appropriate person, they will then pay the bill according to the terms of the contract, such as net-30 (within 30 days) or net-60 (within 60 days), and record it as paid. A company may choose to pay its outstanding bills as close to their due dates as possible in order to improve cash flow.
A strong AP team maintains good relationships with suppliers by keeping vendor information accurate and making sure bills are paid on time. They can also help the company save money by taking full advantage of favorable payment terms and any available discounts.
Calculating Accounts Payable
All outstanding payments due to vendors, suppliers, partners, and creditors are recorded in accounts payable. As a result, if anyone looks at the balance in accounts payable, they will see the total amount the business owes all of its vendors and short-term lenders. This total amount also appears on the balance sheet.
Pros and Cons of Accounts Payable
Pros:
• Keeps debts and future payments organized
• Helps companies stay on track of outgoing money, as well as when they should spend vs. hold
• Provides key financial information to potential investors or lenders
Cons:
• Delaying payment can harm a company’s relationship with its vendors and creditors
• A growing accounts payable suggests a company may be having cash flow issues or a slowdown in sales
• Manual data entry can result in errors, leading to incorrect calculations or incorrect payments
What Is Accounts Receivable?
Accounts receivable is money that customers owe your company for products or services that have been invoiced. Some businesses request payment upon receipt of the invoice, while others give the recipient 30 or 60 days to pay.
Like accounts payable, accounts receivable is recorded on a company’s balance sheet. However, it is listed under current assets (and because it’s an asset, it can be helpful for securing various types of business loans). Also like accounts payable, accounts receivable is for products or services that were given on credit.
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How Accounts Receivable Works
Once a company delivers goods or services to the client, the accounts receivable (AR) team will invoice the customer and record the invoiced amount as an account receivable, noting the terms (such as net-30 or net-60).
If the client pays as agreed, the team records the payment as a deposit. At that point, the account is no longer receivable. If the customer fails to pay on time, the AR team will likely send a late payment letter, which may include a copy of the original invoice and list any late fees.
If a customer is unable to pay its outstanding bill due to bankruptcy or other financial problems, the company may end up reporting it as an allowance for doubtful accounts on the balance sheet. This is also known as a provision for credit losses.
Calculating Accounts Receivable
In accrual basis accounting (which means revenues and expenses are recorded as they are incurred), your general ledger will show your total accounts receivable balance. Under cash basis accounting (which means revenue and expenses are recorded when money is exchanged), however, there are no accounts receivable, since a transaction doesn’t count as a sale until the money hits your bank account.
Several important financial ratios rely on accounts receivable, including:
• Accounts receivable turnover ratio: This measures how efficiently and quickly a company converts its account receivables into cash within a given accounting period. The formula for calculating accounts receivable turnover for a one-year period is:
Accounts Receivables Turnover = Net Annual Credit Sales / Average Accounts Receivables
• Current ratio: Also known as working capital, the current ratio measures liquidity, meaning whether your company is able to pay its short-term obligations with available cash or other liquid assets. The formula is:
Current Ratio = Current Assets / Current Liabilities
• Days sales outstanding: This shows how long, on average, it takes customers to pay your company for goods and services. The formula is:
Days Sales Outstanding = Accounts Receivable for a Given Period / Total Credit Sales X Number of Days in the Period
Pros and Cons of Accounts Receivable
Pros:
• Extending credit can increase sales and large purchases
• Helps your company acquire new customers
• Makes your company more competitive with its peers
• Can be used to receive accounts receivable financing
Cons:
• Diligent record-keeping is required
• May slow down cash flow
• Estimating value of uncollectible receivables can be difficult
• May have to work with collection agencies
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Accounts Payable vs Accounts Receivable
Accounts payable and accounts receivable are two sides of the same coin, which means they have both similarities, as well as distinct differences. Here’s a closer look at how they compare.
Similarities
• Both represent the flow of money within a business
• Both are recorded in a company’s general ledger
• An overview of both is required to gain a full picture of a company’s financial health and can affect getting approved for a small business loan
• Both revolve around short-term financial transactions
Differences
• Receivables are classified as a current asset, while payables are classified as a current liability
• A payable is money to be dispersed; a receivable is money to be received
• Receivables may be offset by an allowance for doubtful accounts, while payables have no such offset
• Payables are recognized as income unless written off; receivables are recognized as a liability until paid
| Accounts Receivable | Accounts Payable |
|---|---|
| Money to be received | Money to be disbursed |
| Current asset | Current liability |
| Result of credit sales | Result of credit purchases |
| May be offset by an allowance for doubtful accounts | No off-sets |
| Generates future cash inflow | Generates future cash outflow |
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How Are Accounts Payable and Receivable Related?
Both accounts receivable and accounts payable revolve around the flow of cash in and out of your business. As such, they are both often used to assess the liquidity of a company.
A liquidity analysis measures whether there are enough funds coming in from receivables to pay for the outstanding payables, and is often done using the current ratio (also called the working capital ratio). As mentioned above, this is simply current assets divided by current liabilities:
Current Ratio = Current Assets / Current Liabilities
A good current ratio is typically considered to be anywhere between 1.5 and 3.
The Takeaway
Simply put, accounts payable is the money you owe, while accounts receivable is the money owed to you. Together, they represent the cash flow of a business.
Understanding and tracking accounts payable and accounts receivable can help you gauge the financial strength of your business and put practices in place to generate a healthier cash flow.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
What are examples of accounts payable and receivable?
Accounts payable are expenses incurred from buying a product or service from a vendor and supplier. For example, when a company buys raw materials from a supplier on credit (meaning it doesn’t pay cash up front), this results in an accounts payable for the company.
Accounts receivables, by contrast, come from selling goods or services. If a customer orders your product and you issue an invoice due in 30 days, the amount owed will be listed as an accounts receivable until it is fully paid.
Do clients pay accounts payable or receivable?
Any money clients or customers owe to your company is listed under accounts receivable.
Should accounts receivable be higher than accounts payable?
Generally, it is better for accounts receivable to be higher than accounts payable. This means a company is bringing in more money than it spends. An accounts receivable- to-accounts payable ratio of two-to-one is often considered a sign of a healthy business.
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