Accounts receivable vs payable are frequently confused because they both represent cash flow. However, there is a key difference between the two. Accounts receivable refers to the money owed to a company while accounts payable is the money a company owes. It is crucial for business owners and finance teams to understand what is accounts payable vs accounts receivable. Failure to do so can affect working capital, the income statement, and business operations.
A good understanding of accounts payable vs receivable will ensure a correct balance between the asset account and liability account on a balance sheet. These processes are therefore important for both large and small businesses.
This in-depth guide will provide more insight into these key financial metrics. We will also list some accounts payable vs accounts receivable examples to help you understand the accounting process better.
What are accounts payable?
A company's accounts payable is the money a business owes to its suppliers and vendors. Accounts payables occur as a result of credit purchases, for example, office supplies. Line accounts payable represent future cash outflow. On financial statements such as a balance sheet, each account payable is recorded under the current liability account.
The accountability for accounts payable lies solely with the business itself. It is important for a business to stay on top of accounts payable to avoid late fees and interest. On the other hand, paying off these short-term obligations or debts in a timely manner can result in favorable payment terms, such as discounts for early payment. There is no offset for accounts payable.
There are different types of accounts payable such as loans payable, wages payable, trade payables, non-trade payables, interest payable, and taxes payable.
Examples of Accounts Payable
- A plastic surgery clinic purchases a new laser machine from the manufacturer.
- A hospital hires the services of temporary front office staff to handle a seasonal increase in patient volumes.
- A medical clinic takes a bank loan to build a new wing.
- A business purchases office supplies or equipment like computers and printers.
- The business owner or employees travel to a conference or buyer-seller meet.
- The business pays for transport of goods sold.
How to Record an Accounts Payable Transaction?
When you make a purchase, you should record accounts payable in your general ledger as a debit to your account and a credit the vendor. When you make a payment for the goods or services received, you should debit the vendor's account and credit your accounts payable.
What are accounts receivable?
A company's receivable accounts is the money customers owe to a business for providing services or goods. Accounts receivables occur as a result of credit sales of goods or services rendered. Therefore, an account receivable represents future cash inflow. On financial statements such as a balance sheet, accounts receivable are recorded under current assets.
The accountability for receivable accounts rests with a company's customers or debtors. Receivable accounts can be offset against doubtful accounts (money owed by customers that a business does not expect to receive). Staying on top of the receivable balance makes a business an efficient debt collector and keeps cash flow intact. It's important for businesses to establish an effective credit approval process for customers before giving them these short-term loans. Credit terms offered to customers should have clearly defined due dates and fees for late payments so that the company receives payments on time.
The different types of accounts receivable are trade accounts receivable and notes receivable.
Examples of Accounts Receivables
- A medical clinic bills a patient for services rendered.
- A CT scanner manufacturer delivers a machine to a hospital.
- A bank lends money to a business to purchase machinery.
- A monthly magazine sells a yearly subscription. This is classified as deferred revenue because the original invoice is to be paid immediately but the goods (magazine issues) are supplied over a period of time.
How to Record an Accounts Receivable Transaction?
When you sell a product or service, you should record accounts receivable in your general ledger as a credit to your account and a debit to your customer. When a customer pays for the goods or services rendered, you should make a journal entry with credit to the customer's account and debit to your accounts receivable.
What is the Accounts Receivable Turnover Ratio?
The ratio is a finance metric that tells you how efficiently a company is collecting short-term debts (receivables) from its customers. The ratio takes a specific time period, for example, a one-year period, and measures how many times receivable accounts were converted to cash during that period.
A high accounts receivable turnover ratio is a sign that a company has efficient collection practices and customers and other debtors that pay by the due date. It indicates a healthy business and can help attract potential investors.
On the other hand, a low accounts receivable turnover ratio indicates non-creditworthy or financially unviable customers, poor collection processes, or inefficient credit policies.
What is accrual accounting?
Accrual accounting is a system in which expenses and revenues are recorded in the accounting software when the transaction occurs rather than when payment is made or received. This method of accounting makes the relationship between accounts payable vs accounts receivables clearer and offers more up-to-date insights into a company's profitability.
What do accounts payable and accounts receivable have in common?
Both accounts payable and accounts receivable are bookkeeping basics and represent the movement of funds in a business. Accounts payables and accounts receivable are listed on a company's balance sheet under short-term liabilities and liquid assets, respectively.
Summary of Differences Between Accounts Payable vs Accounts Receivable
Accounts payable originates from the purchase of goods and services on credit from vendors, suppliers, and other creditors. Accounts receivable originates from the sale of goods and services to customers and other debtors.
Accounts payable is the money a company owes to its vendors and suppliers. Accounts receivable is money owed to a company by it's customers.
Accounts payable are listed as a current liability while accounts receivable are listed as a current asset.
Accounts payable have categories like sales tax payable, interest payable, trades payables, wages payable, and loans payable. Accounts receivable have categories like trade accounts receivable and notes receivable.
Accounts payable have no offsets while accounts receivable can be offset against doubtful accounts (doubtful debts).
Impact on Cash Flow
Accounts payable result in cash outflow and accounts receivable result in cash inflow on the cash flow statement.
The responsibility for accounts payables lies with the company whereas the responsibility for accounts receivables likes with the company's customers and debtors.
An accounts payable audit consists of looking at purchase orders, vendor invoices, and the general ledger. Auditing accounts receivable involves looking at cash receipts, credit memos, doubtful accounts, shipping logs, company invoices, and the general ledger.
The Bottom Line: Accounts Payable and Accounts Receivable Are Closely Related Yet Different
Understanding accounts payable vs accounts receivable is important for a company's financial health. Both processes are equally important and can help business owners know how much they owe and how much they are owed.
The company's balance sheet shows the sum of all outstanding amounts owed to vendors as accounts payable under current liabilities and the sum of all outstanding amounts owed by customers as accounts receivable under current assets. A company's management should attempt to pay all outstanding bills and collect all outstanding payments before their due dates to improve cash flow.
A good accounting software can give business owners the edge by providing key metrics about customers and suppliers. It can also help in analysing the company's overall financial health.
Get in touch with PharmBills today to see how we can help you get paid on time, avoid long-term debt and bad debtors, and build prosperous relationships with your customers.