Accounts Payable vs. Accounts Receivable – What’s the Difference?

Understanding accounts payable vs. accounts receivable can be challenging. Both terms refer to records of money owed to or by your business, but there are essential nuances every business owner should understand.

This article breaks down those nuances with tips on managing your accounts and dealing with tricky issues like late payments.

Get the Essential Accounting Glossary for Entrepreneurs 

Forge stronger connections with financial advisors, accountants, and investors by learning the language of accounting.
Download Your Glossary

Accounts Payable Definition

Accounts payable (AP) refers to money a company owes to suppliers or creditors for goods received but not yet paid for. These are considered current liabilities on a balance sheet and must be settled within a specific period to avoid penalties or damaging supplier relationships. Supplier invoices often include terms such as “Net 30” or “Net 60,” indicating the number of days before payment is due. 

Cash flow management hinges on efficient AP record keeping. It ensures your company maintains liquidity and can meet its short-term obligations while also helping you preserve your credit ratings.

Accounts Receivable Definition

Accounts receivable (AR) represents money owed to a company by its customers for goods or services delivered but not yet paid for. It is recorded as an asset on your balance sheet, reflecting your right to collect these funds in the future. 

Since 79% of small business owners reduce their own pay when invoices are paid late, an effective system for handling AR is crucial to success. 

Accounts Receivable vs. Accounts Payable Cheatsheet

AspectAccounts Payable (AP)Accounts Receivable (AR)
DefinitionAmounts owed by the company to suppliers/creditorsAmounts owed to the company by customers
Balance SheetCurrent liabilityCurrent asset
Transaction TypePurchase on creditSale on credit
Cash Flow ImpactOutflow when invoices are paidInflow when invoices are collected
Management FocusTimely payments to avoid late feesTimely collection to maintain liquidity
RelationshipsVendor relationshipsCustomer relationships 

Advanced Information for Growing Businesses

Beyond the basic definitions, there are many reasons savvy business owners are diligent about managing accounts payable vs. receivable. 

Accrual vs. Cash Accounting: Most businesses begin with “cash basis” accounting, where transactions are counted only when money changes hands. However, by recognizing expenses when they’re committed to, rather than paid, accrual accounting can save your business considerably on taxes by allowing you to take deductions against purchases you’ve not yet paid for.

AR and AP record keeping is key to taking advantage of this tax reduction technique.

Business Loans: Banks will require collateral for most loans, such as real estate or other hard assets. Even when they don’t, interest rates and repayment terms are considerably less favorable than if you had property to secure the loan with.

However, accounts receivable are sometimes considered sufficient collateral; reliable records of on-time customer payments can be vital to securing fresh capital.

Early Payment Discounts: Suppliers often offer discounts for early payments. Maintaining positive relationships can result in better credit terms and more favorable prices.

Cash Flow Forecasting: Accurate AR and AP management allows businesses to create more accurate financial models of future scenarios. By predicting inflows and outflows, you can allocate resources and avoid cash shortages that could disrupt operations.  

accounts payable versus receivable

How to Encourage Customers to Pay on Time

When customers routinely pay invoices late, it can create substantial issues for your business, preventing you from running payroll, purchasing inventory, or servicing loans on time.

Here are some ways to proactively solve this problem:

  • Review late-fee penalties and timelines with new customers at the start of the business relationship. 
  • Provide incentives for early repayment. Something as small as a percentage or two can be motivating.
  • Send invoices as soon as projects are completed, and consider using an automated reminder system.
  • If a customer is late, follow up with them quickly. Communication is key, and in the worst-case scenario, a business owner is more likely to pay a service provider they’re in contact with than one who hasn’t mentioned the missing payment.
  • For customers who are habitually late, consider increasing the size of the upfront payment.

Conclusion

By understanding the differences between AP and AR, business owners can better maintain positive cash flow, foster strong relationships with suppliers and customers, and optimize their financial operations. 

Tracking and managing cash flow is no easy task, but it’s much easier with a professional. Book a consultation with an expert from our online bookkeeping services team today.

Indinero Let our experience guide you blog CTA image 1