Money is always flowing in and out of your business. Money owed is considered accounts payable (AP). The amount you’re waiting to receive is your accounts receivable (AR).
AP and AR are two heads on the same beast. But as a business owner, you need to know the difference between accounts payable and accounts receivable to manage your cash flow and ensure spending doesn’t get out of control.
When you understand what each type of account represents and the role it plays, you can start improving your accounting processes — and reaping the rewards of well-managed AP and AR.
In this article, you’ll learn:
- What accounts payable and accounts receivable are
- How the AP and AR processes work
- The difference between AP and AR
What is accounts payable?
Accounts payable is the money your company owes suppliers and other creditors.
When your business makes a purchase on credit, it becomes a payable. For example, if you buy equipment, raw materials, or other goods or services on credit and you’re invoiced for the purchase, you’ll pay that amount in the future, so it’s an account payable.
You’ll record accounts payable under the current liabilities on your balance sheet, which is a snapshot of a company’s assets, liabilities, and equity for any accounting period.
The accounts payable process explained
Every time your business writes a check or pays a bill online, you’re handling payables. And every good and service your business purchases has to be tracked so you can manage your cash flow.
You also need to ensure that you’re paying the correct amounts for the right goods and services at the right time. Otherwise, your business could be bleeding money without realizing it or risking credit issues.
What you might not know unless you’re the one managing your accounts is that there’s a multi-step process going on behind the scenes to make sure all your business payments happen as they should. Let’s take a look at how the accounts payable process works.
1. Receive the invoice
First, your organization sends a purchase order to a vendor or supplier. You might purchase fuel for your equipment, raw materials to make your products, or supplies your employees need to do their jobs.
Whatever it is, someone at your organization creates the order online, over the phone, or in person. Then the vendor gives you the goods and services and the invoice.
2. Review the invoice
Once you have the invoice, your AP team should add it to your tracking system.
That way, it quickly routes to the correct people, who will review the invoice to verify the invoice details are correct, the goods and services are received, and the price is accurate.
3. Approve
If everything checks out, your company approves the invoice for payment.
4. Pay
You pay the amount owed on time, cash flows out of your business, and your accounting software (or your accounting team) updates your accounts payable aging.
What is accounts receivable?
Accounts receivable refers to the money customers owe your business. When you invoice a customer for goods or services rendered, that amount becomes money owed to you.
As with accounts payable, you’ll record an account receivable on your company’s balance sheet. Accounts receivable is also considered a current account — because you expect to see that cash flow into your business bank account over the next few months, just as you expect to pay your accounts payable in the short term.
The accounts receivable process explained
The AR process is like the process for accounts payable but in reverse.
1. Establish a credit policy
When a customer approaches your business for a good or service, you’ll give them a quote. Then they’ll decide whether or not to purchase from you.
Let’s say they agree to your price. Now what? Your accounts receivable team will establish when the payment is due, any late payment fees, and discounts to encourage early payments.
2. Send the invoice
Once you and the customer agree to terms, you’ll send them an invoice. Sending your invoice right away will help you get paid faster.
Think of it this way: once your customer gets the invoice, they have to put it through their AP process. So, the longer you delay, the longer it could take for them to pay.
3. Track the amount
You’ll reconcile the amount in your AR ledger and track when your company sends out the invoice and when you receive the payment.
4. Follow up
If you did a good job tracking the invoice, you will also see when the payment is overdue, who to contact about late payments, and when to charge late fees, if any.
If you’re running a small business, your process for accounts receivable might be manual. But tracking all your invoices and account tracking information in spreadsheets is time-consuming.
It’s also easy to make mistakes in your accounting. The problem is that small errors can snowball into major issues. You might miss payment due dates, send the wrong amount on invoices, and harm your relationships with suppliers and customers.
That’s where automation can be so useful to businesses of all sizes. Automation software can automate everything from invoice delivery to updating your ledgers.
Accounts payable and accounts receivable software from BILL streamline your accounting processes so you can save time, avoid errors, and get paid on time. Try it today!
The difference between accounts receivable and accounts payable
AP and AR are both short-term amounts—it’s just that one represents money coming into your business and is a short-term asset, and the other represents money going out and is a short-term liability.
Both show you how much money is flowing in or out of the business in the next few months — which is why understanding accounts payable vs. accounts receivable is so important for managing cash flow.
A few mistakes in your AP process can lead to issues in your relationships with suppliers or customers. And if you’re consistently mismanaging accounts payable, you’re eventually going to run into cash flow challenges and see your company’s financial health suffer.
But when you master these accounts, you can see:
- What payments are coming due, and when — so you can avoid late payments
- How much cash will enter your business bank account from paid invoices, and when
- Whether you’ll have enough funds to cover payroll and fund your operations over the next few months
You also know which customers pay on time and are worth doing business with and which ones pay late. These types of insights can help you identify where you need to make changes in your payment process so you can ensure you always have the cash flow you need to operate.
Your business benefits from well-managed AP and AR processes
Think of accounts payable and accounts receivable as two opposite ends of balance. One is revenue. The other is expenditure.
When they’re relatively stable and balanced—when there’s always plenty of money coming in to make up for the money going out—your business has what it needs to stay operational and take advantage of growth opportunities.
That’s why it’s important to stay in control of your accounts. With BILL, managing AP and AR becomes seamless. BILL automates your processes and syncs with your accounting software for accurate, end-to-end tracking. Learn more about how BILL can help your small business.
