As a business grows, there are many interactions with customers, suppliers and stakeholders on an everyday basis, and there’s a constant need to process numerous. Only when revenues and expenditures remain in a healthy equilibrium will there be growth opportunities and positive supplier relationships.

In most cases, the business models aren’t as straightforward as paying cash and obtaining the goods or selling them and getting paid right away. As a business that sells goods or services, it is essential to maintain accounts with credit terms that enable the customers to pay later. Likewise, your suppliers might also let you delay payments.

Without such flexibility, it becomes difficult for businesses to function seamlessly. Identifying how much money is coming in and how much is going out is essential to maintaining a healthy cash flow. And keeping track of accounts becomes critical to the success of the business.

Accounts Payable (AP) and Accounts receivable (AR) are like two sides of the same coin. In fact, they are both essentially opposites. While AP is the money you owe your vendors, AR is that which is owed to you. Knowing your business’s AP and AR situation helps you gauge your financial strength and put in place practices to better manage your working capital.

When it comes to accounting and bookkeeping, these two terms can be confusing for a non-accounting person or someone trying their hands at accounting for the first time, as they are very similar in the way they are recorded in the general ledger. It is important to differentiate between the two as one is a liability account, and the other is an asset account.

What is Accounts Payable (AP)?

Accounts Payable refers to the amount your business or organisation owes to others for the purchased goods or services. It is reflected as a current liability on the balance sheet. For example, your rent, electric bills, postage, office supplies, income taxes, etc., are regarded as AP for your business.

It is up to your vendors or service providers to determine if they are willing to extend credit terms to your business. A mortgage is a very common example of an AP account. You sign a contract to repay a loan over a period and instalments. Payment terms are then established with a definite due date every month. Sometimes, early payment to vendors can result in discounts or rebates on the debt owed or other beneficial payment terms.

The Accounts Payable process includes five major steps: 

  1. Receiving an invoice for goods/services purchased,
  2. Recording the invoice into the AP ledger
  3. Matching the invoice with a purchase order or shipping receipt
  4. The approval process that ensures payment is warranted and accepted as debt
  5. Finally, ensure that invoices get paid on time and accurately. After this, the entry should be removed from the account.

What is Accounts Receivable (AR)?

Accounts receivable refers to the money owed to you by your customers who have been extended credit terms. When you sell products or services, you are increasing your AR balance. AR is also a current asset account and an income statement that keeps track of all the money others owe you and the cash inflow to your company.

The interest received while making investments or saving money in an interest-bearing account is a very common example of an AR transaction. Proper AR management begins at the initial decision to provide your customers with credit and ends with implementing collection activities for those who fail to make payments on time. Calculating your AR turnover ratio is one of the easiest ways to determine how fast your customers are paying you.

The Accounts Receivable process broadly involves three steps:

  1. Sending invoices to customers
  2. Tracking invoices, sending reminders and taking action if necessary
  3. Receiving payment, ensuring it is accurate and recorded in the ledger

The Symmetry between Accounts Payable and Accounts Receivable

Whether a small business or corporate finance, AP and AR functions are essential for a complete transaction and similar functions. While both are recorded in the general ledger, one becomes a liability account and the other an asset account.

Key differences: Accounts Payable Vs Accounts Receivable

  • An invoice will be issued or received for every business transaction. The amount you need to settle will be recorded as AP and the amount that you are expected to be paid as AR.
  • Considering how you’re counting on receiving money within a given timeline at the time of sale, Accounts Receivable becomes an asset to your business. And Accounts Payable becomes a liability as it requires you to pay out a certain amount within a timeline.
  • AP is created because of purchasing material on credit, and AR because of selling goods or services.
  • While AP leads to a decrease in cash flow, Accounts receivables lead to an increase in cash flow.
  • The accountability for AR lies on the debtors, and that of AP lies on the business.
  • AR is recognised as income unless written off, whereas AP becomes a liability until you get paid.
  • While AP is simply the total cost of purchases, AR is calculated as the total sales minus returns, and all the discounts and allowances are given to the customers.
  • Auditors evaluate the efficacy of AP by looking for instances of quality errors or perhaps unethical behaviours exhibited by the vendors. And for AR, they look at accounts that are past due beyond a specific timeframe, which can generally range from 60-120 days.

How to record and calculate AP & AR?

Accounts Receivables are recorded under assets and Accounts Payables under liabilities in a balance sheet. AP is typically recorded upon receiving invoices based on both parties’ payment terms. As companies will purchase goods/services on account, it is recorded under the current head liabilities on the balance sheet. The same amount will be debited whenever the payment is made. And journal entry to AR is straightforward: A debit entry is made in Account Receivable and corresponding credit entry in Sales Account. However, you must remember to separate your sales tax, as the same will need to be remitted to the proper authority whether or not your customer pays your invoice.

Discounts on Accounts Payable Vs Accounts Receivable

Sometimes, businesses attach discounts to their AR accounts to incentivise the customer to pay back the amount sooner. Such discounts benefit both parties as the buyer gets a good deal, while the sellers receive the payment quickly, enabling them to carry out their operating activities smoothly. For example, a business might opt to offer a discount after getting paid back within 20 days.

Accounts receivable discounted is an accounting tactic that discounts the value of AR on a business’s balance sheet in return for cash balances. It refers to the selling of unpaid outstanding invoices to a third party referred to as a ‘factor’ for a cash amount less than the face value of those invoices.

When you pay your invoice, debit AP for the total amount alongside crediting your purchases discount account and crediting cash for the difference between the invoice and the discount. And to record AR with a discount, debit the sales discounts account by the amount of the discount.

How QX helps

Both AP and AR are vital aspects of your organisation’s functioning. Managing them efficiently needs the right combination of People, Process and Platform. Our Accounts Payable and Accounts Receivable Outsourcing services have enabled clients to optimise their processes, leading to faster invoice processing and reduced DSOs. We deliver higher accuracy and lower operational costs via process excellence, standardised AP & AR practices, and strategic use of automation.

Book a Consultation

We hope you enjoyed reading this blog. If you want our team to help you optimise your payables process, improve supplier relationships, reduce costs and transform your business operations, just book a call.

Originally published Mar 30, 2022 10:03:06, updated May 04 2022

Topics: Accounts Payable Automation, Accounts Payable Optimisation, Accounts Payable Process, Accounts Receivable Process

Don't forget to share this post!

Related Topics

Mastering AP Automation: A Guide to Strategic Upskilling

Mastering AP Automation: A Guide to Stra...

24 May 2024

Introduction The accounts payable (AP) automation market is set to surpass $US 7.5 billion by 2030. ...

Read More
How Does Financial Services Outsourcing Drive Digital Transformation

Maximising Digital Finance Transformatio...

23 May 2024

Introduction Digital transformation in finance is picking up pace. Finance’s evolution from being ...

Read More
The 8 Stages of the Essential Order-to-Cash Process Explained

The 8 Stages of the Essential Order-to-C...

23 May 2024

Introduction Gaining new customers is a significant achievement that demands coordinated efforts acr...

Read More
How an Outsourced R2R Process Can Boost a CFO’s KPIs

How an Outsourced R2R Process Can Boost ...

22 May 2024

Introduction Record-to-report or R2R Services have moved beyond being just a checklist item within t...

Read More