Even a newcomer to accounting can likely guess the basic framework to Accounts Receivable vs. Accounts Payable: Accounts Receivable is money “to be received” by your business from a client or customer, while Accounts Payable is money “to be paid” by your company for a product or service provided by a vendor. Fairly straightforward, right? Now let’s examine the subtleties of these two types of accounts and what they mean from the perspective of running and growing your business.
What is Accounts Receivable?
Accounts Receivable is a company’s money spot: it means sales have been made and business is growing. The payment has been earned… it simply remains to be received and recorded in the asset column.
So how do you go about collecting payments from your customers, transforming your Accounts Receivable into a cash inflow? Think about payment terms. Let’s say you’ve opted to give your customer 30 days to repay you for the product or service you’ve provided; in this case, 30 days is the payment term. For your customer, you’ve effectively granted credit (or a short-term loan) from the date the product or service is provided until the date payment is remitted. The longer the payment term, the more credit you are extending to the customer. Establishing payment terms through a clear-cut contract offers your customer convenience and ensures that you get paid on time. (But keep in mind, longer credit terms equate to a longer interval before customers pay, which extends your operating cycle.)
What is Accounts Payable?
While Accounts Receivable is all pending cash inflow, Accounts Payable is pure pending outflow: the overhead operating expenses your company owes, such as salaries, taxes, advertising, utilities, insurance, and the other supplies and services you need to keep the business running. Accounts Payable represents a balance sheet liability; the cash is in hand, but the debt to the vendor/supplier at the end of the set payment term remains outstanding.
Keeping a close eye on Accounts Payable is critical to maintaining an unvarnished perspective on your company’s finances. How can you map out a company budget and plan for growth unless you have a clear way to track who you owe, how much, and when it’s due? Growth also means securing good credit and relationships with vendors: paying bills on time (or even before the contract ends) establishes trust and allows the opportunity for leniency should you need to work out an alternate payment arrangement in the future. Examine whether your budget allows for cash negotiations or payment terms extended by a supplier; longer payment terms shorten the operating cycle, since the business can delay paying out cash, but generally at the cost of interest.
So how do you build healthy Accounts Payable practices?
Sound cash flow management is critical to your company’s success. Competent cash flow forecasting for Receivables and Payables is also vital; you should maintain careful tracking and active management for both, as well as a system for organizing the short- or long-term credit you owe and extend. Launching an automated payments program, such as Procurify Accounts Payable, is a solid start. Like all asset/liability management, monitoring is key, so set calendar alerts several days prior to payment to confirm there’s sufficient cash in the account from which the payment will be drawn. Should you find yourself anticipating difficulties with making a timely payment, reach out to the vendor as quickly as possible to negotiate an alternate payment arrangement. Pay down high-interest debts in months with maximum cash flow, and never get slammed with a late-payment fee. That just makes sense for your bottom line.
Staying on top of your Accounts Receivable and Accounts Payable fuels the actions of your business. Inconsistent or spotty attention to either can starve a company’s growth, while a uniform process results in a well-fed machine capable of achieving all of its goals.