Last editedAug 20202 min read
Knowing the difference between accounts payable and accounts receivable is vital for small business owners who want to gain a better understanding of their accounting process. Find out everything you need to know about accounts payable vs. accounts receivable, right here.
Basics of accounts payable and receivable
Let’s start out with the basics: what is the accounts payable and receivable process?
First off: accounts payable. Accounts payable (also referred to as AP) is an account on your company’s general ledger that represents an obligation to pay off a debt to creditors or suppliers. In short, it’s the money owed by your business to third parties.
So, what’s accounts receivable? Essentially, accounts receivable (also known as AR) refers to outstanding invoices that are owed to your company by customers. It represents a line of credit that has been extended from the client to the customer.
Difference between accounts payable and accounts receivable
So, what is the difference between accounts receivable and accounts payable?
Put simply, accounts payable and accounts receivable are two sides of the same coin. Whereas accounts payable represents money that your business owes to suppliers, accounts receivable represents money owed to your business by customers.
In addition, accounts receivable is considered a current asset, whereas accounts payable is considered a current liability. This is because accounts receivable will be converted to cash within a one-year period (although in some cases, where you’ve offered longer credit terms, accounts receivable may be recorded as a long-term asset).
By contrast, accounts payable is considered to be a current liability because it represents money that you owe to creditors.
Why is accounts payable and receivable important?
Once you’ve understood the basics of accounts payable and receivable, as well as the difference between accounts payable and accounts receivable, it’s important to consider why these accounting processes actually matter.
For many small businesses across the world, late payments are a significant issue. Why? Because late payments can cause severe cash flow problems, leading to working capital getting tied up on your balance sheet.
According to Bacs, almost half of the UK's small to medium sized businesses are being paid late, with the average company waiting for £32,185 in overdue payments. 42% of those companies are spending up to four hours a week chasing late payments. That’s a significant amount, especially considering that this money could be used to fund new products, invest in growth, or boost shareholder payouts.
By optimizing your accounts receivable process, you can ensure that your business is able to maintain a healthy cash flow. This means that you’ll have more than enough cash coming through to cover your business’s expenses. Plus, you won’t have to struggle to survive from day to day but can take a long-term approach to growth.
How to handle accounts payable and receivable
Wondering how to handle accounts payable and receivable? To avoid the cash flow problems that can result from inefficient accounting processes, it’s best to optimize both accounts payable and accounts receivable. Here are our top three tips for how to handle accounts payable and receivable:
Consider automating accounts receivable – There are many different accounting software tools, such as Xero and QuickBooks, that you can use alongside a cloud-based payments system like GoCardless to automate your accounts receivable process.
Streamline invoicing – From an incorrect client address to invoices that simply get lost in the shuffle, there are a broad range of errors that can be introduced during the invoicing process. Be sure to use an invoice template to ensure you’re including all the relevant information. You should also issue the invoice as soon as work is completed to make sure you get paid faster.
Negotiate favorable payment terms – Don’t forget about optimizing accounts payable. One of the best ways to do this is to negotiate longer payment terms for your bur business, which helps to free up cash and boost working capital.
We can help
GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.