What is Accounts Payable versus Receivables?

Accounts payable, often shortened to just AP, is the money a company owes to suppliers, vendors, contractors, and others who have sent them an invoice for goods or services received but not paid for yet. You can think of accounts payable as bills the company needs to pay. Any time a company buys something without paying cash upfront, the purchase goes into accounts payable and becomes a short-term liability on its balance sheet.

How Accounts Payable Works

When a company orders and receives goods or services from suppliers on credit rather than paying cash immediately, those unpaid bills go into accounts payable. Accounts payable tracks the company’s short-term debts to suppliers. Once the company receives the invoice, the AP department records the liability in its accounting system. When the bill is paid, often 30 to 90 days later, the accounts payable liability is removed.

Most companies have a separate department or team that handles AP. Their job is to receive invoices, ensure they are accurate and valid, record them in the accounting system, and pay them on time. The AP department also handles any questions or disputes about invoices with suppliers.

The Accounts Payable Process

There are usually three critical steps in the accounts payable process:

1. The company receives an invoice from the supplier for goods or services
2. The AP department records the invoice as a liability in their accounting system
3. The company pays the invoice, typically 30 to 90 days later, and removes the liability

The AP department ensures all invoices are accurate, valid, and paid on time. This involves carefully reviewing each invoice, matching it to purchase orders, receiving reports, and ensuring invoices aren’t duplicates or contain errors. If there are discrepancies, the AP team contacts the supplier to resolve them.

Once invoices are validated, the AP team records them as current liabilities in the company’s accounting system. This step increases the accounts payable balance. When it comes time to pay the invoices, usually a month or two after receiving them, the AP team initiates the payments through checks, ACH transfers, or other methods. Making the payment reduces the accounts payable balance.

How Accounts Payable Differs From Receivables

While accounts payable (AP) represent money a company owes others, accounts receivable (AR) is money others owe the company. AR is the opposite of AP—it’s the other side of the transaction from the seller’s perspective. If a company lets a customer purchase goods or services on credit, the amount the customer owes goes into the company’s accounts receivable.

Accounts Receivable Explained

Accounts receivable (AR) are the money a company owes its customers for goods or services that have been delivered but not paid for yet. Since the expectation is that customers will pay within one year, it is considered a current asset on the balance sheet. The AR balance goes up when a company makes a sale on credit and goes down when the customer pays their invoice.

Just like companies often have an AP department to handle the bills they owe, they also usually have an AR department to handle the money customers owe them. The AR team invoiced customers, followed up on past-due payments, applied customer payments against outstanding invoices, and resolved any billing disputes.

The Accounts Receivable Process

The typical accounts receivable process also has three main steps:

1. The company provides goods or services to the customer and generates an invoice
2. The AR team records the invoice as an asset in the accounting system and sends it to the customer
3. The customer pays the invoice, and the payment is applied, removing the asset

After a sale on credit, the AR department generates an invoice and records the amount as accounts receivable in the company’s accounting system. This increases the company’s accounts receivable, considered current assets, since they represent money the company will receive soon.

The AR team usually sends the invoice to the customer through email or an online payment portal. The invoice specifies payment terms, often giving the customer 30 to 90 days to pay. The AR department monitors open invoices and follows up with customers as payments become due to ensure they pay on time.

When a customer makes a payment, the AR team applies it to the invoice or invoices in the accounting system. Customer payments reduce the accounts receivable balance. If a customer is late on payment, pays the wrong amount, or has any other issues, the AR team is responsible for resolving them.

Critical Differences Between AP and AR

While accounts payable and accounts receivable are two sides of the same coin, there are several significant differences between them:

Timing of Recording Transactions

Accounts payable are recorded after a company receives an invoice but before they pay it. In contrast, accounts receivable are recorded when a company sends an invoice to a customer before receiving payment. So, AP represents transactions already completed from the buyer’s perspective, while AR represents transactions in progress from the seller’s perspective.

Cash Flow Impact

Accounts payable are considered liabilities because they represent money the company needs to pay out in the future, which will reduce cash. Accounts receivable are assets since they represent money the company will collect in the future, increasing cash. So, in a simplistic sense, high AP is generally considered harmful to a company’s cash flow, while high AR is good.

Turnover Ratios

Both AP and AR have “turnover ratios” used to evaluate how well a company is managing them, but their meanings are quite different:

• Accounts payable turnover measures how quickly a company pays its bills. A high ratio means they are paying swiftly.
• Accounts receivable turnover measures how quickly a company is collecting on sales. Again, higher means faster collections.

Regarding turnover, higher ratios are a good sign for AR because they mean the company collects from customers quickly. However, lower ratios are often better for AP since they tell the company that it is holding onto its cash longer. The ideal turnover ratios vary by industry.

Department Responsibilities

The accounts payable and accounts receivable departments have similar but mirrored responsibilities. While AP focuses on processing incoming invoices, ensuring they are correct and valid, and paying them on time, AR is responsible for generating outgoing invoices to customers, delivering them, and providing timely collection.

Both departments also handle disputes from different sides. AP deals with issues on invoices the company receives, while AR manages customer problems with invoices sent to them. While both record journal entries, AP records liabilities while AR records assets.

The Importance of AP and AR

Accounts payable and receivable are two of companies’ most essential accounting functions. Nearly all companies have both unless they operate on an all-cash basis. AP and AR impact a company’s cash flow, working capital, and relationships with suppliers and customers.

Impact on Cash Flow

Since accounts receivable bring cash in while accounts payable send some money out, the two significantly impact a company’s cash flow. If AR collects cash faster than AP is paying it out, the company’s cash flow will be positive, which is generally the goal. But if AP pays out faster than AR collects, cash flow will be squeezed.

Closely monitoring the timing of AP and AR transactions is crucial to ensuring smooth cash flow. Companies want to collect from customers as quickly as possible while taking as long as possible to pay suppliers to maintain adequate working capital. The AP and AR turnover ratios help companies gauge how well they manage this balance.

Supplier and Customer Relationships

The accounts payable and receivable functions are essential to maintaining good relationships with suppliers and customers. Processing invoices quickly, paying bills on time, and resolving issues promptly help a company be seen as a good customer by its suppliers. Efficient collections, accurate invoicing, and excellent customer service also help customer relationships.

Conversely, habitually paying suppliers late, incorrectly applying customer payments, or aggressively hounding customers for payment can harm a company’s reputation and relationships. Managing AP and AR well is vital to building trust with essential business partners.

The Future of AP and AR

While accounts payable and receivable have been core business functions forever, they are far from static. AP and AR processes are evolving quickly and are primarily driven by technological advances. Automation, AI, blockchain, and other innovations are transforming invoicing, payments, and recordkeeping, making AP and AR faster, simpler, and less labor-intensive than ever.

Automation and AI

Many repetitive manual tasks in AP and AR, such as data entry, invoice matching, and payment application, are being automated by specialized AP/AR software and broader AI and machine learning applications. Automation speeds up processing, reduces errors, and frees the AP and AR teams to focus on more value-added activities like analysis and vendor/customer relations.

As AI gets more sophisticated, it can take over even complex tasks like reviewing contracts, analyzing vendor spending patterns, evaluating customer credit risk, and optimizing payment timing and methods for maximum benefit. These cognitive technologies will enable faster and better decision-making in AP and AR.

Electronic Invoicing and Payments

Paper is quickly disappearing from both AP and AR. A vast majority of invoices are now sent and paid electronically. E-invoicing streamlines invoice delivery and automates data capture in AP. Platforms like ACH, credit cards, wire transfers, and virtual accounts make collecting and applying payments lightning fast in AR, with remittance data flowing seamlessly into the accounting system.

New payment models like dynamic discounting also transform AP by allowing buyers to choose how quickly to pay in exchange for discounts, optimizing cash flow. The move from paper to electronic will continue to accelerate.

Blockchain

While slower to take off, blockchain has significant disruptive potential for AP and AR, particularly in invoicing, purchasing, and payments. Blockchain’s distributed ledger could enable automated execution of complex procurement agreements, instant and secure payment, and complete transparency into transaction history, dramatically streamlining processes and resolving disputes faster. Though adoption is early, blockchain could reshape AP and AR.

As these technologies advance, the AP and AR roles will move away from data entry and repetitive tasks toward more analysis, vendor management, risk management, and working capital optimization. However, the core goal will remain the same—timely, efficient, and accurate money movement in and out of the organization.