Accounts Payable vs. Accounts Receivable

What are accounts payable?

Accounts payable are the amounts you owe vendors and suppliers over a certain period. They are liability items on your balance sheet.

Tracking your accounts payable is essential because it can tell you if you’re relying too much on credit or overspending with vendors. By monitoring accounts payable trends, you can see if the amount you owe is increasing or decreasing over time and compare it to your accounts receivable.

It’s not necessarily bad to have increased accounts payable. If your business is expanding or you need to buy more inventory because sales are up, you can expect higher accounts payable. In addition, you may not want to pay bills before their due dates, to optimize the use of your money. 

It’s important to know why your accounts payable balances are trending up or down and whether you have the cash flow to pay bills when they’re due. This information is vital to understanding how your accounts payable affect your overall business strategy.

>> Read next: What Is an Accounts Payable Aging Report?

Short-term and long-term payables 

Accounts payable are typically divided into short-term and long-term payables. Short-term payables are those you pay a vendor or supplier within a year. They are recorded as a current liability under the accounts payable header on your balance sheet. 

Long-term payables are debts that will take more than 12 months to pay off. They are typically recorded under the long-term liabilities header. They tend to be tied to business financing, such as repayments for one of your top business loans. Any portion of long-term debt that is due within 12 months is included as a current liability.

Accounts payable may also result from typical expenses associated with running a small business, including the following:

• Fuel and energy 
• Transportation and logistics 
• Manufacturing and assembly
• Marketing and advertising 
• Travel 
• Equipment and hardware
• Licensing
• Subcontracts 
• Leases

How do you optimize accounts payable? 

Monitoring accounts payable is a standard part of running a business. By tracking them closely, you can get a better view of how much you’re paying your vendors and suppliers. That will help you identify business partners you are relying on too much and ones you can arrange better terms with if you pay early or buy more from them. 

“The general rule is to negotiate favorable terms on accounts payable,” said Ben Richmond, a managing director at accounting software vendor Xero. “You want to pay as late as possible.”

Delaying payment — without risking penalty by missing the bill’s due date — keeps funds in your account longer. You should strategically allocate your cash and decide which debts make the most sense to square away sooner and which ones can wait.

What are accounts receivable?

Accounts receivable are listed as current assets on your balance sheet and are composed of money owed to you for your goods and/or services. They are recorded any time a customer makes a purchase on credit. Examples include the cost of a residence drawing energy from an oil company, the local dry cleaner charging corporate clients for its services or any small business extending credit to customers. The account receivable stays on the balance sheet from the day you bill the client to the day you get paid.

Keep track of accounts payable to protect your cash flow. If you aren’t on top of what clients owe you and when, you won’t know when a customer pays late. The longer the debt is outstanding, the more difficult it is to collect payments. Accounts receivable usually have terms of a few days to a year. 

“As far as accounts receivable, you are concerned with shortening the window to get paid,” said Dawn Brolin, a certified public accountant and CEO of Powerful Accounting.

Most businesses use the accounts receivable turnover ratio, a common accounting ratio, to measure the health of their accounts receivable. It tells you how well you are collecting payments from customers. Another metric to look at is the average collection period, which tells you how long it takes your clients to pay you. The longer your collection period is, the worse your accounts receivable are. [Check out the best debt collection strategies.]

How do you optimize accounts receivable? 

Managing accounts receivable requires you to stay on top of when your business bills clients and when you get paid. “On accounts receivable, it’s important that you get paid fast,” which means promptly sending customers invoices, following up on unpaid bills and offering discounts to customers who pay early, Richmond said. If possible, make sure your customers are paying you on a 10-day cycle, Brolin noted. 

It’s crucial to keep a level head when you’re collecting from customers who have defaulted. “You have to keep accounts receivable unemotional,” Brolin said. “You can’t get wrapped up in their dismay.” 

Depending on your type of business, you may be able to require a deposit when the customer’s order is placed. By requiring half the payment upfront, Brolin said, you reduce the likelihood that you’ll be chasing money once the job is complete or the order is met.

What is the difference between accounts payable and accounts receivable?

The difference between accounts payable and accounts receivable is who owes the money. 

Accounts payable are based on the amount of money you owe vendors and suppliers for business expenses. These liabilities are typically recurring and are treated as current liabilities on your balance sheet. [See common business liabilities.]

In contrast, accounts receivable are the amounts customers owe you for your goods and services. They are recorded as current assets on balance sheets and other accounting reports. 

Why are accounts payable and accounts receivable important? 

You need to adequately manage your accounts payable and receivable to ensure there are enough funds coming into the business to pay your bills and hopefully have cash left over for a profit. Without staying on top of payables and receivables, you can’t manage your cash flow efficiently. 

“You can have the best product or service, but if you run out of cash, you can’t make more products or deliver more services,” Richmond told Business News Daily. “Accounts payable and receivable are the king and queen of cash flow.”

Managing both types of accounts allows you to budget for upcoming bills, spot ways to get better terms with vendors and suppliers, and incentivize customers to pay their bills faster. It can also cut down the time it takes to collect past-due payments. [Find out the do’s and don’ts of sending an account to collections.]

What are discounts on accounts receivable and accounts payable?

To optimize cash flow, you want to get paid as quickly as possible but take as long as you can to pay vendors. That is where accounts payable and accounts receivable discounts come in. 

Accounts receivable discounts

A common way to get customers to pay faster is to offer them an early-payment discount. This means charging the customer a reduced price if they pay before the due date. Consider your profit margin to determine how much of a discount to offer. Make it worthwhile for the customer, but don’t let it eat away at your profit too much.  

These are some examples of payment discounts.

• 2/10 net 30: Customers get a 2 percent discount on a bill that’s due in 30 days if they pay within 10 days.
• 3/15 net 45: Customers get a 3 percent discount on a bill that’s due in 45 days if they pay within 15 days.
• 4/10 net 60: Customers get a 4 percent discount on a bill that’s due in 60 days if they pay within 10 days.

Accounts payable discounts

As mentioned, the goal is always to pay vendors as late as possible and on the best terms. Depending on your relationship with the supplier and your track record of paying, you can potentially get a discount if you pay early or upfront. This is the same as an accounts receivable discount, but instead of collecting money at a reduced date, you pay it out. 

Discounts also may be available if you buy in bulk or on a consistent basis. No matter what, it can’t hurt to ask.

“A discount is a discount,” Brolin said. “If you get a 1 percent discount on a $10,000 bill, that’s $100. You can utilize [that money] for something else.” 

Best accounting software platforms for managing accounts payable and accounts receivable

Some accounting platforms are better suited than others for tracking and analyzing your accounts payable and accounts receivable. Below, check out our recommendations for the best accounting software solutions to manage accounts payable and receivable.

• Plooto: The quickest, easiest way to manage business bill paying and receivables may be via Plooto. With this platform, you can automate and time your bill payments to improve your cash flow and avoid late fees. You can even pay all of your bills with one click. Note that you must integrate Plooto with Xero, Oracle NetSuite or QuickBooks Online for it to be a full-featured accounting solution. Learn more about this arrangement in our Plooto review.
• Melio: For low-cost accounts payable and receivable management tools, consider Melio. This program lets you make and accept payments from bank accounts for free. The only fees are for card payments, expedited check delivery and international transfers. Melio is easy to use and integrates with QuickBooks. Similar to Plooto, however, it is not full-scale accounting software. Our Melio review has more information.
• FreshBooks: FreshBooks can improve your accounts receivable process with professional, automated invoicing. The invoice creation process is streamlined with a single screen, and you can make recurring invoices for ongoing services. Clients can pay invoices online, directly from the electronic documents. FreshBooks’ easy-to-use platform helps you collect on receivables in a timely manner and improve cash flow. See plans and pricing in our FreshBooks review.

>> Read related article: Choosing the Right Small Business Accounting Software

Take the time to manage accounts payable and accounts receivable

“At the end of the day, if you don’t have cash, you are not in business,” Brolin said. “Your AR and AP are extremely important.”  

With good accounting practices, you should be able to know at any time where your accounts payable and accounts receivable stand and what your cash flow is expected to be in the short and long term. With these insights, you’ll be on your way to maintaining a financially sustainable business.

Sally Herigstad contributed to this article. Source interviews were conducted for a previous version of this article.