When it comes to understanding personal finance, financial literacy is at an all-time low in the USA.
Unless you’re a trained accountant, how much do you really understand about the financial aspects of managing your wages, let alone a business? And nothing could be more fundamental than the interplay between accounts payable and accounts receivable.
Below, we explain the meaning of these crucial finance terms.
Contents
What Is Accounts Receivable?
Accounts receivable is the opposite side of the financial coin from accounts payable. Accountants use this system to control money coming into a business.
An Overview
Accounts receivable is a process a business uses to record the money it needs to collect from customers.
In other words, if your business is owed money from a company, bank, or individual, such as a customer you provided services to, you’d include this income figure in your accounts receivable turnover. Another example of accounts receivable is interest earned from an investment.
It’s what’s known as a current asset.
Basically, if the numbers in your accounts receivable figures are growing, your business is healthy. If they start to look dire, it means your incoming funds are drying up: you’re not selling enough services or products to keep the business afloat.
The Accounts Receivable Process
A company accountant responsible for accounts receivable would go through a similar process when managing a payment, no matter the size of the company.
The three-step process looks like this:
- Send an invoice to the customer after completion of work
- Track the invoices regularly to seek payment
- Receival of the payment and recording it as paid
Keeping track of accounts receivable income is beneficial for a business for practical purposes, for example, knowing what your cash flow will look like over a given period. It can also help you in securing small business loans and using AR financing.
What Is Accounts Payable?
Accounts payable is a calendar of payments you owe. It helps an accountant organize what payments need to be made when, to who, and how much.
An Overview
At the most basic level, accounts payable refers to the expenses of your business. For these expenses to be recorded as accounts payable, you need to have the money in hand already to pay them.
This means everything from the rent or mortgage repayments, utility bills, salaries, insurance, tax obligations, and money you owe to vendors and contractors. It also includes any goods or services you’ve received on credit, as well as the repayments for long and short-term debts.
Fees recorded as accounts payable are considered current liabilities in a business budget because they need to be paid often and quickly.
The Accounts Payable Process
When it comes to business finances, some people consider the accounts payable process trickier than accounts receivable.
This is because there are five steps to consider:
- Receive an invoice requesting payment
- Record the invoice details in the accounts payable record
- Match the invoice with related order information
- Internally approve the invoice for payment
- Make the payment on the invoice and remove it
It might take weeks or months for an invoice to move through the accounts payable system in bigger companies.
Can’t Have One Without the Other
Accounts receivable and accounts payable can’t function alone. Having an understanding of both concepts is critical if you want to keep your business running smoothly. Keep on top of your balance sheets, and you’ll never make a late payment and keep the cash flowing in.
Take a look at the other articles on our blog for more essential financial tips.