When running successful business, you need to keep detailed records of the money you bring in and the money you send out. Without those records, you have no clear idea of who owes you what for your services—or who you owe money to.
That’s where accounts payable and accounts receivable come in. These two processes ensure you’re never left guessing about any revenue transaction. The tricky part is remembering what transaction goes to which department and then using those records to put together a strong view of your business’s finances.
Here’s what you need to know about accounts payable versus accounts receivable and how they play into your overall financial health.
What is accounts payable?
Accounts payable (AP) is he money you owe to vendors or creditors. It includes short-term debts your business needs to settle, typically within 30, 60, or 90 days. For example, when you receive an invoice from a supplier, you record it as an AP entry. As payments are made, the balance decreases.
Key Steps in the AP Process:
- Receive an invoice from a vendor or other third party
- Record that invoice in your accounting system
- Match the invoice to a purchase order to validate it
- Approve the invoice
- Pay the vendor what you owe them
What is accounts receivable?
Accounts receivable (AR) is the money owed to your business by customers or clients. Typically holding a debit balance, your accounts receivable increases when you make a sale (you’re waiting to collect payment) and decreases when you receive cash payment (you’re owed less money overall).
Key Steps in the AR Process:
- Send an invoice to a customer or client
- Record the invoice in your accounting system
- Track the invoice for status updates; follow up if payments are late
- Receive the money the vendor owes
AP, AR, and your balance sheet
As with any accounting process, your accounts payable and accounts receivable will appear on your financial statements—specifically your balance sheet.
Financial data related to AP appears as a liability on your balance sheet because it represents funds your business owes. That’s because those transactions are seen as short-term debt that will be settled in under one year. Your balance sheet will show the total amount under AP for that time period, but you won’t list the individual transactions.
On the other hand, AR appears as an asset on your balance sheet because it represents expected cash inflow. Efficient AR management here will ensure timely revenue collection, contributing to financial stability.
How AP and AR impact your business
While AR and AP are separate accounting processes, they work together to paint a picture of how your overall business is doing, both financially and operationally.
Accounts payable
Your AP data indicates how efficiently you’re paying the money you owe your vendors. Key metric to monitor include your:
- AP turnover
- Days payable outstanding (DPO)
- Cash conversion cycle
When done well, an efficient AP process allows for:
- Strengthened vendor relationships — On-time, or even early payments, make vendors happy and might even open up opportunities for discounts or volume increases.
- Financial stability — You can develop an efficient AP process to maintain a steady cash flow while still keeping up with your obligations.
Accounts receivable
You can use data from your AR processes to inform certain accounting metrics like:
- AR turnover
- Days sales outstanding
- Collection effectiveness index
When done well, successful AR processes let you:
- Increase revenue — You’re not wasting time collecting the money you’re owed and that efficiency contributes to faster revenue growth.
- Reduced debts — As cash from AR rolls in, you can pay down larger debts to reduce your overall liabilities.
Top tips for AP & AR management
As a whole, properly managed AP & AR functions improve cash flow and boosts revenue streams. Take these steps to best position yourself for success!
1. Check creditworthiness
Don’t wait until you’re still waiting six months for a customer payment. Before signing a contract, vet customers before extending credit to reduce collection risks.
2. Establish clear payment terms
During your contract negotiations, make sure both parties know exactly what payment schedule you’re agreeing to. This gives you the chance to renegotiate a schedule that works better for your AP or AR. It also helps avoid delayed payments or quickly resolve any disputes down the road.
3. Leverage Automation
Skip the spreadsheets and switch to a digital accounts payable and accounts receivable platform. Advanced AR/AP automation tools allow you to easily house all invoices and payment data in one place, better manage status updates, automate alerts for payment due dates, and automatically port transaction data to your accounting software.
4. Monitor Cash Flow
Regularly compare AP and AR balances to anticipate cash gaps before they become problems. By keeping a close eye on your cash flow, you can make informed decisions about when to pay invoices and when to focus on collecting receivables. This proactive approach prevents cash shortages and ensures you have the funds to meet your obligations
Empower your team with expert accounts management
Whether you're struggling with invoice management, looking to prevent unauthorized expenses, or simply want to clean up how you manage spend within accounts payable and accounts receivable, the right accounting software makes all the difference.
HilineOS delivers best-in-class tech solutions combined with expert human review so you can transform your AP into a strategic asset and have the necessary insight into your AR without having the headache of constant oversight.
Let’s work together to get you the outsourced accounting system you deserve.
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