Account payables and account receivables are two crucial financial terms that businesses encounter daily. While they may sound similar, they represent opposite ends of business transactions. While AR stands for the money that a company owes its clients, AP stands for the money that a company owes its suppliers.
This article delves into the specifics of each term, providing a clear understanding of account payables vs. account receivables.
What are Account Payables?
Accounts payable (AP), commonly referred to as "payables," signify a company's short-term financial obligations to its creditors or suppliers that remain unpaid. These obligations appear on the company's balance sheet as a current liability. In essence, when a company purchases goods or services on credit, it creates an account payable.
This means the company owes money to its supplier or creditor for the goods or services received but has yet to pay. Another perspective of "AP" relates to the specific business department or division tasked with settling payments owed by the company to its suppliers and other creditors.
What is an example of Account Payable?
Accounts payable arise whenever a business owes money for goods or services that it has received but has yet to pay for. Here are some examples of payables:
● Purchase from a Vendor on Credit: When a business procures goods from a vendor and agrees to pay later, typically within a specified credit period,
● Subscriptions or Installment Payments: This could be for services like software subscriptions where the service is used now but the payment is due later or in instalments.
● Invoiced Amounts: After receiving a service or product, businesses often get invoices detailing the amount owed. This amount remains an account payable until it's settled.
What are Account Receivables?
Accounts receivable (AR) represents the money that a company is entitled to receive for goods or services it has provided but for which it has yet to be paid. These amounts are listed on the company's balance sheet as current assets. Essentially, when a company sells a product or service on credit, it creates an account receivable. This indicates that the customer owes money to the company.
The term "accounts receivable" signifies the right of a company to receive payment because it has furnished a product or service. Typically, the terms of accounts receivable require payments to be made within a short period, ranging from a few days to a fiscal or calendar year.
What is an example of Account Receivables?
Accounts receivable can manifest in various forms, depending on the nature of the business and its operations. Here are some examples of receivables:
● Sales on Store Credit: When a business sells products to customers and allows them to pay later, typically within a specified period.
● Subscriptions: This could be bi-monthly, monthly, or even annually. For instance, a magazine subscription is where the customer receives the magazine now but pays for it later.
● Installment or Lay-bye Payments: Some businesses allow customers to take a product now and pay for it in installments over time.
● Invoiced Amounts: After delivering a service or product, businesses often send invoices to their customers detailing the amount owed. Until this invoice is paid, the amount remains an account receivable.
Key Differences between Account Payables and Account Receivables
Nature of Transaction
● Accounts Payable: Represents the money a company owes to its vendors or suppliers. This typically arises when a company procures goods or services but hasn't made the payment yet. It's a promise to pay the supplier in the near future for the value received.
● Accounts Receivable: Indicates the money that customers owe to the company. This usually happens when a company provides goods or services upfront and expects payment later. It's essentially a claim against the customer for money.
Balance Sheet Representation
● Accounts Payable: This is recorded as a liability on the company's balance sheet. It signifies the company's obligation to settle the debt, usually within a short period.
● Accounts Receivable: This is an asset on the company's balance sheet. It represents the funds that the company expects to collect from its customers in the foreseeable future.
Flow of Cash
● Accounts Payable: In this scenario, cash will flow out of the company when the debt is settled. It's an outflow because the company is paying off its obligations.
● Accounts Receivable: Here, cash will flow into the company when the customer settles their bill. It's an inflow as the company is collecting what it's owed.
Transaction Origin
● Accounts Payable: Arises when a company procures goods or services on credit. The company promises to pay for these products or services at a later time.
● Accounts Receivable: Originates when a company sells goods or services on credit. It's an expectation that the company will receive payment for these goods or services after they've been delivered.
Accounting Method
● Accounts Payable: In the accrual accounting method, accounts payable records every unpaid transaction. These transactions represent the company's commitment to pay for goods or services received. The account is settled once the payment is made.
● Accounts Receivable: On the other hand, this refers to money expected from clients, partners, and investors. It's an anticipation of future cash inflows based on credit sales or services provided.
Abbreviation
● Accounts Payable: Commonly abbreviated as A/P or AP, this term is widely recognized in the financial and accounting world. It's a standard notation used in financial statements, ledgers, and other accounting documents.
● Accounts Receivable: Often shortened to A/R or AR, this abbreviation is universally acknowledged in accounting practices. It simplifies documentation and communication regarding money owed to a company.
Payment Direction
● Accounts Payable: Refers to the money that a company owes to others, primarily vendors or suppliers. It's an obligation of the company to pay for goods or services it has received but hasn't paid for yet
● Accounts Receivable: Represents the money that others, mainly customers, owe to the company. It's an assertion of the company's right to collect funds for goods or services it has provided on credit.
Impact on Business Cash
● Accounts Payable: When settled, accounts payable will decrease a company's cash reserves. This is because the company is fulfilling its financial obligations, leading to an outflow of funds.
● Accounts Receivable: When collected, accounts receivable will boost a company's cash position. It's an inflow of funds, enhancing the company's liquidity and financial health.
Transaction Cause
● Accounts Payable: This liability arises when a company decides to purchase goods or services on credit. Instead of paying upfront, the company agrees to settle the amount at a later date.
● Accounts Receivable: This asset is created when a company sells its goods or services on credit. The company provides value first, with the expectation of receiving payment later.
Execution
● Accounts Payable: This is recorded when an invoice is approved for payment. Many companies have stringent checks and balances in place to ensure accuracy and prevent any potential errors or fraudulent activities.
● Accounts Receivable: This process typically starts with the generation of an invoice that is then delivered to the customer. The customer is expected to pay the invoice within the agreed payment terms, which is often within 30 days, ensuring a structured and organized collection process.
Here's a table summarizing the key differences between Accounts Payable and Accounts Receivable
| | | | | ---------------------------- | ---------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------- | | Criteria | Accounts Payable (AP) | Accounts Receivable (AR) | | Nature of Transaction | Money a company owes to its vendors or suppliers. | Money owed to the company by its customers. | | Balance Sheet Representation | Recorded as a liability. | Recorded as an asset. | | Flow of Cash | Cash will flow out when the debt is settled. | Cash will flow in when the customer pays. | | Transaction Origin | Arises from purchasing goods or services on credit. | Originates from selling goods or services on credit. | | Accounting Method | In accrual accounting, every unpaid transaction is recorded and settled once paid. | Refers to money expected from clients, partners, and investors. | | Abbreviation | A/P or AP | A/R or AR | | Payment Direction | Money that the company owes to others. | Money that others owe to the company. | | Impact on Business Cash | Will decrease a company's cash when settled. | Will increase a company's cash when collected. | | Transaction Cause | Arises from purchasing goods on credit. | Arises from selling goods on credit. | | Execution | Recorded when an invoice is approved for payment. | Involves generating an invoice delivered to the customer, who then pays it within the agreed payment terms. |
Summing Up on Account Payables vs Account Receivables
Understanding the nuances between Accounts Payable (AP) and Accounts Receivable (AR) is fundamental for businesses to maintain a healthy cash flow and ensure smooth financial operations. While AP represents the money a company owes, AR signifies the money a company is owed. By effectively managing these two aspects, businesses can optimize their financial health, anticipate potential challenges, and make informed decisions that drive growth and stability.
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FAQ’s on Account Payables vs Account Receivables
What is an example of accounts payable and accounts receivable?
Accounts Payable Examples
● Purchase of inventory on credit
● Utilities owed
● Rent owed
● Salaries owed
Accounts Receivable Examples
● Sale of goods or services on credit
● Interest earned
● Loans receivable
● Advances to employees
Accounts payable vs. Accounts receivable journal entries
Accounts Payable Journal Entry
| | | | | | -------- | ---------------- | --------- | ---------- | | Date | Account | Debit | Credit | | XX/XX | Inventory | xxx | | | | Accounts Payable | | xxx |
Note: This entry is made when an invoice is received.
| | | | | | -------- | ---------------- | --------- | ---------- | | Date | Account | Debit | Credit | | XX/XX | Accounts Payable | xxx | | | | Cash | | xxx |
Note: This entry is made when the invoice is paid.
Accounts Receivable Journal Entry
| | | | | | -------- | ------------------- | --------- | ---------- | | Date | Account | Debit | Credit | | XX/XX | Accounts Receivable | xxx | | | | Sales Revenue | | xxx |
Note: This entry is made when a sale is made on credit.
| | | | | | -------- | ------------------- | --------- | ---------- | | Date | Account | Debit | Credit | | XX/XX | Cash | xxx | | | | Accounts Receivable | | xxx |