Business owners and entrepreneurs often struggle with basic accounting and bookkeeping concepts. For example, you may have heard of the terms "accounts payable" and "accounts receivable," but what do they actually mean?
When running a business, you should know your potential liabilities and assets. Accounts payable and accounts receivable are two common examples, but there's a big difference between accounts payable and receivable. In this article, we'll tell you how they can affect your business. Stay tuned!
Most online businesses need to track both accounts receivable and accounts payable. In a nutshell, accounts receivable (AR) is the money owed to you by customers or clients, while accounts payable (AP) is the money you owe to suppliers or other creditors. Discover the key differences between these two types of accounts below.
Both accounts receivable and accounts payable are considered liabilities because they represent money owed by the company.
However, they are listed in different sections of the Balance Sheet. Accounts receivable are listed under Current Assets because it represents money that will likely be received within one year. Accounts payables are listed under Current Liabilities because it represents money that will likely be paid within one year.
Not all accounts receivables are collected immediately—some customers may take longer to pay than others. As a result, businesses often set aside an allowance for doubtful debts, an estimate of the receivables that are unlikely to be collected.
This allowance is then used to offset the receivables, reducing the amount of money the business owes. In this way, the allowance for doubtful debts helps to protect businesses from losses due to uncollected receivables.
On the other hand, accounts payable do not have an offsetting entry on the balance sheet. This is because accounts payable represent money you owe—to your suppliers, for instance—but haven't paid yet.
There are three account types with accounts receivable, each with its benefits and risks.
Meanwhile, the most common accounts payable are taxes, wages, loans, and payables for goods and services.
The accountability for accounts receivable lies with the debtors or the people who owe \ money to the business. The business is responsible for sending invoices and keeping track of payments, but it is up to the debtor to make the payment.
The accountability for accounts payable lies within the business itself, as it is up to the business to make sure that all invoices are paid on time. But creditors may also send reminders or take other measures to ensure they are paid promptly.
Besides its nature and accountability, what is the difference between accounts payable and accounts receivable? Cashflow is the answer.
You can think of accounts payable as the "bad debt" account because it represents money that the company will never see again. In contrast, you can think of accounts receivable as the "good debt" account because it represents money that the company expects to receive in payment eventually.
For example, Company B has $100,000 in Accounts Payable and $50,000 in Accounts Receivable. This means that Company B owes its suppliers $100,000, but its customers owe it $50,000. In this case, the net cash flow impact of AP and AR would be positive $50,000.
However, if the balances were reversed (i.e., if Company B had $50,000 in Accounts Payable and $100,000 in Accounts Receivable), the net cash flow impact would be -$50,000. As you can see, accounts payable and accounts receivable can significantly impact cash flow.
Accounts payable must be paid on time to maintain good relations with suppliers and avoid late payment fees. On the other hand, accounts receivable need to be collected promptly to keep cash flow positive. In both cases, it is important to maintain accurate records and stay on top of invoices to avoid costly mistakes.
The goal of any business is to make money, and one of the most important indicators of a company's financial health is its free cash flow (FCF). FCF is the cash that a business has available after paying all of its expenses, and it can be used for things like expansion, paying down debt, or making dividend payments to shareholders.
Because FCF is so important, companies often try to maximize their FCF by extending payables (delaying payments to suppliers) and reducing receivables (collecting payments from customers more quickly). While this can be an effective way to increase FCF in the short term, it can also lead to problems down the road if not managed carefully.
For example, if a company consistently delays payments to suppliers, it may eventually find itself unable to obtain the goods and services it needs to continue operating. Similarly, if a company is too aggressive in collecting customer payments, it may damage its relationships with those customers and jeopardize future sales.
Therefore, while extending payables and reducing receivables can be a helpful way to boost FCF, companies need to be careful not to overdo it.
Accounts receivable and accounts payable are two important processes to understand how to maintain a healthy cash flow for your business. It's essential to be proactive about managing payments, setting due dates, and tracking outstanding invoices. Failure to pay can seriously affect your bottom line and relationships with suppliers.
You need to make sure you're bringing in enough money through sales and investments to cover your costs, but you also don't want to overspend and put yourself in a difficult position down the road. That's why it's important to clearly understand these two important terms to know what steps you can take to improve your business.
If you want to minimize cash outflow and maximize inflow for your ecommerce business, book a call with us today!
Unloop is the first and only accounting firm exclusively servicing ecommerce and inventory businesses in the US and Canada. With the power of people and technology, our team dives deep into COGS and inventory accounting. You are paired with a dedicated bookkeeping team that prepares accurate financial statements, financial forecasts, and can also pay bills or run payroll for you. Come tax time, everything is organized and ready to go, so you don't need to worry. Book a call with an ecommerce accountant today to learn more.