Accounts Payable vs. Accounts Receivable: Understanding How Both Work

Michael Pignatelli
Aug 23, 2022

Debts and payments keep the business world rolling smoothly. In a world where cash is king, borrowing and lending serve as enablers. It is a form of leverage that uses each party's capability to pay and receive money. Using this arrangement helps grow businesses and serve as many people as possible.

That's why Unloop aims to educate ecommerce sellers about the difference between accounts payable and accounts receivable. By knowing why they are important and how they function, ecommerce business owners like you can harness the full potential of leveraging short-term debits and credits for your benefit.

Why Understand Accounts Receivable and Accounts Payable?

Ecommerce sellers involved in business-to-business (B2B) or multi-channel activities must understand the flow of accounts payables and accounts receivables. At high-level business transactions, the volume is large, and the movement is so fast that cash can't keep up—it has to be replaced with something else.

Credit purchase is more efficient than direct cash payments. A buy-now-pay-later policy allows the fast flow of goods while each party keeps score. Businesses do it in the form of accounts payable and accounts receivable.

Understanding how these two things work keeps your business operations flowing. Here’s why.

It Can Affect Your Balance Sheet

Any inaccuracies in the amounts of your business's payable and receivable accounts can lead to a distorted view of your balance sheet. Understanding how both works can help you design checks and balances to ensure each account is properly recorded.

It Can Cause Disruptions in Cash Flow

Payables and receivables that are unacknowledged or incorrectly recorded can cascade into a series of unpaid debts or uncollected credit. This will cause delays in your cash flow, affecting other areas of your business needing cash payments.

It Can Affect Your Business’s Borrowing and Lending Capacity

Another direct result of unresolved accounts payable and receivable is your business's reputation. If your business doesn't have a payable department that monitors debt obligations relative to your business's cash and accounts receivable assets, it can lead to unusually high debts and credit lendings.

This phenomenon can overstretch your borrowing and lending powers and may lead to a bad reputation and business insolvency.

accounts payable vs accounts receivable - Top view of an office table with a desktop and other office items

Features of Accounts Payable

Now that you understand the importance of both, let's dive into the basics, starting with accounts payable.

It’s Your Business’s Short Term Debt

A transaction you make with your vendor or supplier without paying them cash or by cheque is short-term debt. This happens when you purchase a product for sale or raw materials using your privilege of credit purchase.

In this scenario, you are the borrower, and your supplier is the lender. You'll receive the goods immediately, but you'll be given a payment deadline, which you must adhere to.

Your Business Is Given an Invoice

One way to determine accounts payable is by who’s receiving an invoice. This accounting document will let you know the name of the issuing vendor, the goods purchased on credit, the payment amount, payment terms, and other pertinent information.

It’s Part of Your Balance Sheet’s Current Liability

Accounts payable is a short-term debt commonly used to pay for products and raw materials. This being the case, the amount owed earns its rightful place in your balance sheet's current liability as opposed to an expense account in your income statement.

The Accounts Payable Process

Every business that is given credit privileges follows a similar accounts payable process. So it's good to see how the transaction process runs on both ends to get an insight on how you can better participate in it.

1. A business's production or operations department generates a purchase order and forwards it to the accounting or payable department before submission to the vendor.

2. Vendor delivers products to your business and issues an invoice.

3. Accounting or payable department confirms receipt of goods from production or operations, and acknowledges and records the invoice. They authorize and disburse the payment once approved.

4. If all goes well, on the appointed date, money (cash or cheque) is forwarded to the vendor.

5. Vendor acknowledges the payment, issues an official receipt, and forwards it to your accounting or bookkeeping department to confirm that payment is complete.

Features of Accounts Receivable

Accounts receivable is the opposite of payable, yet it is just as important. This account is created when your business allows a credit sale, usually with your loyal clients. Here's how it works.

It’s a Short-Term Credit

Your business gives a minimum of 30 days for this credit to be paid by your clients.

In this scenario, you are the one lending, and your client or customer is borrowing. The business's job is to release the orders according to your client's specific time.

Your Business Is the One Sending Out an Invoice

Similarly, your business must also send out invoices and make sure they are received and acknowledged by your client's accounting or accounts payable department.

Issuing invoices is crucial. You have to include all the necessary details accurately to ensure no pushback will happen that can delay the payment.

It’s Part of Your Balance Sheet’s Current Assets

Because a business is supposed to receive cash in exchange for goods sold, it makes sense to include accounts receivable on the balance sheet as current assets. This cash substitute represents money that you will pay in the foreseeable future or as demanded. Hence, it must be recognized as an asset, just like cash.

The Accounts Receivable Process

Granting credits and collecting payments demands a more thorough and strict process. That's because the risk is on the burden of the one who lends. Thus, the following process is adapted by most ecommerce businesses in retail, wholesale, and manufacturing.

1. Customer makes a purchase using the credit terms as agreed by the seller and the buyer.

2. The lending business delivers the product or raw materials to the client and writes an invoice.

3. Customers are given 30 days to pay by cash or cheque. Additionally, the lending business can also choose to send mid-month payment reminders to prepare the customer for timely payment.

4. If the customer fails to pay after 30 days, the lending business sends payment reminders to the customer.

5. Once a particular accounts receivable balance lapses beyond 30 days, the associated outstanding invoices are tracked and marked as doubtful accounts—amounts that are at risk of defaulting.

5. When payment is completed, the customer's credit is renewed.

6. Alternatively, the accounts receivable balance is written off as bad debt if a customer defaults.

accounts payable vs accounts receivable - A woman checking paid invoices on her laptop

A Note on Bad Debt

If the outstanding invoices of your accounts receivables remain unpaid for 270 days or nine months, the amount can be eligible for a write-off as bad debt which can be part of your deductibles. You'll receive a benefit in the form of reduced income taxes.

Declaring bad debt means the accounts receivable on the business's balance sheet is removed as a current asset. It then becomes part of an expense reflected on the business's income statements.

Accounts Payable vs. Accounts Receivable

Both payables and receivables are vital to your business. But what goes above these two is a good accounting process. Getting good accounts payable and receivable services to build your system allows you to efficiently record, track and approve the inflow and outflow of assets and liabilities within your enterprise.

Combine this system with a team of accounting and bookkeeping experts, and you'll be set. These people can oversee your accounting system and make it feel like your accounting is on autopilot so that you can spend your time making important decisions that keep your enterprise gliding.

Do you want your ecommerce business to thrive in accounts receivable and payable transactions? Let's discuss how you can streamline your process. Call us at 877-421-7270. In the meantime, explore our accounts payable service.

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About unloop
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.
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