When running a business, the word accounts is brought up in most conversations. Accounts are your business’s way of recording transactions, coming or going so that you’ll be able to keep track of how money is spent and how money is earned. The two most common terms you’ll hear in regards to accounts are accounts payable and accounts receivable.
Because these terms are so frequently used, business owners must have a good understanding of each. Accounts payable and accounts receivable are related, and knowing how each works allows for more informed decisions and revenue cycle prediction. Their processes are crucial in all aspects of cash flow and operating your business.
The General Ledger (GL)
Both accounts payable and accounts receivable appear on a business’s general ledger or GL. The general ledger is any record-keeping system that keeps track of all financial data for a business at any given time. It provides all the financial transactions for the life of a business typically.
The GL allows for insight on all debit and credit accounts for a business, and when analyzed properly, can help to predict the financial future for the establishment. It is the key to creating financial statements for a business, as well.
Accounts Payable (AP)
By definition, accounts payable, or AP, consists of accounts on the general ledger that are the debts owed by a business to creditors or suppliers. In large-scale businesses, there are entire accounts payable departments responsible for making sure that debts are paid on time and accurately. This ensures that the business continues to receive the services or supplies it needs to stay operational.
Typically, accounts payable refers to goods or services that are paid for via credit rather than cash. They show up on the general ledger as a liability, specifically, as they document the flow of money away from the business. The monitoring of accounts payable can give insight into the spending needs of a company and indicate the demand for supplies being purchased. Accounts payable are very important for helping to monitor your business’s cash flow.
Using Accounts Payable to Monitor or Adjust Cash Flow
Accounts payable provide a business the ability to monitor their cash flow as well as manipulate aspects of it to allow them to work to their advantage. For example, if a company wanted to increase cash reserves for a while, they’d be able to alter the timing of their payments going out to clients, sending them later on so that they’re keeping more cash on hand.
This can affect the relationships that they have with their suppliers or creditors, however.
Areas of Responsibility for Accounts Payable
Accounts payable are responsible for many things, all of which fall under the umbrella of managing and handling outstanding balances. Here are a few of their typical responsibilities.
- Paying Bills – The main function of accounts payable is paying bills. This means any bills related to the business itself, including utilities and property bills.
- Internal Payments – Accounts payable functions to record any internal costs to employees and make sure these invoices have been satisfied by the company and the employees are paid.
- Vendor Payments – Vendor payments consist of paying suppliers and creditors for their goods and services. This is similar to paying bills but categorized independently for record-keeping purposes.
The Accounts Payable Process
Because accounts payable is the area responsible for outgoing cash being paid to suppliers or creditors, the process for accounts payable is thorough and handled carefully, with a focus on the details.
- The bill is received by the business and lightly reviewed to make sure that it is in fact an outstanding liability.
- Once determined to be a legitimate liability, the bill is reviewed more thoroughly to ensure further legitimacy. The invoice date, number of goods, and vendor/supplier information are verified at this time.
- Records of the bill are updated in the general ledger under the accounts payable section. In order to keep with good bookkeeping, the information is entered timely, and depending on the amount in need of payment, approval is obtained.
- The bill is paid in a timely manner, ensuring that the relationship with the client is kept in good standing. All details, including the date, check number, original bill, and purchase orders, are recorded.
To follow this process accurately, internal protocols should be set in the business to help determine fraudulent bills, identify inaccurate invoices, and prevent double payments. All information is crucial and should be documented accurately.
To clear up some misconceptions, remember that accounts payable cannot be considered a business expense. Expenses and payables differ due to the nature of the transactions. Expenses are listed on the income statement for the firm, while accounts payable are recorded as liabilities on the general ledger.
Accounts Receivable (AR)
While accounts payable may be about the money leaving the business, accounts receivable, or AR, is all about money being received by the business. Accounts receivable is the other side of the coin, and on the general ledger is a representation of the money owed to a business by other entities or establishments.
Nearly all businesses have some sort of accounts receivable department in place, and their primary function is to collect the money owed to them by outside establishments. These purchases made by customers are typically made on a credit basis, hence the need for follow-up and collection of payments. On the general ledger, accounts receivable are considered an asset, as they are accounts documenting the income of cash for a business.
Using Accounts Receivable for Cash Projections
Due to the nature of accounts receivable representing lines of credit that are extended from a business to its customers, cash projections can be made based on their existence using a number of factors. The amount of the invoice, the transaction history regarding payments received, as well as the established relationship with ongoing clients can all play a part in understanding how accounts receivable can predict money flowing into a business.
The Area of Responsibility for Accounts Receivable
Accounts receivable, as a department, is responsible for one thing, and that’s the collection of outstanding invoices for the business. The sole duty of the department is to make sure that payments are received on time and that any bills sent out with errors are reported and corrected so that payment can be received as quickly as possible.
The Accounts Receivable Process
Due to the important nature of accounts receivable departments and their ability to bring cash flow into a business, the general process is rigid and structured. There is little room for error when trying to collect outstanding invoices, and it needs to be done efficiently.
- Determine that an invoice has been sent to the customer or the debtor. Review the invoice to ensure that it was sent correctly.
- Contact the customer or debtor regarding the outstanding invoice, and review the practices and payment deadlines.
- If any errors are present, record them, then verify internally if the invoice is incorrect. Resend a correct invoice if necessary.
- Continue contact with the customer or debtor regarding the outstanding debt until it is paid.
Operationally, accounts receivable departments use the accounts receivable on the general ledger as a database to utilize collections efforts. Determining outstanding payments and categorizing them into priorities by using data about the overdue date, the expected payment, and the client relationship can really help facilitate a larger influx of cash when analyzed properly.
Accounts receivable are one of the fundamental factors in determining a business’s liquidity.
Accounts Payable vs Accounts Receivable
This is purely for comparison. Accounts payable and accounts receivable aren’t in competition with each other; rather they’re both sides of the same coin. Ensuring that both accounts payable and accounts receivable are in working order is crucial for the cash flow management of your business.
For example, when your business orders supplies from another business, you’ll be placing the transaction on your general ledger as a payable account. Meanwhile, the other business places the transaction on their general ledger as a receivable account. In every transaction, both accounts payable and accounts receivable will be utilized.
When taking into account, well, accounts, it’s important to know the difference between accounts payable and accounts receivable. Accounts payable are liabilities; they’re the money your business owes to vendors, suppliers, or creditors. Accounts receivable are your assets; they’re what you can collect money on, and they determine your upcoming cash flow.
Without both sides of the coin, a business is not able to function well. Having independent departments for both payables and receivables can help you to keep your business in tip-top shape. Understanding the functions of these departments and transactions is important to keep things running smoothly!