When it comes to bookkeeping and accounting, there are a lot of terms that get thrown around. “Accounts payable” and “accounts receivable” are two such terms. But what do they mean? And how do they affect your business?
Continue reading to learn more about accounts payable vs. accounts receivable and how each affects your cash flow statements.
Determining the Financial Health of Your Startup With Accounts Receivable or Accounts Payable
Two types of money flow in and out of businesses: accounts receivable (money coming in) and accounts payable (money going out). Both play a role in determining the financial health of your business.
Accounts receivable is the money customers owe you for products or services you’ve provided. It’s crucial because it’s money your business is expecting to receive.
Conversely, accounts payable is the money your business owes to suppliers for goods or services you’ve received. It’s important because it’s money your business needs to pay out.
The critical differences between accounts receivable and accounts payable are:
- Accounts receivable is the money customers owe you. Accounts payable is the money your business owes to suppliers.
- Accounts receivable are considered an asset. Accounts payable are regarded as a liability.
- Accounts receivable means money is coming in. Accounts payable means money is going out.
- Accounts receivable affect your cash flow statement. Accounts payable do not affect your cash flow statement.
If your accounts receivable balance is higher than your accounts payable balance, it means more customers owe you money than you owe suppliers and more incoming cash than outgoing cash.
It’s important to keep an eye on both accounts receivable and accounts payable to ensure your business has a healthy cash flow. If either one gets too high, it could financially strain your business.
What Is Accounts Payable (AP)?
Accounts payable (AP) is money owed by a company to its suppliers for goods or services received. Accounts payable is considered a short-term debt since repayment usually takes place within 30 days.
Most startups use accrual accounting, meaning expenses are recorded when they’re incurred, not necessarily when they’re paid. This means that even though you may not have paid your supplier, you still incurred the expense and need to report it on your financial statements.
A company’s AP department is responsible for maintaining accurate records of all money owed to suppliers and ensuring no late payments.
If you’re using double-entry bookkeeping, each transaction will have two entries: one to accounts payable and one to another account, such as inventory or cash. So, for example, if you purchase $100 worth of office supplies on credit, you would record a $100 debit in accounts payable and a $100 credit in inventory.
Short-term debt is any debt that’s due and payable within one year. It can include credit card debt, lines of credit, and other types of loans. Businesses usually use short-term debt to finance day-to-day operations or to cover unexpected expenses.
Accounts payable fall under the category of short-term debt because they ku are usually repaid within 30 days. It’s different from long-term debt, which is debt that’s due and payable after one year.
Credit terms, also known as terms of credit, are an agreement between a seller and a buyer specifying the timing and quantity of future payments. In other words, this contract specifies the specifics of the seller’s payment criteria, which the buyer must meet to purchase items on credit.
What Is Accounts Receivable (AR)?
Accounts receivable (AR) is the money owed to a company by its customers for goods or services that have been delivered or used but not settled. Accounts receivable are an integral part of a company’s working capital and are often one of the largest sources of short-term funding for startups.
AR appears as an asset on a startup’s balance sheet and is often managed by accounts receivable departments or a dedicated accounts receivable team member. The goal of accounts receivable management is to collect the money owed to the company on time while maintaining good relationships customers.
Accounts receivable are classified as current assets on a balance sheet because they are typically due within one year. However, some companies may extend payment terms to their customers and offer financing, which can cause accounts receivable to be converted into long-term assets.
Companies use various methods to finance accounts receivable, such as factoring, lines of credit, and loans from investors or financial institutions. Each method has advantages and disadvantages, so choosing the right option for your business is important.
An outstanding invoice is used when the buyer/purchaser has already received goods or services but has yet to pay for them.
You don’t need to create a new/separate invoice to tell your consumers they have an outstanding balance. A simple email reminder referencing the initial invoice should suffice.
Furthermore, while making a sales invoice, the payment terms are specified, which implies your buyer has a defined period of time to pay. For example, if a company pays its invoices within 30 days, an invoice dated February 1st would be due on March 2nd. If the company has not paid the invoice by March 2nd, the invoice will be considered outstanding.
The current assets account is a balance sheet line item in the assets section that accounts for all company-owned assets you can convert to cash in less than a year. Current assets are assets whose value reflects in the current assets account.
Current assets, also known as current accounts, include:
- Accounts receivable, cash, and cash equivalents
- Marketable securities
- Stock inventory
- Pre-paid liabilities
- Other liquid assets
How Does AR Affect Your Cash Flow Statements?
Account receivables provide cash to your company while creating a short-term burden for the customer. Therefore, your cash flow factors will influence how long you can go without payment from a customer.
The supplier represents short-term credit as current assets on the balance sheet, affecting cash flow as accounts payable. For example, if you make a $10,000 sale with conditions of 50% cash and 50% credit payable within 60 days, record the $5,000 as sales because it is a cash inflow. When the amount is paid, you will record it as an inflow.
When a startup buys materials, it may only sometimes pay immediately. The buyer may be granted a grace period of 30, 60, 90, or 120 days before the provider needs payment. On the balance sheet, the purchaser represents this short-term liability as accounts payable.
For the buyer, this is equivalent to a cash source because it improves cash flow and cash in hand. Although offering extended payment choices can negatively impact your cash flow.
Seek Out Help for Cash Flow Management Success
airCFO provides highly effective accounts payable services to startups as an add-on to our core packages. We have simplified and streamlined various financial functions using our proprietary tools and experience to achieve high accuracy, helpful insights into cash flow operations, and significant cost savings.
Get in touch with us today to learn more about how we can level-up your accounts payable options today.