Accounts Payable and Accounts Receivable 101
As a business owner, you have probably heard the terms Accounts Payable (AP) and Accounts Receivable (AR). The definition of these terms in the accounting books can cause confusion. To keep it simple: accounts payables are obligations, money that your business owes, while accounts receivables is money that is owed to you. We will guide you through the basics of AR and AP: what they are, some examples, sample scenarios, and why they’re important.
Accounts Payable is what your business owes to suppliers and other creditors for goods and services received for which you have not yet paid; accounts payables are usually short-term in nature and appear on the current liabilities section of the balance sheet.
The following are common examples of accounts payable expenses:
Office Space Lease Payments
Raw Materials Purchases
Company ABC, LLC delivers a shipment of goods to your business along with an invoice for $1,000 that is due in 30 days. When you receive the goods, you record a $1,000 payable to Company ABC, LLC that will stay in your books until the payment is made.
Why is it important?
The Accounts payable account is an important aspect of a company’s balance sheet, not something that should be overlooked. If the accounts payable account increases when compared to a prior period, it means that the business is buying more goods and services on credit, rather than paying cash. Vendors, suppliers, and other stakeholders can see this as an indicator that your business is unable to pay its debts. On the other hand, if the accounts payable account decreases then you may be paying creditors too fast instead of maximizing every dollar to reinvest into your business.
Accounts Receivable is the money customers owe your business for the goods or services you provide on credit; accounts receivables appear on the assets section of the balance sheet.
The following are common examples of accounts receivable:
Sale of Goods
Supply of Service
Your business delivers goods to company ABC, LLC on credit, allowing company ABC, LLC to pay in 30 days. When you deliver the goods, you record a receivable from Company ABC, LLC that will stay in your books until the payment is received.
Why is it important?
Accounts receivable measures your business’ ability to cover short-term obligations without additional cash flows. The reports generated using the accounts receivable account can show you which clients owe you money and how much. If you aren’t on top of what clients owe you and when, you won’t know when a customer pays late. The longer the debt is outstanding, the more difficult it is to collect payments.
Accounts payable and accounts receivable are crucial in managing cash flow to run and grow your business. At CPA By Choice, we don’t expect you to know the intricate world of accounting, we will help you to better understand it while helping you become a stronger business owner. We also understand that accounting can take you away from your day-to-day activities in your business and we would love to help you have more time for the things that matter to you. We are available to answer your questions, feel free to call us or send us a message.