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Accounts payable vs. accounts receivable

A plant decor shop owner using a laptop to manage accounts payable.

Accounts payable (AP) and accounts receivable (AR) are important aspects in examining any business’s financial situation and cash flow health. Both are accounts listed in the company’s balance sheet, representing money that will come in or out of your business in the near future. 

If you find that confusing, we assure you you’re not alone. Almost every small or medium-sized business (SMB) owner, who isn’t a finance professional, can get bookkeeping terms mixed up. 

Read on to find out the differences and similarities between accounts payable and accounts receivable, and their impact on small businesses.

The basics of AP and AR

Businesses have different needs than consumers, which means they sometimes get special treatment. 

Consumer transactions are typically straightforward. A customer goes to a store or a website and buys whatever they need, paying for it on the spot. That’s because consumers often only buy one or two items and are more concerned with the price of a single product than with creating long-lasting ties with the business they shop from.  

Business-to-business (B2B) transactions, on the other hand, are usually much larger and more complex. The B2B relationship between seller and buyer is a long and trusting one, in which both parties are dependent on each other. 

So, unlike consumers, businesses don’t always pay their suppliers and vendors right away. Most B2B transactions come with agreed-upon net terms that can extend the payment to 30, 60, or even 90 days after the goods are delivered and invoiced. This breathing room is crucial for businesses, which are dependent on the revenue from selling their products to pay for their procurement

This means businesses owe and are owed money for short periods of time on a regular basis. And, that’s how the concept of accounts payable and receivable was born.

What’s accounts payable?

Accounts payable is an accounting term that refers to the full amount of all open and unpaid invoices (aka bills) a business has received from other companies for goods and services already rendered. This can mean any payment with net terms as well as installment payments and even loans. Until the transaction is complete and paid in full, each of these bills is calculated into the company’s AP.

Since it refers to money you owe, accounts payable is listed under current liabilities in your balance sheet. Accounts payable will include any financial obligation a business has, as long as you received an invoice and it’s for items or services that were already delivered. This can mean office rent, supplies, utilities, inventory, equipment, professional services, etc.

The importance of accounts payable

You can’t operate a business without spending money on equipment, supplies, or products. Without these things, you won’t be able to generate revenue, which means your business will need to shut down. But AP is about more than just paying the bills. It’s about cash flow and invoice management, as well as your company’s good name. 

Correctly managing your AP—in other words, the money coming out of your account—means: 

  • More control over your cash flow. When you know where you stand, you can create accurate cash flow projections and make sure your payments go out when you’re ready and never too soon. 
  • Better relationships with vendors. Everyone loves to get paid on time and this goes a long way with vendors and suppliers. Smooth payments can mean better future deals and discounts as well as exclusive products or optimized delivery times. 
  • Strong reputation. A business’s best asset is its good name and being organized about your payments is always a good sign of your professional credibility
  • Saving time and money. An inefficient AP process can cost businesses in fees and work hours spent to put out fires. Creating a good process means not every payment needs to be expedited and it also results in fewer mistakes that need to be fixed later.

What’s accounts receivable?

Remember AP? AR is the same thing except you are now the vendor waiting to get paid by your business customers. So, if you have open invoices issued to clients for goods and services already rendered, these are listed as accounts receivable.

This includes deals with net terms, allowing customers to pay after a certain time period, as well as any other form of credit you give your customers, such as installments.

Since it’s money you expect to collect from customers in the near future, AR is listed under current assets in your balance sheet.

The importance of accounts receivable

Let’s state the obvious: If you don’t get paid you won’t stay in business. AR refers to a large portion of income for many companies, which comes from B2B deals. 

If you’re serving business customers, you’ll have to manage accounts receivable. When it’s not done correctly, you might suffer consequences, including:

  • Lost funds. If you’re not on top of things and tracking every open invoice, you might fail to collect on some transactions, effectively losing money. 
  • Unhealthy cash flow. Businesses use AR to establish how much cash they have to work with at any given time. When your receivables don’t come in on time (or at all) it can mean negative cash flow, impacting your ability to cover your own expenses and AP.
  • Wasted staff hours. Chasing down clients and customers to collect funds you’re owed is not only unpleasant, it’s also time consuming.

What’s the difference between accounts payable and accounts receivable?

Most businesses have both accounts payable and receivable to handle. Here are the main elements that differentiate the two.

Your role in the deal

Remember: One business’s AP is another’s AR. If your business provided the goods or service, issued an invoice, and is now awaiting payment, then this transaction should be counted in your accounts receivable. If, on the other hand, you’re the one who received the goods, services, and invoice, but have not yet paid, that would be accounts payable.

The invoice’s place in your financial reports

Both AP and AR are tracked in your balance sheet to provide an accurate estimate of your business’s financial health. The difference is where.

Accounts payable is listed under current liabilities, as it’s part of the business’s financial obligations for the next 12 months. Accounts receivable, on the other hand, is listed as a current asset, since it’s money that’s expected to enter the business in the upcoming months.

Streamline AP and AR processes for your SMB with digital solutions

Both AP and AR are crucial processes in the day-to-day operations of any business. Bigger companies often have whole departments dedicated to them so no detail goes unnoticed. But, small businesses can also take action to improve the process by going digital. 

Here are some of the most crucial benefits offered by online AP and AR tools like Melio.

Better tracking

See all incoming and outgoing payments on a single platform so you’ll never forget to send or collect funds.

Flexibility

Both the payor and the recipient get to choose the payment method that best fits their workflows and needs. You can, for example, pay with a credit card* even if your vendor doesn’t accept cards. They’ll just get a check or an ACH bank transfer. Whatever works for them.

Maximized cash flow

Schedule your payments in advance to ensure they leave your account just in time, not a minute too soon or too late.

Savings in fees

Melio has no subscription fees and offers free ACH bank transfers. The first two checks you send each month are also free while mailing additional checks costs just $1.5.

International payments

Pay all your vendors through the same platform regardless of where they are in the world. For a flat $20 fee, Melio currently supports payments to over 80 countries.

Accounting software sync

A good AP and AR tool integrates with popular accounting software to ensure your books are always up to date. Melio offers integrations with QuickBooks Online, QuickBooks Desktop, and Xero

Let us take some of the load off

Bookkeeping is hard enough, especially for small business owners juggling about a million other tasks. Built specifically with the needs of SMBs in mind, Melio can help you handle both accounts payable and receivable more efficiently. 

This way, you can focus on what matters most: perfecting your product and offering, growing your business, and fostering strong relationships with your customers, vendors, and partners.

Sign up for Melio for a better way to manage your AP and AR, with no monthly fees or strings attached.

*This blog post is intended for informational purposes only and is not intended as financial advice.
**Melio does not provide legal, tax or accounting advice, and you should consult with a professional advisor before making any financial decisions.