Accounts Payable Vs Accounts Receivables

“The creditor hath a better memory than the debtor.”

-James Howell

 

In Chinese we have Ying Yang which represents both black and white. In business Accounts Payables and Accounts Receivables are similar to Ying Yang. For a company to stay healthy, we need to maintain a balance between them. 

 

In this blog, you will find the key differences between both Accounts Payable and Receivables. 

 

Also Read | Unearned Revenue 

 

What are Accounts Payables and Accounts Receivables?

 

Accounts Payable also called AP and Accounts Receivable known as AR are both responsible for the financial health of the company. While the former represents the funds company owes to outsiders, the latter consists of the funds owed to the company. 

 

Let us understand both these concepts one by one.

 

Accounts Payable shows that the amount of money that company owes to its vendors, suppliers, financial institutions, creditors but for a short term. AP does not include long term debt like payroll, mortgage or any other long term due.

 

Once an invoice is received, the accountant records the journal entry of purchase or whatever transaction was incurred. Thereafter, the ledger is updated with the expense. Later on while preparing the financial statement, the balance of Accounts Payable is shown in the Balance Sheet in the liabilities side.

 

When the payment is done based on the time frame decided by the parties, the accountant discharges the amount of expense. There is a proper Accounts Payable department for big companies that is responsible for processing the bills and invoices related to it. 

 

They have to ensure that timely payments are done to the appropriate parties. A company which has successful Accounts Payable analysts can grab more opportunities because:

 

1. Cash flow is maintained accurately

 

2. Mistakes are pinpointed and corrected timely

 

3. Accurate and efficient system of report and statement generation

 

While recording AP there are two methods:

 

1. Where Accrual concept is followed

 

In the Accrual based system, all the unpaid expenses are also recorded. A company purchases goods from the vendor and agrees to pay 50% of the amount on delivery. 

 

According to the accrual concept, the company has to record 100% of the amount at the time of purchase. It is done assuming that the goods are received.

 

2. Where Cash based concept is followed

 

In the Cash based system, all the invoices against which payment has been done will be recorded as expense only. If the payment is done in installments then when the payment is actually done will be considered for recording the expense.

 

In Financial Management we calculate Days Payable Outstanding cycle time to figure when the company makes payment to creditors and how many days are in between two payment cycles. Improving the DPO cycle helps to establish better relationships with the vendors. 

 

The formula to calculate DPO :

 

DPO= (Accounts PayableNumber of Days)/COGS

 

COGS= Cost of Goods Sold= Opening Inventory + Purchases - Closing Inventory

 

Accounts Receivables on the other hand represent the money that is owed to the company either by customers or others for the goods and services. The total amount of Accounts Receivables is shown in the asset side of the Balance sheet. 

 

Usually, a company issues invoices after providing services or delivering goods and decides a payment period as per an agreement between the debtor and itself. Accounts receivables just like accounts payables include only the short term debtors. 

 

After the goods are delivered, AR analysts record the respective journal entries and put the revenue to be received under the head Accounts Receivables. While recording the Accounts receivables, an accrual system is followed in which when the invoice is settled the revenue is recorded. 

 

There is a ratio called Receivables turnover ratio that is used to monitor how efficiently the company is receiving money from its debtors. It is said that higher the Receivables Turnover Ratio, the more efficient and better the collection system of the company. 

 

The formula of Receivable Turnover Ratio is:

 

Accounts Receivable Turnover Ratio= Credit Sale/Avg Accounts Receivable

 

A company that has low Accounts Receivable Turnover Ratios  must improve the collection periods.

 

Also Read | Profitability Ratios

 

Difference Between Accounts Payable and Accounts Receivable

 

The fundamental difference between Accounts Payable and Accounts Receivable Is that an Accounts Payable is a credit concept whereas Accounts Receivable is a debit concept. Credit means outflow of cash whereas debit means inflow of cash. 

 

Accounts Payable represent the money owed to vendors and Accounts Receivable represent money that is owed to the company. Accounts Payable is shown in the liabilities side of the balance sheet as Current Liability. 

 

Accounts Receivables are shown in the asset side of the balance sheet under Current Assets. Both of them deal with the money that has not been processed yet. But Accounts Payable show the amount the company has to pay while Accounts Receivable show the money that company will get. 

 

Given below are some examples of both Accounts Payable and Accounts Receivable:

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Examples of Accounts Payable and Accounts Receivable

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Examples of Accounts Payable

 

1. Raw Materials

 

Every company needs to purchase raw materials, fuel and even power sources to carry on its production. Without raw materials it is impossible to produce goods. Therefore, a continuous supply of raw material is needed every time. 

 

Sometimes bulk orders are placed and sometimes small multiple orders are given. For big orders it is impossible to make cash purchases, so a credit option is chosen. Therefore, until the credit is discharged for raw materials, fuel and power, these accounts remain accounts payables.

 

2. Logistics

 

After purchasing raw materials, they have to be transported to warehouses or places of production. There are 3 ways of transportation- rail, road and air. Some companies prefer the sea route. 

 

These vehicles can be owned by companies or through a third party logistics provider. These service providers can be paid in cash or through credit. In case of credit payments they will fall under Accounts payable.

 

3. Assembly

 

Many times, manufacturers do not have sufficient resources or methods to produce. In such cases they either outsource the job or sub-contract it. The best example is Apple who approaches China for assemblies of Iphones. 

 

If such services are taken for credit then they will fall under Accounts Payable until the liability is discharged.

 

4. Equipment

 

The simple example is a mobile network operator. He needs equipment for telecommunications. These equipment are costly and innovative and therefore require licenses. 

 

Many companies purchase such equipment but need outside approvals for licensing. These accounts are treated as Accounts Payable until the payment is done.

 

5. Leasing

 

Just like in case of equipment, if these are taken on lease rather than purchasing then the installments and interest amounts paid to the vendor will be included in Accounts Payable. Vendor in this case will be called Lessor and the company will be Lessee.

 

6. Licensing

 

The concept of licensing is used only in those companies that want exclusive rights over their machines, equipment or technology. License fee is charged from the company. 

 

The most heard example is Antivirus Software. Such licensing is also included in Accounts Payable depending on the tenure of liability.

 

7. Traveling

 

Telecommunication companies that have to assemble and install equipment all over India have to incur heavy expenses over traveling. Cab drivers, network engineers etc are a part of such missions. 

 

The credit agreements for payments done to people engaged in such activities excluding the workforce will fall under Accounts Payable.

 

Also Read | What is Logistics Management?

 

 

Examples of Accounts Receivables
 

1. Sale of Goods

 

When a company sells goods to customers, customers pay in cash or become a debtor and avail the option to pay later. When we calculate accounts receivables in case of sale of goods, we subtract the cash sales from total sales. 

 

The short term debtors of the company are included in Accounts Receivables including bills received. The time duration is less than 1 year or 12 months. Once the payment is received the balance in Accounts Receivables is reduced and cash flow is increased. 

 

2. Supply of Service

 

In case of provision of service, we have to identify all the revenue related items which are short term and can be clubbed under the head Accounts Receivables. 

 

Just like in the case of Supply of Goods, in order to calculate the credit supply we subtract the total cash supply from overall supply of services. Examples of activities which are the part of service are- Installments, decoration costs, interest payments, certificate costs, assembly costs etc.

 

3. Deferred Revenue

 

There are multiple examples for Deferred Revenue. Let us take the sale of a magazine for instance. Many companies supply magazines on a subscription basis and receive payments in installments or in lump sum. 

 

Since the payment is received in lump sum but the magazine will be provided later on, this becomes the case of Deferred revenue. In simple words, advance payment is received for goods. 

 

In such cases balances are transferred to deferred revenue and when the payment is received the amount is subtracted and cash is recognized. Deferred Revenues are also a part of Accounts Receivables in most cases.

 

4. Money Lending Industry 

 

It includes Banks, Non-Banking Institutions and others that lend money. The people to whom they lend money become the debtor or Accounts receivable for such institutions. 

 

For example- If a bank lends money to a customer for purchasing a machine at a specified rate of interest and amount is paid in installments, the interest plus the principle becomes a part of Accounts Receivables. 

 

If any late fee or additional interest is charged then it is also a part of the same debt based on the situation. But the most important thing is that money lent for the short term (less than 1 year or 12 months) is included in Accounts Receivables.

 

Both Accounts Payable and Accounts Receivables are an integral part of the overall financial health of the company. Mismatch in any will cause an impact on the Financial Statements. 

 

Therefore, keeping a state of equilibrium between both revenues and expenses is very important. Errors, frauds etc must be carefully examined because it will not only impact the internal system but also external relationships with customers and vendors at the same time.