Accounts Receivable, Accounts Payable

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What It Is

Accounts receivable (A/R) and accounts payable (A/P) are recordings on a company’s financial statements that show how much is owed to the company and how much the company owes, respectively. On a balance sheet, businesses want to see a higher A/R and a lower A/P. A/R is considered an asset on the balance sheet; A/P is considered a liability.

 

Why It Matters

In many cases, there is a difference between cash and revenue. For example, if your company sells a product but no cash is exchanged – in other words, the customer paid on credit – you can record revenue, but only in the form of accounts receivable. Accounts receivable is the amount owed by customers for goods and services that a company allowed the customer to purchase on credit. Similarly, any amount of money that your company owes to another entity must be recorded as accounts payable.[1]  Both A/R and A/P are considered current, meaning that the amounts owed are expected to be paid within 12 months.[2]

Another way to look at the terms is to consider lending and borrowing. When a company has A/R, it has essentially lent out money. That is, the company exchanged goods or services for a promise to pay. When a company has A/P, it has essentially borrowed money from another company. 

A/R and A/P must be monitored when running a business. The most basic issue should be intuitive: A/R is important because you need to know (and have records on) how many of your customers owe you money; A/P is important because you need to know how much you owe. 

 

Getting Started

Before extending credit (opening A/R), a company should consider:

    1. 1. The credit-worthiness of the customer
    2. 2. Set up clearly defined terms for A/R.
    3. 3. Consider repayment timing and options in accordance with your budgeting.
    4. 4. Plan around A/R patterns.

1. The credit-worthiness of the customer

Because A/R can be seen as loaning money to a customer, the company must consider the likelihood of actually being paid back. In a basic case, simply think about the customer you’re extending credit to; in more extreme cases, running a credit-check may be an option.

 

2. Set up clearly defined terms for A/R.

If you are uncertain about when you’ll be paid for goods or services, your ability to budget and pay your own bills may also become uncertain. When extending credit (or A/R), clearly define with your customer when you must be repaid.

 

3. Consider repayment timing and options in accordance with your budgeting.

For example, A/R payments may be more convenient when they coincide with a company’s own A/P liabilities. Further, seasonal demands should be planned for.

 

4. Plan around A/R patterns.

Look at past trends in the way in which you have been repaid. If certain times of year or certain customers show patterns, use this information to plan your own budgeting and/or A/P scheduling. 

 

Similarly, managing A/P is important for your business in two ways:

    1. 5. Changing payment terms
    2. 6. Securing invoice discounts

 

5. Changing payment terms

An A/P department’s most powerful weapon affecting cash management is its ability to control when an invoice must be paid. By negotiating this payment date, a company can add flexibility to its current and predicted cash flows. 

 

6. Securing invoice discounts

An A/P department can sometimes secure discounts on goods or services by negotiating the payment details. For example, a common discount term is 2/10 Net 30, meaning a company can receive a 2% discount if they pay within the first 10 days of a 30 day payment period. Securing such discounts can save a company significant amounts of money over time.[4]

 

Resources for More Information

 

Conclusion

Properly tracking your A/R and A/P is vitally important for managing the cash flow in your business. A/R and A/P can come in the form of cash, goods, or services. Ideally, a business will want its A/R greater than its A/P on its balance sheet. That means there is more goods and services owed to a business than the business owes to others.

 

Glossary of Related Terms

Accounts Payable (A/P): The amount of goods, services, or credit you owe to other businesses                        

Accounts Receivable (A/R): The amount of goods, services, or credit owed to you by customers

Assets: A resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit

Liabilities: A company’s legal debts or obligations that arise during the course of business operations

 

 

[1] “Accounts Receivable,” Investing Answers, http://www.investinganswers.com/financial-dictionary/financial-statement-analysis/accounts-receivable-37, accessed 7 August 2013.

[2] “Current Assets,” Investing Answers, http://www.investinganswers.com/financial-dictionary/financial-statement-analysis/current-assets-108, accessed 7 August 2013.

[3] “Accounts Receivable,” Inc., http://www.inc.com/encyclopedia/accounts-receivable.html, accessed 7 August 2013.

[4] “The Importance of AP in Managing Cash Flow,” AP Monthly 1, no. 3 (November 2008): 1-3. Available at: http://www.theaccountspayablenetwork.com/html/library/newsletters/apmonthly_1108.pdf

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