Accounts Payable And Receivable | 4 mins read

Accounts Payable and Receivable What's the Difference?

accounts payable and receivable whats the difference
Chloe Henderson

By Chloe Henderson

Businesses are responsible for paying their financial obligations while simultaneously keeping in touch with clients that still have pending debts. Although this may seem overwhelming for one accounting department, many companies divide these tasks into two segments.

Accounts payable and receivable handle money flowing in and out of the organization, so financial advisors can accurately gauge their financial stability at all times.

What are Accounts Payable?

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Accounts payable (AP) is a department that keeps track of money the business owes to external parties. Typical third parties include suppliers, banks, financial institutions, and even other companies. For retailers, AP usually consists of vendors that provide goods and services.

The AP department pays its recipients on different terms, depending on the individual payment agreement. While some contracts require the total to be paid in full, others may accept incremental compensation.

There are three key steps to AP payment processing.

1. Receive the Invoice - Once the business obtains the loan, goods, or other services, they should receive an invoice from the supplier requesting the payment.

2. File the Invoice - Next, AP employees must file the invoice in their organizational system, whether it is a physical filing cabinet or software.

3. Approve the Invoice - Before the invoice is paid, it must be verified and approved. Typically, there are one or two executives that have the power to complete the approval process.

4. Process the Payment - After the invoice is approved, AP can process the payment and contact the recipient.

What are Accounts Receivable?

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Accounts receivable (AR) is essentially the opposite of AP, meaning that this department keeps track of the business's current assets. In other words, AR monitors how much money each client owes the company. These parties may also consist of banks and other companies.

The AR department is responsible for keeping in touch with clients and collecting their payments.
Much like the AP process, AR runs off of a strict system-

1. Create an Invoice - Once the business fulfills the customer's order, they can create an invoice reflecting the order and payment agreement.

2. Send the Invoice - After double-checking the invoice for accuracy, it can be sent to the recipient.

3. Track the Invoice - Sometimes, clients do not respond to invoices promptly, requiring AR to check in regularly until the amount is paid.

4. Collect the Payment - When the payment is received, AR will record the amount and update the system to reflect the fulfillment.

How to Create Accounts Payable

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In the books, AP is recorded as a current liability, as it represents outgoing funds. This makes keeping an AP ledger and audit trail critical for maintaining financial stability. The books should record each invoice and detail the following.

  • Biller's name
  • Account number
  • Invoice number
  • Expense amount
  • Invoice receipt date
  • Payment deadline
  • Payment status

With an audit trail, AP can monitor the status of each invoice. Therefore, the department should also file-

  • Purchase orders
  • Supplier invoices
  • Contracts
  • Payment agreements

Types of Accounts Receivable

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As a business grows, they begin to extend their AR department so they can offer their customers various payment options. These different segments define the relationship that the company has with each client.

Notes Receivable

Notes receivable is very similar to traditional AR, except it offers flexible repayment terms and deadlines.

Typically, traditional AR gives customers a two-month window to pay their bill in full before penalty fees are applied to their account. On the other hand, a notes receivable account allows clients to sign a promissory note that states they will pay off their loan, goods, or services within the allotted time.

The traditional promissory note gives customers a year to pay their debt, although every business can alter this timeframe. This term can even be negotiated between the customer and business. However, this binding agreement gives the company a legal claim on the payment.

Trades Receivable

Trades receivable is another asset in AR and is the direct result of the business's sales. When a customer purchases a good or service with a limited pay-off term, their sale is reported to trades receivable as it has a quick turnaround. Even if the purchase was made on credit, trades receivable can record it as an incoming asset.

Because of the short-term payoff deadline, trades receivable is typically used by retailers and organizations that offer moderately priced goods and services.

Bad Accounts

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Unfortunately, sometimes situations arise that make it difficult for customers to pay off their debts within the allotted time. A borrower's inability to repay their loan is known as payment delinquency, and there are a few ways that businesses can deal with it.

If it is evident that the borrower will not pay their debt, the company can write off the sum as a tax deduction. The IRS allows businesses to claim debts up to a specific limit. Another option is for companies to report the debt as an allowance, enabling accountants to keep the sum for a limited time as they await the payment.