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Accounts Payable vs. Accounts Receivable: The Heat Is On In the Finance Department

As the finance department continues the debate about the importance of accounts payable vs. accounts receivable, accounts payable automation solutions are streamlining operations and revolutionizing cash flow management.

Business owners and analysts understand the essential roles accounts payable and accounts receivable play in an organization’s bottom line. It is common for people to jump to the conclusion that accounts receivable is the most important department, as this is where customer invoices and payments are registered hence cash floats in. However, many might overlook the fact that accounts payable play a significant role in securing a company’s cash flow. Discover why the heat is on in the financial department as professionals weigh accounts payable vs. accounts receivable.

What Is Accounts Payable?

Let’s start with a brief refresher about the basics of accounts payable and receivable. As a broad overview, accounts payable are obligations of a business to repay a certain amount to another party. Payables are almost always a current liability that must be paid within a year or less. Longer debts are considered long-term debt or another type of obligation that falls outside traditional accounts payable.

Categories are used to organize accounts payable including notes payable, wages payable, interest payable and bonds payable that show how much is owed to different recipients. For example, accounts payable is money owed to suppliers while wages payable is money owed to employees for the work they performed for the company. Summarizing the total of these categories helps businesses ascertain their financial well-being. When short-term assets exceed short-term liabilities, it’s an indication of financial health.

From verification of vendor data to year-end audits, manual processes are time-consuming and inefficient. Humans make inevitable errors, especially when they are working with a vast amount of data. Accounts payable automation makes routine processes touchless, saving time and improving productivity in the accounts payable department. The AP team enjoys a better quality of work focused on thoughtful projects to help the company save money. Cloud-based AP automation solutions put the latest financial data at your fingertips in real time, helping companies keep a finger on the pulse of their financial well-being.

What Is Accounts Receivable?

Now we’re ready to explore accounts receivable, the other side of the financial spectrum. Money owed to an organization is called accounts receivable, which is the balance of money earned that the buyers have yet to pay. Accounts receivable are based on the terms of the company’s agreements or contracts with buyers. Some are payable upon delivery or receipt. Other buyers may have 30 days or longer to pay outstanding bills.

For most companies, receivables accounts are short-term. When buyers purchase "on account," they don't have to pay at the time of purchase, and normally get invoices that offer a nominal discount for payment within 30 days. Most companies add late fees after 60 to 90 days. Some organizations also penalize late-paying customers, which may include the termination of their business arrangement. Fees and penalties are imposed to encourage customers to pay on time. And early paying customers save money by getting small discounts.

A unique factor for accounts receivable is that businesses are often required to make an estimate of what percentage of amounts due to them will not be recovered, which is referred to as bad debt. For some organizations, bad debt can be as high as 1-5% of the sales made. Expensing this amount removes it from accounts receivable, and is no longer part of the cash a company expects to receive.

Do you want to gain a deeper understanding of more typical accounts payable terminology? Visit our glossary for an explanation of other AP terms.

What Do Accounts Payable and Accounts Receivable Have in Common?

The most apparent commonality between accounts payable and accounts receivable is both are shown on an organization’s balance sheet because they play significant roles in a company’s cash flow. The stronger a company’s cash flow, the more stable its financial position. Accounts payable automation tools instantly reveal these bottom line numbers, so the financial team and C-suite know where the money goes.

Both sides work together because selling products on account limits short term cash flow as the receipt of earned revenue is delayed. And buying on account means the company has more cash on hand for other bills or new purchases, including business-building and money-saving tools such as accounts payable automation to manage challenging tasks such as Q4 cash flow management seamlessly.

A company must spend money on the items needed to remain profitable. Then selling these things will result in receivables. With that cycle in mind, without payables there may not be receivables to keep the organization productive and profitable.

What Are the Differences Between Accounts Payable and Accounts Receivable?

The obvious difference between accounts payable and accounts receivable is receivables show the money owed to your company while payables reveal the money your organization owes to creditors and other third parties. Accounts payable indicates the money being spent by the company, and receivables tally how much cash is coming into the business.

Comparing the amounts of accounts receivable and payable is part of a liquidity analysis to see if there are enough funds coming in from receivables to cover the cost of the outstanding payables. And receivables are classified as a current asset while payables are a current liability.

While payables have no offset, receivables can be offset by an allowance for doubtful accounts that may not pay. Receivables typically involve a single trade account and a non-trade account. On the other hand, payables can be comprised of many more accounts, as mentioned above.

The Heat is On - Accounts Payable vs. Accounts Receivable

The way an organization manages accounts payable and accounts receivable is an indication of its overall efficiency. In accounts receivable, companies looking to collect more cash upfront or reduce the time until payment can offer a discount for fast payment. With accounts payable, organizations must compare the benefits of possible interest savings and discounts for paying up front rather than 90 days later and avoid the penalties associated with late payment.

The smart use of accounts payable automation can help companies save money by making data available to everyone in real-time for immediate analyzation. Financial professionals recognize companies with increasing accounts receivable show the business is struggling to get paid for the work performed. Some of these outstanding receivables may turn into bad debt.

An increasing accounts payable can mean less cash is going out, but the money still must be paid. Often an increasing accounts payable is the first sign a company is having cash flow problems. Accounts payable automation shows this increase in real-time, making it easy to detect a pattern and make necessary changes to improve cash flow.

Accounts Payable Are a Source of Cash

To understand how accounts payable can be a source of cash, let’s review the cash conversion cycle (CCC) and how it works. The CCC is an essential metric that reveals how long it takes for a company to convert its resource into cash. This bottom line is determined by how many days it takes the business to sell an item, get paid, and pay back its suppliers. If the CCC is negative, the company is depending on supplier financing to run its operations, and needs to find ways to improve cash flow.

With the right conditions, the AP department can drive activities in six main processes that, when optimized, can free up cash. These processes include master data, contractual reviews, sourcing, invoicing, procurement, and accounting and reporting. Examples of money-saving options include negotiating early payments or volume discounts with vendors and properly managing the invoice process to improve transparency.

Accounts payable automation makes it easy for the AP team to take note of money-saving opportunities that help improve working capital. Ongoing access to financial data and the ability to collaborate in real-time allows the AP department and the C-suite identify and take advantage of money-saving opportunities.

Accounts payable and accounts receivable have a variety of similarities and differences. Staying on top of both is the only way to ensure a company’s financial health. Instead of waiting weeks or months to determine the current financial state of your organization, implement AP automation solutions to get the facts in real-time. Knowing the bottom line right away helps businesses be proactive about making creative decisions to remain profitable and productive in any situation.

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