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Last updated Jan 29, 2025

Understanding Accounts Payable vs Accounts Receivable

Written by Team Airbase
8 minute read

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Understanding Accounts Payable vs Accounts Receivable

Accounts receivable (AR) and accounts payable (AP) are two essential components of a company’s financial operations. Let’s take a look at these critical financial transactions and the processes required to support them.

In a nutshell, accounts payable is the money an organization owes to suppliers, while accounts receivable is the money customers owe the organization. As such, AP is focused on control over outflows, risk mitigation through timely payments, and vendor management. In contrast, AR is more focused on optimizing cash inflows, managing customer relationships, and reducing overdue payments or bad debts.

Keeping a handle on both is essential to ensure cash flow stays healthy but, traditionally, AP comes with a heavier administrative burden in most organizations. This is primarily due to the complexities in the AP process, which involves validating and processing invoices from various suppliers, often in different formats, and needing approval from multiple internal stakeholders. Further complications arise over categorizations, amortizations, and documentation and receipt wrangling. The rise of decentralized spending also raises the complexity of tracking and managing spending across multiple departments.

In contrast, AR tends to be more streamlined, with standardized invoicing and payment collection from customers.

But there are many more differences between these two accounting workflows, which you need to know to manage each one correctly. Fortunately, you’re in the right place! We’ve put together this complete guide to accounts payable vs accounts receivable to help you make sense of these key financial departments.

Understanding accounts receivable (AR).

On the first side of the accounting coin, we have accounts receivable. AR is all about outstanding invoices you’re waiting for customers to pay. When clients receive goods and services from your company on credit, you record those funds as an asset on your balance sheet.

Proper AR accounting principles are a prerequisite for steady cash flow. These principles encompass issuing invoices, following up on payments, and recording transactions in your general ledger.

The faster your company can move through the accounts receivable process, the faster you can convert receivables into cash. You measure that speed with the accounts receivable turnover ratio metric.

Simple enough, right? Well, there are some challenges to be aware of in the AR process. One is that B2B sales often use payment terms like Net 30, Net 45, or Net 90, representing the days before payment is due. Net 30, for example, means that payment is due 30 days after the receipt of the invoice.

AR must closely track customer invoices and follow up on outstanding payments to ensure collections within the agreed-upon terms. That means Net 30 typically results in more frequent and time-sensitive follow-ups to ensure cash inflows, while Net 45 extends the collection period, potentially reducing the frequency of reminders but increasing the risk of aging accounts.

If you’ve been in business for any length of time, you’re probably familiar with some of the other challenging issues:

  • Late payments from customers disrupt cash flow and require additional collection efforts.
  • Uncollectible invoices that progress to write-off status end up as bad debt expenses.
  • Inconsistent collection practices and laxed credit policies compound cash flow issues over time.

Businesses simplify AR workflows with clear credit policies, prompt invoicing, and proactive follow-up to offset these risks.

Many use modern accounting software to automate tasks and closely monitor relevant KPIs, such as days sales outstanding (DSO). The goal is to minimize the AR balance and the time receivables spent in the asset account before converting into cash.

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Understanding accounts payable (AP).

Flip your accounting coin over and you’ll find accounts payable. AP encompasses the short-term obligations your company owes to your suppliers and vendors. When you purchase goods and services on credit, you record the transaction as a liability on your balance sheet.

Following AP management best practices goes a long way in maintaining healthy supplier relationships. Consistently paying on time, or even early when discounts are available, helps a company secure favorable terms and save money. Delayed payments result in penalties and jeopardize a supplier’s willingness to extend credit in the future.

The AP team must manage payment terms like Net 30 to avoid late fees or strained vendor relationships. That requires close monitoring of due dates and regular invoice processing. Longer terms, like Net 45, may reduce immediate pressure but increase the complexity of managing cash outflows across a wider timeframe.

The AP workflow has three main components:

  1. Invoice receipt and approval.
  2. Scheduling payment according to due dates and payment terms.
  3. Executing payments and recording them in your company’s general ledger (with the AP balance reduced accordingly).

In this AP workflow, segregation of duties (SoD) ensures that different team members are responsible for different stages of the process. Without SoD, a single person could potentially authorize, process, and execute payments, creating a risk of fraud, error, or even unintentional duplicate payments. Plus, if someone is responsible for both approving and executing payments, they could easily overlook issues like late payment penalties or missed discounts, contributing to inefficiencies and errors.

Key differences between accounts receivable and accounts payable.

While accounts receivable and accounts payable are two sides of the same coin, they represent distinct financial processes. Here are some important differences.

Cash flow impact.

Accounts receivable and payable have inverse effects on a company’s cash flow statement. As a business makes credit sales, its AR increases, tying up capital you could otherwise use to fund operations or investments. Only when customers pay their invoices does this money become available cash flow, although under accrual accounting, the sale is already recognized as revenue at the time the sale occurs, even if cash hasn’t been received.

On the flip side, accounts payable represents a future cash outflow. The company has received goods or services that it must pay for at a later date.

Consider a manufacturing firm that makes a $10,000 credit sale to a customer, due in 30 days (Net 30). This $10,000 sits in the accounts receivable portion of your balance sheet until collected, at which point the cash becomes available to cover expenses like raw materials, payroll, and rent. The quicker you collect the $10,000, the faster your company can use it to meet its own obligations.

Financial reporting and impact.

On the balance sheet, you record accounts receivables as current assets and accounts payables as current liabilities. A company’s ability to collect receivables and settle payables directly impacts critical KPIs.

The accounts receivable turnover ratio measures how quickly a company collects on its credit sales. A higher ratio indicates the business receives payments faster, unlocking cash tied up in the AR account. Conversely, a low turnover ratio suggests collection inefficiencies or excessively lenient credit policies.

The accounts payable turnover ratio is how many times a company pays off its average payables balance over a given period. A high ratio means the company pays suppliers quickly, which may indicate good cash flow but could also mean the business isn’t fully leveraging credit terms. A low ratio suggests the company is extending its payables and conserving cash in the short term, but it could also indicate cash flow issues.

Administrative burden.

Unlike AR, where transactions are typically straightforward with a focus on collecting payments from customers, AP typically covers a broader spectrum of spending from various departments, each with different budgets, purchase orders, and approval workflows. This decentralized nature makes it harder to track and control payments, leading to more manual oversight, especially if approval processes are not automated.

A significant challenge in AP is the lack of visibility into distributed spend, or the spending that occurs across different parts of the organization. With decentralized spending, departments or teams may make purchases without fully communicating or coordinating with the AP department, creating gaps in visibility. This can lead to duplicate payments, missed discounts, late fees, or errors in payment amounts, all of which require manual reconciliation to resolve.

The impact is not just inefficiency; it can also strain cash flow management, as AP teams may not have an accurate or timely picture of outstanding liabilities, making it difficult to plan for cash outflows.

AP also requires negotiating payment terms, handling complex data like purchase orders and receipts, and managing various payment methods, all of which add to its administrative burden.

In comparison, AR involves simpler data and more consistent payment methods, though it still requires diligent follow-up on outstanding payments.

Best practices for managing accounts payable and receivable.

AP and AR best practices optimize cash flow through rapid collections, improved payment terms, and early payment incentives, while also supporting generally accepted accounting principles (GAAP) standards.

Implement these accounting practices to improve your accounts payable and accounts receivable processes:

  • Maintain clear communication: Outline clear payment terms and obligations from the get-go through well-defined credit policies and regular touchpoints. Build strong relationships with suppliers to optimize AP through upfront payment terms, discount opportunities, and proactive communication during cash flow crises.
  • Implement effective invoice management: Set the bar high by requiring prompt and accurate billing, invoices with clear payment amounts, due dates, and remittance info, and automated accounting software. Practice meticulous invoice tracking and verification, investigate discrepancies, and resolve issues immediately.
  • Set clear payment terms: For both AP and AR, ensure that payment terms are crystal clear so that everyone knows when payments are due, whether or not there is a grace period, and the penalties for late payments or non-payment. For AP, consider early payment discounts, like 2/10 Net 30. Find the balance between term and cash flow needs while considering your client and supplier relationships.
  • Regularly review and reconcile accounts: Catch errors, fraud, and inefficiencies early by cross-referencing invoices, payments, and credit memos with bank statements and the general ledger. Perform regular audits to ensure teams follow policies and procedures to the letter.
  • Optimize cash flow management: Accelerate collection efforts by offering incentives for early payment and manage payment terms to balance payables with receivables. Consider implementing a “just-in-time” inventory system to minimize holding costs and align payment schedules with cash inflows.
  • Leverage technology for automation: Cloud-based accounting platforms are on the rise, with integrated payment solutions and billing software. These solutions can include electronic invoice capture, three-way matching with POs, integration with corporate credit cards and ACH payment systems, and real-time dashboards complete with every metric you could imagine.
  • Establish internal controls: Implement internal checks and balances that ensure the integrity of financial data, prevent fraud and errors, and enforce accountability. These controls should include credit checks, billing and collection duty segregation, invoice matching, access controls, and payment execution. Don’t skip the ongoing monitoring either! You should also ensure your tech stack has state-of-the-art fraud control measures in place.
  • Evaluate and adjust strategies: Review key metrics, like DSO, DPO, average days delinquent, AP turnover, AR turnover, and average outstanding balance. Keep a close eye on customer creditworthiness and supplier performance and adjust terms and policies as needed.

The goal is to strike a balance between maximizing cash flow, minimizing risk, and maintaining positive relationships with customers and suppliers. It’s a delicate juggling act that requires your constant attention and adjustment.

Take control of your accounts payable with Airbase.

Airbase solves the challenges of AP with a comprehensive, streamlined approach from start to finish. As a complete procure-to-pay platform, it integrates purchasing and payment processes in a single, easy-to-use system.

The platform’s robust automated approval workflows ensure that all purchases are aligned with company policies and are reviewed before payments are made, reducing the risk of errors and unauthorized spending.

Airbase’s purchase order (PO) and receipt matching further enhance accuracy by verifying that orders, receipts, and invoices align before payments are processed, preventing overpayments and discrepancies.

With real-time visibility into spend and an intuitive user interface, Airbase provides finance teams with greater control over the full AP lifecycle, enabling faster, more accurate decision-making and ultimately improving cash flow management.

Schedule your free Airbase demo today and see how a dedicated, automated solution can take your financial management to the next level.

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