Accounts Payable vs Accounts Receivable

Diffen › Business › Accounting

How a transaction is recorded in the General Ledger (GL) depends upon the nature of the transaction. Accounts Payable (AP) is recorded in the AP sub-ledger when an invoice is approved for transactions where the company must pay money to vendors for the purchase services or goods. On the other hand, Accounts Receivable (AR) records any money that a company is owed because of the sale of their goods or services. On the company's balance sheet, accounts payables are recorded as liabilities while receivables are recorded as assets.

Comparison chart

Accounts Payable versus Accounts Receivable comparison chart
	Accounts Payable	Accounts Receivable
Refers to	Money that the company owes to others	Money that others owe to the company
Abbreviation	A/P or AP	A/R or AR
Paid to whom?	Accounts payable are amounts a company owes because it purchased goods or services on credit from a supplier or vendor.	Accounts receivable are amounts a company has a right to collect because it sold goods or services on credit to a customer.
Recorded as	Liability (payable always a liability)	Asset (receivable always an asset)
How each affects a business?	Accounts payable will decrease a company's cash	Accounts receivable will increase a company's cash
What Causes this Transaction?	Purchasing goods on credit	Selling goods on credit

Execution

Accounts payable is recorded when an invoice is approved for payment. Many companies use “segregation of duties,” i.e. making sure no single employee can approve a payment alone, to prevent embezzlement.

For most businesses, accounts receivable involves the generation of an invoice, which is delivered to the customer. The customer must then pay the invoice within the payment terms, usually within 30 days.

Working Capital Management

Working capital (WC) represents the operating liquidity of a business. Net working capital is the difference between current assets and current liabilities. It is important for companies to have a healthy, positive net working capital. This is achieved through, among other techniques, astute management of accounts payables and receivables.

Accounts receivables are analyzed by the average number of days to collect payment (called Days Sales Outstanding or DSO), and accounts payable are analyzed by the average number of days it takes to pay an invoice (Days Payable Outstanding or DPO).

$DSO = \dfrac{Accounts\ Receivable}{Average\ sales/day}$

$DPO = \dfrac{Accounts\ Payable}{COGS/day}$ where COGS is cost of goods sold and COGS/day is the daily average of purchases.

DSO of less than 45 days is generally considered healthy.

Working capital can be increased by reducing the DSO or increasing the DPO i.e. collecting payment from customers quicker and delaying payment to vendors. However, there is always a business trade-off because delaying payment to vendors could tarnish the company's reputation and could also result in missing out on early payment discounts. Similarly, customers may be more willing to offer business if the company is not too strict about getting paid on time.