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What Do Accounts Payable And Accounts Receivable Mean?

  • General Information
  • Small Business
person with a takeaway coffee cup working on a calculator on accounting and bookkeeping with papers and a laptop on the desk

Accounts payable and accounts receivable may be familiar terms, but do you know what they are, if you should use them, and how they differ? In a simple answer, accounts payable is a liability on your balance sheet, while accounts receivable is an asset. At first, they may seem confusing, but once you know what each term means, you can use them in your bookkeeping and make better business decisions. That’s why the Shoebox Team has written the following article to help break down accounts payable, receivable, and its related concepts in this week’s blog post.

Where Do I Find Accounts Payable and Accounts Receivable?

Accounts payable and accounts receivable are both types of accounts that can be found on your business’ balance sheets. This means they show up on the left side of your balance sheet, in either your liabilities or assets section (depending on whether they’re an expense or a source of revenue).

You will likely begin to come across the use of accounts payable and receivable if your business is using invoices when ordering supplies on credit or selling goods and services on credit to consumers.

If you are already owing and arranging further agreements with suppliers you should ensure you have an ‘accounts payable’ account for each supplier with which you conduct business. This way, you can combine all these accounts into one total figure for all suppliers who have not yet been paid.

What are Accounts Payable?

Accounts payable, sometimes written as AP or A/P, is a type of financial liability. Accounts payable is considered a liability because it represents money owed to suppliers who have provided goods or services to your business. Accounts payable are recorded on your balance sheet as a current liability because they’re due within 12 months of their creation.

An account payable works like an IOU that you send suppliers when you buy stuff from them (such as raw materials or equipment. The amount listed in accounts payable represents money owed to those companies by your business until it’s paid off.

What are Accounts Receivable?

Accounts receivable, also at times written as AR or A/R, are the money or assets a business expects to receive from its customers. This is recorded as a current assets section on a balance sheet rather than a liability. It can be thought of as the money owed to you by your clients in exchange for goods or services rendered.

Accounts receivable is considered an asset because it’s money you expect to collect from customers sometime in the future, even if there’s no guarantee that you will receive this money. Funds recorded in accounts receivable are still a usable financial resource. If a company has $100 in accounts receivable, it has that amount as a source of funding for its business operations, but the more quickly the company collects on these debts, the better off it will be.

What are Turnover Ratios for Accounts Payable and Receivable?

Turnover Ratios are another important factor when it comes to tracking your accounts payable and receivable. The A/P turnover ratio results from a calculation you can use to determine if your company is meeting its obligations to effectively pay back any outstanding debts to suppliers. You can also use the A/R turnover ratio to calculate how quickly the business collects its receivables from customers. 

An exciting benefit of keeping track of your A/R turnover ratio is that it can indicate important information like how reliable your customers are, how much they can spend and pay back on time and even reflect the current economic climate when it comes to spending. 

The A/P turnover ratio is the number of times a business makes payments to suppliers in a selected period divided by the total amount of inventory purchases. The A/R turnover ratio is calculated by net sales (specifically credit sales) divided by the average number of receivables in a given time period. As a general rule, the higher the turnover ratio, the better the company is at paying its bills on time and receiving expected income from customers.

Who Should Use Accounts Payable and Accounts Receivable?

In a nutshell, everyone who purchases and sells goods and services within their business should track their accounts payable and receivable. Keeping track of money that your business owes and money owed is a fundamental part of accounting and bookkeeping and ensuring the company has enough cash.

This may seem obvious to business owners who use their own money to fund their businesses, but in fact, many small businesses have very little cash left over after paying for expenses and payroll each month—not having an idea of how you are managing the money you owe and are owed can leave you in a position of relying upon financing from banks or other lenders to fund day-to-day operations regularly. 

Accounts payable and accounts receivable are both essential functions in tax records and bookkeeping. Businesses use them every day to keep track of the money they owe vendors and should expect to receive from customers. The balance in each account changes as you pay bills and collect on sales, so it’s important to keep track of these figures throughout the year. 

We hope this article helped, and if you’d like to learn more about different bookkeeping tips, strategies or solutions, please don’t hesitate to get in touch with your local Shoebox Bookkeeper or Accountant today!