For anyone handling business finances in India, there are two important terms they must know. These are Accounts Payable (AP) and Accounts Receivable (AR). These are the foundation of your organization’s cash flow management and understanding the differences between them is essential to running a company.
In this article, we will simplify the main differences between Accounts Payable & Accounts Receivable, and specifically the way they affect Indian companies. We will also explain why you should use accounting outsourcing services to monitor these closely.
What are Accounts Payable?
Accounts Payable is cash your small business owes to vendors or suppliers. Essentially, it’s the amount you pay for a thing you previously received. AP is a short term liability and is written off your company financial statements.
For example, you operate a small manufacturing unit in India and you purchase raw materials from a supplier. The materials arrive and the supplier sends you an invoice. The amount on the invoice is your Accounts Payable. What this means is you owe the supplier that amount and you need to pay them on the terms you agreed on (for instance, in 30, 60 or 90 days generally).
Why is Managing Accounts Payable Important?
Good management of your Accounts Payable is a prerequisite for keeping excellent relations with your suppliers. Paying them on time ensures smooth operations and could qualify you for discounts. Some suppliers in India discount their bills in case you pay them before the due date.
Also, managing AP could improve your business cash flow. You can track just how much you owe and when payments are due to prepare your expenses and stay away from late payment penalties.
A critical metric to remember is Days Payable Outstanding (DPO). This metric measures the average amount of days it takes paying your suppliers. A lower DPO means your business is paying bills faster while a higher DPO could mean cash flow problems or a long cash-holding pattern.
Accounts Payable Examples
Imagine you operate a retail business in Mumbai and you order Rs. 1,00,000 worth of products from a supplier. The supplier sends you an invoice with a thirty day payment term. This 1,00,000 becomes part of your Accounts Payable and you’re in charge of paying it in an agreed number of days.
In case you manage your AP properly, you may obtain better credit terms or early payment discounts.
What is Accounts Receivable?
In comparison, Accounts Receivable is the cash your customers owe you for services or goods you have supplied. AR is an asset as it represents potential funds inflows and it’s shown as an asset on your own financial statement.
For instance, in case you sell products to a consumer and they also offer you credit terms, the total amount the buyer owes you is included in your Accounts Receivable. Quite simply, AR is money you wish to obtain sometime down the road.
Delays in payments are challenging for companies in India, particularly for SMEs. A lot of the small businesses wait for payments from their clientele for days, impacting cash flow, based on a report by the Ministry of MSMEs. Thus, efficient AR management is important to getting dues paid on time and maintaining healthy cash flow.
Why is Managing Accounts Receivable Important?
Managing AR means collecting payments from your customers in the agreed upon time frame. The quicker you get paid, the greater your cash flow is going to be, enabling you to spend your cash on expanding your business and on things like rent and payroll.
An AR efficiency metric is Days Sales Outstanding (DSO). This particular metric measures the average amount of days it takes your business to collect payments after a sale. A lower DSO means quicker payments, and a higher DSO may mean customers are paying way too slow.
Accounts Receivable Examples
Say you operate a service business in Delhi and you finish a project for Rs. 50,000 for a customer. You send the client a 30 day payment term invoice. This 50,000 is currently in your Accounts Receivable and you anticipate the payment in thirty days.
If the client waits on payment, that causes cash flow issues for your business. You might have to send payment reminders or communicate with the client often to prevent this.
Differences Between Accounts Payable & Accounts Receivable
1. Definition:
- Accounts Payable is the money you owe to suppliers for services or goods received.
- Accounts Receivable is the money customers owe you for services or goods received.
2. Placement on Balance Sheet:
- AP is a liability; it’s money you must pay out.
- AR is recorded as an asset because it represents cash you expect to get.
3. Cash Flow Impact:
- Managing AP can help you avoid cash flow issues brought on by late payments to suppliers.
- Managing AR means you get payments from customers on time.
4. Part in Business Relationships:
- Efficient AP management helps you develop relationships with suppliers to keep you regularly supplied with services or products.
- Efficient AR management helps keep you in excellent relations with your clients while safeguarding your company from unpaid invoices.
5. Metrics:
- AP is computed from Days Payable Outstanding (DPO), the amount you pay suppliers.
- AR is calculated based on Days Sales Outstanding (DSO), the amount your customers pay you.
Final Thoughts
Knowing the key differences between Accounts Payable and Accounts Receivable are essential to your business. In a nation where delayed payments are common, effective AR and AP management can ensure cash flow stability and prevent financial setbacks. Taking active actions with payments and collection will keep your business operating smoothly and prepare it for expansion.
For expert assistance managing your AR and AP processes, consult StartupFino for accounts payable services and accounts receivable services.
Read also: Top Features to Look for in Accounts Receivable Management Software
FAQs
What are the primary differences between accounts payable and accounts receivable?
Accounts Payable is the cash a business owes to suppliers for services or goods obtained, recorded as being a liability. AR is money owed by consumers to the business for services or goods provided, captured as being an asset. AP handles incoming payments, whereas AR tracks outgoing payments.
What is the big difference between accounts receivable & accounts payable ratio?
The ratio of Accounts Receivable to accounts Payable demonstrates how fast a company pays consumers. AR ratio looks at incoming money while AP ratio considers outgoing cash management.
What GAAP rules apply to accounts receivable?
Accounts receivable are captured at the net realizable sum (the amount anticipated being collected) under GAAP. This requires companies to estimate and subtract allowances for doubtful accounts to be able to report financial condition accurately.
What is the AR ratio in accounting?
The Accounts Receivable ratio evaluates how fast a business records receivables for a particular period of time. It’s computed from net credit sales divided by average accounts receivable. This ratio measures how fast receivables are converted into money and thus cash flow effectiveness.
