Notepad with 'Accounts Payable' written on in red pen

Contents

  1. 1. What are accounts receivable and accounts payable?
  2. 2. Accounts payable
  3. 3. What is the importance of accounts receivable and accounts payable?

What are accounts receivable and accounts payable?

August 17, 2021
If you're running a business and want it to be successful, you'll need a solid understanding of your business's cash flow. Losing track of payments you owe to suppliers and monies you are due from customers can significantly impact day-to-day operations.Managing cash flow can be a juggling act. As a business owner, you'll be selling goods or services to customers, but you also need to buy or hire materials, equipment and services from other businesses. How can you effectively plan if you don't know what money you have coming in and going out?That's where accounts receivable and accounts payable come in. These accounting principles provide you with a record of all of your incoming and outgoing credit payments that are due – meaning you won't forget about late payments you owe or are owed.In this article, we'll look at the differences between the two, how the entries work in accounting terms, and the benefits they can provide to your business.

What are accounts receivable and accounts payable?

Accounts receivable and accounts payable are significant figures for any business to look at on the balance sheet. They provide a clear picture of the amount of money a business is owed (accounts receivable) and the amount of money that a business owes to suppliers or third parties (accounts payable).One of the most important things for any small business, especially a startup, is managing cash flow effectively. Money is the lifeblood of a business; you need enough coming in from customers to be able to pay your overheads, the salaries of your employees and your suppliers. A negative cash flow means you don't have enough money coming in to pay for everything going out, which will lead to problems.When we talk about cash flow, it's important to note that accounts receivable and payable don't relate to straightforward cash transactions. An example of a cash transaction is buying a bottle of water from the corner shop; you hand over your money in exchange for purchasing the water.The benefit of providing goods on credit is that it can massively increase your customer base. Not everyone wants to pay for purchases at the point of the transaction, especially if they are high-value items. For businesses who sell primarily to other companies, selling goods on credit is part of the norm. If you offer customers the chance to pay at a later date, you will likely find that your sales will increase. However, you do need to keep track of all of the payments you are due – which is where accounts receivable helps.The principles of accounts receivable and accounts payable differ in a couple of ways, so we'll look at each in more detail.

Accounts receivable

Accounts receivable and payable work as cross-entries across different businesses, depending on which side is selling and which side is buying.If you are selling goods to a customer, you will record your entry as a receivable, but your customer will record it as accounts payable, as it is a debt they owe. This process is a bit like opening a tab at a bar. You don't have to pay for your drinks immediately, but you have an obligation to settle up and pay for your orders at the end of the night. With accounts receivable, the time your customer has to pay is longer, but they still have an obligation to pay for the goods or services they receive by the designated due date.

How to record an accounts receivable entry

Any time you provide a customer with goods on credit, you will need to create an accounts receivable entry in your accounting system.If you maintain your own records, this will be a manual entry in your general ledger or something your accounting software does automatically for you once you register the invoice details.The basic process is:1. Create an invoiceAn invoice acts as a legal agreement between you and your customers. When you provide goods on credit, you also need to send an invoice detailing the terms of the sale and requesting payment. Each invoice will list a unique invoice number (which is recorded in your accounts receivable), the date of purchase, the items and quantities ordered, the total amount due, plus the terms of the payment (how long your customer has to pay).It's up to you to decide the payment date, but you won't want to set this too far in the future. Given the choice, most customers will pay as close to the payment date as possible. This means you won't see the money come into your business until this point. To counter this, you could consider offering a discount for early payment, or invoking late fees if they miss they fail to pay by the due date.2. Input entry on accounts receivableYou want to track all of the payments you have outstanding, so ensure that you record the date and number of the invoice, the name of the individual or business who has made the purchase and the amount. You'll also want to make a corresponding credit entry to another account – in this case, the sales ledger.
DateReferenceDebitCredit
1-7-2021Accounts Receivable – G. Jones LtdInv. 1£100
Sales£100
3. Update accounts when payment is receivedWhen your customer has made a payment you will need to update your general ledger to show it has been received and is no longer outstanding. 
DateReferenceDebitCredit
1-7-2021Accounts Receivable – G. Jones LtdInv. 1£100
1-7-2021Sales£100
20-7-2021Cash£100
20-7-2021Accounts Receivable – G. Jones Ltd£100
If for any reason you don't receive a payment, which can happen if a customer simply refuses to pay or a business becomes insolvent, you need to reflect this in your accounts receivable as a bad debt to show it's no longer outstanding. Essentially, you are writing off the debt to show that you won't receive the money.

Accounts payable

It's crucial to keep track of your accounts payable as you don't want to miss any payments that you need to make. If you start missing payments to suppliers, it can affect your working relationship with them. If they think you are unreliable or likely to miss payments, they may stop doing business with you. If you are a business that relies on having an efficient supply chain, it could cost you money and customers.On the other side of the coin, keeping up to date with what you owe can also save you money. As we discussed in the section about accounts receivables, businesses sometimes encourage customers to pay their invoices early so they can get the money into the business. If you have many regular orders on account, taking advantage of discounts for early re-payments could add up and save you a significant amount of money across the year.

How to record an accounts payable entry

1. Check the invoice that is received2. Input entry on accounts payableYou can add as much information as you like in your accounts payable, but at the very least, you should record the supplier's name, invoice date and number and the amount that you owe. This helps keep track of all of your orders to see what payments you have made and what are outstanding.
DateReferenceDebitCredit
15-7-2021Accounts Payable – Office KingInv. x219£250
Office supplies£250
3. Update accounts when the payment is madeTo evidence that you have made a payment to a supplier and no longer have a debt, you need to record the entry in your accounts payable. Using the example above, it will look something like this. 
DateReferenceDebitCredit
15-7-2021Accounts Payable – Office KingInv. x219£250
15-7-2021Office supplies£250
1-8-2021Cash£250
1-8-2021Accounts Payable – Office King£250

What is the importance of accounts receivable and accounts payable?

If you only have one customer who buys on credit every month, it's easy to keep track of your orders. However, this isn't how businesses operate. Many companies will have hundreds of credit sales – as well as credit purchases – every month. Without a proper accounting system to record entries, keeping track of them will be a nightmare. You can miss payments that you are owed and forget to make payments to suppliers, leading to problems with cash flow and struggling to cover your expenses from week to week.In the examples above, we've shown how an entry would be recorded in a ledger if you do your own bookkeeping.However, you don't have to spend hours of your time painstakingly recording every entry. At Ember, we know that accounting can be time-consuming, so we aim to simplify it.Our clever accounting solution does all of the hard work for you, so you can get on with the job of running your business. We do all of the calculations for you; all you need to do is log in and view real-time balances and reports to see what you owe and what you are owed. You can also record and track all of your invoicing online and get automatic reminders about when payments are due – no more having to search through entries manually to keep an eye on deadlines.Give us a try today and see how we can help your business grow.
Cam Finney
Cam FinneyHead of CX

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