Many small business owners go into the world of business and commerce with a brilliant idea and product, but unless you have a background in finances, the concept of accounts payable and account receivable may be confusing. Understanding the difference between accounts payable and accounts receivable can save you a lot of time and stress by keeping your financial accounting equation balanced. Accounts payable and accounts receivable are easy to confuse because of the similarity of the equations, but one is an asset account while the other is a liability account. For questions specific to your business, contact Huntington Group for expert advice and to help you better manage your business’ finances.
Accounts payable and accounts receivable are important to maintain because they allow your finances to be balanced. In every transaction, there is always a debit and a credit. While an individual entity will have both accounts payable and accounts receivable, it is best explained as a single transaction. So, what are accounts payable and accounts receivable?
What are accounts payable?
So what are accounts payable? Well, accounts payable is a current liability account. This is where a business records the accounts it owes to suppliers or vendors for goods and services that were received on credit. Any time your company receives an invoice for a service or product that is delivered before payment, it will go into this category.
For example, business A is a dog food supplier, and business B is a pet shop. Business A sends business B a pallet of dog food and an invoice for the goods to be paid within 30 days. In this case, business B would record the purchase as accounts payable. This purchase is a current liability.
What does this mean for business A? That’s where accounts receivable comes in.
What are accounts receivable?
Unlike accounts payable, accounts receivable is a current asset account. This is where a business will record any amount that it has a right to collect on from customers who have received goods and services on credit.
In the example of business A and B, business A sent out a pallet of dog food on credit to business B. because the invoice has to be paid within 30 days, this means that for those 30 days those goods are not paid for (only promised to be paid for). So business A would record that delivery in accounts receivable as a debit.
All that is left then is to wait for the payment and record it! So…
At the Time of Payment
So, let’s say those 30 days are up and the payment from business B has been made to business A. Now what? Well, now business A has payment for their debit, so their cash increases and their account receivables decrease. On the other side, business B reports a purchase so their cash decreases and their accounts payable decreases as well. Now there is a balance between each respective account.