Key Takeaways
- Effective AR and AP management involves assessing credit risk, invoicing, collections, and payments while ensuring cash reconciliation and invoice management, among others.
- AI-powered AR and AP software can help you keep track of receivables, streamline collections, and provide insights into your payments.
- Clear guidelines for AR and AP help streamline collections, reduce DSO, and control costs by leveraging early payment discounts.
Introduction
Finance is an integral aspect of all businesses regardless of size. As your business grows, you interact with more customers and stakeholders daily and process countless transactions with both your customers and vendors.
For most B2B businesses, the model is not as straightforward as paying cash and getting the goods or selling goods and getting paid. As a business selling goods or services to customers, you will maintain ‘accounts with credit terms’ that enable your customers to pay at a later date. Your credit terms provide some breathing room to your customers in terms of their finances.
Your suppliers also may allow you to delay payments(either fully or partially). This flexibility allows businesses to function seamlessly.
You need to identify how much money is coming in and how much is going out to maintain a healthy cash flow. It is critical to keep track of your accounts.
What is Accounts Receivable (AR)?
Accounts Receivable(AR) is the amount that is owed to your business for goods or services that have been delivered to customers but haven’t been paid for. AR is listed as current assets on your balance sheet. The payment time for such accounts ranges from a few days to an entire calendar year.
The AR process starts by assessing the credit risk of a customer and validating whether they are fit for business with your company. Once the purchase orders are processed and the goods or services delivered, invoices are sent to your customers. You then need to make sure that you follow up with clients, collect the payments, identify deductions, and reconcile these payments to the corresponding invoice.
The AR process, in short, comprises credit risk management, invoicing, collections, cash application, and deductions management.
An example of accounts receivable for the electricity department would be the bills it sends its clients after they’ve consumed the service for a particular time frame. The electricity department records an account receivable for unpaid invoices as it awaits its customers to pay their bills.
What is Accounts Payable (AP)?
Accounts Payable(AP) is the exact opposite of accounts receivable. It is the amount that your business owes to other businesses for the services or goods that you have purchased from them. AP is reflected as a current liability on your balance sheet.
The AP process starts with collecting supply requirements from within the organization and seeking quotes from vendors for the items required. Once the deal is negotiated, purchase orders are prepared and sent. The goods delivered are inspected upon arrival and the invoice received is routed for approvals. The invoice data is matched with other documents such as PO and delivery receipts. It is then coded into the correct ledger and payments disbursed according to the terms agreed upon.
The AP process, in short, comprises supplier management, procurement management, invoice management, PO matching, tax compliance, and payments.
An example of accounts payable would be transportation fees, which you would need to pay after the delivery company delivers your product to the customer.
What is working capital?
Working capital is the difference between a company’s current assets (cash, accounts receivable or customers’ unpaid bills, and inventories of raw materials and finished goods) and its current liabilities (accounts payable and debts payable within one year).
Working capital represents the financial liquidity available to your business for operations. Businesses with healthy cash flow have net positive working capital at most times. For net positive working capital, you must maintain a good balance between your AR and AP.
The role of accounts receivable in cash flow management
Keeping track of your AR is crucial to successful business operations. It ensures that you are billing your customers on time and that all your customers are making payments against those bills.
If you forget to bill a customer or collect your payment, your products or services are not paid for, which impacts your profitability. The delays in sending invoices often result in delayed payments.
Keeping track of your AR also helps you to document proof of income when you file your taxes.
The role of accounts payable in cash flow management
AP is as important as AR. AP represents the unpaid expenses in your company. As your accounts payable stack up, it can get trickier to know which accounts need to be paid off first. Moreover, the quality of supplies you get, your market reputation, and rates at which you get goods or services also depend on ensuring efficient accounts payable.
When you manage your accounts payable well, it enables you to manage your cash position optimally. Efficient AP also lets you focus on other areas of finance like tax management and budgeting. Moreover, when you pay your dues on time, you can maintain good relationships with suppliers and vendors.
Difference between Accounts Receivable and Accounts Payable
| Accounts Receivable | Accounts Payable | |
| Definition | Amount owed to your business for goods or services that have been delivered but haven’t been paid for | Amount that your business owes to other businesses for services or goods that have been purchased |
| Listing | Current asset on the balance sheet | Current liability on the balance sheet |
| Increases with | Sales | Purchases |
| Represents | Positive balance | Negative balance |
| Managed by | Company’s finance or accounting department | Company’s purchasing or procurement department |
| Payment | Received by the company | Made by the company |
Account Receivable vs Accounts Payable: Challenges that Impact Cash Flows
You are bound to have challenges with all types of money matters, and especially with crucial processes such as AR and AP. Here are some common challenges that businesses like yours may face concerning AR and AP functions:
The most common accounts receivable challenges
- Poor customer relations with late-paying customers
- Lack of time to manage the collections process
- Setting credit limits and conducting periodic credit assessments
- Collections from bankrupt customers or customers who are on the verge of bankruptcy
- Payment resolution tracking and resolution
- Not having the right tools to manage AR accounts and data
The most common accounts payable challenges
- Lengthy approval timelines and slow processing due to manual paperwork
- Manually matching invoices with purchase orders and goods provided is time-consuming and error-prone
- Fraud and theft via e-mail and other scams lead to huge losses
- Missing invoices paint a wrong picture of your dues and cash balance
- Duplicate payments due to a lack of acknowledgment from the supplier or use of multiple payment methods
How to optimize Accounts Receivable and Accounts Payable process?
If you want to manage your cash flow well, then your focus should be on AR and AP optimization. Automated AR and AP processes help you minimize effort, reduce errors, and speed-up processes.
Let’s take a deeper look into two ways to optimize AR and AP processes:
1. Automate your finance operations with the latest technology
The automation of crucial yet mundane and time-consuming AP and AR tasks has become easier and affordable with the advent of RPA, AI, and other technologies.
Modern AR automation software lets you check the status of your receivables, track correspondence with your customers, and schedule alerts for payments. Keeping in touch with customers through emails and alerts about payments helps you avoid bad debt and speed up the cash cycle.
For payables, you can almost completely automate all the steps involved except for the approvals, which can be done in a few clicks. Automation software can also help you diagnose problems in your AP workflow and provide insights into your payments with analytics tools. AP automation also improves your payment accuracy. The best AP automation tools in the market capture invoice data at 99.5% accuracy.
2. Establish clear guidelines for AP and AR payments
According to a survey by Receivables Savvy, high-performing companies typically have clear invoicing and payment processing guidelines in place. Of all the companies surveyed, 59% have clear AR and AP policies, 31% do not, and 9% do not know if they have one.
AR guidelines streamline collections and help you avoid delayed collections and reduce your DSO. When it comes to AP, you can make payments within the timeframe as per your guidelines and track cash flow. You can also leverage early payment discounts from suppliers to control costs.
Accounts Payable vs Accounts Receivable: Key Components of Your Cash Flow
Now that we understand AR and AP are both extremely critical and sensitive processes for a business, tackling them smartly is crucial for success.
But when it comes to maintaining better cash flow, which one should you prioritize?
If your business revolves around your suppliers and requires you to maintain an excellent relationship with them, it’s prudent to make timely payments and avoid unnecessary errors. On the other hand, if you have a substantial volume of high-risk clientele, collecting timely payments will ensure steady profitability.
Balancing both AR and AP is crucial for healthy cash flow. Having more payments going out and not enough coming in will result in a negative cash flow. Having a strong and healthy accounts receivable pipeline increases your asset balances and revenue realization.
When you have a thorough understanding of both AR and AP, you can deal with your customers and vendors better as what is AR for you is AP for your customers, and what is AP for you, is AR for your vendors. Thus, you can put yourself in the shoes of your customers and vendors while resolving disputes and achieving favorable outcomes for both parties.
AR Automation Solution for Mid-Size Businesses
Automating AR and AP processes are key to addressing cash flow challenges. We offer AI-powered AR automation solutions for enterprises as well as small and mid-sized businesses at affordable prices. Our RadiusOne AR suite is designed specifically keeping the requirements and constraints of mid-market businesses in mind.
RadiusOne AR solution offers e-invoicing, payment processing, credit risk management, collections prioritizing, and aging reports analysis features. We have helped clients such as ShurTech, J.J. Keller, and others optimize their receivables.
FAQs on AP vs AR
What are accounts payable and receivable examples?
An example of accounts payable is when a business purchases inventory from a supplier but has not yet paid for it. An example of accounts receivable is when a business provides services to a customer, but the customer has not yet paid for the services.
Why is AR and AP important?
Accounts receivable and accounts payable are important for maintaining a healthy cash flow in a business. Managing these accounts ensures timely payments to suppliers and from customers, which can help build strong relationships and avoid any financial difficulties.
