For some of us, the words “accounts receivable” and “accounts payable” conjure up images of a clerk with a giant calculator and a pencil behind the ear. However remote that image seems, we’ve all been on both sides of the transaction at some point in our lives.
Today, you might receive a bill via snail or electronic mail and pay the balance. Tomorrow, you might purchase something for friends or family - maybe a block of movie tickets, for example - and ask the movie-goers to reimburse you.
If you own your own business or happen to work in the accounting department of a large corporation, you may be paying invoices to suppliers and receiving payment for invoices from customers on a regular basis.
Think about the bill you received in the mail the other day. You probably paid it immediately. Has there ever been a circumstance where you didn’t pay a bill on time? Maybe you incurred a late fee, or if the bill was late enough you might start receiving calls from a collection agency.
What about those friends you purchased movie tickets for - did everyone pay you for the tickets? Were there any movie-goers who didn’t pay, or took a long time to pay you? These are all common problems encountered when managing accounts receivable and accounts payable - on a much larger scale.
What are accounts receivable and accounts payable?
Even without the examples above, you probably grasped the idea immediately. The words “accounts receivable” and “accounts payable” have specific connotations - i.e., “receivable” refers to funds coming in and “payable” refers to funds going out. Let’s review definitions for accounts receivable and accounts payable, according to Investopedia, a financial education website.
Accounts receivable (AR) “refers to money owed by customers (individuals or corporations) to another entity in exchange for goods or services that have been delivered or used, but not yet paid for. Receivables usually come in the form of operating lines of credit and are usually due within a relatively short time period, ranging from a few days to a year.”
Accounts payable (AP) is “is an accounting entry that represents an entity's obligation to pay off a short-term debt to its creditors. The accounts payable entry is found on a balance sheet under the heading current liabilities.”
For any given transaction, there’s one side that represents accounts receivable and one that represents accounts payable. If you make purchases on your credit card, you then receive a bill.
You are the accounts payable side of the transaction, as you’re responsible to pay your credit card company. Your credit card company represents the accounts receivable side of the transaction, as they will receive payment from you.
Accounts receivable is always recorded in accounting systems as an asset, as it is money brought in by your business. Accounts payable is always recorded in accounting systems as a liability, as it accounts for money you owe to outside entities.
So why is all of this information important? Just like running a personal budget, a business needs to have more money coming in the door (accounts receivable) than money going out the door (accounts payable) in order to survive.
In accounting terms it’s called working capital (WO), or the difference between a company’s current assets and liabilities. Healthy businesses have a positive net working capital and strive to keep it that way.
Common problems with accounts receivable and accounts payable
Upon first glance, accounts receivable and accounts payable seem pretty easy to manage. Unfortunately this isn’t always the case, and there are a couple common problems that crop up on both sides.
How it affects accounts receivable: Delinquent payment for accounts receivable means that cash coming in the door to a business is delayed. It affects the company’s working capital, it may hinder the company’s ability to pay its own bills, and can cost a lot in time spent following up on late payers.
- How it affects accounts payable: Delinquent payment for accounts payable means that a business is late on paying its debts. It also affects the company’s working capital, may incur additional costs in late fees and interest charges, and it can ultimately damage or sever the company’s reputation with suppliers.
Many businesses’ biggest asset is time, and spending as much of their time on customers as possible. Hours wasted managing the invoicing and payment processes and repeated follow-ups with customers to obtain payment (or suppliers to submit payment) both take away valuable time to could be spent on customer needs.
- Some companies even outsource the task of managing accounts receivable and accounts payable, to take the element of worry out and focus solely on their work and customers.
Best practices for accounts receivable and accounts payable
Given the challenges to managing accounts receivable and accounts payable, what can business owners do to reduce delinquent payments and time loss?
Offer customers incentives for early payment and deterrents for late payment. Offer customers a discount for early payment. Shorten payment terms from the standard 30-60 days to 14-21 days, for example.
Tack on late fees for customers who don’t pay within the required timeframe. Experiment with these types of options to see what works best for your customer base. Some may be responsive to shorter payment terms without a discount, while others may only be incentivized by late fees.
Make the payment process easy. What timeframe works best to bill your customer, given their business cycles? What type of payment would be best for them, and would they consider automatic payment?
Are there supporting documents required with each invoice, like a PO? All of these options can be customized to make timely payment a reality.
Use online/electronic invoicing. The days of mailing a paper invoice to each customer are gone - thank goodness! There are numerous invoicing tools available that allow for online invoicing, whether it means emailing the invoice to the customer, allowing them to log in for access, or both. They all beat shuffling through a pile of desk papers to find the invoice that needs to be paid.
Create a system for managing delinquent accounts. Decide on some target intervals for checking in with customers on payment. Review delinquent customers on a regular basis.
Set up automatic email reminders like the ones in this blog post, and follow up with phone calls for exceptions. For regularly delinquent customers, it may be time to evaluate their value to your business.
Automate payments to suppliers. Ask your suppliers for automated payments, or set one up with your online banking account or other payment source. Automated payments benefit both the customer and the business - the business gets paid on time, and the customer doesn’t have to remember to manually pay a bill.
Be proactive and ask questions. Ask your vendors for discounts when you begin your relationship. Negotiate payment terms that work for your business. And if you do end up having to miss an upcoming payment, let the vendor know ahead of time. If you have a solid payment history and a good relationship, the supplier may be willing to make concessions that will benefit both of you.
- Get rid of high interest debt asap. If you have incurred interest charges on any payments you owe, make sure to pay those first and then move on to paying other debts.
Online billing solutions - how can they help?
The challenges faced in accounts receivable have easy solutions in the many billing systems available online. Most online billing systems allow for online and electronic invoicing, various payment options, attaching documents such as PO’s, customizable terms and cycles for payment, discounts and late fees, subscription billing, invoice chasing, and many more.
There is some setup required when first implementing an online billing system, but it takes on the burden of work over the long haul and helps businesses scale.
Accounts receivable and accounts payable may seem like remote business terms, but we all deal with cash in and cash out in our everyday lives. Businesses will always face some level of difficulty in getting paid and paying their own suppliers.
By applying best practices and using the efficiencies of scale gained from online billing tools, companies can optimize their working capital and continue running healthy businesses.