Accounts receivable vs accounts payable

Say a landscaping firm finishes a maintenance contract for an office park owner on May 3. The landscaper invoices $4,800 on Net 30 terms. The office park owner pays on May 30.

For the landscaper, the seller, that invoice is a receivable. For the office park owner, the buyer, it is a payable.

On May 3, the landscaper records a sale and a receivable. The office park owner records an expense and a payable. On May 30, cash moves from one to the other and both balances go back to zero.

The two sets of books should agree on the amount, the invoice number and the date. When they do not, payment stalls. A buyer's AP team usually matches a bill to a purchase order and a delivery before releasing payment, which is why a missing PO or a wrong invoice number is one of the most common reasons an invoice sits unpaid.

Accounts receivable goes under current assets, usually right after cash. Accounts payable goes under current liabilities.

The SEC's beginner's guide to financial statements defines assets as things a company owns that have value, and current assets as those a company expects to convert to cash within one year. It defines liabilities as amounts a company owes to others, and gives money owed to suppliers for materials as an example. Current liabilities are obligations a company expects to pay off within the year.

The SEC's balance sheet rules for public companies (Regulation S-X, Rule 5-02) list "accounts and notes receivable" under current assets and "accounts and notes payable" under current liabilities. Most private businesses use the same layout.

A receivable is a right to collect money. You have done the work, the customer has agreed to pay, and you expect the cash soon. That right has value, so it is an asset. Our page on whether accounts receivable is an asset covers this in more detail, including the debit and credit entries.

A payable is an obligation to pay money. You have received the goods or the service, and you owe the supplier for them. That obligation is a liability.

One point applies only to the asset side. A receivable is only worth what you will actually collect. Old invoices are worth less than their face value, and the accounts show that through an allowance for doubtful accounts. There is no equivalent discount on a payable. You owe the full amount until you pay it or the supplier agrees otherwise.

Cash comes in when customers pay their invoices and goes out when you pay your suppliers. If customers take 60 days to pay and your suppliers expect payment in 30, you are funding the gap out of your own cash.

Two measures show the timing:

• Days sales outstanding (DSO) is the average number of days it takes customers to pay you. Lower is better for your cash. Our guide to days sales outstanding explains how to work it out.
• Days payable outstanding (DPO) is the average number of days you take to pay suppliers. A higher DPO keeps cash in your account longer, but paying late can cost you supplier goodwill, early payment discounts or late fees.

You control your DPO directly. You only influence your DSO, through clear invoices, sensible payment terms and steady follow-up on anything overdue.

In a larger company, AR and AP are separate teams. In a small business, both usually fall on the same person: the owner, an office manager or a bookkeeper. Paying bills tends to happen on time because suppliers chase you. Chasing your own customers is the job that slips, because nobody else is pushing for it. Your accounts receivable aging report is the quickest way to see how far it has slipped.