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Accounts Payable vs. Accounts Receivable

Understand Accounts Payable vs. Accounts Receivable

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Accounts Payable vs. Accounts Receivable

In This Article
  • What are the definitions of accounts payable vs. accounts receivable?
  • Are accounts receivable and accounts payable recorded as assets or liabilities on the balance sheet?
  • How does an increase (and decrease) in accounts receivable vs. accounts payable impact cash flows?
  • How do accounts receivable vs. accounts payable get captured on the income statement?

Accounts Payable vs. Accounts Receivable Overview

For bookkeeping purposes, two accounting line items to closely track are:

  1. Accounts Payable (A/P)
  2. Accounts Receivable (A/R)

By tracking A/P and A/P, a company can monitor the amount of money it currently owes to suppliers/vendors and how much is owed to them from its customers.

Terminology Review

As a quick review, the definitions of the two terms are as follows:

  • Accounts Payable (A/P) – The total amount of payments owed to suppliers or vendors for products and services already received.
  • Accounts Receivable (A/R) – The amount of cash owed to the company for products and services already delivered by customers that paid on credit rather than cash.

Under accrual accounting, supplier/vendor bills are recorded on the income statement once the invoice is sent to the company, even if the company has not yet paid in cash.

The unpaid obligations are recorded in the accounts payable line item on the balance sheet.

Similarly, for revenue recognition under accrual accounting, sales are recognized once products/services are delivered (i.e. “earned”).

If the customer does not pay upfront with cash, the non-cash portion of the revenue is captured as accounts receivable on the balance sheet until cash payment is ultimately received.

Accounts Payable vs. Accounts Receivable Difference

As for the differences between accounts payable and accounts receivable, the former is recorded as a current liability while the latter is categorized as a current asset on the balance sheet.

While accounts payable represents payment obligations that must be met (i.e. future cash outflows), accounts receivable refers to cash payments not yet received from customers that paid on credit (i.e. future cash inflows).

In other words, accounts payable represents a future economic cost to the company, but A/R represents a future economic benefit to the company.

Unique to accounts receivable, A/R can also be offset by an allowance for doubtful accounts, which represents the amount of A/R deemed unlikely to be recovered (i.e. customers who may never pay).

Cash Flow Impact of Accounts Payable vs. Accounts Receivable

Accounts payable signifies money to be disbursed to third-party suppliers/vendors, while accounts receivable is money expected to be received from customers.

If a company’s accounts receivable balance increases, more customers must have paid on credit, so more cash collections must be made in the future.

But if a company’s A/R balance decreases, then customers that previously paid on credit have fulfilled their end of the transaction by completing the cash payment.

Delayed payments from customers can cause the accounts receivables on the balance sheet to increase.

For accounts payable, an increase in A/P means that more payments to suppliers/vendors were made on credit; thus, more future cash is owed.

From the perspective of companies attempting to maximize their free cash flow (FCF), the objective is typically to extend payables and reduce receivables as much as possible – as doing so implies delayed supplier/vendor payments and efficient collection of cash from customers for credit purchases.

Accounts Payable (A/P) Accounts Receivable (A/R)
  • An increase in accounts payable represents a cash inflow from the delayed payments to suppliers/vendors.
  • An increase in accounts receivable represents a cash outflow because more customers have paid on credit, so there is less cash on hand for the company.
  • A decrease in accounts payable reflects an outflow of cash as the outstanding credit balance of customers is paid off in cash payments.
  • A decrease in accounts receivable reflects an inflow of cash as more cash was collected from sales that were previously paid for on credit.

To summarize, a company’s balance sheet lists accounts payable (A/P) in the short-term liabilities section since it represents future unmet obligations for purchases from suppliers/vendors.

On the other hand, accounts receivable (A/R) is listed in the current assets section as it refers to the cash payments that a company expects to receive from customers.

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