Wall Street Prep

Payables vs. Receivables

Guide to Understanding Payables vs. Receivables

Learn Online Now

Payables vs. Receivables

Payables vs. Receivables: Balance Sheet Accounting

Briefly, the definitions of the two terms, payables and receivables, 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.

For bookkeeping purposes, both payables and receivables represent key working capital line items:

  1. Payables → Current Liability
  2. Receivables → Current Asset

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.

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.

Payables vs. Receivables: What is the 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).

Free Cash Flow Impact of Payables vs. Receivables

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.

Payables Receivables
  • 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.

Step-by-Step Online Course

Everything You Need To Master Financial Modeling

Enroll in The Premium Package: Learn Financial Statement Modeling, DCF, M&A, LBO and Comps. The same training program used at top investment banks.

Enroll Today
Comments
guest
0 Comments
Inline Feedbacks
View all comments
Learn Financial Modeling Online

Everything you need to master financial and valuation modeling: 3-Statement Modeling, DCF, Comps, M&A and LBO.

Learn More
X

The Wall Street Prep Quicklesson Series

7 Free Financial Modeling Lessons

Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts.