Home » Better Manage My Business Finances » Understand Accounts Payable and Accounts Receivable

Use These Popular Accounting Techniques to Stay
on Top of What You Owe and What You’re Owed

Tracking how much money you have coming into and going out of your business is vital to good financial management. You need a constant, clear idea of how much money others owe you and how much you owe to others. In accounting terms, this is known as “Accounts Payable” and “Accounts Receivable.”

Once you’ve read through our guide, you’ll have a much better understanding of how to measure your revenue and expenses and put strong financial management procedures in place.

What Is Accounts Payable?

Accounts payable is where you record any money you owe to others that you’re not going to pay out right now. In other words, you use it to record expenditures and payments that will be due in the future.
Accounts payable should be used to record the following:

  • Money you owe to creditors in the future
  • Money you have received a bill or invoice for
  • Money that is used to pay a short-term debt
  • Money that must be paid to your creditors to avoid defaulting on a bill, invoice or other debt

In other words, accounts payable is used for goods or services you receive “on credit” and creates a debtor-creditor relationship between your business and your supplier. That relationship lasts until you make payment.

Accounts payable is not typically used for:

  • Internal business expenses like staff salaries or interest on loans — these are recorded as “accrued expenses” or “other business debts”
  • Payments that you make right away, like petty cash (these are just part of your normal business expense recording)
  • Tax payments
The Accounts Payable Ledger

When a future invoice, bill or other debt comes in, you record it in the “Accounts Payable Ledger.” The total sum of money recorded in this ledger tells you exactly what you owe, when you owe it and to whom. This ledger records the total amount of “liability” you have with suppliers, and it's a standard part of any accounting or bookkeeping software.

When you know you have a bill or invoice coming due, set up a reminder so you pay it and do not default.

Removing and Recording Debts Paid

Once you have made payment of a bill, invoice or debt in accounts payable, it is removed from your accounts payable ledger. It is then recorded in your “current assets” and expenses (typically your business bank account).

What Accounts Payable Is Used For

Accounts payable is extremely useful for several reasons:

  • Seeing a snapshot of what you currently owe and ensuring you have enough cash on hand to meet future liabilities
  • Helping you manage what you owe effectively, meaning you don’t overspend
  • Recording important information on your income statement and balance sheet

You can find out more about paying bills here.

Remember that a transaction in your accounts payable is sitting in another business’ accounts receivable, and vice versa.

What Is Accounts Receivable?

Accounts receivable is where you record any money owed to you by others that they have not yet paid. In other words, you use it to record goods or services you are invoicing that you do not expect to receive immediate payment for.

Accounts receivable should be used to record the following:

  • Money owed to you from debtors
  • Money you have sent a bill or invoice for
  • Money that must be paid to you so your debtor does not default on their bill, invoice or other debt

Accounts receivable is used for goods or services you supply “on credit” that creates a creditor-debtor relationship between your business and your customer. That relationship lasts until they make payment.

Accounts receivable is not typically used for:

  • Internal business accruals like tax rebates or interest received
  • Revenue and payments that you receive straightaway, like selling retail goods direct to customers (these are just part of your normal business sales recording)
The Accounts Receivable Ledger

When you send out an invoice or bill for future payment, you record it in the “Accounts Receivable Ledger.” The total sum of money recorded in this ledger tells you exactly what you are owed, when you can expect to receive payment and from whom. The ledger records the total amount of “liability” your customers have to you, and it's a standard part of any accounting or bookkeeping software.

When you know you have a bill or invoice coming due with a customer, set up a reminder to let them know
they need to pay.

Removing and Recording Invoices and Bills Paid

Once you have received payment of a bill, invoice or debt in accounts receivable, it is removed from your
accounts receivable ledger. It is then recorded in your “current assets” (typically your business bank account).

What Accounts Receivable Is Used For

Accounts receivable is extremely useful for several reasons:

  • Seeing a snapshot of what you are currently owed and ensuring you have enough cash in the short-term to meet liabilities before you receive payment
  • Helping you manage what you are owed effectively, so you can stay on top of payments due to you
  • Recording important information on your income statement and balance sheet

Remember that transactions in your accounts receivable will be in another business’ accounts payable, and vice versa.

Optimize Accounts Payable & Receivable

There are several ways you can optimize your accounting practices to improve cash flow for your business.

For Accounts Payable:
  • When a bill or invoice comes in, check payment terms and see if there are any benefits for paying the bill early. If so,
    you may want to take advantage.
  • Always record the date payments are due, taking into
    account any lag time for your creditor to actually receive
    payment.
  • Always pay bills by the due date so you don’t incur any penalties.
  • Get into the discipline of recording and reconciling all accounts payable transactions on a daily basis.
For Accounts Receivable:
  • Whenever you send an invoice or bill, take note
    of when payment is due from your debtor.
  • Send reminders as the invoice becomes due to ensure
    you receive payment. Some accounting programs will
    send out reminders automatically.
  • Look into invoice factoring to see if that’s an option
    for your business.
  • Identify problematic creditors who do not pay on time.
    See if you can collaborate to come up with a payment
    plan that works for both of you.
  • Think about whether you want to charge interest
    or other penalties for late payment.
  • Get into the discipline of recording and reconciling
    all accounts receivable transactions on a daily basis.

There you have it: a breakdown of everything you need to know about how to use accounts payable and accounts receivable.

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