A Guide to Accounts Receivable Versus Accounts Payable
Accounts receivable and accounts payable are two key elements of startup accounting that founders and CEOs need to track carefully. They’re two sides of the same coin – accounts receivable (AR) are the funds that others owe you, and accounts payable (AP) is the money that you owe to others.
What are Accounts Receivable?
Accounts receivable are the payments that you should be collecting from your customers. This money is owed to you because your business provides them a service and you want to collect that money on time.
You will find the accounts receivable balances on the asset side of your balance sheet, and there are a number of benefits that come with this particular asset:
- AR is a cheap source of funding. Your accounts receivable income is the cheapest form of financing available for your startup. Customers that pay you on time help you avoid borrowing money or raising more capital.
- Banks love accounts receivable. If you do need to borrow funds, banks love it when you tap accounts receivable as a financing vehicle. This is because loans against accounts receivable are very low risk, and banks know they will be able to collect on it. This means they can actually advance you money, since it’s very likely you’ll get those funds from your customers.
- AR loans have low rates. Because they are low risk, accounts receivable loans have low interest rates. Your accounts receivable serve as an excellent form of collateral for loans.
Automated collections help you stay on track
A great service that’s getting more popular are tools which enable automated collections of your startup’s accounts receivable. QuickBooks and Stripe, among many others, allow you to invoice a client and then, if you haven’t received payment, automatically run the payment after a set period of time. Somewhere between 15 or 30 days post invoice, for instance.
This is becoming a really popular process and, here at Kruze, we think it’s a super healthy accounting strategy. It means you spend far less time chasing your clients on the phone and you don’t miss out on your accounts receivable!
An AR aging report is a useful tool
It is an excellent idea for you to have your startup CPA run an aging report on your accounts receivable every month. ** ** This is a report you should scrutinize in detail because it will present to you all of the AR that is outstanding for different dates. The report should show something along the lines of four columns, one for 0 days outstanding, one for 30 days, 60 days and 90 days etc.
If you have accounts receivable showing as outstanding in the 60 and 90 day columns, then you may be in trouble. This can be an indicator that your customers don’t want to pay you, aren’t going to pay you, or that they could be having financial problems. This will then negatively impact your cash flow, so it’s crucial that your monitor this AR collection aging report so you don’t end up with a revenue shortfall.
What are Accounts Payable?
You will find your startup’s accounts payable on the liability side of your balance sheet, the opposite side from AR. Accounts Payable comes under your liabilities because it is the money you owe and that you will have to pay in the future. Therefore, your balance sheet should reflect that.
AP invoices are important
A mistake we often see startups paying their contractors or vendors without an invoice. This is a big mistake because invoicing is really important:
- Invoices are an IRS accounting requirement. The IRS requires you keep all of your invoices, so paying your vendors without one will leave you with a gap in your financial statements and possibly land you in trouble.
- Invoices let you reconcile your accounts payable. You want to make sure you reconcile the service the vendor promised they would provide and how much they said it was going to cost against the actual cost and what they accomplished.
AP aging reports provide key information
As with accounts receivable, you can also run an accounts payable aging report. This will tell you when and to whom you have to pay money, because every vendor will give you net terms for payment.
These terms will usually be one of the following:
- Payment upon receipt. Which means you pay them immediately.
- Payment within 30 days of invoice.
- Payment with 60 days of invoice.
And so on.
A lot of companies might be tempted to ‘slow pay’ vendors, which is okay up to a point. However, if you want to work with the best service providers, you must keep in mind that other companies also want to be paid on time since they are managing their cash flow too. Paying your vendors late can create issues with your vendors, and they might choose to stop working with you.
AP and AR are crucial for startups
Cash is important for every business, and startups are no exception. Your board of directors and investors will want to know if you’re optimizing your business processes and tracking your cash flow. And knowing how AR and AP work helps founders and CEOs make more informed strategic decisions.
If you have any questions on accounts payable, accounts receivable, startup accounting, taxes, or venture capital please contact us.
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