Accounts Payable vs Accounts Receivable
The former refers to the money a company’s customers owe for goods or services they have already received but not yet paid for, whereas the latter refers to the money a company owes for goods or services they have already received but not yet paid for.
What Is Accounts Payable vs Accounts Receivable?
Accounts receivable refers to the money a company’s customers owe for goods or services they have already received but not yet paid for. This means that customers have made credit purchases from the company.
From the perspective of customers, it is an obligation as they need to pay the company for goods or services on credit.
From the company’s perspective, it is an asset as the company made credit sales.
Example: A customer buys furniture on credit from ABC Furniture Company. After the company delivers furniture to the customer and bills the customer for the furniture, the payment owed is recorded under accounts receivable, and the company awaits payment from the customer.
Accounts payable refers to the money a company owes for goods or services they have already received but not yet paid for. This means that the company has made credit purchases.
From the company's perspective, it is a short-term obligation to pay the suppliers/vendors for buying goods or services on credit. From the suppliers' perspective, it is an asset as they have made credit sales.
Example: A company buys raw materials on credit from XYZ RM Suppliers Company Ltd. After the supplier delivers raw materials to the company and bills the company for the delivered raw materials, the payment owed is recorded under accounts receivable, and the supplier awaits payment from the company.
Accounts receivables are reported as current assets on the balance sheet.
Current assets are short-term assets that a company can use, convert into cash, or sell within one year. In addition, current assets are liquid in nature and less risky, meaning they can be sold/bought easily at their fair value. Examples include AR, Inventories, and Marketable securities.
Accounts payables are reported as current liabilities on the balance sheet.
Current liabilities are short-term obligations that a company is liable to pay within one year. Examples include AP and Short term notes payable.
Accounts Payable vs Accounts Receivable: Calculation
For forecasting accounts receivable, connect accounts receivable to revenue because the amount charged to customers is recorded as revenue once the customers are billed. Still, the cash remains to be collected from the customers for the credit purchases made by the customers.
Days sales outstanding (DSO) is used as a measure to estimate accounts receivables.
Days Sales Outstanding = (Accounts Receivable / Revenue) * 365 Days
Projected Accounts Receivable = (DSO /365) *Revenue
Revenue = Number of units sold * Cost per unit
DSO is the average number of days a company takes to collect cash from customers.
How to interpret higher DSO? The company is collecting cash from customers at a slower pace. The company is slowly collecting its AR, and/or customers are paying slowly.
The company should improve its AR cash collection process to reduce higher DSO. Properly analyze each customer before selling them goods or services on credit; this analysis includes analyzing customers' ability and willingness to make timely payments.
How to interpret lower DSO? The company is collecting its AR/cash from customers at a faster pace. Customers have good credit and pay on time to the company for their credit purchases.
DSO-related example (using the formula):
| Accounts receivable for the year 2019 | $480000 |
| Number of units sold during 2019 | 20000 units |
| Cost per unit sold for 2019 | $150 |
For 2019, Calculating Revenue, DSO, and verifying if accounts receivable = $480,000 using DSO
Revenue or Sales for 2019 = Number of units sold * Cost per unit sold
Revenue or Sales for 2019 = 20000 * $15 = $3000000
DSO = (Accounts receivable/ Revenue) * 365 days
DSO = ($480000/ $3000000) * 365 days = 58.4 days
Verifying if accounts receivable = $480000 using DSO
Accounts receivable = (DSO/ 365) * Revenue
AR = (58.4/365) * $300000 = $480000
Hence, Verified that AR = $480000 using DSO.
Connect accounts payable to Cost of Goods Sold (COGS) for forecasting accounts payable.
Days payable outstanding (DPO) is used as a measure to estimate accounts payable.
DPO= (Accounts Payable / COGS) 365 Days
Projected Accounts Payable= (DPO /365) COGS
COGS=Beginning inventory + Purchases - Ending inventory
The sum of all direct costs involved in making the final product, direct costs include direct costs of materials used in producing or manufacturing of the company's final product (example: Raw materials cost) is COGS.
DPO is the average number of days a company takes to make complete payment for their credit purchases from suppliers after delivery of materials/products by suppliers to the company.
How to interpret high DPO? It indicates the higher buying power of the company.
How to interpret low DPO? It indicates that a company has lower buying power.
DPO-related example (using the formula)
| Accounts payable for the year 2019 | $520000 |
| Beginning inventory for 2019 | 20000 |
| Ending inventory for 2019 | 15000 |
| Purchases made during 2019 | $2000000 |
For 2019, Calculating COGS, DPO, Verifying if accounts payable = $520000 using DPO.
COGS = Beginning inventory + Purchases - Ending inventory = 20000 + $2000000 - 15000
= $2005000
DPO = (Accounts payable/ COGS) * 365 days = ($520000/ $2005000) * 365 days = 94.66 days
Verifying if accounts payable = $520000 using DPO
Accounts payable = (DPO/ 365) * COGS = (94.66/ 365) * $2005000 = $519982 ≈$520000
Hence, Verified that AP = $520000
Calculating Average Accounts Receivable and Payable
The average amount of accounts receivable to be received during a reporting period is called the average AR.
It is calculated as the sum of beginning accounts receivable and ending accounts receivable, taking the average of these two values (i.e., adding beginning AR and ending AR and dividing both by 2).
Average AR= (Beginning AR + Ending AR) / 2
| Beginning accounts receivable | $500000 |
| Ending accounts receivable | $434000 |
Average AR = (Beginning AR + Ending AR) / 2 = ($500000+ $434000) / 2 = $467000
The average amount of accounts payable to be paid during a reporting period is called the average AP.
It is calculated as the sum of beginning accounts payable and ending accounts payable, taking the average of these two values (i.e., adding beginning AP and ending AP and dividing both by 2).
Average AP= (Beginning AP + Ending AP) / 2
| Beginning accounts payable | $754700 |
| Ending accounts payable | $867000 |
Average AP = (Beginning AP + Ending AP) / 2 = ($754700 + $867000) / 2 = $810850
Impact on Financial Statements and Financial Variables
Accounts receivable are recorded as a short-term asset since it represents future cash and economic benefit to the company as AR is collected.
Current assets on the balance sheet increase due to AR, and Working capital would also increase. The current ratio, which measures current assets relative to current liabilities, would increase.
The amount charged to the customer is recorded as revenue on the income statement after the customer is billed. Hence, revenue increases, increasing profit and profit margins. Accounts receivable generates cash and therefore is a source of cash inflow, increasing cash inflow.
Higher revenue and profit indicate that the company is performing well. Investors consider high cash flow a core variable before making investment decisions, especially cash flow from operations.
Accounts payable are recorded as a short-term liability since the company needs to pay for its credit purchases. Hence, current liabilities on the balance sheet increase due to AP, and Working capital would decrease. Accounts payable result in cash outflow and, therefore, use of cash, decreasing cash.
If the company pays AP without any delay, it would indicate investors to consider that company meets or is capable of meeting its short-term obligations and is less risky. Such a company can also borrow at a lower cost and increase its value quickly.
Impact of Accounts Receivable and Payable on Financial Ratios
The current Ratio will increase due to an increase in AR as AR is considered a current asset.
Current Ratio = Current Assets/ Current Liabilities
- Current assets (CA) = Accounts receivable, Marketable securities, Inventory, Cash
- Current liabilities (CL) = Short-term notes payable, Accounts payable, Accrued expenses.
- Current ratio > 1 means the company has higher liquid assets, higher liquidity, and lower liquidity risk (i.e., CA>CL).
- Current ratio < 1 means the company has lower liquid assets, lower liquidity, and higher liquidity risk (i.e., CL>CA).
- Current ratio = 1 means CA=CL
Accounts receivables $30000 Accounts payable $50000 Marketable securities $400 Short-term notes payable $4560 Inventory $5000 - - Cash $50000 Accrued expenses $670 Total CA $85400 Total CL $55230
| Accounts receivables | $30000 | Accounts payable | $50000 |
| Marketable securities | $400 | Short-term notes payable | $4560 |
| Inventory | $5000 | - | - |
| Cash | $50000 | Accrued expenses | $670 |
| Total CA | $85400 | Total CL | $55230 |
Calculating Current Ratio = Current assets/ Current liabilities = $85400 / $55230 = 1.55
Quick ratio will increase due to AR. A higher quick ratio is good, meaning sufficient current assets
Quick ratio = Current assets - Inventory / Current liabilities
| Inventory | $555 | Current liabilities | $67000 |
| Current assets | $80000 | - | - |
Quick ratio = $80000 - $555 / $67000 = 1.19
Working capital will increase if AR increases as AR is a current asset.
Working capital = Current assets - Current liabilities
Higher working capital is good for the company as this can be used by the company to pay wages/salaries, fund project-related costs, meet short-term obligations, and so on.
Example: if Current assets = $347890 and Current liabilities = $267800, then working capital = $80090
Revenue will increase, Profit (Gross Profit, Net Profit) will increase, and Profit margins will also increase (Gross profit margin, NP margin) because the customers were billed from their credit purchases by the company even if cash is still to be received, under accrual accounting.
Gross profit (GP) = Revenue - COGS
Gross profit margin = GP / Revenue
Net profit (NP) = GP - Selling, distribution, and general expenses - Interest - Taxes
Net profit margin = NP / Revenue
Higher profits are good as it indicates that the company is performing well. Example:
| Revenue | $890000 |
| COGS | $87650 |
| Selling, distribution expenses | $5900 |
| Interest | $6000 |
| Taxes | $900 |
Gross profit (GP) = Revenue - COGS = $890000 - $87650 = $802350
Gross profit margin = GP / Revenue = $802350 / $890000 = 0.90 = 90%
Net profit (NP) = GP - Selling, distribution, and general expenses - Interest - Tax = $802350 - $5900 - $6000 - $900 = $789550
Net profit margin = NP / Revenue = $789550 / $890000 = 0.89 = 89%
Accounts receivable turnover ratio = Credit sales / Average AR
If Average AR is higher than credit sales, then the accounts receivable turnover ratio will decrease and vice versa. Lower AR turnover is considered bad as it is indicative that a company is not efficiently managing its AR. Example:
| Credit sales | $760000 |
| Average AR | $56000 |
Accounts receivable turnover ratio = Credit sales / Average AR = $760000 / $56000 = 13.57
Days sales outstanding = 365 days / Accounts receivable turnover = 365 days / 13.57 = 26.90 days
That means the company is collecting AR faster, quickly, and efficiently. The cash conversion cycle will be short if receivables are collected faster.
The Current Ratio will decrease due to an increase in AP, as AP is considered a current liability.
Current Ratio = Current Assets / Current Liabilities
- Current assets (CA) = Accounts receivable, Marketable securities, Inventory, Cash
- Current liabilities (CL) = Short-term notes payable, Accounts payable, Accrued expenses.
- Current ratio > 1 means the company has higher liquid assets, higher liquidity, and lower liquidity risk (i.e., CA>CL).
- Current ratio < 1 means the company has lower liquid assets, lower liquidity, and higher liquidity risk (i.e., CL>CA).
- Current ratio = 1 means CA=CL
Example:
| Current assets | $290000 |
| Current liabilities | $500000 |
Current Ratio = Current assets / Current liabilities = $290000 / $500000 = 0.58
In the previous example, a current ratio of 0.58 indicates that current liabilities > current assets.
Working capital will decrease if AP increases as AP is a current liability.
Working capital = Current assets - Current liabilities
The higher the working capital, the better the company's position. It enables the company to meet short-term obligations, project expenses, and wages/salaries.
For example, if Current assets = $234500 and Current liabilities = $400000, then working capital = -$234500.
In the above example, working capital is negative because current liabilities > current assets.
Accounts payable turnover ratio = Credit purchases / Average AP
If Average AP is higher than credit purchases, then the accounts payable turnover ratio will decrease and vice versa. Lower AP turnover is considered good as it is indicative that a company is efficiently managing its AP. Example:
| Credit purchases | $345670 |
| Average AP | $900000 |
Accounts payable turnover = Credit purchases / Average AP = $345670 / $900000 = 0.38
Days payable outstanding (DPO) = 365 days / Accounts payable turnover = 365 / 0.38 = 966 days
In the previous example, the company is stretching it's payable and effectively managing its AP. The cash conversion cycle will be faster if DPO is higher.
Interpreting Increasing and Decreasing AR and AP
Let's see the interpretation of increasing and decreasing AR and AP below:
1. Increasing AR: The company is increasingly making credit sales. Too many credit sales can create a risk for the company if customers default and fail to make payments for their credit purchases. Ultimately the company will have to bear losses.
2. Decreasing AR: The company is successfully collecting cash payments from customers for credit sales made to customers. The shorter the collection cycle, the better the company can manage core activities like paying their debts early and reducing overall costs.
3. Increasing AP: The company is delaying supplier payments for their credit purchases. This indicates that the company is either having liquidity issues. Hence no/low cash is available to make payment for credit purchases, or the company is using the cash elsewhere, like to invest and grow cash and then pay suppliers from returns on investments.
Options to face liquidity issues are to borrow funds, liquidate liquid assets to generate cash, and keep some cash in reserves to use such cash to pay for credits as and when required.
4. Decreasing AP: The company is paying the supplier properly at the proper time without delay. This is an indication that the company has sufficient liquidity.
Accounts Payable Vs Accounts Receivable FAQs
AR can be positive or negative.
Yes, accounts payable can be negative.
Under cash flow from the operating activities section of the cash flow statement.
If AR is negative, then it means that the company owes more money to creditors than cash in hand.
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