If you’ve been in the financial world for any length of time, you’ve probably heard the terms “accounts receivable” and “accounts payable” being tossed around. Although these words may sound similar, they’re actually very distinct.
Some bookkeepers and accountants (myself included) may use both terms interchangeably, but it’s worth noting that these terms are typically associated with accrual accounting instead of cash accounting.
Let’s break it down.
Accounts Receivable
Accounts receivable, often abbreviated A/R, are payments that are credited towards you, such as when you bill a client for services or products provided. In short, this is money that you can reasonably expect to be able to collect sometime in the future. Accounts receivable are counted as assets, but they are not counted as revenue. In short, this is because you plan on receiving them, but because they haven’t been received yet, they don’t count as revenue. Assets can be found on your balance sheet, but revenue is found on your income statement.
Accounts Payable
Accounts payable, or A/P, are payments that you owe towards someone else, such as an electricity payment or a car loan. These are counted as liabilities or debts, but are not counted as expenses. In short, expenses are the day to day operating costs for running a business (such as sandwich ingredients or truck maintenance) and are expected to be paid almost immediately, but a liability implies a more long term investment. Liabilities can be found on your balance sheet, but expenses are found on your income statement.
What Happens If the Expected Payment Never Occurs?
Sometimes empty wallets happen.
If your account receivable never gets paid, eventually you would be forced to write it off as bad debt. Bad debt is an unfortunate consequence of doing business that happens to all business owners at one point or another. Depending on the amount of payment owed to you, you might consider taking some legal action. However, financially, the best you can do is write it off as an expense.
Depending on the size and age of your company, it might be worth using some statistical models based on past experience to predict the likelihood of your clients defaulting on you, so that you can budget around it.
The good news, however, is that bad debt can be written off on your tax returns. Additionally, if the bad debt were to be unexpectedly paid, it would be recorded as bad debt recovery.
What Happens If My Company Can't Make a Payment?
Unfortunately, this will likely be a case by case situation. In general, most companies would rather work with you to find a solution rather than take legal action. In some cases, you might be able to convert your liability into a long term note, or essentially extend the lifespan of your debt repayment. In other cases, you may be forced to get creative to find a solution that satisfies both parties. However, it’s impossible to know for sure what the outcome will be without first talking to your creditor and seeing what your options are.
In Conclusion
At their simplest forms, accounts receivable are debts that someone owes you and accounts payable are debts that you owe someone else. That being said, sometimes the financial world can get messy and these simple categories can get complicated quickly. Accounts receivable and accounts payable are two services that I offer to almost all of my clients. If you need help with either, please reach out to M. Root Bookkeeping today!