Accounts Receivable (AR) is money owed to your business by customers. Accounts Payable (AP) is money your business owes to suppliers. Understanding and managing both is essential for healthy cash flow in any Pakistani business.
This guide explains the difference between AR and AP, how to manage each effectively, and their impact on your financial statements.
Accounts Receivable Explained
Accounts Receivable represents money customers owe you for products or services delivered on credit. It appears as a current asset on your balance sheet.
AR Examples
- You sold goods worth PKR 100,000 to a retailer on 30-day credit
- You provided services and invoiced the client for payment next month
- A customer issued a post-dated cheque for goods received today
AR Management Goals
- Collect payments as quickly as possible
- Minimize bad debts
- Maintain customer relationships
- Optimize credit terms
Accounts Payable Explained
Accounts Payable represents money you owe to suppliers and vendors for goods or services received on credit. It appears as a current liability on your balance sheet.
AP Examples
- You purchased inventory from a supplier on 45-day credit
- You received services (accounting, legal) to be paid next month
- Utility bills due but not yet paid
AP Management Goals
- Pay on time to maintain supplier relationships
- Use full credit terms (dont pay early unless discounted)
- Avoid late payment penalties
- Optimize payment timing for cash flow
AR vs AP: Key Differences
| Aspect | Accounts Receivable (AR) | Accounts Payable (AP) |
|---|---|---|
| Definition | Money owed TO you | Money owed BY you |
| Balance Sheet | Current Asset | Current Liability |
| Cash Flow Impact | Cash inflow when collected | Cash outflow when paid |
| Goal | Collect faster | Pay strategically |
| Related To | Sales/Revenue | Purchases/Expenses |
| Terms | You set credit terms | Supplier sets terms |
Impact on Cash Flow
The balance between AR and AP directly affects your cash position:
If AR > AP: You are financing customers (cash tied up)
If AP > AR: Suppliers are financing you (using their credit)
Cash Conversion Cycle = Days to Collect AR + Days of Inventory - Days to Pay APA shorter cash conversion cycle means better cash flow efficiency.
Managing Accounts Receivable
1. Set Clear Credit Terms
- Define payment terms upfront (Net 30, Net 60)
- Set credit limits for each customer
- Document terms in writing
2. Invoice Promptly
Send invoices immediately upon delivery. Delayed invoicing delays payment.
3. Track Aging
Monitor receivables by age:
| Aging Bucket | Status | Action |
|---|---|---|
| Current (0-30 days) | Normal | Monitor |
| 31-60 days | Overdue | Send reminder |
| 61-90 days | Seriously overdue | Call customer |
| 90+ days | At risk | Escalate/stop credit |
4. Follow Up Consistently
- Send payment reminders before due date
- Call on due date if not received
- Escalate overdue accounts
- Stop further credit for chronic late payers
5. Offer Early Payment Incentives
Offer 1-2% discount for early payment (e.g., 2/10 Net 30 means 2% discount if paid within 10 days).
Managing Accounts Payable
1. Track All Payables
Maintain a complete record of all amounts owed, due dates, and payment terms.
2. Use Full Credit Terms
If you have Net 30 terms, pay on day 30, not day 15. Keep cash working for your business longer.
3. Take Early Payment Discounts
If offered 2/10 Net 30, the discount is worth taking if you have cash—2% for 20 days equals 36% annual return.
4. Prioritize Payments
- Critical suppliers (will stop supply)
- Suppliers with late fees
- Tax obligations
- Less critical vendors
5. Negotiate Terms
Build relationships with suppliers to negotiate longer payment terms when needed.
AR and AP in Software
Modern accounting software automates AR and AP management:
- Automatic aging reports: See overdue receivables and payables at a glance
- Payment reminders: Automated customer follow-up
- Due date alerts: Never miss a supplier payment
- Cash flow forecasting: Project future cash based on AR/AP
- Statement generation: Customer and supplier statements
Key Metrics to Track
Days Sales Outstanding (DSO)
DSO = (Accounts Receivable / Credit Sales) × Number of Days
Lower is better—means faster collection.Days Payable Outstanding (DPO)
DPO = (Accounts Payable / Purchases) × Number of Days
Higher means you are using supplier credit effectively (but dont strain relationships).Frequently Asked Questions
Is accounts receivable an asset or liability?
What is bad debt in accounts receivable?
How do I handle advance payments from customers?
Should I offer credit to all customers?
What happens if I pay suppliers late?
Conclusion
Effective management of both accounts receivable and accounts payable is essential for business cash flow. Collect receivables quickly, pay payables strategically, and monitor both regularly to maintain financial health.
Need better visibility into your receivables and payables? HysabOne provides automated aging reports, payment reminders, and cash flow insights. Contact us on WhatsApp for a demo.
Last Updated: December 2024