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Business Finance Management
July 7, 2022
Accounts receivable and accounts payable (AR and AP) are balancing acts that keep startups stable and growing. Both support giving startup owners a balanced picture of their debt-to-income ratio, shows proper money management, and presents opportunities for expansion.
This article looks at the differences between accounts receivable and accounts payable, where to find these numbers on your balance sheet, and the importance of properly managing these reports accurately.
Accounts payable and accounts receivable shows money the company owes to vendors or suppliers and money owed to the company by customers, respectively. Both numbers are recorded on your company’s monthly balance sheet which is then handed over to the controller or accounting manager at the end of each accounting period for reconciliation.
Accounts receivable refers to the money owed to the business by clients who have received products or services. This can also include money expected to come in from partners and investors. Money owed to the company is recorded as an asset.
Depending on your startup’s accounting method, there are two ways to record accounts payable. In accrual accounting, every unpaid transaction is a gap filler for cash. The total amount is then recorded and settled once paid.
When using cash-basis accounting, credit-based sales remain uncounted until the company receives the cash.
Accounts payable is the money a business owes in short-term debts such as vendor and supplier fees. Payroll and long-term debt, like mortgages, are not included. These debts are recorded as liabilities.
The accounts receivable general ledger is a comprehensive list of a company’s short-term liabilities and the records of outflow transactions.
Accuracy is key. You want a precise reflection of your company’s financial standing. Monitoring cash inflows and outflows, especially in the early stages, is crucial for all startups.
When an error occurs in either of these accounts without being fixed the error then transfers over to your financial reports. Missing a recording of payment to a vendor can result in double the amount paid. Or, it can disrupt proper cash flow projections by distorting true net income – the company, on paper, will show more money to spend than is available because the payment was not recorded.
No founder wants to see late-payment notifications from vendors, nor do they want to send them out to loyal clients. However, problems arise that can cause late payments on both ends. If a client misses a payment, suddenly, your budget is missing a massive chunk of cash for the following month.
A single cash flow issue can become a massive financial pile-up. Up-to-date transactions on accounts payable and receivable help stop cash flow problems or, at the very least, act as an alarm. Startups working with a set amount of cash and limited runway need to supervise where money is going and if the cash return is enough to cover operational expenses.
Vendors are just as important as customers. Having stellar relationships with vendors and suppliers can often lead to discounts for trustworthy companies and on-time payments. If something throws a wrench in your budget, you’ll need to settle accounts payable before anything else.
Not only does accruing debt hinder a startup’s potential growth, but you can also damage your reputation with vendors. Vendors and suppliers can end contracts due to insufficient or consistent late payments. Bank loans rack up interest for each missed payment. Eventually, debt can lead to bankruptcy.
Receivable turnover shows how effectively a company collects its debts. Turnover is another critical metric to track your company’s overall operating performance. The higher your turnover rate, the more efficiently your company is managing finances and operational expenses. However, you do not want an overly aggressive debt collection plan. Too much force can sour customer relationships and end up in a loss.
Average receivable turnover is dictated by your specific industry. Say your company has a 15.7 turnover ratio, meaning your average debt collection is almost 16 days, in comparison to X company which has a 26.9-day turnover. Another competitor has a turnover of 8.7 days for the current month with fluctuation between 7.6 and 12.2.
In the scenario above your company falls between two extremes. While company X has a low turnover they are able to retain consistency compared to the company that has a fluctuating turnover. Find a consistent middle ground that co-exists well with your business's cash flow and doesn’t stand in the way of future expansion.
Beginning accounts receivable + ending accounts receivable / 2 = average accounts receivable
Net credit sales / average accounts receivable = receivable turnover
Keeping accurate records of all financial transactions is a necessary habit for every business owner. Traditional bookkeeping is excellent for keeping track of all your transactions but doesn’t allow you to see problems on the horizon. And detailed AP and AR tracking is time-consuming especially for startups with smaller teams or a single financial employee
Having consistently updated information reduces the number of unnoticed errors, allows you to track every payment made and received, and allows you to run reports at any given time.
Streamlining the process of invoicing, collections, and bill pay with highly popular accounting software integration not only saves time, it assures proper records are kept and updated as transactions happen. Yet, AP and AR are often added services with many bookkeeping services or traditional finance firms.
At Zeni, we believe that AP and AR related services should come with every bookkeeping package, as they are pillars of your company’s financial standing. And that’s precisely what we offer, including invoicing and management of your bill pay software — it all integrates directly into your dedicated Zeni dashboard. Additionally, our bookkeeping services are supported by smart-AI technology so that you always have real-time, organized transaction reporting as the cash is coming in or going out.