Accounts receivable and accounts payable, AP/AR in bean-counter jargon, is about business credit. Credit makes the business world go ‘round. The vast majority of businesses cannot get by as all-cash operations.
If you give credit to your customers, you have to track your accounts receivable, managing and collecting the money owed to your business by your customers. Having accounts receivable means you need to track invoices and credit notes issued to your customers and deduct payments they make. You also a need to make miscellaneous adjustments, such as interest charges on overdue accounts, chargebacks for NSF (not sufficient funds) checks, and so on.
Accounts payable, on the other hand, involves managing what your business owes to others. AP can mean all your short-term payment liabilities, including payroll and taxes, but we will focus on trade payables, normal business expenses such as raw materials, products for resale, and services.
While there are some similarities in processing AR and AP, there are also some significant differences. Both should be recorded and paid when due, but AR usually relies on more complex procedures, particularly in the area of monitoring credit and collecting overdue receivables.
How sophisticated your credit-granting, monitoring, and collections procedures need to be will vary significantly depending on your business. As a rule of thumb, if you have many smaller customers, top-notch automated procedures in collections can be essential to efficient AR management; otherwise you’ll spend too much time and effort on getting paid, or else you won’t get paid promptly enough. On the other hand, if you sell to only a few larger customers, it may not be important to have automated processes. You may not need to perform much collection follow-up, other than a phone call or two to chase a slow payment.
If your business is involved in importing or exporting, you may need to be able to deal with foreign currencies to properly track AR and AP. Not all systems offer foreign currency support, and those that do rely on varying procedures for calculating foreign currency gains and losses on translation. In these cases, you’ll want to make sure your accountant approves of the method of foreign currency translation calculation in the accounting system you use.