What do the financial terms accounts receivable and accounts payable mean?
This video covers the definitions of accounts receivable and accounts payable, where you
can find accounts receivable and accounts payable in the financial statements, and how
the journal entries work for accounts receivable and accounts payable.
Accounts receivable and accounts payable are financial terms
that you can find on the balance sheet.
A balance sheet is one of the financial statements, and it shows at a point in time what you own
on the left (often called assets) and what you owe on the right (often called liabilities).
As the term balance sheet suggests, the sum of the amounts on the left has to equal the
sum of the amounts on the right.
Typical line items on the left side of the balance sheet are cash, receivables, inventory
and fixed assets.
Typical line items on the right side of the balance sheet are payables, accrued liabilities,
debt and equity.
Different companies use different names.
Receivables are sometimes called Accounts Receivable, or Trade Receivables, or Debtors,
or are abbreviated as A/R.
Payables are sometimes called Accounts Payable, or Trade Payables,
or Creditors, or are abbreviated as A/P.
How do accounts receivable and accounts payable
fit into the picture of a company’s operational process?
Well, they are related to the incoming and outgoing invoice streams
that a company may have.
Accounts Payable is on the incoming side.
The definition of accounts payable is: invoices from suppliers that you haven’t paid yet.
From a cash flow standpoint, this is a great thing, as you are basically getting a free
loan from your supplier: goods or services are delivered to you, and you do not have
to pay for them in cash yet.
Accounts Receivable is on the outgoing side.
The definition of accounts receivable is:
invoices to customers that they haven’t paid yet.
It is a promise to pay in the future by your customer, and a right to collect for you.
From a cash flow standpoint, this is a challenge, as you are basically supplying a free loan
to your customer: you have delivered goods or services, but you have not been paid for
them in cash yet.
In order to manage cash flow, collect your accounts receivable as quickly as you can,
and negotiate extended payment terms with your supplier.
How do the journal entries work on the accounts payable side?
Remember, accounts payable are related to incoming goods and services “on credit”
or “on account”.
Let’s assume you bought inventory for your trading company, on credit from your supplier.
The journal entry for this is debit inventory, credit accounts payable.
Once you pay the invoice (30 days, 45 days, or 60 days later), you debit accounts payable,
and credit cash.
How do the journal entries work on the accounts receivable side?
Remember, accounts receivable are related to outgoing goods and services “on credit”
or “on account”.
Let’s assume your trading company sold goods, on credit to your customer.
The invoicing part of the journal entry for this is
debit accounts receivable, credit revenue.
There is also an inventory movement aspect to the sales transaction, but that is a topic
for a different video (that I will link to in the description below).
Once the customer pays the invoice (30 days, 45 days, or 60 days later), you debit cash,
and credit accounts receivable.
So remember: accounts payable and accounts receivable are related
to incoming and outgoing invoices.
Accounts payable is: invoices from suppliers that you haven’t paid yet.
Accounts receivable is: invoices to customers that they haven’t paid yet.
If that is a helpful explanation, then please press the “like” button for me.
On this end screen, there are a few suggestions of related videos you can watch next.
On the left, a video discussing both the invoicing and the inventory movement sides of the journal
entries relating to a sales transaction.
On the right, a video discussing the difference between profit and cash flow, and the effect
accounts receivable and accounts payable have on them.
Please subscribe to the Finance Storyteller YouTube channel!
Thank you.