A company has to purchase various items (such as raw material) for its business operations. Similarly a company has to make sales of finished goods to earn money. A company can procure various items by paying in cash or by obtaining credit from its vendors. Similarly a company can sell its goods for cash or can offer credit period to its customers.

Any amount of money that a company owes to its vendors is called accounts payable while any amount of money that is owed to the company by its customers is called accounts receivables. Accounts payable and accounts receivable represent two critical business processes. It is a must for every organization to develop effective policies, procedures and control for these two processes.

Accounts Payable

Accounts payable is a current liability for a company. Accounts payable occur whenever a company purchases items or obtains services on a credit basis. For Instance, a company has purchased raw material worth $ 50,000 from one of its vendors. This vendor offers a credit period of 45 days from the date of invoice.

As soon as the invoice is received by the company, it will have to record an accounts payable of $ 50,000 in its books of accounts. Even though a high amount of accounts payable may indicate that a company is able to obtain preferable credit terms from its creditors, it may also indicate a company’s inability to clear its dues on time on account of non availability of funds.

Accounts Receivable

Accounts receivable is a current asset for a company. Accounts receivable occur whenever a company sells goods or offers services on credit basis. For Instance, a company has rendered services worth $ 20,000 to one of its customers. Company offers a credit period of 30 days from the date of invoice. Till the time money is not received from this customer, the company will have to record an accounts receivable of $ 20,000 in its books of accounts on the asset side of its balance sheet.

Nowadays it is quite common to extend credit to customers because of fierce competition in the industry. A high amount of accounts receivable may result in a high current ratio which is frequently used to measure the short term liquidity of the company. But at the same time, it may indicate that the company is not able to recover its money on time. Funds blocked in accounts receivable may not get utilized for various investment, expansion and diversification purposes.

Also, any amount of money realized by a company from its debtors can be used to pay off accounts payable and other business liabilities. It is important to understand the concept of credit period while recording accounts payable and accounts receivable. Ideally a company should try to obtain a credit period from its vendor which is higher than the credit period it offers to any customer. This will help the company to generate enough money before its liability to pay any outstanding amount arises.

Even though a company may adopt stringent recovery measures for recovery of outstanding dues from its customers, it cannot eliminate the risk of delay or nonpayment of money from some of its customers.

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