Accounts receivable vs. accounts payable: A complete guide

Accounts receivable (AR) represents money your business is owed by customers for goods or services provided, while accounts payable (AP) is money your business owes to suppliers or vendors. In short, AR is incoming cash, and AP is outgoing cash.

Cash flow confusion? Let’s make it simple.

For new small business owners or independent operators, the jump from freelancer to business owner can feel bigger than expected. Suddenly, bills, invoices, and payment deadlines are all part of your daily workflow.

Understanding the difference between accounts receivable and accounts payable (and breaking it down into clear steps) can give you control and clarity when managing your money.

Learn the key differences between AR and AP, how each process works, best practices to keep them organized, and tips for streamlining payments in your business.

Table of contents

• What’s the difference between accounts receivable and accounts payable?
• What is accounts receivable (AR)?
• What is accounts payable (AP)?
• Accounts payable best practices
• Accounting methods for AR and AP
• Streamline payments with PayPal
• FAQ

What’s the difference between accounts receivable and accounts payable?

Accounts receivable (AR) and accounts payable (AP) are two sides of your business’s cash flow. AR tracks money owed to you, while AP tracks money you owe to others. Understanding this distinction is important for managing healthy business finances and avoiding cash flow gaps.

What is accounts receivable (AR)?

Accounts receivable is the money your customers owe your business after buying goods or services on credit. In other words, it’s the outstanding invoices you’re waiting to collect. Since AR represents future cash you expect to receive, you’ll list it as an asset on your balance sheet.

Examples of accounts receivable

Here are some example scenarios of accounts receivable in action:

• Unpaid invoices for products or services delivered: Imagine a graphic designer who completes a project and sends a $2,000 invoice to the client with 30-day payment terms. Until the client pays, that invoice is recorded as accounts receivable.
• Recurring billing for subscription-based services: In this example, a software company offering monthly subscriptions bills customers at the start of the month. Each unpaid balance, whether $10 or $100 per customer, counts as accounts receivable until payments are collected.
• Payment plans where customers pay in installments: A furniture store may let customers pay for a $1,200 sofa in four monthly installments. The remaining balance after each payment is tracked as accounts receivable until the full amount is settled.

How accounts receivable works

Here’s how the AR process typically works for a small business:

1. Work completed or order made: Your business delivers a product or service. At this point, you’ve earned the revenue, but haven’t collected any cash yet.

Tip: For small business owners, tools like an online invoice tracker can make AR management easy.

2. Invoice sent or credit opened: You issue an invoice (or extend credit), and record the balance as accounts receivable. This formalizes what the customer owes you.

Tip: The faster you send invoices, the faster you’ll likely get paid. Consider offering digital invoicing for convenience.

3. Payment received: Once the customer pays, the outstanding balance is cleared and AR decreases.

Tip: Offering multiple payment options (e.g., credit card, PayPal, ACH) can speed up collection.

Accounts receivable best practices

Slow collections can create cash shortages, even when sales are strong. Following AR best practices can help small business owners get paid faster and keep cash flow predictable.

What is accounts payable (AP)?

Accounts payable refers to the money your business owes vendors, suppliers, or service providers. Put simply, it’s your outstanding bills waiting to be paid. Since AP represents obligations to others, it appears as a liability on your balance sheet.

Maintaining accurate AP records is important for your business financial statements and overall accounting health.

Examples of accounts payable

Here are some example scenarios of accounts payable in action:

• Utility bills: A small business may receive monthly invoices for electricity, internet, or phone services. These remain accounts payable until the company pays the provider.
• Office supplies purchased on credit: When a business orders paper, printer ink, or software licenses on credit terms, the unpaid invoice is recorded as accounts payable.
• Vendor invoices: A restaurant that orders food and beverages from a supplier typically receives an invoice to be paid later, creating an accounts payable entry.
• Professional services: If a business hires a lawyer, consultant, or marketing agency and is billed after services are delivered, the unpaid balance becomes part of accounts payable.

How accounts payable works

Here’s how the AP process generally works:

1. Vendor completes work or delivers goods: You receive products or services from a supplier. This creates an obligation to pay, even if cash hasn’t yet left your account.

Tip: Check that the goods or services match what you ordered before accepting.

2. Invoice received: The supplier’s invoice is entered into your system as accounts payable. This records the liability on your books.

Tip: Forgetting to record invoices can lead to missed payments or poor cash flow visibility.

3. Internal processing: The invoice is reviewed, matched against purchase orders, and tracked. This step helps prevent duplicate payments or fraud.

Tip: Even if you don’t have a formal three-way match system, you can create a simple checklist (order, receipt, invoice) to confirm details like quantity, price, and vendor name before approving payment.

4. Approval: A manager, owner, or designated approver reviews the invoice and authorizes payment.

Tip: Establish approval limits (e.g., invoices over $1,000 require owner approval) to maintain control without bottlenecks.

5. Payment issued: You pay the invoice, reducing accounts payable.

Tip: Take advantage of early payment discounts when cash flow allows, but don’t pay so early that it strains your working capital.

Accounts payable key practices

Strong accounts payable (AP) practices help small business owners stay on top of bills, protect cash flow, and build trust with vendors. Here are a few ways to manage AP more effectively.

Accounting methods for AR and AP

There are two main ways to track accounts receivable (AR) and accounts payable (AP):

• Cash method records income when you receive payment and expenses when you pay bills. It’s often preferred by small businesses because it gives a real-time view of cash on hand.
• Accrual method records income when it’s earned (like when you issue an invoice) and expenses when they’re incurred (like when you receive a vendor bill). This method provides an accurate picture of long-term profitability but may need detailed tracking.

Understanding how each impacts AR and AP can help you better manage working capital and keep financial planning on track.