Accounts receivable and accounts payable are two crucial aspects of managing the financial health of an e-commerce business. While they may sound similar, they serve different purposes. Accounts receivable refers to the amount customers owe the business for products or services purchased on credit, while accounts payable represents the amount the business owes to suppliers or vendors for goods or services received on credit.
Establishing a solid accounts receivable process early on is vital for maintaining a positive cash flow, as delays in customer payments can lead to financial difficulties. Managing accounts payable is equally important to avoid defaulting on payments, maintain good relationships with suppliers, and forecast future cash flows.
This article explores the differences between accounts receivable and accounts payable, the impact of managing them on an e-commerce business, examples of both, and strategies to effectively manage these financial aspects through robust internal systems, clear payment terms, follow-ups, detailed invoices, multiple payment options, caution against fraud, and the use of accounting software for automation.
- Accounts receivable differs from accounts payable (A/P)
- Accounts receivable is where your business’s cash flow is measured.
- You should set up a solid accounts receivable process early in your business’ life
- Accounts payable is the amount your business owes to vendors or suppliers
- Managing accounts payable is a detailed process but keeps your business finances in order
What Is Accounts Receivable?
Accounts receivable is the amount that a customer is yet to pay you for a product or service that they have purchased through credit. The time until you receive the payment depends on the credit period, ranging from a couple of days to a year.
It’s documented through outstanding invoices that you (the seller) are responsible for issuing to the customer. This unpaid invoice describes the nature of goods, the total amount the customer owes you, and the due date for the payment. Since customers are legally obligated to pay you by the due date, accounts receivable is considered an asset on your balance sheet.
How Is A/R Different From Accounts Payable?
While accounts receivable are a current asset for your business, accounts payable are a liability. Accounts payable is the amount that your company owes to a supplier as opposed to the amount that customers owe you.
Let’s say you buy raw materials from a supplier (Company Y) for your e-commerce business using credit. The amount you agreed to pay Company Y at a later date is considered your accounts payable (since you owe money). In contrast, for Company Y, this amount is counted as their accounts receivable (since they are owed money).
How Does A/R Affect Your E-commerce Business?
Accounts receivable is the soul of your business’s cash flow. Having an accounts receivable balance indicates that a portion of your revenue hasn’t been received as a cash payment yet. If you aren’t consistent with collecting payments from customers, you could face a significant cash crunch that would adversely affect your company’s liquidity.
Staying on top of your accounts payable invoices is relatively easy since your vendors are required to be paid by a specific date. You should set similar standards when collecting your accounts receivable.
Typically, businesses operate on a net 30 basis, which means customers are expected to pay their dues within 30 days of receiving an invoice. You must ensure that your customers are paying you on time so that you can subsequently pay your bills. Ensuring you’re receiving your revenue on time also gives you enough cash to fund growth and pay back debt.
As your business grows, making mistakes in handling your accounts is easy. Small mistakes can compound quickly, causing major issues down the road. Additionally, it may be tougher for e-commerce businesses to collect accounts receivable since all your sales occur online and you aren’t dealing with customers in person. However, if you have a solid strategy, you can avoid payment irregularities and maintain a positive cash flow.
What Are Examples of Accounts Receivable
Most online shops allow at least part of their sales to be completed on credit. This enables customers to quickly purchase your products without immediately having to pay the full amount. It also builds customer loyalty since customers feel trusted and valued.
Some examples of accounts receivable include:
- An online cosmetics company that allows customers to purchase products and pay in monthly installments
- An education website that bills students at the end of every month instead of after every class
- An online supplier of plastic containers and cutlery that bills restaurants at the end of every three months instead of after every shipment
How To Manage Accounts Receivable
We’ve seen why effective accounts receivable management is important. But what strategies can you implement to ensure effectiveness?
We’ve listed some of the best solutions to help you maintain a low accounts receivable balance:
Establish a Robust Internal System
Create a process for handling accounts receivable and stick to it religiously. Sending out invoices is the seller’s responsibility, so set a day in the week when you create and send out all invoices. The sooner you invoice your customers, the faster you’re likely to be paid. We recommend sending invoices with delivery, so customers immediately have all the required information to prepare for payment.
You could pick a different day to contact customers to remind them of upcoming payments or inform them of defaulted payments.
Follow Up and Ask for Payment
Just sending out initial invoices doesn’t guarantee that you receive payments on time. Include a system for following up with customers when due dates are approaching. You shouldn’t feel guilty and hesitate when following up about upcoming or overdue invoices. On the contrary, your customers might even appreciate the reminder.
You can encourage on-time payments by charging interest or a late fee for customers who regularly default on credit terms. Meanwhile, discounts and other benefits are great incentives for customers who pay you on time or even before the due date. This could even boost the customer experience and sales.
Set Clear Payment Terms
Be clear about your payment processes from the get-go. The initial terms you set anchor your customer’s expectations and behaviors, so be as transparent as possible. For example, include details about how purchasing on credit works, when to expect an invoice and follow-ups, and the different credit periods you offer. This can reduce confusion and conflict at the time of payment. You can also use the initial terms and conditions to establish penalties and late fees.
Send Detailed Invoices
Like your terms and conditions, make sure that your invoices provide detailed and clear information for your customers. Avoid sending generic invoices that simply state the amount due. Instead, your invoice should present a breakdown of the products and services you provided, the amount for each, the total amount owed, and the due date for the payment. This reduces the likelihood of any delays.
It’s good practice to maintain a copy of the invoice in addition to sending one to your customer.
Provide Multiple Payment Options
Customers may have personal preferences regarding how they would send payment. For example, they may prefer to pay through credit or debit cards, bank deposits, or send a wire transfer to your business when the payment is due. Either way, you should clearly mention the different payment methods you accept, even for purchases made on credit.
Cash usually isn’t the most practical option for e-commerce companies when dealing with accounts receivables.
Be Wary of Suspicious Accounts
One of the biggest risks with accounts receivable for e-commerce businesses is that customers are online users who often use a guest account to check out purchases from your website. This increases the chances of fraud.
One way to manage this could be through registering an allowance for doubtful accounts, which shows that you anticipate that you may not receive some balance payments. This reduces accounts receivable and writes off account balances that you failed to collect due to fraud or scammers.
Another precautionary step could be asking customers to fill in their credit card or bank account details while making the purchase but charging them only at the end of the credit period. You should only accept their transaction once their account number and related information check out. This way, you have some leverage over them, and there’s little to no chance of payments defaulting.
Use Accounting Software
The entire process of creating and sending invoices, confirming their receipt, and following up, can be pretty time-consuming. Not to mention finally computing your accounts receivable and payable.
Consider automating the process by using accounting software to record transactions and track your accounts receivable and payable. Most software provides an organized, user-friendly interface that simplifies the process. You can also integrate them into your e-commerce website for a seamless experience for you and your customers
What Is Accounts Payable?
Accounts payable is the amount you owe to creditors or suppliers. For example, if you bought goods on credit with net 90 payment terms, you’re liable to pay the supplier within the next 90 days. During the time between the purchase and the payment, the liability is classified under the accounts payable section of the balance sheet.
How Is Accounts Payable Different From Accounts Receivable?
Accounts receivable (A/R) is the exact opposite of accounts payable. Accounts receivable represents the amount that’s owed to your company by other firms. This may be for services rendered to them or for products they have purchased on credit from your company. For accounting purposes, accounts payable is noted as a liability for your firm but accounts receivable is considered an asset.
How Does Accounts Payable Affect Your Small Business?
Keeping track of accounts payable is extremely important for a small business owner. Since your business has taken a short-term loan, you need to repay the loan on time to avoid having your company be classified as a defaulter. Paying off your accounts payable dues on time can also help you maintain better relations with your suppliers. This may translate into better deals and discounts for future purchases.
Understanding your accounts payable transactions can also help you gauge the health of your business and forecast future cash flows. If a company’s payables increase over a period, it implies that the business is purchasing more goods and services on credit. Similarly, if a firm’s payables decline, it indicates that the company is repaying its debts faster than it’s buying on credit.
Examples of Accounts Payable
Some common accounts payable transactions made by e-commerce businesses include:
- Short-term loans: You might need to take short-term loans for research and development, to launch new products, or to get through a tough phase— regardless of what you take the loan for, it’s classified under short-term loans.
- Invoices for purchases: Businesses frequently need to purchase office supplies, packaging materials, equipment, and other goods for their day-to-day functioning. For these transactions, the purchases are often not paid upfront, and the supplier sends an invoice for payment.
- One-time service fees: This includes payments due to contractors and consultants. Often, their payments are due after the completion of the task and, therefore, this is accounted for as accounts payable.
- Internet services and web hosting: Most e-commerce businesses need a reliable hosting service with a 99.99% upkeep time. Depending on the size of the business, the business may also need strong servers and databases. However, the payments for these services are usually made every quarter, and so these are classified under accounts payable.
How Do You Manage Accounts Payable?
Managing your accounts payable is a time-consuming and detail-oriented process. However, it can be made simpler by referring to the points listed below.
Track Every Payment Carefully
You need to ensure that every due payment is accounted for in your books or expense management software. To do this, you need to keep three main points in mind:
- How much do you owe?
- Who do you owe the amount to?
- When is the payment due?
It may help to set up recurring payments for regular expenditures. However, you should keep a tab on these payments to ensure that you aren’t paying for purchases that you’re no longer using.
Automating the Accounting Process
Managing your accounts manually leaves your business prone to several human errors. No matter how good your accountant is, you can always improve the process by using accounting software. Modern accounting software is designed to suit various requirements, so you can rest assured that you find the ideal fit for your company. Here’s an overview of three of the best software available:
Zoho Books offers a highly intuitive accounting system that includes account payable and receivable functions. Its automated procedures help businesses save a lot of time when dealing with recurring transactions.
It’s also customer-friendly and allows you to send payment reminders for each client. An incredibly versatile software, Zoho Books is available on Android, Windows, and iOS.
Patriot offers many helpful features to simplify the accounting process. Its cash-to-accrual toggle switch saves your business precious time as it allows clients to enter their transactions as they understand them. Patriot’s team then translates this into the accounting format required for your firm.
FinancePal has been designed to keep small business owners in mind. It assigns you a dedicated team of United States-based financial experts who work closely with you to ensure your success. It handles all aspects of your finance, from making payments to paying your taxes.
Update Cash Forecasts Regularly
Try to maintain weekly cash forecasts for at least a few months ahead. This allows you to understand where your firm stands and plan for upcoming accounts payable.
This forecast should be updated each week based on the transactions of the previous week. Through this, you can keep track of all accounts payables and accounts receivables, better preparing you for cash shortages in the future.
Improve Communication With Your Suppliers
It’s entirely possible that your ability to make accounts payable might be restricted due to unforeseen circumstances. If this is the case, it’s best to let your vendors know and negotiate a payment schedule with them. Additionally, prioritize payments to suppliers who are essential to your revenue generation process.
Better communication with your vendors allows you to negotiate terms and discounts for the products or services that you regularly purchase.
Maintain a Record of Invoice Disputes
Invoicing discrepancies can cause problems for your company’s cash flow. It’s imperative that you keep track of any such inconsistencies to ensure your business’s solvency. This also helps you supervise all vendor transactions.
What Should You Do Next?
Having an up-to-date and holistic idea of your company’s financials is crucial to building a successful e-commerce brand. The best way to deal with the stress of calculating your accounts payable is to streamline the accounting process by using accounting software. If you’re yet undecided about which is the best accounting software, you should read our in-depth article that explains the pros and cons of the most popular accounting software of 2023.