Hey there! TallyDekho will discuss the concept of trade receivables and trade payables in detail to make the readers understand the key difference in both terminologies. In today’s article, we’ll learn what are trade receivables and payables and how these two accounts play an indispensable role in settling business fund flow.
In day-to-day business activities, not all transactions are done in cash. There is n number of credit purchases or sales that take place as a part of business operations. Therefore, all such amounts receivable and payable on account of credit sales and purchases are referred to as trade receivables and trade payables.
Just like cash inflow and outflow are managed through effective cash management, in the same way, trade receivables and payables are managed through a management process that we’ll discuss in our upcoming blog series. For now, let’s understand both the terms separately.
The distinction between Trade Receivables and Trade Payables
When a business conducts any credit sale of a product or service, the payment on its account is yet to be received. In this condition, the account holder to whom such credit sale was made, will be addressed as a debtor of the firm.
Sometimes, a written bill of exchange is generated to the debtor which is generally known as Bills Receivable (B/R). In Bills Receivable, the amount which is due to be received on a specific date is mentioned. Also, trade receivables are seen as an asset to the company and are recorded at the asset side of the balance sheet.
Trade Receivables = Debtors + Bills Receivables
Significance of analyzing trade receivables in business
As the trade receivables show the inflow of cash in the business, therefore, it is the indicator of a business’s debt collection capacity of the firm. Thus, it is very important to efficiently analyze the trade receivables in order to run the business smoothly.
Helps in meeting payment obligations
Sometimes, when there is more cash utilization in the production process, the situation of lack of availability of cash arises. In such circumstances, the collection of cash with respect to trade receivables can be used to meet the payment obligations that arise in the normal course of business.
Helps in reducing the chances of bad debts
Also, when timely analysis of trade receivables is done, the collection process speeds up and therefore, the chances of bad debts ultimately reduce.
Helps in maintaining an adequate working capital level
Yes, every business planning fosters on the adequate availability of cash for day-to-day business operations. But sometimes, the working capital gets short and hampers the liquidity of the firm. In such a situation, the collection of trade receivables acts as a reviving element as the funds collected under this head can be used in case the working capital gets short.
When a business makes any credit purchase of a product or service, the payment on its account is yet to be made. In this condition, the account holder from whom the credit purchase was made, will be addressed as a creditor of the firm.
Sometimes, a written bill of exchange is accepted by the business stating the amount to be paid to the creditor which is generally known as Bills Payable (B/P). In Bills Payable, the amount which is due has to be paid by the company to the creditor on a specific date as mentioned in the bill. Also, trade payables are seen as a liability of the company and are recorded at the liabilities side of the balance sheet.
Trade Payables = Creditors + Bills Payables
Significance of analyzing Trade Payables in business
Just like trade receivables hold an important place, the trade payables also possess the same significance. As the trade payables show the outflow of cash from the business, therefore, it is the indicator of the creditworthiness of the business firm.
Helps in determining the outstanding amount to the creditors
The analysis of trade payables helps in estimating the outstanding amount that has to be paid to the creditors within the stipulated time period.
Enhances the creditworthiness of the concern
When the business concern always meets all the obligations on time, it ultimately enhances the creditworthiness of the business in the market. Therefore, the business manages to capture a good public image.
Indicates the paying capacity of the firm
The timely settlement of trade payables indicates a sound paying capacity of the business, and this is why the vendors or suppliers don’t hesitate in making credit sales to such business.
Thus, it is pretty clear that both of these aspects are very important for any business irrespective of the scale of operation. Keeping and maintaining both the accounts effectively can help the business to reap beneficial results with good market value.
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