How do accounts receivable and payable affect working capital?

Accounts receivable and payable directly impact working capital by affecting a company's current assets and liabilities.

Working capital, in simple terms, is the difference between a company's current assets and current liabilities. It is a measure of a company's operational efficiency and short-term financial health. Accounts receivable and payable are two key components of this calculation.

Accounts receivable are the amounts owed to a company by its customers for goods or services provided on credit. They are considered current assets because they are expected to be collected within a year. When accounts receivable increase, it means the company has sold more goods or services on credit, which could potentially increase its working capital, assuming these amounts are collected on time. However, if these amounts are not collected, it could lead to bad debts, reducing the company's working capital.

On the other hand, accounts payable are the amounts a company owes to its suppliers for goods or services received on credit. They are considered current liabilities because they are expected to be paid within a year. When accounts payable increase, it means the company has purchased more goods or services on credit, which increases its current liabilities and reduces its working capital.

Therefore, effective management of accounts receivable and payable is crucial for maintaining healthy working capital. Companies need to ensure they collect their receivables promptly and manage their payables wisely to avoid cash flow problems. For instance, if a company is too lenient in collecting receivables, it may face a cash crunch. Similarly, if it pays its suppliers too quickly, it may deplete its cash reserves, reducing its working capital.

In conclusion, accounts receivable and payable have a direct and significant impact on a company's working capital. They need to be managed effectively to ensure the company maintains a healthy cash flow and is able to meet its short-term financial obligations.