AP & AR Management: Optimizing Your Working Capital Operations
Accounts payable and accounts receivable aren't just administrative functions—they're working capital levers. How quickly you collect from customers, and how strategically you pay vendors, directly impacts your cash position and borrowing needs. This guide covers the processes, technology, and strategies for optimizing both sides of working capital.
Every business deals with AP and AR. But most treat them as back-office necessities rather than strategic functions. That's a missed opportunity.
Consider this: if you collect receivables 10 days faster and extend payables by 10 days, you've just freed up nearly three weeks of cash flow. For a $15M company, that could be $400,000 or more in working capital that doesn't need to be financed.
The difference between well-managed and poorly-managed AP/AR operations isn't just efficiency—it's real money.
AP and AR as Working Capital Levers
Working capital is the money tied up in operating your business. It's calculated as current assets (primarily AR and inventory) minus current liabilities (primarily AP).
Working Capital Equation
Working Capital = Accounts Receivable + Inventory - Accounts Payable
To reduce working capital needs: collect AR faster, reduce inventory, or extend AP terms.
The Cash Conversion Cycle
The cash conversion cycle (CCC) measures how long cash is tied up in operations:
CCC = DSO + DIO - DPO
Where: DSO = Days Sales Outstanding (AR), DIO = Days Inventory Outstanding, DPO = Days Payables Outstanding (AP)
A shorter cash conversion cycle means less cash tied up in operations. A negative CCC (rare, but possible in some business models) means you're funded by vendors and customers.
The Cost of Poor AP/AR Processes
Accounts Payable Costs
- Late payment fees: Penalties for missing due dates
- Lost discounts: Missing early payment discounts (2/10 Net 30 = 36% annualized)
- Vendor relationship damage: Slow payers get deprioritized
- Duplicate payments: Manual processes lead to errors
- Fraud exposure: Weak controls enable payment fraud
Accounts Receivable Costs
- Delayed cash: Every day of slow collection is a day of working capital tied up
- Bad debt: Uncollected receivables become write-offs
- Borrowing costs: Must borrow to cover slow collections
- Customer friction: Poor invoicing creates confusion and delays
- Staff time: Manual follow-up is expensive and unpleasant
Quantifying the Cost
For a $15M revenue company with 45-day DSO instead of 30-day DSO, that's $625K in additional working capital tied up. At a 10% cost of capital, that's $62,500 annually in unnecessary financing cost—not counting bad debt, staff time, or lost discounts.
Accounts Payable Management
Effective AP management balances efficiency (processing invoices quickly) with optimization (paying strategically).
The AP Process
- Invoice receipt: Capture invoices from all channels (email, mail, portal)
- Data entry: Extract invoice data (vendor, amount, due date, coding)
- Matching: Match to PO and receiving documentation where applicable
- Approval: Route for approval based on amount and type
- Scheduling: Schedule payment based on terms and cash strategy
- Execution: Execute payment via appropriate method
- Recording: Record payment in accounting system
AP Optimization Levers
- Payment timing: Pay on due date, not early (unless discount warrants)
- Term negotiation: Negotiate Net 45 or Net 60 with large vendors
- Early payment discounts: Take discounts when they exceed cost of capital
- Payment method: Use cards for rebates, ACH for cost efficiency
Accounts Receivable Management
AR management is about getting paid as quickly as possible while maintaining customer relationships.
The AR Process
- Invoicing: Generate and send invoices promptly and accurately
- Delivery: Ensure invoices reach the right person/system
- Follow-up: Send reminders before and after due date
- Collections: Escalate overdue accounts systematically
- Cash application: Match payments to invoices accurately
- Dispute resolution: Handle billing questions quickly
AR Optimization Levers
- Invoice immediately: Don't wait to send invoices after service/delivery
- Make payment easy: Multiple payment options, clear instructions
- Proactive reminders: Reminder before due date, not just after
- Clear terms: Ensure customers understand payment expectations
- Credit management: Assess credit risk before extending terms
Technology for AP/AR Automation
Automation transforms AP and AR from manual, error-prone processes into efficient, controlled operations.
AP Automation Capabilities
- Invoice capture: OCR/AI to extract data from invoices
- Coding: Auto-coding based on vendor and history
- Approval workflows: Digital routing and approval
- Payment execution: Direct bank integration for payments
AR Automation Capabilities
- Invoice generation: Auto-generate from sales system or time tracking
- Delivery: Electronic delivery with confirmation
- Reminders: Automated dunning sequences
- Payment portals: Customer self-service payment
- Cash application: Auto-match payments to invoices
Common Tools
AP Automation
- Bill.com
- Ramp / Brex
- Tipalti
- Stampli
AR Automation
- Invoiced
- YayPay
- Billtrust
- QuickBooks/Xero built-in
Metrics and KPIs
Key AP Metrics
- DPO (Days Payable Outstanding): Average days to pay vendors; higher = better cash position
- Invoice processing time: Days from receipt to approval; target under 5 days
- Early payment discount capture: % of available discounts taken
- Error rate: % of invoices with processing errors
Key AR Metrics
- DSO (Days Sales Outstanding): Average days to collect; lower = better cash position
- Aging buckets: Distribution of AR by age (current, 30, 60, 90+ days)
- Collection effectiveness: % of AR collected within terms
- Bad debt %: Write-offs as % of revenue
Sample Targets
AP Targets:
- DPO: Match or exceed terms
- Processing time: <5 days
- Discount capture: >90%
- Error rate: <2%
AR Targets:
- DSO: Within 5 days of terms
- 90+ days: <5% of AR
- Collection effectiveness: >90%
- Bad debt: <1% of revenue
Outsourcing AP/AR Functions
AP and AR functions can be outsourced partially or fully to specialized providers.
When Outsourcing Makes Sense
- Volume without scale: High transaction volume but not enough to justify dedicated staff
- Expertise gap: Need professional collections without hiring collectors
- Technology access: Get automation without buying and maintaining software
- Focus: Free internal team for higher-value activities
What Can Be Outsourced
- AP processing: Invoice entry, coding, approval routing
- Payment execution: Running payment batches
- AR invoicing: Invoice generation and delivery
- Collections: Follow-up and collection calls
- Cash application: Matching payments to invoices
Partial Outsourcing
You don't have to outsource everything. Many companies keep approvals and vendor relationships in-house while outsourcing data entry and processing. Similarly, early-stage collections might stay internal while late-stage escalations go to specialists.
Connecting AP/AR to Cash Flow Forecasting
Your AP and AR data should feed directly into cash flow forecasting.
AP to Cash Forecast
- AP aging tells you when payables will become cash outflows
- Scheduled payments feed directly into near-term forecast
- Historical DPO helps predict timing of unscheduled payables
AR to Cash Forecast
- AR aging predicts when receivables will convert to cash
- Historical collection patterns improve forecast accuracy
- Customer-specific data refines timing assumptions
The tighter the integration between AP/AR systems and your cash forecast, the more accurate your projections. Real-time data beats manual spreadsheet updates.
Frequently Asked Questions
What is the difference between AP and AR?
Accounts Payable (AP) is money you owe to vendors and suppliers—your bills. Accounts Receivable (AR) is money owed to you by customers—your invoices. Together, they represent the two sides of your working capital operations. Managing both effectively improves cash flow and reduces the cash conversion cycle.
What is a good DSO (Days Sales Outstanding)?
DSO varies by industry, but generally 30-45 days is good for most B2B companies. Compare your DSO to your payment terms—if terms are Net 30 and your DSO is 45, you're collecting 15 days slow on average. The goal is to collect as close to terms as possible.
What is a good DPO (Days Payable Outstanding)?
DPO should match or slightly exceed your payment terms. If you have Net 30 terms with vendors, a DPO of 28-32 days is appropriate. Higher DPO improves cash flow but can strain vendor relationships. Lower DPO means you're paying early and not using your full terms.
When should we automate AP and AR?
Consider automation when you're processing 50+ invoices per month (either direction), spending significant time on manual entry, experiencing errors or delays, or having trouble tracking aging. At that volume, automation typically pays for itself in 3-6 months through time savings and reduced errors.
How do AP and AR affect cash flow?
AP and AR are your primary working capital levers. Collecting AR faster brings cash in sooner. Paying AP slower keeps cash longer. The difference between when you collect and when you pay is your "cash conversion cycle." Shorter cycles mean better cash flow; longer cycles require more working capital financing.
Need Help Optimizing AP & AR?
Eagle Rock CFO helps growing companies optimize working capital operations. From process design to automation selection to outsourcing decisions, we help you collect faster and pay smarter.
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