Accounts Payable (AP): Understanding Short-term Financial Obligations
Accounts payable (AP), often called “payables,” represent a company’s short-term obligations owed to its creditors or suppliers that have not yet been paid. These appear on a company’s balance sheet as a current liability.
AP, on another level, can also refer to the department or division within a business responsible for managing the payments owed by the company to suppliers and other creditors.
Accounts payable can be easily compared to accounts receivable.
Key Takeaways
- Accounts payable (AP) are amounts due to vendors or suppliers for goods or services received that have not yet been paid for.
- The sum of all outstanding amounts owed to vendors is shown as the accounts payable balance on the company’s balance sheet.
- Changes in the total AP from the prior period appear on the cash flow statement.
- Management may choose to pay outstanding bills close to their due dates to improve cash flow.
Delving Deeper into Accounts Payable (AP)
A company’s total accounts payable balance at any given moment will appear on its balance sheet under the current liabilities section. AP is essentially a short-term IOU from one business to another. The counterparty would record this as an increase in its accounts receivable.
An increase in AP over time usually indicates a company is buying more on credit, while a decrease indicates a company is settling its outstanding credit faster than it is making new purchases. This makes AP a crucial element in managing a business’s cash flow.
In the indirect method for preparing the cash flow statement, the net increase or decrease in AP from the prior period appears in the section covering cash flow from operating activities. Management can leverage AP to control the company’s cash flow to a certain extent. For example, if recovery of cash reserves for a particular period is needed, management can delay payment of AP.
However, it’s always crucial to weigh this tactic against maintaining good vendor relationships and adhering to payment terms.
Recording Accounts Payable
Proper double-entry bookkeeping dictates that all ledger entries must include an offsetting debit and credit. To record accounts payable, the accountant credits AP when the bill or invoice is received. The corresponding debit generally goes to an expense account for the goods or services that were purchased. In certain cases, the debit might go to an asset account.
For instance, suppose a business receives a $500 invoice for office supplies. Upon receipt, the AP department records a $500 credit in accounts payable and a $500 debit to office supply expense. When the bill is paid, the accountant credits the cash account and debits accounts payable, balancing the ledger.
A company may have numerous payments due to various vendors at any one time, all recorded in AP.Individual line items provide an understanding of what the company owes.
Accounts Payable vs. Trade Payables
People often use ‘accounts payable’ and ’trade payables’ interchangeably, referring to similar but somewhat different scenarios. Trade payables are amounts owed for inventory-related goods. Conversely, accounts payable encompasses all short-term obligations.
For instance, a restaurant’s payable for received food and beverages falls under trade payables, while cleaning services for staff uniforms fall under accounts payable. Both come under the broader umbrella of accounts payable.
Accounts Payable vs. Accounts Receivable
Accounts receivable (AR) and AP are opposite dynamics. AR represents funds that customers owe to the company, while AP refers to what the company owes its vendors. When companies transact on credit, AP emerges on one’s books, while AR appears on the other’s books.
Real-World Examples of Payables
A payable arises whenever a firm owes money for given services or products not yet paid for, whether it’s a vendor purchase on credit or installments due post-delivery.
Locating Accounts Payable on Financial Statements
AP is listed under a firm’s balance sheet as a current liability, indicating money owed to others.
Differentiating Payables and Receivables
Receivables are logged as assets for owed services payable soon afterward, catering to services rendered. Payables represent funds owed to suppliers and appear as liabilities.
Are Accounts Payable Considered Business Expenses?
No. Despite a common belief, AP does not lump routine business expenses under themselves. Expenses populate the income statement, while payables are insured on the balance sheet.
The Bottom Line: Managing AP is Key
Accounts payable underscore company obligations pressed for resolution within the short term. Appearing on the balance sheet, they typically cover supplier invoices, legal fees, contractor payments, etc.
Related Terms: Accounts Receivable, Balance Sheet, Current Liabilities, Cash Flow Statement, Accrual Accounting, Double-entry Bookkeeping.
