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What is Accounts Payable?

Accounts payable is a line item that companies report in the balance sheet under current liabilities. It represents a company’s obligation to pay the short-term debt it owes to suppliers for goods or services purchased to run its operations, where they have received an invoice. A company will have several suppliers, so it will report the total amount outstanding in accounts payable.

The movement of accounts payable from the previous period to the reported one will appear in the cash flow statement. An increase from the previous period means that a company has bought more goods or services on credit, instead of paying cash. A decrease depicts that a company has paid its outstanding supplier invoices at a faster rate than it has accumulated new ones.

Managing the accounts payable account is important to a business to ensure healthy cash flow. Accounts payable differ from notes payable, which are debts created by formal legal documents. IFRS companies often refer to accounts payable as trade payables.

Example

When a business receives an invoice from its supplier for goods or services purchased, the accountant will credit it to accounts payable so that the short-term liability reflects and will debit an expense to offset the entry.

If a business received an invoice from its cleaning materials supplier for $100, the entry would look as follows:

Purchase of cleaning materials on credit Assets L&E
Cleaning Materials

100.0

 Accounts Payables

100.0

Once the business has paid the creditor, the entry would be:

Payment of invoice Assets L&E
Cash

(100.0)

 Accounts Payable

(100.0)

 

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Points To Note

  • Cleaning materials is an expense reported through the income statement so retained earnings decrease and accounts payable increases, balancing the balance sheet.
  • Cash decreases when the company pays the creditor.
  • The key difference between accounts payable and accruals is that the company has received an invoice, so they are 100% certain of the liability, as opposed to an estimate with an accrual.

Below is an extract from The Hershey Company Balance Sheet at 12/31/2019:

Key Ratio

  • Payable Days Ratio – Measures the number of days a business takes to pay its creditors. In other words, it measures the average time cycle for payments to creditors in days.

Example

Company A reported the following items:

Day 1 Accounts Payable

300.0
Day 30 Accounts Payable

350.0
All Year Purchases

4000.0

All figures are in ($) thousands

Total Payables Turnover =

Total purchases / ((Beginning AP + Ending AP) / 2)

$4,000,000.0 / (($300,000.0 + $350,000.0) / 2) = 12.3

Average Payable Days =

365 / TAPT

365 / 12.3 = 30 days

Points To Note

  • Companies need to use the total purchases for the year when calculating total payables turnover, not just cost of goods sold.
  • The above example shows that Company A pays creditors within 30 days of invoice.
  • Companies who take too long to pay creditors risk jeopardizing their relationship and may forfeit credit terms.
  • Companies who pay creditors too soon might have cash flow issues.

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