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.
Key Learning Points
- Accounts payable is a current liability which represents amounts owed to suppliers for goods and services where an invoice has been received
- If an item is purchased on credit then the accounts payable balance will increase, this impacts net income but has no impact on cash balances
- When a company receives an invoice, they are 100% certain of the liability
- An accrual is an estimated amount where no invoice has been received
- Payable days measures the number of days a business takes to pay its creditors
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.
A business receives an invoice from its inventory supplier for $1000. How will this transaction impact the balance sheet?
Points to Note
- Inventory represents the purchase price of goods held for resale and is reported as a current asset
- 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
- 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.
Company A reported the following items and we are asked to calculate two key ratios:
Total Account Payables Turnover (TAPT) = Total purchases / ((Beginning AP + Ending AP) / 2)
Average Payable Days = 365 / TAPT
The calculation becomes:
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 the invoice (after rounding)
- 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