When your company purchases goods on credit that need to be paid back in a short time, it is known as accounts payable. As a business owner, you have to pay a handful of bills each month, and thus accounts payable become an evil. It’s a source of money going out - instead of coming in, so it’s unpleasant to think about it.
In this article, we’ll take you through everything about accounts payable to provide better insight into what they are, how they affect your business, and how you manage them.
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What Are Accounts Payable (AP)?
Accounts Payable (AP) is a liability on a balance sheet that represents a company’s obligation to pay off a short-term debt to its creditors or suppliers. It is a short-term debt payment that needs to be paid within a given period to avoid default.
Understanding Accounts Payable
Accounts Payable come under the head's current liabilities on the balance sheet. If AP increases over a prior period, that means the company is buying more goods and services on credit, rather than paying cash. If AP decreases, it means the company is paying its prior period debts at a faster rate than it is purchasing new items on credit.
Accounts Payable is an important indicator that can be used to manage and sometimes manipulate a business’s cash flow to a certain extent. When preparing the cash flow statement, the net increase or decrease in AP AP from the prior period appears in the top section, the cash flow from operating activities. A company’s management can inflate its cash flow by delaying the recognition of funds leaving or extending the time to pay until the next period. In this way, they can increase cash reserves for a certain period. These are only short-term fixes, the company’s cash flow is actually reducing during the new period.
However, thus the flexibility to extend payments must be weighed against the ongoing relationships the company has with its vendors and creditors. It’s always good business practice to pay bills on time when they come on due dates.
How to Recording Accounts Payable
Proper double-entry bookkeeping always requires a debit and credit for all entries made into the general ledger. To record accounts payable, the accountant debit the assets or expense account to which related goods or services were purchased. Meanwhile, the accountant credits the accounts payable when bills or invoices are received.
For example, your business purchases office supplies for $500 on credit. When your bookkeepers receive the $500 invoice, they record a $500 credit in account payable and a $500 debit to office supply expense. The company records the purchase transaction even though cash has not been paid out. Then the company pays the bill on the due date, the bookkeepers enter a $500 credit to the cash account and a debit for $500 to accounts payable.
A company typically has to purchase goods and services or borrow money from a handful of vendors and creditors, so it has many open payments at one time. As a result, just take a quick look at the balance in accounts payable record, and you can see the total amount the business owes all of its vendors and short-term lenders.
Accounts Payable Process
Your business should implement the accounts payable process in place to streamline incoming bills and invoices. The AP process can be broken down into 7 steps. The steps mainly involve: Step 1: The company issues purchase orders to require any items from the supplier.
Step 2: The supplier receives the purchase order and delivery items to the company along with an invoice.
Step 3: The company receives items and inspects whether there are any defective goods.
Step 4: Then, based on the invoice received from the supplier, the company enters it into the book of accounts on the liability side. The way of recording invoices could differ from the company. While some companies manually track invoices, others use accounting software to record invoices. The less paperwork, the more beneficial the process.
Step 5: When the invoice is recorded, the account payable balance increases. The balance sheet is used to show the sum of all outstanding amounts whereas the increase or decrease amount of accounts payable from the prior period appears on the cash flow statement.
Recording the invoice also matches the purchase order and the item receipt.
Step 6: Now, the company could start the payment process by releasing payment and making payment
Step 7: At the end of a fiscal period, the account payable should be reconciled to ensure the process goes smoothly.
Accounts Payable vs. Accounts Receivable: Key Difference
Accounts payable and accounts receivable are two sides of the same coin, and they are both recorded in a company’s ledger. Whereas accounts payable represents money your business owes to suppliers and creditors, accounts receivable represents money owed to your business by customers.
Additionally, In your company balance sheet, accounts receivables are considered a current asset, whereas accounts payable are considered a current liability.
Accounts Payable | Accounts Receivable |
The money you owe to vendors | The money owed to your business |
Recorded as a current liability account on the balance sheet | Recorded as a current asset account on the balance sheet |
Lead to future cash outflows from a company | Lead to generate future cash inflows to a company |
How to handle accounts payable
Subconsciously (or maybe blatantly), all small business owners hate seeing money go out the door. However, there are some things you can do to make it sting a little less:
Ask about discounts for early payment or for outstanding payment history. Just like you want your customers to pay you on time and in full, your creditors want the same thing so they may be willing to offer an early payment discount. That’s a good thing to take advantage of in flush months. Additionally, some creditors will reduce interest rates or offer discounts for a certain number of payments made on time and in full. You’ll never know if you don’t ask.
Set up automated payments and alerts. Remember those “set it and forget it” infomercials? The same can apply to Accounts Payable (to an extent). Automatic or recurring payments are a great way to ensure that you never forget to send the check or log-in to your bank and allocate the money. And if you’re worried about how that impacts month-to-month cash flow management, set up recurring calendar alerts a few days prior to the bill due date and double-check that the account it draws from has the available cash.
Negotiate your terms. Many contracts come with standard terms, net 30 or net 60, but that doesn’t mean that your supplier won’t consider other options. After all, contracts are meant to be negotiated! So why would a vendor offer you alternative terms? Well think about it this way: they want to make a sale just as bad as you do. So if 10 additional days is the difference between making a sale and not, many vendors will be willing to negotiate. But be careful: negotiating terms could raise suspicion about your cash flow.
Be proactive. If you anticipate that you will have a problem paying a creditor down the line, approach them as early as you can. Discuss the issue with them instead of avoiding them. Not only is this the right thing to do, but it’s also your best way to start the discussion around new terms or a modified payment plan.
Pay down debts with high interest first. Say you have a great month and you have extra cash on hand. Use that opportunity to pay off high-interest debt. You will reduce the amount of cash going out the door to interest, which isn’t really helping your bottom line at all.
Managing your Accounts Payable efficiently and responsibly is great for your bottom line. Who knew that paying bills could feel so good?
We can help
Irvine Bookkeeping Services offer a finance and accounting solution to help small businesses save time, improve control and increase productivity by handling both invoice processing and payments. With our help, you have real-time insights into the entire accounts payable process to reduce the potential for lost bills for fraudulent payments. Get a Free Initial Consultation Here.
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