What is Accounts Payable? Definition & Examples

Accounting
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Fincent Team

As a small creative business, you partner with several vendors - be it to receive essential supplies that support your company or services that help streamline operations. Without these valued partnerships, running your business efficiently can be a struggle.

An important aspect of maintaining these relationships is to ensure that your vendors have paid their dues on time. Sometimes payments made earlier than the due date also come with some benefits.

Ensuring that your AP are released on time is important for your business's integrity and positive financial health. If you are wondering what accounts payable is, this simple guide can address all your queries.

What Is Accounts Payable?

Accounts Payable is the term used to denote the amount in payment owed by your business to your vendors, i.e., the suppliers of goods or services received.

It is the total outstanding amount that is yet to be paid to vendors, and it is typically shown as the "accounts payable balance" on the business's balance sheet. This is a liability account, not an expense account.

Vendors send you an invoice for their services, and once the dues are settled, these amounts appear on the cash flow statement. Typically, AP must be settled within 30 days.

Accounts Payable vs. Accounts Receivable

Let's look at the main difference between accounts payable and accounts receivable:

Accounts payable is when you owe your vendor for their products or services. For example, you purchased new laptops for your team from your tech supplier, and they send you an invoice for $1,500. This amount will reflect as AP on your account books.  

On the other hand, accounts receivable refers to the amount that is owed to you by customers and clients.

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Let's assume you run a stationery business and send your customer an invoice of $350. This amount would appear in the AR section of your account books. It would, however, appear in the AP section of your customer's books, as they owe this amount to you.

Why You Need to Be on Top of Accounts Payable

Being on top of accounts, in general, is great for the financial health of your business. However, keeping track of accounts payable is especially important. Not doing so comes with risks, while paying in advance can come with some benefits!

If you miss the payment due date, some vendors levy an interest. However, if you have a good relationship with your suppliers, they may be understanding. The key is to not abuse this trust.

But paying off AP early presents some financial perks, too. Some vendors offer discounts to customers who pay their dues in advance.

For example, a supplier might offer a 2.5% discount if you settle accounts payable in 10 days. If the invoice amount is $1,500 and you pay in 10 days, then you save $37.5.

Availing several discounts can amount to quite a pile. This is a great opportunity to save money and channelize it towards a marketing campaign or some new equipment you have been eyeing for your business.

What If You Are Unable to Pay?

You might be behind on payments for a variety of reasons - business might be slow, or a major shipment may be delayed.

If this is the case, it's a good idea to have a backup plan so that your relationship with the vendor does not go sour or result in an increased interest rate beyond your control.

The Financial Accounting Standards Board has established a set of guidelines known as the Generally Accepted Accounting Principles (GAAP), which recommends that businesses design a plan to make payments within a year.

You can request your vendor to reclassify accounts payable as a long-term note, which means it is due in 12 months or more. Usually, long-term notes are accompanied by interest, but it's best to talk to your supplier and come to an agreement.

If you're struggling to figure out a plan that honors the framework of the long-term notes, Fincent's team of expert bookkeepers can help out.

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Review Accounts Payable Turnover Ratio

A great way to interpret a company's financial health is to review its accounts payable turnover ratio. This entails measuring the average number of times a business pays its AP over the accounting basics period.

Here's a simple formula that indicates the track record of your business in settling AP:

Accounts Payable Turnover Ratio = Total Supplier Purchases / Average Accounts Payable

The average accounts payable can be derived by adding the starting and ending accounts payable over a period of time, divided by 2.

If you are looking to hire a potential vendor, you can give them access to your financials, especially if you have a positive AP turnover ratio. Every vendor wants to be paid on time, and it could help you close a new partnership faster.

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Put an Accounts Payable Aging Schedule in Place

To help keep track of various accounts payable, many businesses set up an AP aging schedule, which classifies accounts into five stages:

  • Current (under 30 days)
  • 1-30 days past due
  • 30-60 days past due
  • 60-90 days past due
  • More than 90 days past due

Businesses typically leverage aging schedules to keep track of which invoices need to be prioritized and settled first. It's always a good idea to have more accounts payable in the 'current' bracket so that you get the benefit of discounts and avoid massive interest rates.

Best Practices for Managing Accounts Payable

Committing to some amount of discipline, building positive financial habits, and leveraging technology can collectively help improve your AP ratio and build positive relationships with all your suppliers and vendors.

Here are some proven methods to follow so you can manage your business's accounts payable:

  • Schedule Every Payment: Setting digital reminders is a great way to ensure that you never miss a payment!
  • Centralize Invoices: Make the shift from paper invoices to e-invoices, as these can be digitized and imported into your accounting software. They are easier to keep track of and do not get lost.
  • Build an Emergency Fund: Sometimes, cash flow can be a problem due to unforeseen circumstances. It's a good idea to put some buffer money away when the going is good, to compensate for times when you are unable to process your accounts payable.
  • Double-Check for Duplicate Payments: Before releasing a payment, make sure you or someone from your team has not already paid. Some vendors are honest and will refund the money or adjust it against future purchases. But it's best not to duplicate payments.

The Takeaway

Once you get your accounts payable systems in place, you'll be able to focus on running your business with a lot more ease, sans the hassles of dealing with vendors who constantly follow up for payments.

To support you in this transition, you can also get assistance from Fincent, a professional bookkeeping service that caters to small creative partnerships. Discover how we take care of all your bookkeeping needs so you are free to grow your business.

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