Bookkeeping 101: What is accounts payable?

Accounts payable is central to bookkeeping. It helps small business owners determine to whom they’ll pay debts, and it’s also helpful in noting the amounts on your balance sheet.

While you may think accounts payable only refer to short-term debt, there are some valuable things you should know. Continue reading to learn important things you should know about accounts payable as a business owner.

What is Accounts Payable?

Accounts payable represent the debts owed to vendors and suppliers for services and goods sold. In essence, accounts payable encompass the outstanding payments awaiting settlement, acting as a vital component of your business's financial obligations.

Accounts Payable vs. Accounts Receivable

Accounts payable differs from accounts receivable in a significant way: accounts payable is a liability, but accounts receivable is an asset. 

Accounts Payable vs. Trade Payables

While accounts payable and trade payables are similar, there are distinct differences between the two terms. 

Trade payables are also liabilities but for different purposes. Trade payables comprise money a company owes to its vendors for inventory-based goods. These goods are ready to sell or materials used to make goods that are also ready to sell. 

You can list trade payables as current liabilities or long-term liabilities, but you can only list accounts payable as a current liability. 

Where to Find Accounts Payable

You’ll find accounts payable in the general ledger, and you’ll also find accounts payable on the balance sheet.

You’ll find accounts payable as a current liability on the balance sheet, which is what a business owes but has yet to pay.

Accounts Payable Process

The accounts payable process has five steps:

  1. Create the Purchase Order

The first step of the AP process begins with the purchase order, a document that signals your intent to acquire goods or services from a vendor. It will outline the details of the transaction, including quantities, prices, and delivery terms.

  1.  Acquire Assets

Next, the assets arrive. Once they arrive, inspect them with a discerning eye. Ensure they meet your expectations and match the details specified in the purchase order. 

  1. Evaluate Vendor Invoice 

You will then receive an invoice that will request vendor payment. The vendor invoice contains information regarding the services or goods sold, their respective costs, payment terms, and contact info. Pay attention to their details.

  1. Process Vendor Invoice

Enter the realm of invoice processing, a meticulous dance of scrutiny and accuracy. Invoice processing consists of validating the invoice against the purchase order and receipts. Check for discrepancies and resolve any issues promptly, for accuracy.

  1. Approve and Pay

Once the invoice is verified and approved, it's time to make the much-anticipated payment. Update your records and prepare your resources, be it checks, electronic payments, or direct deposit. Fulfill your financial obligations, ensuring timely and accurate invoice payments to maintain healthy vendor relationships. After making the vendor payment, you’ll record how the debit decreased the liability by the amount paid.

Accounts Payable Turnover Ratio

The accounts payable turnover ratio is a ratio used to show how frequently a company pays its accounts payable. This ratio can decrease or increase over a period, with different meanings in both cases.

Decreasing accounts payable turnover ratio shows that a small business: 

  • Has or is working with different payment arrangements with suppliers
  • Is taking longer to pay off its suppliers compared to previous periods
  • Is or may be in financial distress
  • Increasing accounts payable turnover ratio shows that a small business: 

  • Has enough working capital to pay off its debts
  • Has effective debt and cash flow management 
  • Is paying off suppliers at a faster pace compared to previous periods
  • While an increasing accounts payable turnover appears to be a great sign, there are other things you’ll need to know about this ratio. Short-term increasing turnover ratios are a good indicator that a small business can sustain its financial stability. 

    However, if a small business has an increasing turnover ratio for several periods, it could have some consequences. Small businesses in this situation may not be reinvesting their funding back into their businesses. This may cause a small business to have a lower growth rate and fewer earnings over time.

    AP Aging Schedule

    Aging schedules help small businesses see their accounts payable in a more detailed manner. Small businesses can organize the accounts from:

  • 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 
  • How to Handle Accounts Payable

    There are a few ways to handle accounts payable for the best results.

    Use Electronic Invoicing

    Electronic invoicing (also known as e-invoicing) is a way that you can send bills online rather than sending paper-based invoices. By using electronic invoicing, you’ll have a few advantages: 

  • You can print or reproduce e-invoices when needed
  • You can receive or send e-invoices faster for business use and data collection purposes
  • You’ll be able to search and sort for dates, names, and terms within invoices
  • Have a Buffer

    A buffer in your accounts payable serves as an emergency fund, but for accounts payable. Having money on hand to pay for accounts payable will ensure you don’t have any late payments.

    Log into Your Calendar

    Finally, you’ll want to log in the payment information into a calendar. This will ensure that you won’t forget the due dates and the amount paid.

    You’ll want to make notes of the details, such as when a payment is due, to whom it is due, and when it’s due.

    Is Accounts Payable an Expense?

    Accounts payable isn’t an expense. Accounts payable is a liability, which is what a small business owes but hasn’t paid. 

    Expenses are costs a small business pays to create revenue.

    The Importance of Accounts Payable

    There are several benefits of accounts payable that you should be aware of: 

  • Maintains Cash Flow – Accounts payable play a crucial role in your cash flow statement. By carefully monitoring your payables and adhering to payment terms, you strike a harmonious balance between cash outflows and inflows, ensuring the financial vitality of your enterprise.
  • Builds Strong Vendor Relationships – By diligently managing your accounts payable, you foster trust, reliability, and mutually beneficial partnerships with your vendors. Timely payments, clear communication, and a dash of appreciation create a harmonious symphony of collaboration and prosperity.
  • Creates Accurate Financial Statements – Financial statements rely on accurate accounts payable data. By maintaining precise records, you ensure the credibility and transparency of your financial statements. These documents provide insights for making informed decisions and attracting potential investors.
  • Let Us Help You with Your Bookkeeping Needs

    While operating a small business has a lot of needs, it shouldn’t be stressful. We’re here to help you with bookkeeping for small businesses. Work with a small business tax accountant from 1-800Accountant to make sure your bookkeeping needs are handled accurately. 

    This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. 1-800Accountant assumes no liability for actions taken in reliance upon the information contained herein.