What are accounts payable?
Accounts payable are funds you owe others—they sent you an invoice that is still “payable” by you.
Accounts payable are usually due within 30 days, and are recorded as a short-term liability on your company’s balance sheet.
Only accrual basis accounting recognizes accounts payable (in contrast to cash basis accounting).
Where do I find accounts payable?
You can find accounts payable under the ‘current liabilities’ section on your balance sheet or chart of accounts. Accounts payable are different from other current liabilities like short-term loans, accruals, proposed dividends and bills of exchange payable.
What’s the difference between accounts payable and accounts receivable?
Accounts payable are a liability account, representing money you owe your suppliers. Accounts receivable on the other hand are an asset account, representing money that your customers owe you.
Let’s say a fictional business called Paint World sends you an invoice for $500 to pay for a shipment of paint.
When you get the invoice, you’ll record it as an account payable in your books, because it’s money you have to pay someone else.
Keith’s Furniture will record it as an account receivable on their end, because it represents money they will receive from someone else in the future.
Are accounts payable an expense?
Accounts payable is a liability account, not an expense account. However, under accrual accounting, the expense associated with an account payable is recorded at the same time that the account payable is recorded.
(If you want to understand why someone would record one transaction with two accounting entries, check out our guide to double-entry accounting.)
Why should I pay attention to my accounts payable?
Keeping track of your debts and making sure you’re paying them back on time isn’t just important for maintaining good relationships with your suppliers. It can also literally save you money.
Many vendors offer discounts to buyers who settle their accounts payable early. For example, a vendor might ask you to pay an invoice within 30 days, and then offer you a 2 percent discount if you pay within 15 days.
For example, let’s say that on July 10, 2019, you order $500 in paint from Paint World. On that day, you make the following journal entry in your books:
|Accounts Payable—Paint World||-||$500|
Let’s say that on the invoice they sent you, Paint World offers you a 2 percent discount for paying within 15 days. To take advantage of it, you end up paying them exactly one week later, on July 17, 2019.
That day, you would make the following entry to record three things:
the discount you’re eligible for because you paid early (500 * 2% = $10)
the cash payment you made to Paint World ($490)
the closing out of the account payable for Paint World (debit $500)
|Accounts Payable—Paint World||$500||-|
What happens if I can’t pay?
According to Generally Accepted Accounting Principles (GAAP), accounts payable are supposed to be current liabilities, i.e. liabilities that you plan to pay back within a year.
But what happens when you can’t pay an account payable back in the short term?
If you’re super behind on a payment but have an otherwise good relationship with the vendor you owe money to, they might agree to reclassify the account payable as a long-term note. Long-term notes are due in 12 months or more, and usually involve some kind of interest payment.
What is the accounts payable turnover ratio?
The accounts payable turnover ratio is a simple financial calculation that shows you how fast a business is paying its bills. We calculate it by dividing total supplier purchases by average accounts payable.
Let’s say you’re considering doing business with a fictional company called XYZ Inc. You just had a bad experience with another vendor who paid you very late, so you’re super careful about bringing on new vendors now.
As it turns out, XYZ Inc. is a transparent company. They hand you their financials for the year 2018 to prove to you that they’re fast at paying bills. Which numbers should you look at?
Let’s say that at the beginning of 2018 (Jan 1), XYZ Inc. had total accounts payable of $3,200. Let’s also say that at the end of 2018 (Dec 31) its total accounts payable was $2,600. It also had total supplier purchases of $48,000 for 2018.
To get the average accounts payable for XYZ Inc. for that year, we add the beginning and ending accounts payable amounts and divide them by two:
$3,200 + $2,600 / 2 = $2,900
To calculate the accounts payable turnover ratio, we then divide total supplier purchases ($48,000) by average accounts payable ($2,900):
$48,000 / $2,900 = 16.55
In this case, XYZ Inc. has an accounts payable turnover ratio of 16.55. The higher this ratio is, the faster a company is at paying its bills.
To calculate the average payment period—the average time that it takes a company to pay its suppliers—we divide 52 (the number of weeks in one year) by the accounts payable turnover ratio (16.55):
52 weeks / 16.55 = 3.14 weeks
This means that in 2018, it took XYZ Inc. an average of 3.14 weeks to pay their bills. If that sounds like an acceptable payment period to you, you should go ahead and start doing business with them!
What is an accounts payable aging schedule?
If you have many suppliers and lots of different accounts payable, it can get difficult to remember exactly who you owe what. Some businesses will create an accounts payable aging schedule to help keep track.
Here’s an example accounts payable aging schedule for the fictional company XYZ Inc.
Accounts Payable Aging Schedule
XYZ Inc., as of July 22, 2019
|Supplier Name||1-30 days||30-60 days||60+||Total|
|Keith’s Furniture Inc.||$500||$0||$0||$500|
|Dot Matrix Printing||$2,000||$500||$500||$3,000|
|Forest Paint Supply||$480||$0||$0||$480|
This schedule is useful because it immediately shows you which suppliers XYZ Inc. is on track to pay back within 30 days, which late payments it should start worrying about, and which payments it’s really behind on.
For example, the Dot Matrix Printing accounts payable look a little dicey. Suppliers don’t normally wait more than 60 days to get paid, but XYZ has one account payable with Dot Matrix that is more than 60 days old. It should double check with Dot Matrix to make sure the payment isn’t overdue and accruing late charges.
More ways to stay on top of accounts payable
Not paying an invoice because you forgot about or misplaced it can put a serious dent in your relationship with a supplier. To make sure that never happens, take the following steps:
Many vendors offer electronic invoicing and payment options—take them up on that offer. Electronic invoices are easier to store, searchable, and easier to import into your accounting software. Electronic payments are easier to send, automatically leave a paper trail, and are automatable.
If anyone ever sends you a physical invoice, scan it and make sure it’s with all of your other documents. The better you are at keeping all of your accounts payable documents in one place, the less likely you are to forget about one of them. Going paperless is one of the best ways to do this.
Put them into your calendar
The moment you see a due date on an invoice from a supplier, put it into your calendar and schedule a reminder. If you use a payment system that takes a few days to process, make sure to schedule the reminder before the due date.
Have a financial buffer
There’s no bigger incentive to forget about an invoice than not having the money to pay for it. If you can, make sure you have at least enough cash on hand to pay for a few months of accounts payable. Need help planning your future cash flow? Check out our Cash Flow Forecast guide and template.
Use purchase orders
Purchase orders are like invoices that a buyer sells to the vendor. They give you legal protection in supplier disputes, help you avoid audit problems, make life easier for your vendors, and they’re the single most effective tool that a business has to keep track of large and complex purchases.