It’s sometimes helpful to go back over the basics. Accounts payable (AP) is a big concern for any business that purchases goods and services, pay bills, or manages its credit. However, if you don’t know how they work or if they are an asset or a liability, it’s a smart idea to look deeper to learn about their impact on your financial reporting and working capital.
To answer the question is accounts payable a current liability requires basic knowledge of double-entry (also called accrual accounting), and your company’s financial statements. You can make more accurate financial statements and manage your cash flow better by understanding how accounts payable functions in your accounting system. This will help you ensure that your company meets its financial obligations.
What are accounts payable?
Accounts payable, in general, are the result of your business purchasing goods or services from vendors on credit instead of cash. On their balance sheets, purchasers list accounts payable as current liabilities. These are financial claims against company assets. These are short-term obligations with a clear due date, which is usually 90 days or less but can last up to a year. One type of account that is payable is Trade payables.
Payments made in cash and not credit is not trade payables. Because AP is a relationship between a debtor/creditor, it requires that you negotiate terms and conditions with the supplier/debtor.
These terms include the amount you will pay and how long you must pay it. A major supplier might offer 90-day terms for large quantities of raw materials and components at a high price. An office supply store or local luncheonette might offer 15-day or 30-day terms for smaller purchases.
They are different from assets and other liabilities such as:
- Long-term liabilities
- Payable dividends
- Income taxes
- Payroll taxes
- Unearned revenue
Why accounts payable are important?
For your business’ strategic and competitive success, it is essential that you have accurate and clear accounts payable entries. Every account payable journal entry has a direct impact upon working capital (current assets and current liabilities).
To assess an organization’s ability and ability to meet its short-term financial obligations, creditors, auditors, or companies themselves use two other metrics, Accounts payable Turnover and Day Payable Outstanding (DPO).
- APT refers to a frequency indicator that measures how often a company pays its creditors, vendors, and service providers each accounting period. It’s the ratio of your cost-of-goods sold (COGS), to accounts payable. High APT can indicate that a company is having difficulty finding credit or not making the most of the money they have. Low APT could indicate that the company has not paid its bills on time or is being granted extremely favorable credit terms.
- DPO refers to a duration measure that shows how long it takes for a supplier to pay you. This is calculated by multiplying the number of days by APT. Your company’s DPO values are less than the speed and efficiency with which it meets its short-term obligations.
If you don’t have accurate information about each account payable, your creditworthiness, ability to manage cash flows properly for investments and unexpected expenses, as well as your reputation for being a bad debtor, could all be at risk?
Sample Journal Entry for Accounts Payable
Let’s suppose that Company A has bought office supplies worth $1,000 from Company B using credit.
This is how bookkeeping looks:
- Your accounting department creates an entry in a debit journal for the office supplies expense account, amounting to $1,000
- Your accounting department creates simultaneously a credit journal entry for accounts payable in the amount of $1,000.
- Paying off the debt with a corporate credit card a few days later will reverse the entries.
- Your accounting department creates an entry in your credit journal for $1,000 cash.
- The accounting department creates simultaneously a debit journal entry to the Company B account payable.
- This will reconcile the debt and take it out of the books.
Note: Companies may also use accounts payable for the purchase of equipment, property, and other assets. In this situation, your accounts team would debit an asset account, rather than an expense account.
It can be a great asset to manage your liabilities effectively
It doesn’t need to be hard to keep track of current liabilities for your company. Understanding the importance of accounts payable to your business will help you to create accurate financial statements, improve your ability to manage working capital, and build a good reputation with suppliers.