What is Accounts Payable?

Accounts payable is the aggregate amount of one's short-term obligations to pay suppliers for products and services that were purchased on credit. If accounts payable are not paid within the payment terms agreed to with the supplier, the payables are considered to be in default, which may trigger a penalty or interest payment, or the revocation or curtailment of additional credit from the supplier. The term can also refer to the department that processes payables.

Accounts payable are considered a source of cash, since they represent funds being borrowed from suppliers. When accounts payable are paid, this is a use of cash. Given these cash flow considerations, suppliers have a natural inclination to push for shorter payment terms, while creditors want to lengthen the payment terms. When a business is short on cash, management frequently mandates that the payment of accounts payable be delayed, since this represents a no-interest loan from suppliers.

Accounts Payable Turnover

Accounts payable turnover is a ratio that measures the speed with which a company pays its suppliers. If the turnover ratio declines from one period to the next, this indicates that the company is paying its suppliers more slowly, and may be an indicator of worsening financial condition. A change in the turnover ratio can also indicate altered payment terms with suppliers, though this rarely has more than a slight impact on the ratio. If a company is paying its suppliers very quickly, it may mean that the suppliers are demanding fast payment terms, or that the company is taking advantage of early payment discounts.

To calculate the accounts payable turnover ratio, summarize all purchases from suppliers during the measurement period and divide by the average amount of accounts payable during that period. The formula is:

Total supplier purchases ÷ ((Beginning accounts payable + Ending accounts payable) / 2)

The formula can be modified to exclude cash payments to suppliers, since the numerator should include only purchases on credit from suppliers.

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Accounting for Accounts Payable

The normal accounting for accounts payable is to debit either the expense or asset account associated with a purchase, and credit the accounts payable account (which is a liability account). When the liability is paid, the entry is a debit to the accounts payable account (thereby eliminating the liability) and a credit to the cash account (reducing the balance in that account). This accounting is used in a double-entry bookkeeping system.

When individual accounts payable are recorded, this may be done in a payables subledger, thereby keeping a large number of individual transactions from cluttering up the general ledger. Alternatively, if there are few payables, they may be recorded directly in the general ledger. Accounts payable appears within the current liability section of an entity's balance sheet.

Examples of Accounts Payable

An account payable is generated whenever a supplier renders services or delivers goods for which payment is not immediately made in cash. Examples of these transactions are the delivery of goods to a company’s warehouse for resale, or the provision of office supplies, or the liability incurred when a magazine subscription is initiated, or when a business enters into a rent agreement, or when the local utility provides electricity to a business. Other types of payables that are not considered accounts payable are wages payable and notes payable.

Accounts Payable Procedure

From a management perspective, it is of some importance to have accurate accounts payable records, so that suppliers are paid on time and liabilities are recorded in full and within the correct time periods. Otherwise, suppliers will be less inclined to grant credit, and the financial results of a business may be incorrect. This means that accounts payable must be processed exactly in accordance with a strict procedure that is followed in exactly the same way, every time. This procedure includes the activities noted below.

Step 1. Receive the Supplier Billing

All supplier invoices are immediately routed to the payables department as soon as they are received. This can be a difficult processing step, since invoices might have been sent to the person authorizing a purchase, or perhaps to a subsidiary. In either case, there must be a firm requirement for the recipient to immediately forward the invoice to the payables department. A particular concern is when invoices are sent to people who no longer work for the company - perhaps by email; if so, it may take repeated inquiries from the supplier before the invoice is found.

Step 2. Review Billing Details

Each received invoice should be examined to verify whether the company actually owes the indicated amount, as well as to determine whether it contains the correct unit quantities, unit prices, and payment date. If not, the payables department must contact the supplier to request that a corrected invoice be sent. The department may also compare the invoice to the authorizing purchase order to ensure that the delivery was authorized, and compare it to receiving documentation to ensure that the billed amounts were actually received. Also, depending on the company’s approval threshold, it may be necessary to obtain a supervisor’s approval before an invoice can be paid.

Step 3. Update Accounting Records

Once the preceding step has been completed, the invoice is recorded in the company’s accounting system, using the invoice date as the entry date. The payment date is based on the invoice date. For example, if an invoice has a date of September 1 and should be paid in 30 days, then it is logged in as of September 1, so that the accounting system will pay it on September 30.

Step 4. Pay Suppliers

On each scheduled payment date, the accountant runs a preliminary check register and reviews it to ensure that all stated payments should be made. If not, they are flagged to be paid at a later date. The remaining payments are made, using either checks or electronic payments. Depending on the controls used, these payments may need to be approved before they are issued.

Presentation of Accounts Payable

Accounts payable are nearly always classified as current liabilities. This is because they are generally due for payment within a short period of time, such as 30 days from the invoice date. Consequently, accounts payable normally appears near the top of the liabilities section of the balance sheet, typically as the first line item presented. In those rare cases in which an account payable is not due for payment for more than a year, it is instead classified as a long-term liability, and so is presented lower in the balance sheet, between the current liabilities section and the equity section. A sample presentation of accounts payable appears in the following exhibit, which contains a balance sheet.

Accounts Payable Best Practices

There are multiple ways to improve the operation of an accounts payable process. One is to require all new suppliers to fill out a Form W-9 before they are initially paid. This is the only point at which the company has leverage over them to obtain the form, so that it can issue a Form 1099 following the end of the year. Another best practice is to immediately load all received supplier invoices into the accounting system and then obtain manager approval; this approach ensures that supplier payments will not be delayed, thereby avoiding supplier complaints. Another best practice is to use negative approvals, where managers are assumed to have approved each invoice unless they state otherwise; doing so reduces the effort required to obtain manager approvals for invoices. Yet another best practice is to make electronic payments, thereby streamlining the payment process; printing and mailing checks is less efficient. All of these best practices are intended to improve the efficiency of the payables process.

Trade Payables vs. Non-Trade Payables

A trade payable is an amount billed to a company by its suppliers for goods delivered to or services consumed by the company in the ordinary course of business. These billed amounts, if paid on credit, are entered in the accounts payable module of a company's accounting software, after which they appear in the accounts payable aging report until they are paid. Any amounts owed to suppliers that are immediately paid in cash are not considered to be trade payables, since they are no longer a liability. Non-trade payables, such as accrued expenses, dividends payable, or wages payable, are recorded in other accounts in order to more easily identify them.

A key difference between trade payables and non-trade payables is that trade payables are typically entered into the accounting system through a special accounts payable module that automatically generates the necessary accounting entries, whereas non-trade payables are typically entered in the system with a journal entry.

Accounts Payable vs. Accounts Receivable

The reverse of accounts payable is accounts receivable, which are short-term obligations payable to a company by its customers. The essential difference between the two is that accounts payable represent the short-term obligations of a business to its suppliers, while accounts receivable represent the short-term obligations of customers to the business. Another difference is that accounts payable is classified as a short-term liability, while accounts receivable is classified as a short-term asset. Also, an account payable is recorded with a credit to the accounts payable account, while an account receivable is recorded with a debit to the accounts receivable account.

Is Accounts Payable a Business Expense?

Accounts payable is all current liabilities owed to suppliers and other parties. As such, accounts payable is a liability account; it is not a business expense. Because of this difference, accounts payable is stated as a line item in the current liabilities section of the balance sheet, while business expenses are contained within multiple line items on the income statement.