Accounts Payable (AP) is a short-term obligation and is owed to your creditors.  You could also think of AP as a bill that your business needs to pay in the near future.  This includes your suppliers, creditors, subscription fees, utility bills, and tax obligations.

 

How does it work?

Let’s say your business has ordered materials goods from your supplier.  Your supplier then issues you an invoice for those materials or goods.  Your accountant will record this invoice under accounts payable.  Your supplier will record this invoice under their accounts receivable.  

Before or on the invoice due date, you are required to pay this invoice to avoid any potential late payment penalties.  Once the invoice is paid, the record will then be removed from AP and is no longer a liability on your balance sheet.

 

How do you analyse Accounts Payable

AP sits under the current liabilities section of your company’s balance sheet.  It can give you an insight into your company’s financial performance. 

If it increases over the previous period, this means you may have incurred more expenses or purchased stock that you have yet to pay for.  Larger orders put to your suppliers or purchases made on credit is also a contributor to an increase in Accounts Payable. 

If AP has decreased when compared to the previous period, this means the company is paying off its obligations at a faster rate than purchasing goods on credit. 

 

Accounts Payable Turnover Ratio

Accounts Payable Turnover Ratio can be used to calculate how fast a business is paying off its creditors and whether it has sufficient cash flow to meet its short-term obligations.

AP Turnover Ratio = Total supply purchases / ((Beginning accounts payable + Ending account payable) / 2)

A decrease in AP Turnover Ratio indicates a slower rate of paying debt.  This means the business is taking longer to pay off its debts which could be a bad sign.  But on the brighter side, it could also mean that the company has managed to extend its payable terms with its supplier.

An increase in AP Turnover Ratio indicates a faster rate of paying debt, a sign of effective debt management.  However, too fast means the business is not using available cash to reinvest in the business which could result in slower growth. 

 

Who carries out the Accounts Payable function?

In a larger company, there will be a dedicated Accounts Payable team who manages incoming invoices and to ensure payments are made on time.  They could also be negotiating better terms and discounts with suppliers.

The Accounts Payable team is also responsible for managing a section of the company’s cash flow by

  • Making sure the cash flow forecast stays accurate.
  • Managing the company’s cash reserve by extending payment terms with suppliers.

 

 

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