Last updated by
June 10, 2022
Accounts payable is a credit balance classified as a current liability in the liability section of a balance sheet.
The balance sheet is comprised of three sections: Assets, Liabilities and SHAREHOLDERS’ Equity.
Accounts payable is a credit balance classified as a current liability in the liability section of a balance sheet. The current classification is a designation of an amount that will be paid within 1 year or less. Typically accounts payable are payable within 30-60 days. Long-term liabilities have payment terms that extend beyond one year.
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Accounts payable is the amount of money owed to creditors, suppliers and vendors and is considered short term debt payable in 30-60 days as noted above. It represents obligations incurred during the normal operation of a business and includes bills and invoices for utilities, rent, insurance, internet, supplies and raw materials.
The accounts payable balance on the balance sheet is calculated by adding all unpaid invoices to arrive at a grand total. These unpaid invoices are recorded and tracked in a report called the accounts payable ledger.
A real-life example of accounts payable on an actual balance sheet may give you a better visual of how accounts payable fits into a company’s financial picture.
Below is a balance sheet example for Teddy Fab Inc. The balance sheet is a snapshot of the financial condition of a company at a point in time, in this example December 31, 2100.
You will notice the 3 sections ASSETS, LIABILITIES AND SHAREHOLDER’S’ EQUITY. Also notice assets and liabilities are subdivided into current and long term.
Assets are debit balances, liabilities and shareholder equity are credit balances. You will notice that total assets of $472,100 equals the total of liabilities and shareholder equity of $472,100. The total debits must always equal the total credits. Accounting is known as a double entry system and this is what keeps debits and credits balanced.
Assets are things you OWN that have value. Liabilities are things you OWE. Equity is what is left and is the book value of the company. But don’t be confused, the book value isn’t the market value of the business.
So, to locate the accounts payable balance look under the Liabilities and Shareholders’ Equity section and you will find the accounts payable balance of $30,000. The $30,000 is the amount Teddy Fab Inc owes to its suppliers and must be paid in 30-60 days.
Accounts payable is important as it impacts cash flow, borrowing costs, credit rating and attractiveness to investors. Because of these reasons, it is important to have an effective and efficient process to handle accounts payable.
Cash flow is the life blood of a company, failure to maintain accurate records will lead to poor decisions in spending cash. If accounts payable are understated you may overspend. If accounts payable are overstated it may lead to delay in payments.
Trust is developed with 3rd party institutions when accounts payable are managed properly. Banks are more likely to loan money or reduce borrowing costs, your credit rating will improve because you pay on time and your suppliers are more likely to sell their products and services to you on credit thus freeing up cash.
Maybe the best way to present this comparison is to show it in table format and list how accounts payable (AP) and accounts receivable (AR) are similar and how they are different.
The answer to this question is not a simple yes or no, rather it depends.
Accounts payable and accounts receivable go hand in hand in determining your cash flow. Accounts payable are what you owe and accounts receivable are what is owed to you. You can see the correlation. If you are slow to collect accounts receivable it may cause problems in paying what you owe.
With the above correlation stated, it is preferred to have a higher accounts receivable balance and a lower accounts payable balance as this indicates you have more resources coming in than obligations needing to go out.
However, if accounts payable is higher than accounts receivable doesn’t mean the company is in a bad position. You would also want to consider cash balances. Cash on hand is better than accounts receivables as it is a resource available to use immediately. Possibly the combined cash and accounts receivable creates a balance higher than accounts payable.
Overall, it is better to have more assets than liabilities, but each company is different and needs to be considered in its entirety.
Regardless of the balance of accounts payable or accounts receivable, they both need to be managed effectively. More than likely if these two areas of your business are being neglected there is probably a cash flow challenge.
Here are a few tips to consider in effectively managing either accounts payable or accounts receivable:
If you follow these simple suggestions you should see a steady stream of collections coming in from accounts receivable to pay your accounts payable.