What Is Accounts Payable? Everything You Need To Know

Managing a business’s finances can feel overwhelming, especially when staying on top of supplier payments. Accounts payable (AP) refers to the money a business owes to suppliers for goods or services purchased on credit. It’s an important liability on your balance sheet that’s crucial for maintaining cash flow and strong vendor relationships.

In this article, we’ll explain what AP is, how it works, and why it’s an important element of your business’s overall financial health. You’ll also learn useful strategies for streamlining your accounts payable process, such as using accounting software, as well as how to avoid penalties and build stronger relationships with suppliers.

Key Takeaways

• Accounts payable (AP) is the money your business owes to vendors and suppliers for goods and services on credit. It’s recorded as a current liability on your financial statements.
• Effective accounts payable management helps ensure timely payments to vendors, minimise late payment penalties, and optimise cash flows.
• Accounts payable processes can be partially or fully automated with accounting software, saving teams time, reducing errors, and improving visibility into your company’s payables history and balance.
• Understanding the difference between accounts payable and accounts receivable is an important element for maintaining your financial records and ensuring your business’ financial health.

What Is Accounts Payable?

Accounts payable, aka AP or A/P, refers to the amount a business owes its vendors and suppliers for goods or services purchased on credit. AP is listed as a short-term liability on the balance sheet because these types of debts are generally due in 30, 60, or 90 days, depending on the terms of the purchase order.

If your business purchases inventory on credit, the amount owed to the supplier is recorded as an accounts payable liability until the balance gets paid. AP is similar to an individual making a purchase with a credit card—your bank transfers funds to the seller, and then you’re required to pay off the credit card balance within 30 days.

Accounts payable in action

Let’s explore an example of how AP works in a common scenario. The accounts payable process begins when your company receives goods or services you paid for on credit. This could include inventory, office supplies, hiring contractors, professional services from lawyers, accountants, or consultants, and more.

We’ll use purchasing inventory as an example to break down how AP works step-by-step:

1. Make a purchase on credit: First, your business contacts your supplier and purchases inventory on credit.
2. Receive the invoice: The supplier sends your business an invoice detailing the goods provided, the amount owed, payment terms, payment methods, and the payment due date (typically 30, 60, or 90 days).
3. Approve the invoice: The invoice is reviewed and approved by your company’s manager, accounting team, or accounts payable team to ensure accuracy.
4. Record the liability: After invoice approval, the invoice amount is recorded by increasing accounts payable in the current liabilities section of your balance sheet.
5. Process the payment: The supplier invoice must be paid by the due date listed on the invoice. If no due date is listed, it must be paid based on your original agreement with the vendor (such as agreeing to pay bills within 30 days of delivery). The payment must then be recorded as an expense on the income statement.
6. Remove the liability: Once the invoice is paid, the accounts payable balance should be reduced by the amount of the invoice, and the inventory expense line on the income statement should be increased by the same amount.

The Role of Accounts Payable in Financial Management

Accounts payable plays an important role in financial management because it allows businesses to track and manage short-term debts to vendors and suppliers, which impacts a business’ cash flow.

Maintaining a timely and accurate accounts payable process helps improve cash flow by minimising late fees, taking advantage of early payment discounts with suppliers, and preventing overpayments. These improvements help companies increase their liquidity, allowing them to allocate funds to other areas of the business.

How managing AP strengthens supplier relationships

Similarly to how effective AP management improves cash flow, it strengthens supplier relationships. Communicating clearly and maintaining a history of on-time payments builds trust with vendors and suppliers, which can lead to better credit and payment terms, improved service, and potential discounts on future orders.

The Difference Between Accounts Payable and Accounts Receivable

If you’ve already heard of accounts payable, then you may also be aware of something called ‘accounts receivable.’ Accounts receivable, aka AR or A/R, is the other side of AP. When a business sells goods or services on credit, it records an accounts receivable balance until the purchaser pays the invoice. AR is for payments you’re owed, while AP is for payments you owe.

For example, if you purchase inventory on credit from your supplier, the supplier records an accounts receivable balance in the same amount as your company’s accounts payable balance. When the invoice gets paid by your company, you’ll reduce your accounts payable balance, and the supplier will reduce their accounts receivable balance.

For a more in-depth look at this topic, read our guide to accounts payable vs accounts receivable.

How To Record Accounts Payable

Recording accounts payable accurately and efficiently is an essential element of maintaining your business’ financial records and staying compliant with accounting standards. To record AP accurately, it’s important to use double-entry bookkeeping, which is an accounting standard designed to ensure financial records always balance logically.

Double-entry bookkeeping means that when one account increases or decreases in value, another account (or accounts) must also increase or decrease proportionately. These increases and decreases are called ‘debits’ and ‘credits.’ Every debit must be offset with a corresponding credit, and vice versa.

Where is accounts payable reported?

Accounts payable is considered a short-term liability that generally must be paid within 30, 60, or 90 days. As a result, it’s reported under the short-term liabilities section of a company’s balance sheet.

Accounts payable will also show up on a company’s general ledger, which is an internal document that lists all financial accounts and all transactions in each account. This document can be complex, but it offers accountants a detailed view of a business’s financial information. Locating accounts payable on the general ledger is a fast way to see all transactions related to the account.

It’s important to remember that businesses often have different accounts payable balances due to working with multiple vendors simultaneously. As a result, the accounts payable balance on your balance sheet is likely to change regularly as you purchase new goods or services on credit and pay off past accounts receivable balances.

Recording accounts payable example

Assets, expenses, and dividends are increased with debits, while income, liabilities, and equity are increased with credits. For example, if your business receives £1,000 in inventory on credit plus a £1,000 invoice, you would amend the balance sheet as follows:

Then, once the invoice has been paid, record the following journal entries as such:

In the past, this process was done using a pen and paper. Today, however, modern accounting software drives much of the process, automating some complex tasks and freeing up owners, managers, and accounts personnel to focus their time and energy on other aspects of the business.

Track, Manage, and Optimise Accounts Payable Processes With Accounting Software

Even basic accounting software platforms can be game changers for businesses managing financial information like accounts payable. It can help streamline or automate processes, reduce errors, improve efficiency, and decrease administrative costs.

Accounting software can improve AP management in the following ways:

• Automate invoice processing: Entering accounting data manually can be time-consuming and prone to errors. Accounting software can automate many aspects of the accounts payable process, such as capturing invoice details, matching them to purchase orders, and recording them in your accounting system.
• Streamline approval workflows: Several modern accounting software providers allow users to set up custom approval workflows, ensuring the right payable department team members can review and approve invoices quickly and easily prior to payment. This eliminates sluggish manual processes and allows for efficient, error-free approvals.
• Centralised documentation: Accounting software allows businesses to capture and record important financial documentation efficiently and store it in one centralised location. For instance, you can record and store purchase orders, payment discounts, shipping details, invoices, and past payments with a few clicks.
• Enhance visibility and tracking: Accounting software provides businesses with up-to-date visibility into accounts payable balances, outstanding invoices, and upcoming due dates. Features like dashboards and accounts payable ageing reports can help track due dates and prioritise imminent payments.
• Improve accuracy and compliance: Compliance issues often result from errors in manually recording, reviewing, and approving elements of financial reports. Accounting software removes much of the risk of manual input error, allowing you to automate AP processes and double-check your work with ease.
• Scales alongside your business: Many accounting software options are capable of scaling alongside your business, remaining useful and capable over the long term. As your financial needs become more complex, accounting software can continue to optimise and improve your accounting processes.