What is Accounts Payable?

Ensuring the continued growth of your business and keeping your customers happy means doing everything you can to protect and optimize your production lines.

If your flow of goods grinds to a halt, you’ll experience customer frustration, leading to reputational damage and, ultimately, significant losses in revenue. Preventing those issues is where production management comes into play, a process that is equal parts art and science.

It’s about ensuring that your activities are well-facilitated and that your staff resources, budget, and materials are all in optimal use to produce finished goods, allowing you to seize emerging growth opportunities.

As you might expect, though, production management workflows that are bumpy or outright inefficient cause every aspect of your operations to suffer.

With that risk in mind, below is a rundown of everything you need to know regarding production management and how to succeed.

What is Accounts Payable?

Managing a business’s finances can often feel like solving a complex puzzle. Among the many pieces of this puzzle is accounts payable (AP). 

But what is accounts payable, and how does it compare to some other financial terms like accounts receivable (AR)?

This guide defines accounts payable and provides some other basic information you need to know about AP as it pertains to your business.

Accounts Payable Definition

Accounts payable is the money a business owes to its trading partners and creditors. Accounts payable only include any debts or obligations that you have not yet settled or paid. 

Imagine accounts payable as a tab you’re running at your favorite coffee shop. Every time you order a coffee, the shop adds it to your tab, which you agree to pay later. 

Keeping up with accounts payable is a fundamental aspect of managing your business’s finances, as it involves obligations that need to be paid off to avoid debt accumulation. 

AP and accounts receivable are often mentioned in the same breath, as they are opposites of one another, but more on that in a bit.

How to Record Accounts Payable

Recording accounts payable is a multi-step process. Typically, your finance department will record accounts payable when it receives an invoice or bill from a supplier. It will be entered as a liability into the accounting system or ERP. 

The receiving team member will verify the invoice details, such as the amount, terms, and the goods or services received. Accurate recording is essential to ensure that payments are made correctly and on time.

When you pay the invoice, this transaction will be documented as an expenditure, and the line item on your accounts payable log will be notated accordingly. This documents that you no longer owe that obligation to your trading partner or vendor. 

Accounts Payable vs. Trade Payables

Accounts payable and trade payables might sound similar, but there is a subtle difference. Trade payables refer specifically to money you owe to suppliers for inventory-related goods. Trade payables are a form of AP; not all APs are trade payables.

Accounts payable is a broader term encompassing all short-term liabilities to suppliers, including trade payables and other goods or services that might not be directly related to your inventory. 

Generally, you’ll need to track both to understand what percentage of your obligations is directly related to inventory and what percentage entails other costs.

Accounts Payable vs. Accounts Receivable

Let’s continue with our coffee shop analogy. If accounts payable is your tab at the shop, accounts receivable is the shop’s ledger of tabs run by its customers. 

In business terms, AP is the money your company owes others, and accounts receivable (AR) is the money others owe to your company. It’s crucial that you balance these two types of accounts to maintain a healthy cash flow.

If your accounts payable greatly outweigh your accounts receivable, you will probably have a cash flow problem shortly. Conversely, if you’ve got a lot of cash coming in and very few AP obligations, you’ve probably got money that could be used to grow your business. 

Naturally, you don’t want to take on too many obligations. However, you don’t want to underutilize your resources, either. It’s all about balance.

Examples of Accounts Payable

Let’s consider a couple of examples of accounts payable. Here is one scenario where you take on a trade payables obligation and another that shows general AP debt. 

Suppose you run a restaurant and purchase to-go cups, napkins, and disposable trays from one of your vendors. It sends you an invoice for the purchase of $2,000. You would record this as an account payable. This obligation also constitutes a trade payables obligation, as it is part of your core inventory. 

Now, suppose you hire a consulting firm to help you generate better brand awareness in your community. You agree to pay them later. 

They bill you $5,000 for services rendered, which is due at the end of the campaign. This obligation becomes part of your accounts payable, too, but it is not a trade payable.

Are Accounts Payable Expenses?

While the answer to this question may seem obvious, it’s not. Accounts payable are not expenses; they are liabilities. When you purchase goods or services on credit, you’ll document the expense on your balance sheet. Expenses are recorded on the income statement. 

Why does this matter? Let’s continue with the example above and assume you bought the $2,000 in restaurant supplies on credit in December. However, you don’t have to pay the debt until January, as your supplier offers net 30 payment terms. 

Therefore, the December accounts payable line item won’t impact your income statement for that month. Instead, your AP will reduce your net income in January when you pay back what you owe. 

On the other hand, if you had to settle the accounts payable obligation in the same month, it would impact your income statement. Still, you would document the AP on your balance sheet at the time of purchase and then notate the expense on the income statement when you remit payment. 

Get Advice on Accounts Payable

Managing accounts payable can be a headache, especially as your business grows. Keeping up with AP, AR, and other aspects of financial management is even more tedious. 

However, it’s critical that you get AP right so you can maintain good relationships with your suppliers and avoid overstretching your budget.

If you’re unsure about managing your accounts payable effectively, it’s a good idea to seek advice from financial professionals and business solutions providers. 

Contact us for more information.