What Is Accounts Payable?
Accounts payable are short term debts to creditors or suppliers for goods or services. Also known as “AP,” accounts payable are outstanding bills that need to be paid. Tracking accounts payable allows businesses to monitor their cash flow.
This guide will cover accounts payable examples, how accounts payable differ from accounts receivable and why your business needs to record accounts payable in the general ledger.
Accounts payable definition
Accounts payable appear as a current liability on a company’s general ledger and balance sheet. It shows the sum of a company’s short-term debts (also called outstanding bills) to vendors or creditors — essentially an IOU from your business to another for the goods or services rendered. Once your business pays the account, it’s removed from the balance sheet.
Recording accounts payable allows you to monitor your business’s cash flow. Some businesses may choose to wait to pay invoices until their due dates to free up cash for other expenses or investments, so keeping track of the amounts owed is critical. Still, it’s generally best practice to pay on time to avoid interest and maintain good relationships with your suppliers.
When your accounts payable balance is increasing, it shows that your business is relying more on credit to make purchases. When there’s a decrease in your accounts payable balance, it shows that your business is paying off debts faster than it’s acquiring new goods or services.
Days payable outstanding (DPO)
The average time it takes you to pay your debts — called days payable outstanding (DPO) — is a measure of how well your business manages its accounts payable. While it’s an important metric of your business’s financial position, there is no single benchmark for a healthy DPO; rather, it will vary by industry and the company’s competitive position.
If your DPO is too high, it could mean your business is struggling to come up with enough cash to meet its obligations to vendors and creditors, or that your creditor offers a generous payment term. If your DPO is too low, it could mean you’re not taking advantage of the full credit period. It could also reflect shorter credit terms.
Accounts payable examples
Here are a few examples of how accounts payable works for different types of debts a business may incur:
- Equipment: Your business buys $10,000 worth of office equipment from a vendor, and the payment is due in 30 days. This purchase increases your tangible assets while also increasing your liabilities. You would then record a debit in the equipment account and a credit in your accounts payable.
- Services: That new printer breaks down, so your business hires a service professional to repair it. The cost is $500 and payment is due in 60 days. You would record a debit in your repairs and maintenance expense account and a credit in your accounts payable.
- Utilities: Every month you pay $1,000 for high-speed internet for your business. At the beginning of each month, you would debit your utility expense account and credit your accounts payable.
Because accounts payable are short-term debts, they don’t go on your business debt schedule, a tool used to get a birds’ eye view of long-term business obligations.
Accounts payable process
Here’s a summary of the accounts payable process:
Receive the bill
First, you’ll receive an invoice from the vendor or creditor. Some vendors may offer you a trade credit, which is a discount for paying early. For example, if you receive an invoice that says 2/10 Net 30, that means you’ll receive a 2% discount if you pay within 10 days.
Record the bill
Use double-entry bookkeeping to maintain balanced accounts and an accurate view of your company’s assets, liabilities and equity. Typically, you’ll add a debit to an account on the left side of the ledger at the same time you add a credit to your accounts payable. For example, if you bought a piece of equipment on credit, you would debit your assets to balance the credit to your accounts payable.
Pay the bill
You should make every effort to pay your bills on time, but not early (unless you’re aiming for a discount). Once the cash has changed hands and the invoice is paid, you’ll record the amount paid as a debit to your accounts payable — that will show your debt balance has been reduced. You’ll also credit your cash account to indicate that you’ve spent the money to pay the bill.
Accounts receivable vs. accounts payable
While accounts payable is a liability account that will typically go on the right side of the general ledger, accounts receivable represents an asset account, the balance of which shows the total amount owed to you by other businesses or entities.
For example, if you ran a marketing company and needed to renew a design software license annually, you would add that as a credit to your accounts payable. If, however, another business asked your company to design a logo and offered $1,000 within 30 days of receiving your design, you would record that as a debit to your accounts receivable.
Frequently asked questions
Are accounts payable on the balance sheet?
Yes. Accounts payable is an example of a current liability account that appears on a business’s balance sheet.
Is accounts payable a liability or an expense?
Because accounts payable is a short-term debt that hasn’t yet been paid, it’s considered a liability. An expense would be a good or service you already spent money on.
What are examples of accounts payable? Is an invoice an account payable?
When you receive an invoice from a third-party, that is considered accounts payable. Examples include bills for business equipment or services provided to your company by another entity.
What are accounts payable and accounts receivable?
Accounts payable is a liability account listed on your company’s ledger that keeps a running balance of outstanding bills owed to third parties. Accounts receivable, however, is an asset account typically listed on the other side of your company’s ledger; this keeps a running balance of debts owed to your business. In other words, accounts payable is money that you owe, while accounts receivable is money owed to you.
What is the difference between accounts payable and trade payables?
Some businesses may categorize accounts payable into trade payables and expense payables and track those accounts separately. Trade payables are typically debts incurred when a business purchases physical goods or inventory and owes the supplier.