What is Accounts Payable?
Accounts payable (AP) is money owed by a business to its suppliers to vendors and suppliers for goods that have not been paid for. The term AP is often used to describe a function within a business that is focused on processing payments for suppliers and vendors.
Specifically, accounts payable is the debts that a company owes to its suppliers and partners. These debts must be paid in full within a given period to avoid default. AP is an essential figure on a business’ balance sheet, and can tell you a lot about its health and prospects for growth.
Examples of accounts payable
There are hundreds of different types of payables which a business may have on its balance sheet under current liabilities. Often, these are short-term financial obligations which the company will pay quickly in order to balance their books.
Here are a handful of accounts payable examples to give you an idea of why a business may owe money to partners and vendors:
- Raw materials/fuel – When a manufacturing company invests in raw materials, the items are bought on credit because they haven’t yet earned the cash needed to purchase production materials outright. This is accounts payable, and will normally have a credit period of 30 days or more.
- Transportation and logistics – When a company needs to transport raw materials or goods which it has produced, it’s common practice to rely on transportation providers as part of an accounts payable credit agreement, with businesses paying for the cost of logistics later down the line.
- Subcontracting – When a business partners with another company to fill in skill and workforce gaps, this is regularly done via accounts payable. The subcontracting work will take place on the basis that the company will pay the other for the work at a specified time in the future.
- Equipment – The leasing of equipment is commonly paid for by accounts payable. When a business requires a piece of equipment on an ad hoc basis, they’re provided with it on the condition that they pay within a set period.
How does accounts payable work?
Accounts payable is essentially a running balance of how much money a business owes for the goods and services of another. It works on a similar basis to that of an ‘I owe you’ agreement, in which a business agrees to carry out work or provide goods and materials on the condition that it gets paid at a later date.
Here is a step-by-step guide on how the accounts payable process works in principle:
- One business seeks the goods and services of another as a means of meeting its objectives (for example, a furniture company buying wood from a wholesale timber yard).
- Rather than paying in cash, the transaction is logged as accounts payable, meaning the amount owed is filed under ‘current liabilities’ to be paid at a later date.
- The counterpart business provides the goods or services; they will log the transaction under ‘accounts receivable’, meaning that they will receive funds in the future.
- In order to avoid defaulting on its commitments, the company with accounts payable must pay their debt in full within the agreed timeframe.
- To keep their books balanced, it’s important that a business doesn’t have significantly more accounts payable than accounts receivable. When a business pays its debts, this is called balancing the books.
Is accounts payable a credit or debit?
Accounts payable is a credit transaction. This means that one company is essentially ‘borrowing’ goods and services from another, under the arrangement that the debt owed will be settled with a payment at a later date.
The ledger in which a company logs its accounts payable is often referred to as a liability account. This is where it records the money owed to third-party providers in a section labelled ‘current liabilities’. It’s a way for businesses to keep track of their debts and make sure that accounts payable is balanced with accounts receivable.
What is the difference between accounts payable and accounts receivable?
Think of accounts payable and accounts receivable as opposites. When a business owes money, the debt is listed as accounts payable; when it’s due money, it goes on the balance sheet as accounts receivable.
Say a manufacturing business purchases some raw materials from another organisation. They would list the purchase as accounts payable, while the provider would list it as accounts receivable.
It’s vital that businesses keep accounts payable and accounts receivable as balanced as possible. If the number of transactions listed under accounts payable becomes too high, this may indicate that a business is struggling to pay its debts or investing too quickly.
What is accounts payable full cycle?
The term full cycle accounts payable refers to the process required to complete a purchase on a historic order which was listed as accounts payable, AP. Also known as a ‘Procure to Pay’ or ‘P2P’, the process involves the accounting and procurement arm of a business carrying out the necessary administrative work required to complete a purchase – including approving invoices, issuing checks, recording payments and matching documents.