Are you a first-time bookkeeper trying to create a balance sheet for your small business, or the head of a large company trying to better understand your future financial obligations?
The process can be extremely confusing if you’re unfamiliar with the jargon around accounting, but fear not — you can learn how to read a balance sheet and establish a financial statement for your business or household by studying up on a few key terms.
Chief among those key terms is the concept of accounts payable, one of the essential elements of any company’s balance sheet.
If you’re trying to manage how much your company is spending and where, you have to understand this term, as it’s one half of the basic accounting function of recording the act of providing goods and services for money.
What Is Accounts Payable?
Anytime a company purchases goods or services on credit with an agreement to pay it back over a particular time period, it falls under this umbrella.
Because of that definition, accounts payable is considered a current liability account and a short-term debt payment.
Therefore, accounts payable is located under “current liabilities” on a balance sheet.
Accounts payable classifies any good or service a business does not provide cash for immediately, or basically anything bought on credit.
Companies routinely make purchases on credit, but even the usage of a regular household credit card is considered accounts payable.
If your company or household receives a regular heating bill or has a cable television subscription, those companies are considered an account payable, as you’ll need to send them money in a short period of time (usually at the end of the month).
The amount of a bill or invoice is considered the trade payable.
When you, Company A, receive a bill for a service or good delivered to or consumed by Company A on a regular basis, you owe the trade payable.
For example, if your office’s monthly internet bill is $200, that fee is the trade payable to Company B, the internet service provider.
Your company has consumed the service (the internet service) but has yet to pay Company B for it.
Had you paid up front for the internet service, you wouldn’t record it as an account payable.
Examples of Accounts Payable
This business term covers a lot of ground: The hammer and nails a carpenter purchases on credit from a hardware supply company is an account payable, as is the cell phone bill he or she uses to conduct business.
The easiest way to classify accounts payable at your small business is to total up all of your monthly bills.
If you’re paying on a regular cycle for a good or service, no matter the type, that’s an account payable.
However, paying a salary to an employee or repaying a long-term loan on a monthly basis is not considered an account payable.
You can also take an inventory of your office supplies, services, and equipment.
The basic rule of thumb is that if you’ve already paid for it, it’s an asset.
If you haven’t, it’s a liability and should exist in the accounts payable section of a ledger.
How to Separate Accounts Receivable and Payable
Accounts receivable is the opposite end of the equation from accounts payable.
Accounts receivable is the amount a company is owed for providing a good or service on credit rather than receiving immediate payment.
Just as accounts payable are considered current liabilities, accounts receivable are considered current assets on a company balance sheet.
The easiest way to separate accounts payable and accounts receivable is to think of the terms as a complementary balance between two businesses.
For instance, if Company A performs a service for Company B for the fee of $50, that service becomes an account payable for Company B (who owes money) and an account receivable for Company A (who is owed money).
Think of this way: Accounts payable can’t exist without accounts receivable.
For every action to create an account payable at one business, there should be a corresponding account receivable for the good or service provided.
Accrual Accounting vs. Accounts Payable
How the concept of accounts payable affects your financial statement depends on the type of accounting system you employ.
Accrual accounting occurs when a good or service is delivered from Company B to Company A prior to Company A paying Company B.
For example, if that internet service provider in your office gives you a month of service and bills you (Company A) at the end of the month, that’s considered accrual accounting.
The revenue for Company B providing the internet is first recorded as accrued revenue in the month the service was provided.
This created an accounts receivable asset account.
When you, Company A, actually send Company B your $200 payment for the Internet service, the accounts receivable account decreases accordingly.
An account payable works differently.
These are debts to be paid off in a given period.
While this is usually a short-term time frame and almost always within a year’s time, it is not necessarily a monthly cycle.
For instance, a batch of goods or a license for software might be charged to a company all at once to be paid in a six-month span.
Usually an account payable is for a good or service related to your business’s expenses, like office supplies or equipment rentals.
Monitoring Accounts Payable
By aggressively monitoring your short-term liabilities in accounts payable, you can create an accurate business forecast and predict trends.
If you’re looking to find a period inside the upcoming business year where your company cash flow will be particularly strong or weak, tracking your accounts payable history can help identify a trend.
If your business reliably experiences a large amount of revenue at a certain time of year, you can engineer accounts payable accordingly.
That could be the time in which your company pays its annual taxes or regulation fees, rather than a month in which revenue is low.
Understanding Accounts Payable Can Save Your Business
At the end of the day, accounts payable is the identification and organization of money you and your business owes.
The payment of those bills and the ability to forecast for future payments is often the difference between keeping your business afloat and shutting down completely.
There’s also an incentive to show strong a strong record with accounts payable, and that’s good credit.
The more efficient and reliable your business is at handling accounts payable in a timely manner, the more credit your business will be able to negotiate, as well as the timeframe in which you set up future accounts payable.
It doesn’t matter if you’re a first-time small business owner or you’re a veteran of corporate finance — the more you know about your working capital and your ability to survive a short-term downturn in revenue depends on how much money you’ll owe in that time.
That’s why accounts payable is so crucial.
If you can properly identify what fees, invoices and bills are coming, you can better prepare your business to survive.