An Introduction to Accounts Payable: What It is and What It Does?

What is an accounts payable

When buying goods for your company, you won’t always pay for those goods in advance, but will often receive an invoice from the vendor. You need to keep these invoices in check if you want to avoid double payment, being late on paying your suppliers and so on.  That is what the accounts payable is for.

An accounts payable, or trade payable, is only present in businesses that use an accrual accounting system. This type of accounting system means recording income and expenses as they happen and not when the cash changes hands. For example, an accrual would be an invoice received for the goods this month, but is due for payment next month. This will present a clear picture of the company in review, but has the downside of not always giving an accurate portrayal of the cash flow.

An opposite of the accrual accounting is cash-based accounting, which is used by businesses that have regular and instant cash dealings.

What is an Accounts Payable?

Simply put, an accounts payable is nothing more but a ledger that shows the invoices you still owe money for. These are short-term liabilities, meaning you need to pay them within a shorter period of time, up to a year, compared to long-term liabilities such as employee payrolls. These do not belong in the accounts payable.

You can record purchase orders, contracts, invoices from suppliers and agreements with vendors under accounts payable. When recording accounts payable, you should use double-entry bookkeeping, which means having two entries for every transaction in order to balance your books. One entry will increase the account and is credited and the other will decrease it and is debited.

The AP is usually recorded in the general ledger, under “current liabilities” and is credited when the invoice is received and debited when the bill is paid to the vendor.

Here is what the accounts payable typically contains:

  • The name of the creditor
  • Invoice number
  • Date of invoice receipt
  • Account number
  • Type of expense
  • Invoice payment deadline
  • Invoice status (paid, pending or past deadline)

Why is an Accounts Payable Useful?

Bookkeeping without an accounts payable can be overwhelming, so the AP allows the company to better track its finances. Moreover, the AP will:

  1. Help the company maintain its business relationship with creditors, vendors and suppliers by paying its invoices on time
  2. Prevent possible financial fraud due to bad bookkeeping
  3. Avoid overpayment as you can see the exact amount due for every invoice you have pending at the moment
  4. Help improve the company’s credit score. A business paying its debts on time will always be in more favorable light than one that is constantly late with payments.

Conclusion

Most importantly, however,  an accounts payable will show you if your company is profitable or not. If you keep having low cash at hand, but your AP is high, that means you owe more than you earn.

Are you using an accounts payable or have another system or keeping track of what you owe to creditors? Let us know what you think about this system in the comments below the article and don’t forget to sign up and try Purchase Order Plus for free to better manage your purchase orders.

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