Last week we learned about Accounts Receivables (A/R). Check it out here if you missed the email.
Also, let us know if there’s one accounting concept you want us to cover. We’d love to tailor it to your specific needs.
We’re staying in the balance sheet this week and looking at another type of account. Except this time it’s on the liabilities side of things.
This week’s lesson: Accounts Payable (A/P)
What is An Account Payable (A/P)?
A/P is a short-term outstanding debt (credit) from a company’s supplier or vendor. AP represents the total amount due to suppliers for goods and services that the company hasn’t paid.
Another way to think about it: one company’s A/P is another company’s A/R.
Last week we looked at a credit exchange to show A/R. We viewed this transaction from the company’s perspective. But remember, one company’s A/R is another entity’s A/P.
Part of operating a lemonade stand is buying key supplies like lemons and sugar. You have a great relationship with a local lemon supplier, Lemons, Inc.. You need 100 lemons for next week’s forecasted demand.
But you don’t have the cash right now. You spent it all on advertising/marketing to attract new customers.
So you go to Lemons, Inc. and say, “Hey, I need 100 lemons and I’ll pay you within 30 days from receipt of the lemons.”
The other company agrees because they know the relationship and they know you’ll pay on time. They ship you the lemons with a $200 payment due in 30 days.
That $200 payment is a new account payable for that period.
Account Payable Effects on Cash Flow
A/P has a positive effect on a company’s cash flow. This makes sense because you’re foregoing payment now, with the promise of paying later. You can see it on Facebook (FB)’s cash flow statement below:
Every $1 of new A/P means $1 more you don’t have to spend today.
That said, those payments must be made over time.
Here’s a couple heuristics for gauging A/P figures:
- Increase in A/P = more goods/services bought on credit
- Decrease in A/P = company paying off prior debts faster than buying new goods/services on credit
Summary: A/P Helps Cash Flow, But Take Caution
A/P management is a great way to maintain high levels of cash flow. The less you have to pay out upfront, the better. That said, lookout for companies with ever-rising A/P balances on weak balance sheets. If a company doesn’t have the cash to pay it’s A/P, it could slip into default.