Sometimes, it’s necessary to make a purchase on credit. And when your business does purchase goods or services on credit, you’ll see an accounting entry called “Accounts Payable” on your balance sheet. Find out everything you need to know about accounts payable journal entries, including the importance of this accounting function to the smooth running of your business’s finances, with our definitive guide. First up, take a look at our accounts payable definition.
What is accounts payable?
Accounts payable, also referred to as AP, is all the money that your business owes to third parties, such as vendors or suppliers. It’s essentially the yin to accounts receivable’s yang.
Generally speaking, accounts payable is an entire department, although in smaller companies, it may be handled by just one member of the accounting staff. Because it covers almost every payment that a company makes outside of payroll, accounts payable is a critical part of your overall accounting function.
Why is the accounts payable process important?
If you don’t manage your accounts payable process efficiently, your business could experience a number of negative ramifications. For a start, if you don’t have a clear picture of how much money you owe to vendors and suppliers, it’s impossible to gain any real insight into your company’s overall financial health. This can make it much more difficult to make accurate financial projections, which in turn, can make gaining investment or bank loans more of a challenge.
Furthermore, gaining a reputation for sloppy accounts payable practices can cause damage to your brand. Vendors and suppliers may be unwilling to work with you, and your supply chain may suffer as a result. There’s also the financial consequences. Missed or late payments can lead to late fees or late payment interest. That might not sound too harmful, but these sorts of charges can quickly mount up to serious money if your company is late on multiple invoices.
How does the accounts payable process work?
The accounts payable process is relatively simple. First, you’ll receive the invoice. Then, you’ll need to record it on your accounts payable ledger. Finally, when the payment is due, you’ll send the payment and the accounts payable journal entry will be removed from the account. Remember, with accounts payable, the aim isn’t to send payments as soon as the invoice arrives, as that could contribute to cash flow problems for your company. Instead, your goal should be to send payment at a time that’s optimal for your business.
Is accounts payable an asset or a liability?
Because accounts payable represents a debt that your business owes, rather than an amount that is owed to your business, accounts payable is classed as a liability. As accounts payable tend to be short-term debts, they’re referred to as “current liabilities.” However, if the debt persists for longer than a year, then they may be moved to “long-term liabilities” instead.
Accounts payable vs. accounts receivable
Accounts payable is essentially the opposite of accounts receivable. Whereas accounts payable refers to money that you owe to third parties, accounts receivable refers to money that your business is owed. In addition, accounts receivable is listed as an asset on your balance sheet, while as we’ve already established, accounts payable is understood as a liability.
Read our guide for more information about accounts payable vs. accounts receivable.
Managing your accounts payable process
As we’ve seen, the accounts payable team is an important part of your company’s accounting function. While you shouldn’t stall payments unnecessarily, it can be helpful to slow the flow of money out of your business’s accounts, at least to a certain extent. You can do this by using several different strategies, including negotiating longer credit terms and building up goodwill with your suppliers.
What does accounts payable days outstanding mean?
Days payable outstanding, sometimes referred to as accounts payable days outstanding, refers to the average amount of time that your company requires to repay your accounts payable. It’s an important metric that can help you understand how effectively you’re managing your accounts payable process and whether you need to make any changes.
Read our full guide to accounts payable days outstanding.
We can help
GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.