Last editedNov 20212 min read
Bookkeeping for any business is a complicated process, with calculations involving transactions that have both been carried out or those that must be completed in the future. It’s essential to keep track of both the payments that your business is making as well as those that it is receiving to get a better idea of financial health.
Accounts payable is one such figure that has an influence on your company’s finances. Put simply, it is a record of all of the money that is owed to third parties such as vendors and suppliers, and therefore represents the payments that you are due to make. There is a clear relationship between accounts payable and cash flow, making it a crucial metric to understand. Read on to find out more about how this can affect your business.
What is accounts payable?
Before answering the question ‘how does accounts payable affect cash flow?’, it’s important to understand exactly what is meant by the term accounts payable, also referred to as AP.
Sometimes it’s necessary to make a business purchase on credit. For example, this might be a good idea if you do not currently have the funds available or if these funds are reserved for another purpose. These transactions will appear under the accounting entry ‘accounts payable’, which shows all the money that your organization owes to third parties like vendors and supplies.
This is such a large and important part of bookkeeping that in many bigger companies, there is a whole department dedicated to handling accounts payable. It usually covers nearly all the payments that are made outside of payroll, and therefore forms a large part of your accounting function.
How does an increase in accounts payable affect cash flow?
Of course, making a purchase without immediately paying for it will have an impact on your cash flow. But how does an increase in accounts payable affect cash flow, exactly?
The answer might seem counterintuitive, but an increase in accounts payable actually leads to a positive cash flow. The reason for this is that AP is actually an accounting term, and this indicates that a company has not immediately spent cash. The fact that these funds have not left the company account therefore indicates an increase in cash for the accounting team.
How does a decrease in accounts payable affect cash flow?
Now that you understand the effect of an increase in accounts payable, how does a decrease in accounts payable affect cash flow?
As you might now expect, it’s the opposite of an increase in accounts payable. If the accounts payable has decreased, this means that cash has actually been paid to vendors or suppliers and therefore the company has less cash. For this reason, a decrease in accounts payable indicates negative cash flow.
Managing accounts payable to improve cash flow
You can use this information to improve the operation of your business. Since accounts payable and cash flow are so closely linked, you can manage your payments in such a way that maximizes your company’s cash flow.
The basic rule is as follows: always pay your bills on time, but do not pay them before they are actually due. It might seem like a good idea to get bills out of the way as soon as possible, but this can actually have a detrimental effect on your cash flow. Essentially, a bill that is due to be paid represents an increase in accounts payable, whereas paying that bill will reduce the accounts payable.
By extending the payment period of your bills, you create a healthier cash flow. For example, let’s say you have an average purchase of $200 a day over a payment period of 10 days. If you can extend this period to 20 days, you can free up an extra $2000 in cash flow for this time period.
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.