Accounts Payable Meaning
Accounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liablities on the balance sheet as these obligations must be satisfied within an accounting period. It is critical to understand that accounts payable exist solely in the case of accrual accounting and not in cash accounting.
In simple terms, Accounts Payable is money that needs to be paid to the Suppliers of raw materials, services to the company. From Walmart 2016 filing, we note that accounts payable was $38,487 million in 2016 and 38,410 million in 2015.
source: Walmart 2016 10K Filings
Understanding Accounts Payable on the Balance Sheet
Accounts Payable is an important concept in an organization if it follows an accrual method of accounting. In cash accountingCash AccountingCash Accounting is an accounting methodology that registers revenues when they are received & expenditures when they are paid in the given period, thereby aiming at cash inflows & outflows. read more, there is only cash inflow and cash outflow and there is no existence of accounts payable or accounts receivableAccounts Payable Or Accounts ReceivableWhile Accounts Receivable is the capital amount that the clients/customers owe to the business, Accounts Payable is the capital amount that the business owes to its suppliers. read more.
As businesses are run on a large scale, not every purchase or sale can be in cash. So companies purchase or sell on credit to create more convenience for their partners in business. As a result, the concept of accounts payables and accounts receivablesAccounts ReceivablesAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. read more needs to be understood.
Let’s say Company A produces shoes for men and women. And Company B supplies leathers to Company A. Now, Company A (debtor) took $40,000 worth of supply from Company B (creditor) on a credit that needs to be paid within a month. In this case, Company A will report its accounts payable as $40,000.
Company B on the other hand will report $40,000 as accounts receivable.
How to Interpret?
- First of all, as an investor, you are an outsider, and you always don’t have a clue where the company stands. Irrespective of shiny financial statements, the actual position of the company hides, which the investors need to discover. And that’s why accounts payable is important. By using it to calculate days payable outstanding, Days Payable Outstanding, Days Payable Outstanding (DPO) is the average number of days taken by a business to settle their payable accounts. DPO basically indicates the credit terms of a business with its creditors. read morean investor can find out after how many days the accounts payable was cleared. And if there is any delay, why?
- Second, depending on the payment schedule, vendors decide the merit of the company. If a company pays the payable amount within the mutually decided period (i.e., 15 days, 30 days, or 45 days), then the vendors look at them as esteemed customers. Otherwise, the vendor may change the terms and conditions of the contracts.
- Thirdly, accounts payable helps the company strike a balance between paying too early and paying too late. Delaying the payment for a few days will be helpful for a company that needs to make the payment to the vendors. Because delaying the payment will enable the company to hold more cash. However, waiting too long for making the payment can also be critical for the relationship between the company and the vendors; because vendors may not too much delay in making the payment.
Calculate Accounts Payable
Let us understand accounts payable calculation with one case study –
Mr. A has sources of raw materials from Mr. B for producing leather jackets and selling it to the end customers. We could only find the following information –
Total Purchase – $39,000
Cash Purchase – $15,000
Mr. B mentioned that if Mr. A paid the invoice within 30 days of the transaction, he will be entitled to get another 2% discount on the total purchase.
So, what’s the amount to be paid if the actual payment is made within 30 days?
It’s a simple example. We just need to follow a step-by-step approach to find out how much needs to be paid.
The total purchase is $39,000.
A cash purchase is made in cash i.e., $15,000.
That means credit purchase would be = ($39,000 – $15,000) = $24,000.
As it is mentioned that the amount for credit purchase is paid within 30 days of the stipulated time, it’s assumed that a 2% discount on total purchase is also received.
So, the actual payment that needs to be made is = ($24,000 – $39,000*2%) = $23,220.
Accounts Payable Video
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