Quick Definition: Accounts payable is the total of the bills that you have to pay, but that you haven’t paid yet. This is a business’s short-term debt that must be paid.
When your business gets a bill in the mail, what happens? Do you pay it immediately, or do you maybe hold onto that bill for a little while before you pay it?
If you run your business like I run mine, you probably hold on to that bill and pay it toward the end of the month. Or, maybe you have a regular day each month where you pay all of your bills.
Sometimes—and this is perfectly normal—you might even delay payment on a bill while you wait for your customers to pay you. Like most businesses, you might have more cash to pay bills at certain times of the month, and less flexibility at other times. If this sounds like you, don’t worry too much—you’re not alone!
All of those unpaid bills have a name: accounts payable, also known as “AP.” Accounts payable is the amount of money that you owe to your vendors and suppliers. Essentially, it’s a total of all the invoices that you have received but that you haven’t paid yet.
In your company’s financial statements, accounts payable will show up on your balance sheet as a liability.
Ideally, you should keep your business’s financial books organized and enter your bills into your accounting system as they arrive. This doesn’t mean you have to pay your bills right away, but it helps you keep track of who you owe and what your liabilities are.
You can also get reports from your accounting system (or right in LivePlan if you use the Scoreboard feature) that tell you the average amount of time it takes you to pay your bills—AP Days—and which vendors you typically wait the longest to pay.
Why is accounts payable important?
Tracking your accounts payable is a critical component to managing your cash flow. As your business grows, you may be spending money on different services for your business and you will receive invoices that need to get paid. If you can’t manage your debts, you could find yourself in a cash crunch, or worse, defaulting on a debt.
Especially when you are growing quickly, you may need to buy more inventory and invest in business expansion at a faster rate than your customers are paying you. This means that you will have bills that come due before you receive money from your customers.
To stay on top of a situation like this, you need to keep track of your accounts payable and make sure that you have enough cash on hand to continue paying your bills. Ideally, you should forecast your growth and make sure that you plan to have enough cash to cover the costs of growth.
What’s better? Higher or lower?
In general, having a lower accounts payable balance is better. This means that you are paying your bills on time, and aren’t risking getting into any trouble with your vendors and suppliers.
Of course, as your company grows, your accounts payable will also naturally grow as you purchase more supplies and have bigger bills to pay. Don’t worry, though. This is totally normal.
If you are growing, you’ll want to track what’s called accounts payable turnover ratio to make sure the percentage of accounts payable compared to your total purchases remains fairly constant.
Accounts Payable Turnover Ratio = Total Purchases ÷ Average Accounts Payable
This ratio tells you how frequently you pay your bills. As you grow your business, tracking this number will help you see if your business is paying its bills faster over time or slowing down. Sometimes, vendors will want to know this number so that they can anticipate how fast you will pay them. We’ll review this ratio in more detail in another post, but in the meantime you can track this ratio as you grow to make sure that you continue to pay your bills in a timely manner.
How to improve your accounts payable
If your accounts payable is growing and you need help paying your bills, there are a few strategies you can explore to help reduce your AP, or at least manage it better:
- Negotiate with your suppliers. Most suppliers would rather see you pay their bills than have you default and not pay at all. A simple call to your vendors to negotiate a payment plan can often help ease the pain. Also, this method can keep you in good standing with your supplier so you can continue to do business with them.
- Encourage your customers to pay faster. For most businesses, getting cash in the door from customers is the best way to help pay bills faster. I covered a few ideas in my post on accounts receivable, so take a look at those and see what you can do to get your customers to pay you faster so you can pay your bills and reduce your accounts payable.
- Establish a business line of credit. You should do this before you have an accounts payable problem as banks are less likely to lend to you if you already have too much debt. If you do open a line of credit, that can help ease the pain of certain times of the month or year where you have less cash on hand than you normally do. Just be careful not to overextend your business and add even more debt. Instead, think of a line of credit as a very temporary loan that is allowing you to pay your bills while you wait to get paid by your customers.
- Lower your costs. This is probably the most obvious option for lowering your accounts payable, but it’s always worth mentioning. When you shop around for different vendors, you might be able to lower your expenses and therefore lower your bills. It’s always good to be on the lookout for better deals for your business, so reserve some time every few months to look at your expenses and see where you might be able to cut costs.
Tracking accounts payable is one of the critical components to managing your company cash flow well. You’ll want to know how much you owe and whom you owe it to.
With the right strategies for managing accounts payable, you’ll keep a solid cash position which is crucial for any growing company.