What Is Accounts Payable?

Accounts Payable Explained in Less Than 5 Minutes

Person in office going through accounting paperwork
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The term “accounts payable” refers to the unpaid debts incurred by a business for products or services that are provided by a third party, such as a supplier. These are considered short-term debts to be paid within the current time period listed on a financial document known as the balance sheet. Accounts payable, commonly referred to as “AP,” is represented on the balance sheet in the current liabilities section, as these are the debts the business is responsible for paying within the current period.

It’s crucial for business owners to understand how accounts payable works so they know the importance of keeping track of the debts owed to suppliers and understand their overall impact on liabilities.

Tracking accounts payable expenses can help businesses avoid paying added interest, maintain a good working relationship with suppliers, and it can help provide insight about their overall financial standings and cash flow.

Definition and Examples of Accounts Payable

Accounts payable includes the debts owed to suppliers, vendors, businesses, and any other third party. Essentially, it is the total amount of unpaid expenses from conducting business-to-business transactions. These debts owed include the costs associated with the purchase of products and services that have not yet been paid for. For example, the inventory that a manufacturer has provided but has not received payment for would be included in accounts payable.

For suppliers to receive payment, they usually provide an invoice with details about the purchase to collect the funds owed. The invoice is based on information provided on the original purchase order (PO). Once the invoice is received by a business, it is added into the liabilities section of the balance sheet as a bill under accounts payable. Many companies have a department to manage the accounts payable process. These employees are responsible for processing invoices and making sure payments owed to other businesses are accurate and paid in a timely manner.

Smaller businesses without such a department can assign accounts payable tasks to an administrative worker or contract bookkeeper, or can use accounts payable software or automation services.

How Accounts Payable Works

To understand how accounts payable works, you’ll need to understand each part of the accounts payable cycle:

  • Categorize data in chart of accounts
  • Include vendor purchase information in accounts payable
  • Understand payment terms and methods
  • Check invoices for accuracy
  • Process payments
  • Record payment information in general ledger

The process begins with a report known as the chart of accounts. This report includes all transactions of the business, including accounts payable, and keeps the process organized by categorizing them. The chart of accounts can be created with accounting software or can be created manually using a spreadsheet.

After tracking all relevant information regarding the business’s transactions, you’ll want to narrow the focus specifically for accounts payable. This is where you need to include information about the purchases made from vendors, suppliers, or other businesses to which you owe payments. You’ll want to include all relevant information, such as invoice numbers, payment terms, product descriptions, due dates, emails, addresses, and other contact information. Here, you’ll also make sure the payment terms and methods within each invoice are understood.

To avoid owing interest, make sure payments are being processed within the time frame outlined by the supplier in the payment terms. For example, if a supplier includes net 30 terms on its invoice, this means the payment must be received within 30 days of the invoice date.

When all relevant data is collected, you’ll need to confirm the purchase order number. Make sure the invoice is accurate and matches the products and services received. If the information on the invoice does not match the products, services, or any other information in the company’s system, the invoice may be sent back to the supplier or put on hold until resolved. When all invoices are deemed accurate and correct, you’ll need to begin processing the payments. 

Payments may be processed via direct deposit, check, wire transfer, credit card, or by using accounting software. Once the payments are processed, they should be recorded in the general ledger or in a journal to show the payment has been made.

Types of Accounts Payable Debts

Accounts payable generally refers to the payments due to external vendors or suppliers, although the meaning can be interpreted differently in various industries. Businesses might categorize expenses according to their purposes within the business.

For example, one business might list a contract worker’s salary under operating expenses if seen as an everyday expense necessary to operate the business, while another might list it under accounts payable if simply seen as payment to a third party.

When considering all transactions your businesses conducts with other businesses and third parties, the types of debts that may be listed under accounts payable may include payments owed for products and services, such as:

  • Inventory
  • Production materials
  • Services for maintenance and repairs
  • Freight bills
  • Travel expenses
  • Purchasing card bills
  • Recent capital assets purchases

Key Takeaways

  • Accounts payable refers to the debts a business owes to suppliers, vendors, or other third parties that have not yet been paid. It is listed as a current liability on the balance sheet.
  • Invoices are commonly used for accounts payable to show products or services provided by the third party. Invoices list important details, such as the cost, payment terms, purchase order number, services or products provided, and contact information.
  • The types of transactions that are recorded as accounts payable include bills such as inventory purchases, production materials, services provided for maintenance and repairs, and travel expenses.