What is Accounts Payable: Definition, Process, and Examples

Learn about accounts payable, its role in managing liabilities, cash flow, vendor payments, and how it differs from receivables and trade payables.
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Accounts Payable
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3 min
05 September 2024

Accounts payable (AP) is an important part of every business’s finances. It affects cash flow, relationships with suppliers, and overall business stability. AP is more than just paying bills — it helps manage short-term debts, build trust with vendors, and support long-term growth.

This article explains what accounts payable means, its main parts, and how it works as a business expense. You’ll also find out how AP is different from accounts receivable and trade payables. Real-life examples and the full procure-to-pay (P2P) process will be covered, along with how to record AP and common problems businesses face.

These tips will help make your business run smoothly and improve financial management.

What are accounts payable?

Accounts payable (AP) is the money a business owes to its suppliers for goods and services bought on credit. It appears as a current liability on the company’s balance sheet and shows the total of approved but unpaid bills from suppliers. Businesses need to pay these bills on time to avoid late payments or penalties.

In the business environment, accounts payable is an important part of managing working capital and the working capital cycle. When a business buys goods on credit, it has to pay the supplier within a short period. This amount owed is called accounts payable.

If accounts payable increases over time, it means the company is buying more on credit, which can affect its working capital needs and may lead to taking business loans. If accounts payable decreases, the company is paying off its debts faster than it is buying new goods or services on credit, which can improve cash flow and strengthen the working capital cycle.

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Key components of accounts payable

Accounts payable might not always be called exactly that in your ERP system. It can have different names. Here are some common parts of accounts payable:

  • Vendor invoices: These are bills your suppliers send to your company for goods or services used in making and selling your products.

  • Utilities: Running a business involves many expenses like electricity, water, phone, and internet. These bills come regularly and are part of accounts payable.

  • Employee reimbursements: Sometimes employees spend their own money for business expenses and need to be paid back. These repayments are included in accounts payable.

  • Accruals and bills payable: Some expenses, like wages, interest, taxes, or other costs, may be owed but not yet paid. These also need to be recorded in accounts payable.

What does accounts payable do?

Accounts Payable (AP) is a crucial department in any business, responsible for managing and recording the company’s short-term liabilities. So, what accounts payable exactly? It refers to the amounts owed to suppliers for goods or services received but not yet paid for, which are recorded as short-term obligations on the company's general ledger. Proper management ensures a balanced capital structure.

Accounts payable meaning goes beyond just tracking what the company owes. It involves ensuring that all vendor invoices are paid on time, managing supplier relationships, and maintaining financial accuracy. In larger companies, Accounts Payable is usually a separate department from Accounts Receivable. However, smaller businesses often combine these functions into one.

For clarity, let's look at some accounts payable examples. Common examples include bills for utilities, office supplies, or inventory purchases. These are everyday transactions that a company needs to track and settle within agreed terms.

In summary, the accounts payable process is not just about paying bills—it plays a vital role in managing a company's cash flow and ensuring smooth business operations.

Are accounts payable business expense?

Yes, accounts payable are considered a business expense. They represent money owed to suppliers for goods or services received on credit. While accounts payable reflect short-term liabilities, they are essential for sustaining business operations. Timely payment of accounts payable ensures smooth relationships with suppliers and enables continuous access to necessary goods and services.

Business loans can help manage accounts payable by providing immediate funds to settle outstanding invoices. This ensures that suppliers are paid on time, avoiding late payment penalties and maintaining trust. Additionally, loans offer flexibility in managing cash flow, allowing businesses to cover expenses while waiting for receivables to come in. With timely payments facilitated by business loans, companies can uphold their financial obligations and strengthen their reputation in the market.

With Bajaj Finserv Business Loan, you can get loans of up to Rs. 80 lakh with flexible tenures. Apply for a Bajaj Finserv Business Loan and manage your expenses with ease.

Examples of accounts payable

Here are a few examples of accounts payable:

  1. Supplier invoices: Bills received from suppliers for goods or services provided.

  2. Utility bills: Invoices from utility companies for services like electricity, water, or gas.

  3. Rent payments: Monthly rent payments for office space or facilities.

  4. Loan payments: Installments due on loans taken to finance business operations.

  5. Inventory purchases: Payments owed for inventory purchases from suppliers.

  6. Professional fees: Fees owed to lawyers, accountants, or consultants for professional services.

  7. Office supplies: Invoices for office supplies purchased on credit.

Tracking and managing accounts payable accurately is essential for maintaining good supplier relationships and ensuring timely payments.

Accounts payable vs accounts receivable

Aspect

Accounts Payable (AP)

Accounts Receivable (AR)

Type of account

A current liability on the balance sheet, showing money the company owes in the short term.

A current asset on the balance sheet, showing money the company is owed.

Direction of cash flow

Money going out of the company in the future.

Money coming into the company in the future.

Perspective

The buyer’s view – tracking payments the company must make to suppliers.

The seller’s view – tracking payments expected from customers.

Invoicing

The AP team receives bills from suppliers that need paying.

The AR team sends bills to customers for payment.

Management focus

Paying suppliers on time to keep good relationships and avoid fines.

Collecting payments quickly to keep cash flowing and reduce unpaid debts.

Related financial metrics

Days Payable Outstanding (DPO): Average days taken to pay suppliers.

Days Sales Outstanding (DSO): Average days taken to collect from customers.

Accounts payable vs Trade payable

Accounts payable

Trade payable

Represents all amounts owed to suppliers for goods or services purchased on credit.

Includes only amounts owed to trade creditors for goods or services purchased on credit.

Recorded in the balance sheet as a liability.

Also recorded in the balance sheet as a liability.

Encompasses a broader range of liabilities, including non-trade payables like taxes and utilities.

Specifically refers to payables related to trade creditors.

Managed by the accounts payable department.

Managed by the purchasing or procurement department.

Includes invoices, bills, and other documents from various suppliers.

Limited to invoices and bills from trade creditors.

Accounts payable and trade payable both represent amounts owed to suppliers, but trade payable specifically refers to obligations related to trade creditors, whereas accounts payable may include a broader range of liabilities.

Procure-to-pay (P2P) process in accounts payable

The P2P process, or procure-to-pay process, is part of the overall accounts payable cycle. It covers everything from deciding to buy something to paying for it. Here’s how it works:

  1. The company decides what products it needs and gets approval.

  2. It looks for suppliers and chooses a few to consider.

  3. It asks for quotes and picks the supplier that best fits its needs.

  4. The company negotiates prices, credit terms, discounts, delivery, and shipping costs.

  5. It creates purchase orders and sends them to the chosen suppliers.

  6. The supplier confirms the order and agrees to the terms.

  7. The supplier ships the goods and informs the company.

  8. The company receives and checks the goods to make sure they are the right quality and quantity. Then it sends the invoice for approval.

  9. Once approved, the company processes the payment, tells the supplier, and marks the payment as done.

How to record accounts payable?

Recording accounts payable involves documenting the amounts owed to suppliers or vendors for goods or services received but not yet paid for. Here is a step-by-step guide on how to accurately record accounts payable:

  1. Gather invoices: Collect all invoices received from suppliers for purchases made on credit.

  2. Review invoices: Check each invoice for accuracy, ensuring it matches the goods or services received and the agreed-upon prices.

  3.  Enter invoices in the accounts payable ledger: Record each invoice in the accounts payable ledger, detailing the supplier name, invoice number, invoice date, amount owed, and payment terms.

  4. Assign general ledger codes: Allocate the appropriate general ledger codes to each invoice based on the nature of the expense.

  5. Accrual accounting: If using accrual accounting, recognise the accounts payable as a liability on the balance sheet, reflecting the amount owed to suppliers.

  6. Payment approval: Obtain necessary approvals for payment of invoices according to company policies and procedures.

  7. Payment processing: When ready to make payments, issue checks or initiate electronic transfers to suppliers, updating the accounts payable ledger accordingly.

  8. Reconciliation: Regularly reconcile accounts payable records with supplier statements to ensure accuracy and identify any discrepancies.

By following these steps, businesses can effectively manage their accounts payable, maintain positive supplier relationships, and ensure timely payment of outstanding invoices.

Challenges in the accounts payable process

The procure-to-pay (P2P) process in accounts payable is an integral part of the overall accounts payable cycle. Also known as the P2P cycle, it covers the end-to-end journey from deciding to purchase goods or services to completing payment. Here's a streamlined overview of the process:

  1. The company identifies the products or services it needs and obtains internal approval.

  2. It begins searching for vendors or suppliers and shortlists a few options.

  3. After receiving quotes, the company selects the vendor that best meets its requirements.

  4. Terms such as pricing, credit policies, discounts, delivery schedules, and freight charges are negotiated.

  5. A purchase order (PO) is created and sent to the chosen supplier.

  6. The supplier confirms the order, agreeing to the stated terms and conditions.

  7. Once the goods are shipped, the supplier informs the company.

  8. The company inspects the received goods for quality and quantity, and the invoice is sent for approval.

  9. Following approval, payment is processed, and the vendor is notified. The payment is then marked as complete.

This entire process ensures efficient purchasing and payment procedures, maintaining smooth vendor relationships and financial operations.

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Frequently asked questions

What are the 4 functions of accounts payable?

The four main functions of accounts payable are receiving invoices from suppliers, verifying the accuracy of invoices, recording the amounts owed, and making payments to suppliers. This process ensures that businesses manage their expenses efficiently and maintain good relationships with their suppliers.

Where Do I Find a Company's Accounts Payable?

You can find a company's accounts payable in its financial statements or accounting records. Look for the "Accounts Payable" or "Creditors" section, which shows the money the company owes to suppliers for goods or services received. It's usually listed under current liabilities.

Is accounts payable a debit or credit?

In accounting, accounts payable is a credit. It represents money owed by a business to its suppliers for goods or services purchased on credit. When recording a transaction, accounts payable increases as a credit, while the corresponding entry decreases cash or increases another asset account as a debit.

How do you record accounts payable transactions?

Recording accounts payable involves several steps, starting with receiving an invoice from a vendor. The amount owed is recorded as a liability under "accounts payable" on the balance sheet. The expense is simultaneously recorded in the relevant expense account. Once the payment is made, the liability is reduced, and the payment is recorded against the bank account. This process ensures accurate tracking of debts owed by the business to suppliers or vendors​.

What is the role of accounts payable?

Accounts payable plays a crucial role in managing a company's financial obligations. It ensures that all incoming invoices from suppliers and vendors are tracked, processed, and paid accurately and on time. Additionally, it helps maintain healthy supplier relationships by ensuring timely payments, which can also allow businesses to take advantage of early payment discounts. Efficient accounts payable management improves cash flow, operational efficiency, and supplier trust.

What is accounts payable compliance?

Accounts payable compliance refers to ensuring that a company adheres to internal controls, regulations, and industry standards when managing supplier payments. Compliance involves following established protocols for recording and processing transactions, maintaining audit trails, and ensuring payments are legitimate and authorized. Additionally, it helps companies mitigate risks such as fraud, late payments, or errors in recording.

Is accounts payable a credit or debit?

Accounts payable is typically recorded as a credit in the company’s general ledger because it represents a liability, which is an amount the company owes to its suppliers. When the company receives goods or services but hasn’t yet paid for them, the accounts payable balance increases with a credit. When a payment is made, the accounts payable is debited, reducing the balance​.

What is an accounts payable turnover ratio?

The accounts payable turnover ratio measures how quickly a company pays off its suppliers. It is calculated by dividing total supplier purchases by the average accounts payable balance during a specific period. A high ratio indicates quick payment to suppliers, while a low ratio might suggest delays in settling liabilities, which could strain supplier relationships.

How do you calculate accounts payable?

To calculate accounts payable, you add up all unpaid invoices, bills, and amounts owed to vendors at a given time. The accounts payable amount is typically recorded as a liability on the balance sheet. This calculation helps businesses understand their short-term obligations and manage cash flow effectively.

What is GAAP for accounts payable?

GAAP (Generally Accepted Accounting Principles) provides guidelines for accurate and consistent financial reporting, including for accounts payable. Under GAAP, accounts payable must be recorded as a liability when goods or services are received, even if payment has not yet been made. Companies must adhere to principles like consistency and full disclosure to ensure transparency and reliability in financial statements​.

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