Making full payment at the time of business transaction is not very convenient. For this reason, most companies ask extra time for payment to their vendors, suppliers, or service providers. In the accounting term, this due payment is called “Accounts payable”. It is a legal liability for the business, where the company has to pay the amount within a short period.
\All accountants treat this due amount as a short term debt, which it owes to the vendors, suppliers, or service providers. Let’s learn how accounts payable work and what are the advantages and disadvantages associated with it.
How does it work?
Most companies do not pay the regular supplier or vendor the full amount for their raw material, goods, or services. Instead, they ask the supplier for some extra time for the payment. During this time the company can sell the manufactured product to the customer and recuperate the cost of raw materials. It makes the long-term business easy.
Here, the suppliers send an invoice at the time of supplying raw material, goods, and services. Now, the company is obligated to pay the amount within an obligated time frame. For most business transactions it can be 15, 30, or 45 days.
For example, a shirt company acquires raw material worth $50,000 from the supplier. With this raw material, the company will also receive an invoice of $50,000 and payable within 30 days limit. Legally, the shirt company has to pay this due amount in 30 days or the supplier can ask for late fees or refuse to do business in the future.
The accounts payable matrix in the balance sheet showcases a company’s cash flow condition. If the accounts payable number increases then it could mean the company is procuring more raw material and services. If the accounts payable number decreases, then it could mean the company paying off its supplier quickly.
Advantages of Accounts Payable
Most businesses use this matrix in their balance sheet. It helps them pay off the debt to the supplier in an orderly manner. Account payable is a short term loan. For this reason, most companies prefer to have an extended date for pay off. It helps the company gather cash for the payment and improves its cash-flow condition. This method of payment also strengthens the company and its supplier relationship. In the modern-day of business, it is quite normal to have some accounts payable in the balance sheet.
Disadvantages of Accounts Payable
Accounts Payable is a burden for the suppliers. In this process, lots of capital from the suppliers stuck to the business. For this reason, they want to give less time for the payment. Extending the payoff period only puts pressure on the supplier’s financial position.
A company balance sheet with prolonged accounts payable is also not a good sign. It indicated the dwindling cash position of the company and reflects its financial trouble. Any delay in the accounts payable payoff can shatter the company and its supplier relationship and cause harm to the long-term business relationship.
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