Making full payment at the time of a business transaction is not very convenient. For this reason, most companies ask extra time for payment to their vendors, suppliers, or service providers. This due payment is called “Accounts payable” in the accounting term. 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 the advantages and disadvantages are associated with it.
- Accounts payable refer to the money a company owes suppliers or creditors for goods or services received but still needs to be paid.
- It is a liability recorded in the balance sheet and essential to managing a company’s financial health and cash flow.
- Accounts payable can be managed through various methods, such as ageing reports, vendor management, and invoice processing systems.
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 long-term business easy.
The suppliers send an invoice when supplying raw materials, goods, and services. Now, the company must pay the amount within an obligated time frame. Most business transactions can take 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. The company procures more raw materials and services if the accounts payable number increases. If the accounts payable number decreases, then it could mean the company is 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 the payoff. It helps the company gather cash for payment and improves its cash-flow condition. This method of payment also strengthens the company and its supplier relationship. In modern-day business, having some accounts payable on the balance sheet is quite normal.
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 company’s dwindling cash position and reflected 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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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.