As a small business owner, you often buy items for your company. You don’t always pay for the items up front. Instead, a vendor sends you an invoice. If you receive vendor invoices, you need to manage your accounts payable. What is accounts payable?
What is accounts payable?
Accounts payable includes all the money you owe to vendors. You use accounts payable to keep track of credit that vendors have extended to you. Accounts payable is also referred to as payables or AP. The entries in your accounts payable account are called payables. A payable represents an invoice you need to pay.
For example, you buy supplies from a vendor. You do not pay the vendor when you receive the supplies. Instead, the vendor sends you an invoice with a due date for the payment. The accounts payable account in your books shows you which vendors you owe money to.
Record accounts payable if you use accrual accounting. With the accrual method, record expenses as soon as you incur them instead of when you make payments. That means you record an expense as soon as you receive an invoice, not when the vendor deposits the check.
Since you usually owe payments within a short period, accounts payable is a short-term liability. Short-term liabilities are paid quickly, often within one year.
Accounts payable summary
Track payables in an accounts payable summary. Create a list of vendors and the corresponding balances due to keep your accounts payable process organized.
Typically, the summaries are used with an aging system. List the payables by when they are due.
Let’s say you own a heating and cooling business. Here is what your accounts payable summary looks like. The vendors you owe money to are listed in the first column and the balances due are in the appropriate aging column.
Accounts Payable Summary for July 1-5
|Payee||Current||Past Due 1-30 Days||Past Due 31-60 Days||Total|
From the summary, you see that you bought supplies from Office Mart. You incurred a debt of $373.28 since funds were not exchanged at the time of the transaction. Assuming the due date hasn’t passed, you report the amount due in the current column of the aging report.
If you do not pay Office Mart within the defined time, move the amount due to the next aging column. This process allows you to keep tabs on how much money you owe and when payments are due.
Recording AP in your books
Using the accrual accounting method, you must record accounts payable in your books. Track accounts payable as a liability on your business balance sheet.
You need to use double-entry bookkeeping when you balance accounts payable with accrual accounting. For every business transaction, record two entries. The accounts payable entries balance your books. While one entry increases an account, the other decreases an account.
For each accounts payable transaction, make two entries. One entry is credited, and the other is debited. Accounting debits and credits affect each type of account differently. Here is a guide to help you:
Accounts payable is a liability. Liabilities are increased by credits. And, liabilities are decreased by debits.
Breaking down accounts payable and double-entry bookkeeping
Let’s look at when you buy supplies from a vendor. When you receive the invoice, you increase the amount of payables you have. Accounts payable is a liability, so you gain a liability. Since liabilities are increased by credits, you credit the payable in your books.
Keep in mind that you need to make two entries for every transaction. Since you credited the payable, you need to offset the entry with a debit.
In the transaction, you gained supplies, which are assets to your business. By gaining the supplies, you increased your assets. From the chart above, you can see that assets are increased by debits. Debit the asset account to offset the credited payable entry.
Recap: When you are invoiced, credit the payable and debit the purchased item.
Why accounts payable is important
You should be aware of how much you owe to other businesses, as it is a significant factor in determining if you are profitable. Carrying consistently high accounts payable with low available cash means you regularly owe more than what you earn.
You may find that you need to adjust your operations to better manage accounts payable. For example, you might need to hold off on buying equipment if you struggle to cover payables.
Accounts payable provides data for budgeting and planning. By looking ahead at expenses, you can decide when to make large purchases or if you are ready to expand. You can also avoid situations where you do not have enough cash on hand to cover costs.
Tips for managing accounts payable
You have a lot to juggle as you run your small business. Accounts payable process improvement makes paying vendors easier. And, it can get you back to working on revenue-generating tasks.
Here are five tips for managing payables:
Tip 1: Create an accounts payable system
Record each invoice using the same method in your books. Set up a system for accounts payable and track your unpaid invoices. Make it clear who you owe, how much you owe, and when the money is due.
Tip 2: Look for discount opportunities
Pay attention to early payment discounts in vendor invoice payment terms. Some vendors give money off the total bill for sending early payments. These discounts can add up. Before paying early, check your bank account to see if you will have enough money left over to operate efficiently.
Tip 3: Set up reminders
Have reminders for approaching invoice due dates. Whether you use a hard-copy calendar or technology, you need a way to alert yourself when payables are due. This will help you avoid late payments and manage small business cash flow. Make a habit of checking payable due dates on a regular basis.
Tip 4: Update your contact information
Make it easy for vendors to find you by keeping your contact information current. Make sure your website, business card, and other public listings have the correct addresses and phone numbers. When a vendor takes your information, verify that it is accurate.
Tip 5: Maintain vendor relationships
As a small business owner, you need to maintain good relationships with vendors. But, sometimes, you can’t make a payment on time. When this happens, talk with your vendor to negotiate payment terms. You might be able to go on a payment plan where you pay the money owed in installments.
Are you looking for an easy way to keep track of your small business’s transactions? Patriot’s cash-basis accounting software is made for the non-accountant. Use the cash-in, cash-out system to complete your books in a few simple steps. And, we offer free, U.S.-based support. Try it for free today.
This article was updated from its original publication date (8/16/2012).