What Is Accounts Payable and How Does It Work?

As a business owner, there are terms that you'll need to be familiar with and that may even become a part of your everyday language. One of those terms is accounts payable. It refers to any money you owe when your company purchases goods and services from vendors or suppliers on credit.

At the end of every accounting period, that amount accounts for all the outstanding debt you owe to your vendors. Your business's accounts payable will be shown in the balance sheet and increases and decreases will be recorded in your cash flow report (more on what that means for your business below).

In this guide, we'll walk you through why understanding your accounts payable is important in running your business.

What Is Accounts Payable?

Accounts payable are bills and other debts your business owes to suppliers and vendors that need to be paid off in a short period of time. For instance, if you are a small business owner who makes arts and crafts for your online store on Etsy or Shopify, you probably don't pay for your supplies each time you pick them up. As many businesses do, you might have an agreement with your supplier that you'll pay for your orders within a specific number of days, such as 30 days from the invoice date.

The amount you owe the vendor will be included in your accounts payable, which represents your current liabilities. Similarly, the vendor would count the amount as accounts receivable on their end. Proper management of your accounts payable is vital to your business because it affects your cash flow, credit rating, and relationship with your vendors.

Large amounts on your accounts payable could be an indication that you're ordering more products or services than you need, or it could mean you're not paying your vendors on time. A zero accounts payable balance may not be good either because it means you're not taking full advantage of the grace period you've negotiated with your suppliers.

Thankfully, these issues can be avoided when you learn how to record and keep track of your accounts payable properly.

How Do You Record Accounts Payable?

Large companies have entire accounts payable departments (otherwise known as AP departments) that are responsible for receiving invoices, processing payments, and managing records. For a few small and medium enterprises, it may be one person who's managing both accounts (payable and receivable). For most small business owners, however, record-keeping, receiving payments, and sending out payments are all part and parcel of running their businesses.

So, how do you record accounts payable correctly? Honestly, unless you take a crash course in accounting, it can be a little daunting. You start with a ledger, brush up with double-entry accounting principles, and learn how to debit and credit amounts to different accounts.

Luckily, platforms and products like Skynova's accounting software allow you to do only half the work. Now, managing your business's accounts is simpler. Follow along as we walk you through the payable process.

Create a General Ledger

A general ledger is used to record, sort, and summarize business transactions. In manual accounting, the ledger is a book with a separate page for each account found in the company's balance sheet and income statements. In a computerized system, the general ledger is a file containing a list of accounts that includes:

• Asset accounts: Cash, accounts receivable, inventory, materials on hand, equipment, land, buildings
• Liabilities: Accounts payable, amortization on vehicles or buildings
• Income statement accounts: Revenues and expenses

To navigate the general ledger, you need to understand the double-entry system of accounting and bookkeeping. It is accounting's version of "for every action, there is an equal and opposite reaction." This means that every business transaction affects two or more general ledger accounts and every account has a standard debit or credit balance.

In general, asset and revenue accounts (e.g., cash, accounts receivable, and income) have a normal debit balance because they are plusses to your business's liquidity and valuation. On the other hand, liability accounts (e.g., accounts payable and expenses) have a normal credit balance because they reduce your company's cash flow and valuation.

In this regard, the double-entry system ensures that the general ledger's total amount of debits equals the total amount of credits.

General ledgers are available to purchase from your office supplies store if you want to manually track your accounting. However, if you want a digital approach, you can create a ledger with Skynova's accounting software. It even allows you to select between accrual accounting and cash accounting.

Under the accrual accounting method, you record your income when it's earned and not when payments are received. For instance, if you fulfilled an order for December but got paid for it in January, the accrual method will still record the revenue for December's income statement. As you've probably guessed, the cash accounting method records income when it's received regardless of when the goods are delivered or the services are rendered.

Record the Bill Under Accounts Payable

Now, you're ready to start recording transactions. There are three steps that commonly occur in a business transaction.

• You, as the buyer, place your order.
• You receive your order with a vendor invoice.
• You pay the invoice amount.

It's similar to going to a store to buy something. However, in this case, the process usually involves significant amounts and may take a few days, weeks, or even months to be completed. Hence, it's important to keep receipts and proper records.

Let's look at the example entry below. You ordered office supplies worth $1,000 on credit. To record the bill, you add $1,000 to the office supplies account and add $1,000 to the accounts payable. This entry means you've received the order but you haven't paid for it yet.

Pay the Bill

When the due date comes and you pay the bill, you'll also need to make the adjustments in your ledger. To record the transaction, debit accounts payable for $1,000 and credit the payment mode, which is generally cash. The entry shown below reduces your total accounts payable with the same amount.

What's the Difference Between Accounts Payable and Accounts Receivable?

As discussed, accounts payable are short-term debts and expenses of your business that you owe to vendors and suppliers. On the other hand, accounts receivable are money owed to you by clients or customers. Just as your suppliers and vendors agree on payment terms with you, you probably extend the same to your customers.

Accounts receivable represents orders you've fulfilled or services you've rendered but haven't yet been paid. You'll find both accounts in your balance sheet.

Let Skynova Help You Manage Your Cash Flow

Small businesses depend primarily on having enough working capital to keep operations going and remain afloat. That's why you must have a dependable accounts payable system. It will help you keep an accurate record that you can use to plan for short- and long-term financial goals you have for your business.

A proper record-keeping system will also help you have internal controls in place to make sure you're paying your vendors on time. Late payments could harm your relationship with your suppliers and may even cost you fees. You'll also want a proper invoice processing system to make sure you're not paying vendors twice or paying for orders you haven't received.

Try Skynova's all-in-one invoicing and accounting software and simplify your payables. Automate your system and stay organized. This product sorts your expense reports by vendor, category, or date. It can also create financial statement reports any time you need them.

You can also take advantage of Skynova's free business templates for invoicing, purchase orders, bids, receipts, and more. Our software products are made specifically for small businesses, yours included.