What Is Accounts Payable?
Accounts payable is an accounting term that can mean several things in different contexts, but it’s generally used when talking about short-term debts that a business owes and the department that’s tasked with paying those debts.
But more specifically — and for our purposes here — it’s also the name of a specific recording tool used to keep track of bills and invoices that aren’t yet paid when businesses use the double-entry bookkeeping method – the gold standard for accounting.
What is accounts payable?
Accounts payable, also known as “A/P,” is a type of liability account within a business’s chart of accounts. It’s used to record bills and invoices that have come in but have not yet been paid. It’s essentially an IOU from your business to another for the goods or services rendered.
When you enter in these transactions, you’ll see them appear as “accounts payable” in your business’s general ledger. This will appear as part of a single journal entry used in the double-entry bookkeeping system: a “debit” on the left, which records what type of expense your business incurred (such as an equipment or inventory purchase), and a “credit” on the right, which notes that your Accounts Payable balance has increased.
Recording accounts payable allows you to generate financial business statements such as cash flow analyses and balance sheets. This gives you an accurate picture of your business’s financial standing and can help you make important business decisions going forward, such as whether you have enough capital to make new business investments or not. These statements are also generally required if you’re applying for a small business loan.
Accounts receivable vs. accounts payable
While accounts payable is a liability account that will typically go on the right side of the general ledger, accounts receivable (“A/R”) represents an asset account, the balance of which shows the total amount owed to you by other businesses or entities.
You’ll record accounts receivable entries in your general ledger using a similar two-part entry as for accounts payable: a “debit” on the left that shows your Accounts Receivable balance has increased, and a “credit” on the right which shows where that money owed is coming from (such as a consulting fee or merchandise sale).
For example, if you run a marketing company and receive an invoice to renew a license for your design software, you would add that as a credit to your accounts payable. If, however, you send an invoice to another business after designing a new logo for it, you would record that as a debit to your accounts receivable.
Example: How accounts payable works
Accounts payable can be used for any expense that isn’t immediately paid in full from your bank account.
- Equipment: Your business buys $10,000 worth of office equipment from a vendor and receives an invoice that’s due in 30 days. This purchase increases your tangible assets while also increasing your liabilities. You would then record a debit in the equipment account and a credit in your accounts payable.
- Services: That new printer breaks down, so your business hires a service professional to repair it. The cost is $500 and payment is due in 60 days. You would record a debit in your repairs and maintenance expense account and a credit in your accounts payable.
Utilities: Every month you pay $1,000 for high-speed internet for your business. At the beginning of each month, you would debit your utility expense account and credit your accounts payable.
Accounts payable process
The routine of paying your business’s bills is also known as the “accounts payable” process. Depending on how your business operates, this could take a few different shapes. Here’s a summary of how it works:
1. Receive the bill or invoice
First, you’ll receive an invoice from the vendor or creditor after your business purchases goods or services from another company. Your business might have a formal process for submitting purchase orders in advance of this, such as if you’re buying a fleet of delivery vans. Or, you might simply receive a bill after you’ve already made the purchase, such as if you get an invoice from a contractor.
2. Record the bill
Most businesses use the double-entry accounting method which balances each debit with a corresponding credit to track where money is coming from and where it goes. Typically, you’ll add a debit to an account that tracks the type of purchase you made on the left side of the ledger at the same time you add a credit to your accounts payable, on the right side of the ledger on the following line. This makes up a single journal entry within your general ledger.
For example, if you bought a piece of equipment on credit, you would add it as a debit to your “equipment” account on the left side of your ledger. You’d then add a matching entry as a credit on the right-hand side of the next line to your Accounts Payable account. This notes that you’ve made an equipment purchase, but you haven’t yet paid the bill.
| Date | Account | Notes | Debit | Credit |
|---|---|---|---|---|
| 6/1/24 | Equipment | Pizza oven: Invoice #8574 received | $10,000 | — |
| Accounts Payable | Pizza oven: Invoice #8574 received | — | $10,000 |
3. Approve the bill
Now you’ve officially recorded that you owe the money as a short-term debt, but you still need to pay it. Before you do, it’s wise to verify that it’s a legitimate expense and that everything is in order. After all, you wouldn’t just pay every invoice that shows up from an unfamiliar vendor in the spam folder of your personal email account, would you?
If your business uses purchase orders, this is fairly straightforward. Just make sure that the quantity and type of goods or services you received match what’s listed on the purchase order and the invoice. Otherwise, you’ll need to vet each invoice or bill as it comes in to make sure it’s accurate and true.
4. Pay the bill
Different vendors accept payment in various ways, which you should verify before sending payment in. Some companies don’t accept credit card payments, for example, or only allow you to pay by ACH transfer. Whatever the payment type, you have until the due date to pay the bill. Some companies offer discounts if you pay early; while others charge late fees and interest if you pay late.
Once the cash has changed hands and the invoice is paid, you’ll record the amount paid as a debit to your accounts payable — that will show your debt balance has been reduced. You’ll also credit your cash account to indicate that you’ve spent the money to pay the bill. This tracks the progress of a single invoice, but you can get a better idea of how your business is handling bill payment as a whole by using a metric known as the “days payable outstanding,” or DPO.
| Date | Account | Details | Debit | Credit |
|---|---|---|---|---|
| 6/1/24 | Equipment | Pizza oven: Invoice #8574 received | $10,000 | — |
| Accounts Payable | Pizza oven: Invoice #8574 received | — | $10,000 | |
| 6/30/24 | Accounts payable | Pizza oven: Invoice #8574 paid | $10,000 | — |
| Cash | Pizza oven: Invoice #8574 paid | — | $10,000 |
What is a good DPO?
The average time it takes you to pay your debts — called days payable outstanding (DPO) — is an important metric in measuring how your business handles its cash flow. There is no single benchmark for a healthy DPO; rather, it will vary by industry and the company’s competitive position. A DPO of 30 to 40 days is normal in many industries, but businesses operating in the healthcare industry, for example, typically have DPOs ranging up to 70 days or more.
If your DPO is too high relative to your industry’s norms, it could mean your business is struggling to come up with enough cash to meet its obligations to vendors and creditors, or that your creditor offers a generous payment term. If your DPO is too low, it could mean you’re paying bills far earlier than they’re due, and may not be making the most use of your cash flow. It could also reflect shorter credit terms.
Calculate your business's DPO
(Total Accounts Payable / Cost of Goods Sold) x # of days in account cycle = DPO (in days)
For example, if your year-end balance sheet lists $5,000 in Accounts Payable and $50,000 in sales, your DPO is 37 days ([$5,000 / $60,000] x 365).
How to handle accounts payable for your small business
Depending on your business’s size and how often you need to pay bills, you might opt for one of the following ways to manage your accounts payable:
- Software: Programs like Quickbooks are easy for many small business owners to use, and can serve as an all-in-one business accounting platform.
- Hire a contractor: Business owners with more complicated situations or who don’t have a good grasp on bookkeeping may choose to outsource this task to a bookkeeping or accounting firm.
- Hire dedicated employees: Very large businesses often hire dedicated employees within an accounting department to handle accounts payable for vendors.
How to prevent accounts payable fraud
Given that money flows out of your business through the accounts payable department, it’s no wonder that this is a major source of business fraud. This can occur knowingly or unknowingly. For example, a vendor may accidentally submit an invoice twice. Or, a thief may impersonate one of your real vendors, submitting an invoice to be paid straight into their own bank account.
Here are some tips to guard against this:
- Make sure at least two people are involved in accounts payable, one of which can provide oversight.
- Use two-way or three-way matching to verify that the purchase order, invoice and packing slip all agree for each purchase.
- Create written procedures for how your business vets new vendors, processes accounts payable, conducts audits and handles any discrepancies.
- Use automated accounting software to help limit errors from humans, such as manually entering in the invoice number from each transaction.
Frequently asked questions
Yes. Accounts payable is an example of a current liability account that appears on a business’s balance sheet.
Because accounts payable is a short-term debt that hasn’t yet been paid, it’s considered a liability. An expense would be a good or service you already spent money on.
When you receive an invoice from a third party, that is considered accounts payable. Examples include bills for business equipment or services provided to your company by another entity.
Some businesses may categorize accounts payable into trade payables and expense payables and track those accounts separately. Trade payables are typically debts incurred when a business purchases physical goods or inventory and owes the supplier.