I'm the manager of gurufocus. Please create a Accounts payable (AP) explanation video for gurufocus users. Please make it easy to understand and fun to watch. In your video, please consider the following questions: Accounts payable (AP), or simply "payables," is the amount still outstanding that a business owes for goods and services purchased on credit. If payables are increasing, this can indicate the business is taking greater advantage of favorable vendor credit. However, rising payables might also signal financial distress—a company might be delaying payments because it doesn't have enough cash on hand to meet its obligations. Key Takeaways Accounts payable (AP) is a short-term liability representing a company's obligation to pay off outstanding debts to creditors or suppliers. It is important to differentiate between AP and accounts receivable since they represent opposite sides of a credit transaction. Properly recording AP involves understanding double-entry bookkeeping and the associated credit and debit entries. Managing AP well can improve cash flow and keep up good vendor relationships. Accounts Payable Investopedia / Alison Czinkota What Are Accounts Payable (AP)? Companies often buy things on credit, and when they do, they record outstanding amounts as AP. This item appears on the balance sheet as a current liability, which typically comes due at intervals of 30, 45, 60, or 90 days, depending on the repayment terms. AP is short-term financing that helps a company conserve cash by deferring payments for a time. Nevertheless, paying AP on time is essential for building strong relationships with vendors and getting the best credit terms. AP terms usually follow a standard structure, with formats such as the following: Net 30: Full payment is required within 30 days of the invoice date or delivery date. This is a common payables structure across many business sectors. 1/10 or 2/10 Net 30: Paying the invoice within 10 days provides buyers a discount of 1% (or 2%, etc.) off of the invoice total. If the buyer misses the discount period deadline, they owe the full amount within 30 days. If AP is increasing, this suggests the company is buying more goods or services on credit rather than cash payments. Declining AP indicates that the business is clearing past obligations faster than it takes on new credit purchases. The effective management of AP is essential so that a company has enough to pay its bills and has a stable cash flow. Important Accounts payable is not classified among expenses, which are found on the income statement. Instead, payables are booked as liabilities and are found on the balance sheet. Examples of Accounts Payable AP includes these business obligations: Supplier invoices: When a company buys inputs or raw materials on credit. Contractor payments: Businesses often contract external service providers—for instance, cleaning services or IT support. Subscription services: Subscriptions often provide services (such as media content or provision of some service) and then invoice them later. Utility bills: Monthly bills are due at the end of the month (after their use), such as those for electricity, water, phone, and the internet. Professional services: Legal fees, consulting services, and accounting work paid at the end of each quarter. Maintenance: Upkeep for equipment or facilities paid on a semiannual basis. For example, when a restaurant orders $2,000 worth of ingredients from a food supplier and has a payment due in 30 days, it creates an AP entry for the same amount. The restaurant can then use those supplies to generate revenue (e.g., by selling meals to patrons) before the payment is due. Tip AP essentially functions as a form of interest-free short-term credit offered by suppliers. The Role of Accounts Payable in Financial Statements AP appears in a company's financial statements on the balance sheet under current liabilities. Because AP represents obligations due within one year, it is a handy indicator of a company’s short-term liquidity and working capital. If not managed carefully, a growing AP balance could signal potential cash flow problems or indicate that the company is relying too heavily on supplier credit. Managing AP well does more than simply record liabilities; it's also an important variable used in managerial accounting and fundamental analysis to understand a company's financial position. AP Turnover Ratio The payables turnover ratio can reveal how efficient a company is at paying what it owes over the course of a year. A higher ratio suggests that the company is quickly and consistently settling its liabilities, which can signal efficient cash management. Here is the formula: AP Turnover Ratio = Net Credit Purchases ÷ Average Accounts Payable Example: Suppose a company’s net credit purchases for the year total $130 million. Its beginning AP balance was $25 million, and its ending AP was $15 million (so its average AP is $20 million): AP Turnover Ratio = $130M ÷ $20M = 6.5 times per year. Days Payable Outstanding (DPO) Days payable outstanding (DPO) is the average number of days a company needs to pay its bills and obligations. Companies with longer DPOs might be delaying payments to increase their working capital and free cash flow, or they might be struggling to come up with the cash. Here's the formula: DPO= (Average Accounts Payable ÷ Cost of Goods Sold) × 365 days Example: If the average AP is $15 million and the cost of goods sold is $100 million: DPO = ($15M ÷ $100M) × 365 ≈ 55 days. Cash Conversion Cycle (CCC) The cash conversion cycle (CCC) estimates the number of days it takes for a company to convert its inventory into cash flows from sales. Here's the formula: CCC = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) – DPO By subtracting the DPO from DIO (how long it takes to clear inventory) and DSO(how long it takes to collect from customers), the CCC provides an overview of how well a company manages its working capital. A shorter CCC means it converts products into cash more quickly. Recording Accounts Payable Proper double-entry bookkeeping requires that there must always be an offsetting debit and credit for all entries made into the general ledger. In double-entry bookkeeping, asset accounts like cash decrease with a credit entry. When you pay an invoice, you debit the AP account (reducing the liability) and credit the cash account, which reflects that cash has decreased. Even though cash is leaving, the credit entry is used because that's how reductions in asset accounts are recorded in accounting: debits increase assets and decrease liabilities, while credits decrease assets and increase liabilities. Initial recording (when receiving goods/services): Debit: (+)Expense or asset account Credit: (+)Accounts payable Payment recording (when paying the bill): Debit: (-)Accounts payable Credit: (-)Cash Example Suppose a company purchases office furniture invoiced at $10,000 on credit, with payment due in 45 days: Step 1: Initial Recording Debit: Assets +$10,000 This records the addition of the equipment as an asset. Credit: Accounts Payable +$10,000 But the company now has a liability that it still hasn't paid for that asset. Step 2: Payment Recording (45 days later) Debit: Accounts Payable -$10,000 The original liability is canceled when the bill is ultimately paid Credit: Cash -$10,000 The payment is made in cash, so it's deducted from the company's cash position. This method ensures that all transactions are properly tracked and the company's financial position is accurately represented. Trade Payables Trade payables are the subset of AP that specifically relate to the purchases of goods used in production or resale. Accounts Payable Management When AP is managed well, companies can postpone payments to suppliers with set terms to save cash for immediate investments or prospects while preventing late payment charges and credit problems. This involves the following: Timely invoice processing: Modern accounting systems make timely invoicing straightforward, which should cut down on mistakes and automate timely payments to prevent penalties. Negotiating favorable payment terms: Negotiate extended payment periods or early payment discounts to improve cash flow. Regular reconciliation: Perform routine reconciliations between the AP ledger and general ledger to detect discrepancies and maintain accurate records. Monitoring key metrics: Use the AP turnover ratio and DPO to assess payment efficiency and liquidity. Maintaining vendor relationships: Establishing trust helps both sides negotiate better terms and flexibility. Accounts Payable vs. Accounts Receivable While AP is the money a company owes to its vendors, accounts receivable is the money owed to the company by its customers. The two are essentially a mirror image on a company’s balance sheet—AP is a current liability, while accounts receivable is a current asset. Accounts Payable vs. Accounts Receivable Payables Money the company owes to vendors/suppliers Current liability Short-term credit obligations Receivables Money owed to the company by customers Current asset Earned revenue not yet received in cash The Bottom Line AP is more than a set of bills to be paid since it's a key element of business accounting and financial management. Effectively managing AP can strengthen vendor relationships, improve cash flow, and contribute to a company's overall financial health.