Accounts payable represent obligations of the firm to pay for goods purchased and services consumed but not yet paid for. Accounts payable is listed as a current liability on the firm’s balance sheet.
Suppliers often provide goods and services to their business customers on terms which call for future payment. For example, an inventory wholesaler may require payment within 60 days from the invoice date.
Accounts payable are an important component of operating cash flow. When the accounts payable balance increases from the prior period, it means that the firm’s purchases are greater than the associated cash outlays. When the accounts payable balance decreases from the prior period, it means that the firm’s purchases were less than the associated cash outlays. In other words, an increase in accounts payable is a source of cash while a decrease in accounts payable is a use of cash.
Although it may seem like trade terms represent a free financing source, there is an important caveat. Vendors often give their business customers early payment discounts. When this occurs, firms may be better off paying their vendors sooner rather than stretching out payment.
Many investors and creditors view rising accounts payable balances as a concern. If accounts payable are rising faster than sales, it could mean that the firm is not paying its bills on time. Since suppliers will likely stop selling to firms which are not timely paying their bills, increasing accounts payable balances could threaten the company’s ability to operate.
