Understanding Accounts Payable: A Simple Guide

 

If you’re new to business or recently out of college, the terminology of accounting can be frightening. One of the first terms you will come across is the Accounts Payable (AP)—and believe us, it’s much more than what’s listed on your balance sheet.

In simply words, accounts payable is the money that your business owes to other people. But if managed correctly, it can be a great tool to build relationships, improve your cash flow and grow your business.

Let’s take a closer look at what accounts payable actually is, why it counts, and how you can handle it like the seasoned pro you’ll soon be even if you’re new to the game.

What Is Accounts Payable?

AP is the money you owe to suppliers, vendors, or service providers when you purchase goods or services on credit. You don’t pay right then, and instead agree to pay later, typically within 30, 60 or 90 days.

Example:

Let’s say you run a small digital agency and purchase a software subscription or office supplies, but the supplier gives you 30 days to pay. That bill becomes part of your accounts payable until you settle it.

In accounting terms, it’s recorded as a liability—something you owe—on your balance sheet.

Why Accounts Payable Is So Important (Especially for Small Business)

Keeping your Cash Flow healthy

Money is the bloodline of a company. Though, by stretching payment out (while still meeting agreed upon terms), you can keep more cash in hand, some of that cash can be used for the more pressing needs like paying employees, marketing your business and buying inventory. But don’t wait around — late payments can ding your reputation and rack up additional late fees.

It Promotes Good Supplier Relationships

When you pay on time (or even early), you’re proving that your business is dependable. This can enable you to negotiate better terms, receive priority service and potentially early payment discounts in the future.

Where Do You See AP on Your Financial Statements?

You’ll generally see accounts payable in two locations:

Balance sheet: Found in current liabilities, since it’s the money you owe soon.

Cash Flow Statement: It impacts your cash flow from operating activities — how much cash is received and paid from day-to-day operations.

How to Record AP Transactions (When You’re Not an Accountant)

You don’t have to be a CPA to understand basic journal entries. Here are examples of how you might record two typical AP transactions:

Time to use credit to make a purchase:

Credit: Software Expense (or the appropriate expense account)

Credit: Accounts Payable

When you pay that bill later:

Debit: Accounts Payable

Credit: Cash or Bank

This lets your system know that you’ve paid off debt, and decreased your cash balance.

✅ How to Keep Your AP Balance Under Control

While taking credit can be a good thing, letting your AP balance get too large can cause cash flow problems. Here’s what to do with it wisely:

·         Protect/ Safe payment terms (example: 60 days instead of 30)

·         Use early payment discounts (some suppliers give a 2–3% discount for prompt payments)

·         Leverage software to automate your AP process (never miss a deadline again!)

·         Pay with cash when it’s worth it, at the cost of no interest or fees

Common Reports to Track AP Like a Pro

1. AP Summary Aging Report

Breaks down how long you’ve owed each bill (e.g., 0–30 days, 31–60, etc.). Helps you prioritize payments and avoid overdue penalties.

2. AP Detailed Aging Report

Gives invoice-level details—who you owe, how much, and when it’s due.

Both reports help you stay organized and make sure no bills slip through the cracks.

Useful AP Formulas You Should Know

Even as a beginner, these basic formulas will give you insights into your payment habits and financial health:

Accounts Payable Turnover Ratio

Shows how many times you pay off suppliers during a period.

Formula:

Purchases on Credit ÷ Average Accounts Payable

Days Payable Outstanding (DPO)

Tells you how many days, on average, you take to pay your suppliers.

Formula:

(Average AP ÷ Cost of Goods Sold) × Number of Days

Average Age of AP

Helps measure how long it takes your business to pay off debts.

Formula:

(Accounts Payable ÷ Annual Credit Purchases) × 365

Understanding these numbers helps you spot issues early and make better financial decisions.

Final Thoughts: Why You Should Care About AP

If you're new to business, you probably agree that accounts payable management doesn't sound like the most exciting subject to learn about— but it’s essential. Managing accounts payable can help prevent the following problems:

·         Cash shortages

·         Keeping suppliers' trust

·         Mainlining discounts

·         Sustainably expanding the business

So don’t ignore it! Start with a simple spreadsheet or accounting software, review your reports regularly, and treat your payables like the powerful tool they are.

Are you launching your first business or looking to get better at handling finances? Accounts payable is a great place to start. Keep it clean, keep it smart—and your business will thank you for it.