Day 11/60 Day of CFO: Accounts Payable
Accounts Payable
➡️ What it means
Money a company owes to its suppliers and vendors for goods and services purchased on credit
➡️ Where it shows up
On the Liabilities section of the Balance Sheet
➡️ Why it’s important
1️⃣ Cash Flow Management - a higher AP balance can mean that you are utilizing favorable cash flow measures for the near future, however it’s important to keep track as the amount can catch up with you
2️⃣ Relationship with Suppliers - It’s important to keep track of your AP balance or your relationship with suppliers may worsen, leading to future issues with purchasing goods & services on credit, or legal action
➡️ Common AP formulas
1️⃣ Accounts Payable Turnover Ratio: Measures how many times a company pays off its accounts payable balance during a specific period.
Formula: Purchases on Credit / Average Accounts Payable
Alternate Formula: COGS / Average Accounts Payable Balance
💡A high Accounts Payable Turnover Ratio means that the company is paying off it’s outstanding AP more quickly
2️⃣ Days Payable Outstanding (DPO): Represents the average number of days it takes a company to pay its suppliers.
Formula: Accounts Payable / Purchases on credit * Number of days.
Alternate formula: Average AP / COGS * Number of Days
💡A Lower DPO means the company is paying off it’s AP balance more quickly
3️⃣ Average Age of Accounts Payable: Measures how long a company takes to pay off its debts
Formula: Accounts Payable / Annual Credit Purchases / 365
Alternate Formula: Accounts Payable / Average Daily Cost of Goods Sold
💡A lower Average Age of Accounts Payable means the company pays it’s AP balance more quickly
➡️ Common Journal Entries
1️⃣ When purchasing good or services on credit…
Debit Software expense (or the relevant account)
Credit Accounts Payable
2️⃣ When paying off AP balance
Debit Accounts Payable
Credit Cash
Those are my notes on Accounts Payable
There’s much more to it!
What would you add?
Let us know in the comments below 👇
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Besides tracking common accounts payable formulas like turnover ratios and Days Payable Outstanding, I've found it's crucial to understand AP's role in daily cash management and supplier partnerships. For example, consistently monitoring the Average Age of Accounts Payable helps me anticipate payment cycles and avoid late pay penalties. This proactive approach also nurtures trust with vendors, encouraging better credit terms. It's important to note that while leveraging credit offers cash flow flexibility, unchecked AP growth can strain finances. Hence, I regularly reconcile AP balances with invoices and purchase orders to maintain accuracy and control liabilities. From my experience, integrating AP tracking into your accounting system with clear journal entries—for purchases on credit and payments—simplifies financial reporting and audits. In short, mastering these AP formulas and their practical implications can empower CFOs and finance teams to optimize working capital and supplier relations effectively.
