What Is an Account Payable? Definition and Process

Businesses often exchange goods and services on credit rather than with immediate cash. This practice forms the basis of Accounts Payable (AP), a fundamental accounting concept. AP reflects the money a company owes to its suppliers for purchases made on credit terms.

Defining Accounts Payable

Accounts Payable (AP) represents short-term financial obligations a company owes to its vendors or suppliers for goods or services received but not yet paid. These amounts are classified as current liabilities on a company’s balance sheet, meaning they are due within one year. This distinguishes them from long-term debts, such as mortgages or bonds, which have repayment periods extending beyond one year.

Common examples of AP include invoices for raw materials, merchandise, utility bills, and rent for office space or equipment. These operating expenses incurred on credit contribute to a company’s AP balance.

AP functions as a company’s promise to pay a vendor for something already received. It represents a credit arrangement where the supplier extends terms, such as “Net 30,” allowing the buyer 30 days to pay. This arrangement benefits both parties, giving the buyer time to generate revenue before payment is due, and the supplier a reliable payment commitment.

The Accounts Payable Process

The Accounts Payable process begins when a company receives an invoice from a vendor for goods or services. Invoices can arrive through various channels, including mail, email, or electronic data interchange (EDI) systems. Initial logging of these invoices is a first step.

Following receipt, the invoice undergoes a verification and approval process to ensure its accuracy. This involves matching the invoice with a purchase order and a receiving report, which confirms delivery. This “three-way match” helps prevent errors and ensures the company pays only for what it ordered and received.

Once verified and approved, the invoice is recorded in the company’s accounting system, within the general ledger or an Accounts Payable sub-ledger. This recording creates a liability entry, increasing the Accounts Payable balance and reflecting the company’s obligation. The entry debits an expense or asset account, depending on the purchase.

Payment processing involves disbursing funds to the vendor on or before the invoice’s due date. Payments can be made via physical checks, automated clearing house (ACH) electronic funds transfers, or wire transfers. Payment timing considers terms, such as early payment discounts, to optimize cash flow and maintain good vendor relationships.

Reconciliation is a regular activity where the company’s internal Accounts Payable records are compared against vendor statements. This helps identify and resolve discrepancies, such as missing invoices or incorrect amounts. Regular reconciliation ensures accurate financial records and helps prevent disputes with suppliers.

Accounts Payable vs. Accounts Receivable

While Accounts Payable represents what a company owes to others, its counterpart, Accounts Receivable (AR), signifies what is owed to a company by its customers. Accounts Receivable arises when a company provides goods or services to its clients on credit, expecting payment at a later date. This means AR is an asset on a company’s balance sheet, representing future cash inflows.

The fundamental difference lies in their nature: Accounts Payable is a liability, a debt the company must settle, while Accounts Receivable is an asset, a claim the company holds for future payment. For example, when Company A sells goods to Company B on credit, Company A records an Accounts Receivable, and Company B records an Accounts Payable.

Together, Accounts Payable and Accounts Receivable are fundamental components of a company’s working capital. Working capital, calculated as current assets minus current liabilities, indicates a company’s short-term liquidity and operational efficiency. The effective management of both AP and AR is important for maintaining healthy cash flow and ensuring the company can meet its immediate financial obligations while collecting its due revenues.