A current liability generated by buying supplies on credit
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Accounts Payable (AP) is generated when a company purchases goods or services from its suppliers on credit. Accounts payable is expected to be paid off within a year’s time or within one operating cycle (whichever is shorter). AP is considered one of the most current forms of the current liabilities on the balance sheet.
Accounts Payable Turnover
Accounts payables turnover is a key metric used in calculating the liquidity of a company, as well as in analyzing and planning its cash cycle. A related metric is AP days (accounts payable days). This is the number of days it takes a company, on average, to pay off their AP balance.
The cash cycle (or cash conversion cycle) is the amount of time a company requires to convert inventory into cash. It is tied to the operating cycle, which is the total of accounts receivable days and inventory days. The cash cycle, then, is the operating cycle minus AP days.
Reducing Accounts Payables
AP is an accumulation of the company’s current obligations to suppliers and service providers. As such, accounts payables are reduced when a company pays off the obligation. Using double-entry accounting, cash is reduced alongside AP. As such, the asset side is reduced an equal amount as compared to the liability side.
How to Calculate Accounts Payable in Financial Modeling
In financial modeling, it’s important to be able to calculate the average number of days it takes for a company to pay its bills.
The formula for calculating AP days is:
AP Days = (Accounts Payable Value / Cost of Goods Sold) x 365
The formula for calculating AP value is:
AP Value = (Accounts Payable Days x Cost of Good Sold) / 365
Note: The above examples are based on a full year 365-day period.
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Impact of AP on Cash Balance
Since AP represents the unpaid expenses of a company, as accounts payable increases, so does the cash balance (all else being equal).
When AP is paid down and reduced, the cash balance of a company is also reduced a corresponding amount.
This is a very important concept to understand when performing financial analysis of a company.
Learn more about Balance Sheet reporting standards at FASB.
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