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Accounts Payable

A current liability generated by buying supplies on credit

What is Accounts Payable (AP)?

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 longer).  AP is considered one of the most liquid forms of the current liabilities on the balance sheet.

 

accounts payable theme

 

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. This 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 is 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.

 

accounts payable in a financial model

 

 

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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Balance Sheet (Accounts Payable) Template

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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 http://www.fasb.org/balancesheet.

Watch the video tutorial below to learn more about accounts receivable and payable:

 

Learn more about the Balance Sheet

Thank you for reading this CFI accounting guide. To learn more, see the following free CFI resources.

  • Intangible Assets
  • Bonds Payables
  • Retained Earnings
  • Share Capital

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