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 one operating cycle (whichever is longer).  AP is considered one of the most liquid forms of the current liabilities on the balance sheetAccounts payables for one entity is often the accounts receivable for another.

 

accounts payable

 

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, or accounts payable days. This is the number of days it takes a company to pay off their AP balance, on average. The cash cycle is the amount of time a company requires 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 obligation 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 for an equal amount 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.

 

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 also reduces.

This is a very important concept to understand when performing financial analysis on a company.

 

Learn more about the Balance Sheet