Accounts payable is the sum of money owed to suppliers and creditors by a business. It represents the current liability on the balance sheet and operating activity on the cash flow statement.
Accounts payable can impact the cash flow of a business in the short term. Therefore, it represents an important line item under the operating activities of the cash flow statement.
What Is Accounts Payable?
Accounts payable refers to the sum of short-term debt that a company owes to its creditors and suppliers.
Companies often make purchases for inventory on credit terms. It is necessary for a business to make the most of credit terms to manage its cash flows. The cumulative balance of credit accounts represents the accounts payable line on the ledger.
Accounts payable is represented on the balance sheet and the statement of cash flow of a business. On the balance sheet, it represents the current liability and is recorded under the current liability section.
On the cash flow statement, the accounts payable is a line item under the operating activities section. It represents the change in cash flow on the cash flow statement.
How Does Accounts Payable Increase?
Accounts payable is the current liability of a business. When a business makes more purchases on credit terms, the accounts payable balance increases.
When a business purchases inventory, assets such as machinery, and other items on credit terms, it creates liabilities. The short-term debts that are purely trade-related are categorized under the accounts payable section.
Since a business regularly purchases inventory, it’s likely to keep consistent or even increase accounts payable balance.
Accounts payable represent a change in the cash flow on the cash flow statement. Therefore, when a company does not pay its creditors and suppliers, it is keeping cash. Thus, an increase in the accounts payable will increase the cash flow.
When a business makes purchases on credit, it keeps the cash and uses it for other activities. Therefore, an increase in the accounts payable balance will have a positive impact on the cash flow as long as it remains under control.
How Does Accounts Payable Decrease?
A decrease in accounts payable occurs when a business makes a payment to its creditors for its outstanding balance.
Settlement of short-term credit with suppliers and vendors decreases the current liability of accounts payable. However, if the business makes new purchases on cash terms, it does not change the previous accounts payable balance.
A decrease in the accounts payable means a decrease in the available cash. Thus, it will be denoted through a decrease in the cash flow statement. It means a payment to creditors actually has a negative impact on the cash flow of a business.
What Is the Cash Flow Statement?
A cash flow statement (CFS) or the statement of cash flow represents the cash movement of a business.
Whenever a business makes a payment, an investment, or receives cash, its cash flow statement changes. A business can have several types of cash flows. Then, it must record cash inflows and outflows to record the net impact of cash movement.
Broadly, a business can categorize its cash movements into three categories.
- Operating Activities
- Investing Activities
- Financing Activities
The cash flow statement represents the cash position of a business. It can help a business analyze the cash spent on each category.
For example, a business may want to analyze whether it is spending more on its interest payments or inventory purchases. It can then plan to efficiently use cash resources for the most valuable business activities.
In short, the cash flow statement is critical to a company’s liquidity analysis for the short-term as well as the long-term planning.
Accounts Payable Representation on Cash Flow Statement
Accounts payable and receivable are recorded under the operating activities section. Therefore, a change in the accounts payable will directly change the operating activities’ cash balance.
Although accounts payable would represent a small proportion of cash flow on the CFS, it will directly impact the operating activities section. Also, it is an important item to calculate the net impact of cash flow movements under the operating activities of a business.
Suppose a company wants to analyze the impact of accounts payable on the cash flow statement. It prepares the CFS by starting with the net income figure. Then, it adjusts for operating, financing, and investing activities.
Operating activities include accounts payable and receivables. Suppose the company started with a balance of $50,000 for accounts payable. During the period, it purchased inventory worth $100,000 and made payments of $40,000 only.
Therefore, the company will have an increased ending balance of $110,000. Thus, its cash will increase for the period as it held the cash at its disposal instead of paying the creditors.
The company will add back $110,000 to its net income as it has to pay the cash in the future. Remember, the cash flow statement is prepared to represent the cash movements and not the net income or loss.
The Relationship Between Accounts Payable and Cash Flow
The simple rule to understand the relationship between the accounts payable and cash flow is to follow the directional movement of the cash flow.
When a business delays its accounts payable payments, it is keeping the cash. However, delaying cash payments for suppliers and creditors can only benefit a business if it does not incur interest expenses.
Contrarily, if a business makes cash payments to its suppliers and vendors, it is reducing cash on hand.
Simply, accounts payable can help a business increase its cash flows positively. However, the business must account for the accounts payable interest expenses. Usually, suppliers allow an accounts payable period without charging interest.
Managing Accounts Payable for Improved Cash Flow
Suppose a company has an average accounts payable period of only 30 days. It means the company pays its suppliers and vendors within 30 days.
Suppose the company’s average accounts payable per day are $150. So, the monthly payables balance would be $4,500.
If the company can negotiate better credit terms with its suppliers, it can improve cash flows. Suppose the company successfully negotiates the credit period to 60 days.
The company does not need to make any payments for the first 60 days. In other words, it can now utilize additional cash of $4,500 for 30 extra days.
It is important to note that delaying accounts payable will increase cash in hand. However, it will also increase the accounts payable balance by the same amount. It does not eliminate the short-term liability of a business to pay its creditors.
Accounts Payable and Net Cash Flow
The business can calculate net cash flow for its operating activities by analyzing the accounts payable and accounts receivable.
First, the company can calculate a net increase or decrease for its accounts payable. A net increase in accounts payable means it is keeping cash. Conversely, a net decrease means it is paying in cash to its suppliers.
Second, it needs to calculate the net increase or decrease in its accounts receivable.
Finally, the company can calculate its net operating cash flow by deducting accounts payable from the accounts receivable balance.
A negative cash flow occurs if the company pays more than it receives. A positive cash flow occurs when it receives more cash than it pays to its creditors.
