Is accounts payable a current liability?
Is accounts payable a current liability? Accounts payable is a major concern for every company that has had reason to make purchases of goods or services on account. It appears on the company’s balance sheet under the liabilities section.
After goods or services are bought on credit, the amount owed to the vendors or service providers is recorded as an increase in the company’s accounts payable.
The accounts payable is any amount that a company owes for goods, services, or both they have received on credit and generally have to pay for within a month.
As with other business transactions, accounting for accounts payable correctly is important, hence our focus here shall be to understand if the accounts payable is a current liability.
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Understanding accounts payable and current liability
For us to know whether the accounts payable is a current liability or not, we need to first understand what accounts payable is, we further need to understand what a current liability is. These we shall discuss here.
What are accounts payable?
Accounts payable are short-term debts that have clearly stated due dates that typically last between one to three months although some may be up to one year.
Any account payable that will take more than one year before it is settled is usually classified as long-term debt.
Although accounts payable typically refers to the company’s obligations that are due in one to three months, one particular account payable that normally has a due date of up to one year is the trades payable.
The trades payable refers to payments made directly to vendors for goods or services that were collected on the account and consumed during the regular business operation cycle.
The payment terms for accounts payable are usually indicated on the payment invoice or negotiated between the buyer and the seller. These terms stipulate how long from the time of purchase the buyer has, to pay up their debt and whether the payments will be made in installments or cleared up at once.
Generally, large purchases have a longer payment window than small purchases. When a company buys most of the goods and services it uses on credit rather than cash, the balance of its accounts payable increases.
A decrease in the accounts payable indicates that the company is paying up the vendors and service providers they owe and that they are not making more credit purchases.
In some instances, accounts payable is used to refer to the company’s department that is in charge of making payments to vendors and service providers that are owed by the company.
For example, if Tesla buys parts for its electric cars on credit, it will record the amount resulting from such a purchase as an increase to its accounts payable. This means that Tesla has an obligation to pay its suppliers the amount for the parts in the future.
Uses of accounts payable
- Meeting obligations to vendors and service providers
- Understanding the company’s health
- Proper use of funds
Meeting obligations to vendors and service providers
Accounts payable are useful when calculating a company’s Days Payable Outstanding (DPO) and Accounts Payable Turnover (APT). These two metrics are used when calculating the company’s ability to meet its obligations of paying vendors and service providers in the short term.
Days Payable Outstanding is calculated by dividing the number of days in each accounting period by the accounts payable turnover for that same period. It is a duration metric that measures the average number of days a company needs to pay off its service providers, creditors, vendors, etc.
Accounts Payable Turnover is calculated by dividing a company’s cost of goods sold (COGS) by its accounts payable. It is a frequency metric that measures how often a company pays off its debts to service providers, creditors, vendors, etc.
Understanding the company’s health
Accounts payable is useful in understanding a company’s competitive and strategic health. This is because the accounts payable have a direct impact on the company’s cash flow as payments to clear up the accounts payable reduces the company’s working capital.
Inaccurate accounts payable information can affect a company’s creditworthiness as well as put its reputation in jeopardy since it runs the risk of paying its vendors and service providers more or lesser than what they owe.
Proper use of funds
Without the records of the accounts payable, companies will not be able to accurately tell how much they owe to service providers and vendors with certainty.
Hence having an accurate account payable account aids companies in properly managing their cash flow to best decide what amounts to use for obligation settlements, investments, and other expenses.
What is a current liability?
Simply, a current liability is any amount owed to creditors, debtors, service providers, clients, vendors, etc that must be settled within a fiscal year.
Current liabilities are commonly referred to as short-term liabilities and are mostly settled using current assets. The current liabilities of a company are recorded on its balance sheet under the liabilities section and comprise all recurring operational costs.
This includes taxes, electricity and utility bills, salaries, and all other financial obligations that must be settled in the short term.
Other liabilities that are recorded on the balance sheet of companies are long-term and contingent liabilities.
Long-term liabilities are those liabilities that take over a year to be settled. Contingent liabilities are liabilities resulting from the outcomes of future happenings in the company.
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Is accounts payable a current liability?
Since accounts payable records all monies owed to suppliers and service providers that usually have to be paid within 30 to 90 days, it is therefore a current liability.
Accounts payable are reported as a current liability on the balance sheet of companies. It is a liability because the accounts payable record amounts that will go out of the company in the future.
Payables are monies owed for goods or services that have been received on credit. When an accounts payable is settled, it reduces the assets (cash) of the company which further reduces its working capital.
Accounts payable appear on the balance sheet of companies along with other current liabilities such as taxes, electricity and utility bills, salaries, and all other operational costs that have to be settled in the short term.
The trades payable which are a type of accounts payable that are usually due in one year are also considered current liabilities.
Conclusion
Is accounts payable a current liability? Yes, accounts payable is a current liability. Accounts payable records all financial obligations that companies incur in the course of their operations which they did not pay for immediately but instead, took on credit.
Since most accounts payable are liabilities that have to be settled within a fiscal year, they are recorded on the balance sheet as current liabilities.
Accounts payable typically comprise legal fees, payments due to contractors and other service providers, supplier invoices, payments to vendors, etc.
The accounts payable has payment terms stating how and when payments are to be made, in order to avoid default, companies need to meet up to the payment terms.
When companies default on their payments to vendors and service providers, it affects their creditworthiness, reputation, and credit score.
Furthermore, defaulting on payments makes it harder for companies to access further services or goods on credit. It could also lead to penalties such as payment of lateness fees.
In the case of services received on credit, it could lead to the discontinuation or disconnection of such services by the service providers.
Accurately recording the accounts payable aids companies in managing their cash flow more efficiently in order to keep up with their obligations. It also aids in having accurate financial reports of transactions carried out on credit.
Having the accounts payable accurately recorded and payments owed to service providers and vendors made on schedule reduces the company’s current liabilities.
As a company’s current liabilities reduce, it will have more working capital and a positive reputation with suppliers and service providers. This will further drive up their creditworthiness and credit score.
