Accounts Payable Law and Legal Definition

Accounts payable is the term used to describe the unpaid bills of a business; the money owed to suppliers and other creditors. The sum of the amounts owed to suppliers is listed as a current liability on the balance sheet. The accounts payable category is, along with accounts receivable, a major component of a business's cash flow. Aside from materials and supplies from outside vendors, accounts payable might include such expenses as taxes, insurance, rent (or mortgage) payments, utilities, and loan payments and interest.

For many small businesses, limited access to capital leaves little room for error in managing cash flow and accounts payable. Mismanaging of accounts payable can lead to significant problems with overdue payments. For this reason, it is absolutely essential for entrepreneurs and small business owners to deal with the accounts payable side of the business ledger in an effective manner. Bills left unpaid or addressed in a less than timely manner can snowball into major credit problems; these can easily cripple a business's ability to function.

By making informed projections and sensible provisions in advance, the small business can head off many credit problems before they get too big. Obligations to creditors should be paid off concurrently with the collection of accounts receivable whenever possible. Payment checks should not, however, be dated any earlier than the bills' actual due date. In addition, many small companies will find that their business fortunes will take on a cyclical character; they will need to plan for accounts payable obligations accordingly.

For instance, a small grocery store located near a major factory or mill may experience surges in customer traffic in the day or two immediately following the days on which the neighboring facility pays its workers. Conversely, the store may see a measurable drop in customer traffic during weeks in which the factory or mill is not distributing paychecks to employees. The observant shop owner will learn to recognize these patterns and address the accounts payable portion of his or her business accordingly.

Generally, not all bills will need to be paid at once. Expenses such as payroll, federal, and local taxes, loan installment payments, and obligations to vendors will, in all likelihood, be due at various times of the month. Some—such as taxes—may only be due on a quarterly or annual basis (tax payments should always be made on schedule, even if it means delaying payment to vendors; it is far better to dispute a tax bill after it's been paid than to run the risk of being charged with costly fines). It is important, then, for small business owners to prioritize their accounts payable obligations.

PRIORITIZING AND MONITORING

Every business must work to keep a reasonable balance between the money coming into and flowing out of its coffers. This task is especially important for small business owners who often have limited flexibility in dealing with shortfalls of cash. Entrepreneurs who find themselves struggling to meet their accounts payable obligations have a couple of different options of varying levels of attractiveness. One option is to "rest" bills for a short period in order to satisfy short-term cash flow problems. This basically amounts to waiting to pay off debts until the business's financial situation has improved. There are obvious perils associated with such a stance: delays can strain relations with vendors and other institutions that are owed money, and over-reliance on future good business fortunes can easily launch entrepreneurs down the slippery slope to bankruptcy.

Another option that is perhaps more palatable is to make partial payments to vendors and other creditors. This good-faith approach shows that an effort is being made to meet financial obligations; it can help keep interest penalties from raging out of control. Partial payments should be set up and agreed to as soon as payment problems are foreseen or as early as possible. It is also a good idea to try to pay off debts to smaller vendors in full whenever possible unless there is some clear benefit to be had in making installment payments to them.

Usually, signs of cash flow problems will start to show up well before the company's financial fortunes become truly desperate. One clean sign of cash flow problems is an increase in aged payables. Aged payables are those for which the due date has passed. Bills should never be allowed to "ripen" more than 45 to 60 days beyond the due date unless a special payment arrangement has been made with the vendor in advance. At 60 days, a company's credit rating could be jeopardized; this could make it harder to deal with other vendors and/or loaning institutions in the future.

Outstanding balances can drive interest penalties way up, and this trend is obviously compounded if many bills are overdue at the same time. Such excessive interest payments can seriously damage a business's bottom line. Explaining to vendors and creditors one's current problems and their planned solutions can deflect ill feelings and buy more time. It is often in the best interest of the vendor or other creditor to keep a fledgling business solvent so that continued business may be done with this client. Some—though by no means all—creditors may be willing to waive, or at least reduce, growing interest charges, or make other changes to the payment schedule.

It is crucial to the success of a small business that accounts payable be monitored closely. Ideally, this aspect of the firm's operations would be supervised by a financial expert (either inside or outside the company) who is not only able to see the company's financial "big picture" but is able to analyze and act upon fluctuations in the company's cash flow. This also requires detailed record keeping of outstanding payables. Reports ought to be checked on a weekly basis, and when payments are made, copies should be filed along with the original invoices and other relevant paperwork. Any hidden costs, such as interest charges, should also be noted in the report. Over a period of time, these reports will start to paint an accurate cash flow picture.

Effective monitoring practices not only ensure that payments are made to vendors in a complete and timely fashion, but also serve to protect businesses against accidental overpayment. These overpayments, which often take the form of overpaying sales and use taxes, can be caused by any number of factors: internal miscommunication, encoding errors, sloppy or inadequate record keeping practices, or ignorance of current tax codes. Internal audits of accounts payable practices can be an effective method of addressing this issue, especially for expanding companies. "As companies grow, owners tend to become less involved in day-to-day operations and relinquish control of some functions to staff," stated Cindy McFerrin in Colorado Business Magazine. "Set up systems and procedures in your company that encourage communication, provide for staying current with tax codes, and lessen the risk of multiple payments and other mistakes. Laying the groundwork for accuracy today can keep you profitable and in control tomorrow."

SEE ALSO Cash Management

BIBLIOGRAPHY

Anthony, Robert N., and Leslie K. Pearlman. Essentials of Accounting. Prentice Hall, 1999.

Bannister, Anthony. Bookkeeping and Accounts for Small Business. Straightforward Company Ltd, April 1, 2004.

Longenecker, Justin G., Carlos W. Moore, J. William Petty, and Leslie E. Palich. Small Business Management. Thomson South-Western, January 1, 2005.

Ludwig, Mary S. Accounts Payable: A Guide to Running an Efficient Department. John Wiley, 1998.

McFerrin, Cindy. "Understanding Overpaying." Colorado Business Magazine. December 1997.

Hillstrom, Northern Lights

updated by Magee, ECDI