One interesting area that is frequently confused in accounting is whether certain creditors are considered accounts payable. Both the terms creditor and accounts payable look similar to each other but they are related words with somewhat different meanings. It is crucial to have a clear understanding of the distinctions and the connection between creditors and accounts payable to appropriately report these items on the balance sheet and use them effectively in managerial financial reporting.
A creditor is a person or an organization legally entitled to be paid by a business organization for goods, services, or cash received through a credit sale or for any other form of credit extended to it. Common examples of creditors include:
- Companies that sell inventory and allow the buyers to pay after some time or within the agreed time. Many companies get products from a supplier but do not pay for these products for about 30- to 60-days. When the buyer obtains a loan, the supplier is a creditor during this time.
- Law firms, accounting firms, utilities companies, and other vendors are examples of these parties They work and submit an invoice for payment later; hence, they are creditors until they receive their money.
- Holders of debt securities of a firm, including banks and other financial institutions that have extended credit to the firm, for instance, through an advance of cash via a term loan or line of credit or an issue of a bond. It can be seen that the lender collects interest and principal repayments, hence, the lender is a creditor.
Thus, if there is a company and a party who is due some form of payment from the business, then that party is considered a creditor. This can be for the purchase of any products or services where the supplier has not yet been paid. Creditors enable companies to have flexibility when handling cash since they do not demand that payment be made upon receipt of goods or delivery of services.
Accounts payable is specifically related to creditors of a business that has provided goods or services to the business on a credit basis. Accounts payable is subcategorized under current liabilities in the balance sheet.
There arises an accounts payable whenever there is the purchase of inventory from a supplier, but payment has not yet been made. Accounts payable balance captures the short working cycle and outstanding payment to all those suppliers who have extended credit on inventory.
Accounts payable is also viewed as one of the most essential current liabilities to control because it has a direct effect on the cash flow and the company’s liquidity. Thus, paying down accounts payable balances guarantees that the company maintains good working relations with essential suppliers and vendors.
In other words, it could be defined as one of the creditors, for example, a supplier or a vendor who supplies the goods to the company on a credit basis. More specifically, they are a trade creditor, that is to say, to credit buyers' goods in the expectation of receiving cash from the buyer. However, trade creditors cannot be regarded as the only category of the company’s creditors.
It is important to note that although all account payable amounts represent creditor balances, not all creditors are account payable. Creditors: Creditors is the more general term for all parties that are entitled to be paid, while accounts payable refers to those amounts due to suppliers of inventories only.
For instance, an equipment leasing company that accepts lease payments to be made after a certain period in the future will be a creditor but will not give rise to accounts payable because it has never received any inventory. The same can be said for any party that is offering services for an extended period such as a law firm or a utility company.
- Accounts Payable sometimes referred to as Creditors
- Every account payable indicates how much the business owes creditors or suppliers.
- But creditors are accounts payable plus any other persons or business that is owed money
It is important to differentiate between creditors and accounts payable so that the company’s balance sheets can accurately reflect the various amounts owed to them. Total creditor balances are recorded in accounts of total liabilities. However, the accounts payable balances in trade creditors only reflect in the working capital. The inability to properly get this accounting treatment will distort the financial statement to depict liquidity and leverage.
It also assists in treating trade creditors as different from other people and organizations owing money from the business while also successfully navigating relationships with inventory suppliers, who are arguably crucial to their operations. It allows for smooth supplier relations and minimizing Account Payable associated risks of exposure to high risk and concentrations.
Therefore, the segregation of current creditors and accounts payable balances provides a positive impact both in accounting and in managerial decision-making. Although at first glance the terms may seem to be broad and relatively similar, having a clear understanding of the definitions of the two can assist organizations in making sound financial decisions. Applying this knowledge can help to achieve sustainable development for any company that sources its essential inputs from external suppliers.
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