Which Activity Results In An Increase To Accounts Payable?

AP is an essential function of accounting and it is a critical element in analyzing the financial position of an enterprise. It refers to the short-term items that are due to the creditors for the services or merchandise for which payment has been availed sometime later. Many reasons can contribute to the changes and growth of a company’s accounts payable balance. It is important to know what triggers the AP levels to go up to assist in the planning of each organization’s cash inflows and cash outflows.

What Is Accounts Payable?

Accounts payable is another current asset which includes all the unpaid invoices from the suppliers and service providers that a business has purchased goods or services from. This is taken to be a current liability on the balance sheet most of the time since the amounts required are usually needed in one year or less. Accounts payable is one of the most common lines of credit which is created when a company purchases inventories, materials, equipment, utilities, or any other raw material or service on credit.

Some of the main components that contribute to accounts payable include the following;

There are three main business events and activities that commonly result in higher AP balances:

1. Purchasing Inventory and Services: The largest direct impact on accounts payable is acquired by purchasing operating items, which are needed for the company’s functioning, on credit. This can include; Raw material for production, merchandise for retailing, stationeries, and services such as cleaning services among others. Accounts payable increase every time supply orders and service invoices are paid later than the time of their receipt or even months later depending on the agreed payment term. This is another form of credit accumulation that is, however, only temporary since the timing gap between taking delivery and making payments is what results in this.

2. Growth in Sales Volume: When a company is having its demand and sales volume increase, this only means that there is a need to increase the level of purchasing to support the inventory levels. Development has to be backed up by more inputs, greater production rates, and a larger number of finished products. Rarely does growth mean that a business would have to extend the payment terms to its customers; instead, more credit purchases from vendors are likely, which in turn, increases the AP balances. This is a crucial movement for young innovative ventures and SMEs.

3. Tight Cash Flow Conditions: Self-funded business cash flow shortages or short-term cyclical business lows and major economic business downturns and recessions see suppliers paid out over longer time-frames. This often involves delaying payment for bills to be made slightly after the due dates or the maturing dates, which leans on vendor financing. The best example of early accounts payable being paid is when cash receipts from customers are low, but inventory is still being ordered. This creates AP accumulation which can offer operating liquidity, however, it can not go on endlessly without payment.

The Common Thread

The concept that is shared within all of the three categories is that using accounts payable to buy something means that a company can continue to acquire goods and continue business as usual when it does not have the requisite cash to pay for the needed supplies at the time of its purchase. Trade credit financing which is essentially employed for temporary purposes is mainly a form of financing working capital. The expectation though is that at some later date, the company will retire the higher AP balances.

What Are The Risks?

While accounts payable provide necessary operating flexibility, relying too much on credit from vendors does involve risks, such as:

- There may be other late fees or interest charges that need to be paid
- Strain in supply chain partnerships
- Threats to suspension of orders or services
- Increased borrowing needs
- This reduces cash reserves available for short-term needs.

If accounts payable are pushed out of control, there may be issues. However, when applied selectively for expansion or stabilization of fluctuations it can be considered as a good example of proper utilization of AP to achieve successful capital management.

How is the Management of Accounts Payable Possible?

Skills in AP management include tracking accounts payable turnover rates or AP turnover rates and having realistic AP turnover targets. Some best practices include:

- Accept trade discounts for early payments wherever it is possible
- Negotiate the time frames of payment in case they have to be adjusted
- Specify deadlines for payable days Outstanding
- Pay a sequence of payments to have the highest discount and lowest fees.
- Automate approval of materials to be published and the payment of bills.
- Check on the dynamic discounting programs with your major trading partners

That is why the reconciliation of AP with the monthly cash flow forecast can be a good way to keep working capital needs in balance. In conclusion, accounts payable should offer considerable operational versatility without becoming an overly burdensome and out-of-control expense. To optimize this tool, it is useful to maintain AP trends in tandem with the sales and corresponding expectations for collections.

Conclusion

Overall, the five primary business activities that lead to higher accounts payable include procurement of inventory and services, support of sales, and managing cash flow pressures. The fact that AP allows accumulation means that it is easier to pay the essential operating costs when cash is tight through credit. However, Accounts payable require strict monitoring and control to avoid over-reliance on the trade credit by the vendors. Monitoring the sources of increasing AP over time, implementing proper AP policies, and correlating AP balances with cash flow expectations are some of the effective AP management benchmarks that result in maintaining accounts payable at the right level.