Accounts payable is the term used to describe the amounts owed by a company to its creditors. It 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, the significance of every overdue payment can often be greatly magnified. 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 that are unpaid or addressed in a less than timely manner can snowball into major credit problems, which 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, ideally, should be paid off concurrently with the collections of accounts receivable. Payment checks should also be dated no earlier than when the bills are actually due. In addition, many small companies will find that their business fortunes will take on a cyclical character, and they will need to plan for accounts payable obligations accordingly. For instance, a small grocery store that is located near a major factory or mill may experience surges in customer traffic in the day or two immediately following the days in which paychecks are disbursed at that facility. 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 canny shop owner will learn to recognize these trends 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, and 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.
This is especially true for fledgling business owners who are often stretched pretty tightly financially. 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 into 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, and 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 forecast, 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 key concern is aged payables. 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, and 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. Business owners should keep in mind, however, that it is in the best interest of vendors and other creditors to keep the fledgling business solvent as well. Explaining current problems and their planned solutions to creditors can deflect ill feelings and buy more time. 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 overpayment of sales and use taxes, can be caused by any number of factors, including internal miscommunication, encoding errors, sloppy or inadequate recordkeeping 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."
Anthony, Robert N., and Leslie K. Pearlman. Essentials of Accounting. Prentice Hall, 1999.
Cornish, Clive G. Basic Accounting for the Small Business: Simple, Foolproof Techniques for Keeping Your Books Straight and Staying Out of Trouble. Self-Counsel Press, 1993.
Ludwig, Mary S. Accounts Payable: A Guide to Running an Efficient Department. John Wiley, 1998.
McFerrin, Cindy. "Understanding Overpaying." Colorado Business Magazine. December 1997.