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What is accounts payable?

Accounts payable is money that a company owes to its suppliers for products or services purchased on credit. It sits on the balance sheet as a current liability, representing an obligation to pay in the near future—typically within 30 to 90 days, depending on the payment terms negotiated with suppliers.

Accounts payable is the flip side of accounts receivable. If Company A buys materials from Company B and doesn't pay immediately, Company A has an accounts payable liability, and Company B has an accounts receivable asset. This "trade credit" is a form of short-term financing. A company that negotiates favorable payment terms with suppliers can use the suppliers' money to finance working capital, a competitive advantage when cash is tight.

Understanding accounts payable is essential because it reveals how suppliers view the company's creditworthiness, whether the company is managing suppliers well, and how much working capital financing the company is getting for free.

Quick definition: Accounts payable is a current liability representing money a company owes to suppliers for goods or services purchased on credit but not yet paid. It is a form of short-term trade credit.

Key takeaways​

  • Accounts payable appears on the balance sheet as a current liability and represents short-term obligations to suppliers
  • Accounts payable is trade credit: the company uses the supplier's money for a period before paying
  • Payment terms vary widely: Net 30 means pay within 30 days; Net 60 or Net 90 are common for larger or weaker companies
  • Days Payable Outstanding (DPO) measures how long a company takes to pay its suppliers, on average
  • Rising accounts payable relative to purchases might signal financial stress or improved supplier terms; falling payable might signal cash conservation
  • Suppliers reduce payment terms or require cash-on-delivery if they lose confidence in the company's creditworthiness
  • Accounts payable is non-interest-bearing debt, making it cheaper than borrowing from banks
  • Aggressive use of supplier financing can inflate free cash flow while masking deteriorating business fundamentals

How payment terms work​

When a company purchases supplies, the supplier issues an invoice. The invoice specifies the payment terms—when the company must pay.

Common payment terms:

Net 30: The company has 30 days from the invoice date to pay. Most small-to-medium businesses use Net 30.

Net 60 or Net 90: Larger companies or companies with strong negotiating power often get 60- or 90-day terms. Walmart is famous for using Net 60 and beyond with smaller suppliers, effectively using supplier capital to finance operations.

2/10 Net 30: The supplier offers a 2% discount if the company pays within 10 days; otherwise, it's due in 30 days. This is an incentive to pay early. For a company with spare cash, paying in 10 days to get a 2% discount is often worthwhile. For a company with tight cash, forgoing the discount to get an extra 20 days is an implicit cost of capital.

COD (Cash on Delivery): The company must pay immediately when goods arrive or even before. This is used for suppliers who don't trust the buyer's creditworthiness.

Consignment: The company doesn't pay until the inventory is sold. This is rare and only given to trusted, large customers. Retail companies with strong leverage sometimes negotiate consignment terms for inventory.

The terms are negotiated when the company first establishes a supplier relationship. Companies with strong credit ratings and consistent payment histories get favorable terms. Struggling companies get shorter terms or must pay COD.

Accounts payable and cash flow​

Accounts payable is a critical component of working capital and cash flow management. When a company receives an invoice but hasn't paid yet, it has the use of that money—a free loan from the supplier.

Example:

A manufacturer buys $100,000 in raw materials on Net 30 terms on January 1. The invoice is recorded as accounts payable on the balance sheet, but cash doesn't leave the bank until January 31 (assuming Net 30 is exact).

During those 30 days:

  • The company's balance sheet shows a $100,000 accounts payable liability
  • The company's cash balance is $100,000 higher than it would be if it paid COD
  • The company can use that $100,000 to pay employees, invest in equipment, or pay other bills

This is trade credit financing. The supplier, in effect, lends the company $100,000 for 30 days at zero interest. For a company generating significant revenue, this can represent millions of dollars of free financing.

A company that manages working capital skillfully will:

  1. Collect from customers quickly (low Days Sales Outstanding)
  2. Keep inventory moving quickly (low Days Inventory Outstanding)
  3. Pay suppliers slowly (high Days Payable Outstanding)

This extends the "cash conversion cycle"—the time between when the company pays for inventory and when it collects cash from customers. A long cash conversion cycle strains liquidity. A short cycle (or negative cycle) is a competitive advantage.

Days Payable Outstanding (DPO)​

Days Payable Outstanding is a metric showing how long the company takes to pay suppliers on average:

DPO = (Accounts Payable / Cost of Goods Sold) × Number of Days

Or alternatively:

DPO = (Accounts Payable / Daily Cost of Goods Sold)

Example:

A company has:

  • Accounts payable: $50 million
  • Cost of goods sold (annual): $400 million
  • Days in period: 365

DPO = ($50M / $400M) × 365 = 45.6 days

The company takes about 46 days on average to pay suppliers.

Interpreting DPO:

  • Rising DPO: The company is taking longer to pay suppliers, either because it negotiated better terms or because it's running low on cash. This increases accounts payable relative to purchases. Rising DPO can improve cash flow temporarily but might signal financial stress if suppliers start demanding payment.

  • Falling DPO: The company is paying suppliers faster, either because payment terms tightened (suppliers losing confidence) or because the company has abundant cash and chose to pay early (to capture discounts or maintain supplier relationships).

A company's DPO should be compared to:

  1. Historical DPO: Has it risen or fallen? Sudden changes are meaningful.
  2. Industry DPO: Different industries have different norms. Retail (especially big box) uses much longer DPO than manufacturing. Tech companies typically have shorter DPO because they have more cash.
  3. Supplier mix: A company with few large suppliers might negotiate longer terms than one with many small suppliers.

Rising accounts payable as a red flag​

Accounts payable can increase for two reasons: more purchases (normal growth) or deliberate delay of payments (cash stress).

To distinguish:

Compare accounts payable growth to COGS or revenue growth. If accounts payable is rising much faster than COGS or revenue, the company might be stretching payments.

Example:

Company's year-over-year changes:

  • Revenue: +10%
  • COGS: +8%
  • Accounts payable: +25%

This large payable increase relative to purchase growth is suspicious. It could signal:

  1. Financial stress: The company is stalling payments to conserve cash.
  2. Supplier pressure: The company is buying more but delaying payment.
  3. Accounting change: Different supplier mix or payment term negotiations.

To clarify, investors should read the management discussion and analysis (MD&A) for any disclosure of payment difficulties or supplier negotiations.

Additionally, if suppliers are demanding faster payment (rising DPO is forced, not voluntary), the company's accounts payable might rise sharply as the company scrambles to find cash.

Aggressive supplier financing and cash flow quality​

Some companies use accounts payable strategically to manage cash flow. A company with deteriorating operations might extend payables aggressively to prop up reported cash flow.

This is why the cash flow statement matters: an increase in accounts payable appears as a positive adjustment to operating cash flow (cash from operations increases when payables increase). A company can boost reported cash flow without any underlying business improvement by simply paying suppliers later.

Example:

A company reports:

Operating cash flow (before working capital)    $50 million
Increase in accounts payable                    +$40 million
Reported operating cash flow                    $90 million

On the surface, operating cash flow is strong. But if the increase in accounts payable is due to the company stretching payments (not normal growth), the underlying business is deteriorating. The $90 million in reported cash flow includes $40 million that's really deferred liabilities.

A company can only stretch suppliers for so long. Eventually, suppliers either:

  1. Stop extending credit (demand COD or shorter terms)
  2. Reduce credit limits (won't sell large orders)
  3. Increase prices to compensate for extended payment terms
  4. Escalate collection efforts

When suppliers lose patience, the company faces a cash crisis. It must suddenly pay what it owes, draining the cash flow that looked so good when payables were increasing.

Investors analyzing companies with rising accounts payable should investigate:

  • Are payment terms changing? (Check MD&A for disclosure)
  • Is the supplier base shifting? (Are weaker suppliers replacing strong ones?)
  • Are suppliers reporting payment delays? (Watch for news or SEC filings mentioning supplier disputes)
  • Is days sales outstanding rising too? (Rising DSO + rising DPO together suggest overall financial stress)

Accounts payable in different industries​

Payment terms and accounts payable balances vary significantly by industry:

Retail: Retailers like Walmart and Amazon negotiate extended payment terms (60, 90, 120+ days) with suppliers, creating massive accounts payable balances. Walmart's suppliers often finance the retailer's inventory. This is a form of negative working capital and a competitive advantage.

Manufacturing: Manufacturers typically have Net 30–60 terms with suppliers, creating moderate accounts payable. Automotive suppliers often have even longer terms (90+ days) negotiated with large OEMs.

SaaS and software: Software companies have minimal accounts payable relative to revenue because they have little COGS (mostly cash operating expenses like salaries). Their suppliers are landlords and service providers, not product suppliers.

Utilities: Utilities have very long payment cycles (90+ days) in some regions because they often get long-term contracts with suppliers (e.g., coal suppliers). This inflates accounts payable relative to revenue.

Healthcare: Hospitals and medical providers often negotiate extended terms with pharmaceutical and medical device suppliers, creating significant accounts payable.

When comparing accounts payable or DPO across companies, always normalize for industry. A software company with 30-day payables is normal; a retailer with 30-day payables might signal squeezed suppliers.

Accounts payable and trade discounts​

Many suppliers offer discounts for early payment (e.g., 2/10 Net 30: 2% off if paid in 10 days, otherwise due in 30 days).

For a company, the decision to take the discount depends on the implicit interest rate:

If you pay 10 days early to save 2%, you avoid 20 days of financing. The annualized rate of return is approximately:

Discount rate = (Discount % / (1 - Discount %)) × (365 / (Full term - Discount term))
= (2% / 98%) × (365 / 20) days)
= 36% annualized

A 36% return on capital is very attractive. If the company has access to cheaper capital (bank loans at 5%, for example), it should take the discount. If the company can only borrow at higher rates, or if it has no credit line, it should decline the discount.

Many companies have a policy: take all discounts if cash is available; decline if cash is tight. This is a sign of disciplined financial management.

Supplier financing arrangements​

Some companies use suppliers as a source of capital. Supplier financing arrangements can take several forms:

Extended payment terms: Negotiated longer payment periods (120+ days) in exchange for volume commitments or long-term contracts.

Supply chain financing: The company and supplier agree that the supplier will provide inventory (consignment) or extend credit beyond normal terms, sometimes with a third-party financer providing the capital.

Factoring arrangements: The company sells invoices to suppliers at a discount, providing immediate cash. This is less common but used by struggling companies.

The SEC requires disclosure of supplier financing arrangements in the MD&A if they are material. Investors should read these disclosures carefully because they can signal financial distress or, conversely, strong supplier relationships.

Accounts payable on the cash flow statement​

On the cash flow statement, changes in accounts payable appear in the operating cash flow section:

Net income                          $100 million
Adjustments to arrive at cash flow:
  Depreciation                      +$20 million
  Change in accounts receivable     -$10 million (increase in AR is a use of cash)
  Change in accounts payable        +$15 million (increase in AP is a source of cash)
  Change in inventory               -$25 million
Adjusted operating cash flow        $90 million

An increase in accounts payable is reported as a positive (source of cash), because the company is deferring payments—keeping more cash in the bank. A decrease in accounts payable is reported as a negative (use of cash), because the company is paying down what it owes.

If accounts payable spikes upward (creating a large positive adjustment to cash flow), the underlying business might be deteriorating even though reported cash flow looks strong. Conversely, if accounts payable falls sharply (creating a large negative adjustment), the company might be paying down suppliers aggressively, which is better for cash flow quality but requires more cash.

Common mistakes when analyzing accounts payable​

  1. Ignoring industry norms. A retailer with 90-day payables is normal; a SaaS company with 90-day payables is unusual and might signal problems.

  2. Not comparing payable growth to purchase growth. Accounts payable should grow roughly in line with COGS or revenue. Much faster growth is a red flag.

  3. Assuming rising DPO is always good. Rising DPO might indicate better negotiating power (good) or financial stress (bad). Context matters.

  4. Overlooking supplier disputes. If suppliers are complaining about payment delays in the news or in SEC filings, accounts payable metrics alone won't reveal the deteriorating supplier relationship.

  5. Not reading the MD&A for payment term disclosures. Companies often disclose material changes to payment terms in the MD&A. These disclosures are more reliable than trying to infer from balance sheet numbers.

  6. Confusing accounts payable with accrued liabilities. Accounts payable is amounts owed to suppliers for goods/services received. Accrued liabilities include other obligations like wages payable, taxes payable, and interest payable.

A diagram: working capital and payment timing​

FAQ​

Q: What is the difference between accounts payable and accrued liabilities?
A: Accounts payable is amounts owed to suppliers for goods or services purchased. Accrued liabilities include all other short-term obligations: wages payable, taxes payable, interest payable, warranty obligations, and others.

Q: If a company has zero accounts payable, is it financially healthy?
A: Not necessarily. It could mean the company pays suppliers immediately (strong cash position and credit rating), or it could mean the company is pre-paying for everything (less common). More likely, zero AP would be unusual and warrant investigation.

Q: Can accounts payable be a strategic competitive advantage?
A: Yes. Companies like Walmart and Amazon have turned supplier financing into a moat. By negotiating extended payment terms, they finance working capital cheaply and pass inventory carrying costs to suppliers, reducing their own capital requirements.

Q: What happens if a company doesn't pay accounts payable when due?
A: The supplier can demand immediate payment, place the account on COD status, or take legal action. For a public company, unpaid supplier obligations can trigger covenant breaches on debt and signal insolvency risk.

Q: How does accounts payable affect working capital?
A: Working capital = Current assets - Current liabilities. Accounts payable is a current liability, so higher AP reduces working capital. But the relationship is not simple: a company needs suppliers to operate, so having accounts payable is normal and often beneficial.

Q: If accounts payable is rising but inventory and revenue are stable, what does it mean?
A: It likely means the company is stretching payments (paying suppliers later), which is a potential sign of cash stress. Alternatively, the company might be negotiating better terms. Check the MD&A.

Q: Is paying suppliers faster always good?
A: Not necessarily. Paying faster preserves supplier relationships and might allow the company to earn discounts, but it requires cash. A company should balance maintaining supplier goodwill with preserving liquidity.

Summary​

Accounts payable represents money a company owes to suppliers for goods or services purchased on credit. It is an essential component of working capital and provides trade credit financing—effectively a zero-interest loan from suppliers. Payment terms vary by industry and company creditworthiness, with strong companies negotiating Net 60+ terms and struggling companies facing COD requirements. Days Payable Outstanding measures how long the company takes to pay suppliers on average; rising DPO can signal improved negotiating power or financial stress, depending on context. Aggressive extension of payables can boost reported cash flow in the short term but can strain supplier relationships and create a future cash crisis when payments come due. Accounts payable should grow roughly in line with purchases; much faster growth is a red flag for cash management problems. Retail and consumer companies often have high accounts payable relative to revenue due to extended supplier terms, while SaaS and service companies have lower payables because they have minimal purchase-based COGS. Investors should read MD&A disclosures about payment terms, monitor supplier payment disputes, and understand that rising payables can mask underlying business deterioration if cash flow is not carefully analyzed.

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Accrued liabilities and accrued expenses