Accounts payable are obligations due to trade suppliers who have provided inventory. They are the inverse of accounts receivable. A company's payables are a suppliers's account receivable. Like the company, suppliers are forced by the industry to offer terms. Since the supplier's competition offers payment terms, all suppliers will offer terms.
Trade suppliers can refuse to ship additional inventory should the company become delinquent in payment of payables. Without inventory the company will be unable to sell. Happy trade suppliers, therefore, are critical to a company's success. Typically, the supplier will offer to ship inventory to a company on payment terms roughly equivalent to the company's inventory cycle. The supplier is willing to finance a company's inventory, but because the supplier is not a bank, it has no interest in financing the company's receivables. As a result, the supplier wants to be paid prior to the company's conversion of inventory into a receivable - that is, prior to sale.
To analyze the company's payables position and relationship with suppliers, there are two quality indicators:
- Actual days payable should not exceed payable terms.
- Payable levels should not exceed inventory levels.
Days Payable = Actual Accounts Payable / Cost of Goods Sold Per Day
Actual Accounts Payable is the average level of payables on the balance sheet during the time period being evaluated.
Cost of Goods Sold Per Day is the cost of goods sold in the time period divided by the number of days in the time period.
If the company is paying its suppliers in a timely fashion, days payable will not exceed the terms of payment. Also, if the company is paying its suppliers before it sells its inventory, payables will not exceed inventory. If payables exceed inventory, the company has sold inventory without paying the supplier, a nearly certain indicator of an unhappy relationship.
To age your accounts payable, use a convenient multiple of your terms. For ease, use Net 30 (this is also the most common) as the terms given by your suppliers. Create a schedule and analyze which vendors may not be willing to continue shipping your company inventory supplies.
|Supplier Aging||0-30||31-60||61-90||Over 90||Total|
Total accounts payable are $2,042. Of this, $1,360 are past due. It is very likely vendors 3, 4, and 6 will not sell us anymore items, unless it is on a COD basis. Without their raw material input we will find it very hard to make our product. Thus, the long term viability of our business is in jeopardy.
Once identified, the past due vendors must be contacted and arrangements must be made to pay these accounts. Often, vendors will be willing to work with your company if they are kept thoroughly informed of your situation. Without the support of your vendors, your business is on the road to failure.