Accounts payable—one of the least glamorous (but oh-so-important) aspects of a company’s balance sheet. You’re probably more interested in revenue growth, profits, or how much the CEO gets paid, but trust me, accounts payable is the financial equivalent of the unsung hero who makes sure the office coffee machine keeps running. Sure, it doesn’t make the headlines, but without it, things would grind to a halt.
So, if you’re an investor looking at a company’s financial health, accounts payable might not be the first thing you think about. But believe me, it’s one of those numbers that’s definitely worth paying attention to.
What Is Accounts Payable?
In the simplest terms, accounts payable (AP) is the money a company owes to its suppliers and creditors for goods or services that have been delivered but not yet paid for. Think of it as the company’s credit card bill—it’s what they owe, but haven’t yet settled.
It appears on the balance sheet under current liabilities, and unlike debt (which is often longer-term), accounts payable is typically due in 30 to 90 days. If the company is playing its cards right, it’s essentially a short-term liability—a pay-now-or-later situation.
Why Should Investors Care About Accounts Payable?
You’re probably thinking, “Why should I care about something that’s basically a company’s to-do list for paying bills?” Fair point, but here’s the thing: accounts payable can reveal a lot about a company’s liquidity, financial health, and how well it’s managing cash flow. You might not be sending checks to suppliers, but knowing how a company handles its payables is crucial for understanding how well it manages its operating cycle.
1. Liquidity and Cash Flow Management
- For investors, cash flow is king. The ability to manage cash flow efficiently is a big indicator of whether a company can pay its bills on time, reinvest in growth, and—most importantly—reward you with dividends or capital appreciation.
- If a company’s accounts payable is growing disproportionately to its revenues, it could indicate that the company is stretching its payments and taking longer to pay its suppliers. While this might give the company short-term cash flow relief, it’s also a red flag. Suppliers might get frustrated, and the company could risk losing favorable credit terms or, worse, damaging its reputation. That’s not a position you want your investment in.
2. Supplier Relationships and Risk Exposure
- While companies don’t like to broadcast it, their supplier relationships matter a lot. If you’re looking at a company with significant accounts payable but not enough to show for it in terms of inventory turnover or product sales, it could signal that the company is over-leveraging its suppliers to fuel operations.
- Short-term credit from suppliers is a great tool to manage cash flow, but if the company relies too heavily on this and fails to pay on time, supplier relationships can sour, potentially leading to higher costs or a loss of critical partnerships. For investors, this supplier risk is something you’ll want to monitor closely.
3. An Indicator of Operational Efficiency
- The age-old saying “time is money” applies to more than just speeding up product delivery or getting a deal done. In the world of accounts payable, the longer a company waits to pay its suppliers (within reason), the better its short-term cash position looks. Companies that have their payables stretched out over time are effectively using someone else’s money—that’s working capital efficiency at its finest.
- But here’s the catch: there’s a fine line. A company that stretches its payables too far might run into late fees or lose vendor discounts, which would hurt profitability in the long run. In your role as an investor, understanding whether a company is managing this balance is key. Excessive accounts payable might be a sign of financial stress or inefficiency, while a well-managed system shows operational savvy.
4. Sign of Financial Health or Red Flags?
- High accounts payable in itself isn’t inherently bad—it can be a sign of healthy credit lines or a growing business. But when combined with low cash flow or high debt, it can signal trouble. If the company’s operating in a tight cash position, it might be using its suppliers as a source of temporary funding—not the best look, especially if those accounts payable are growing faster than revenues.
- Investors need to be careful here. If accounts payable keep increasing but the company’s cash flow or profitability isn’t growing in tandem, it might be a sign that the company is delaying payments or getting into a bad habit of “kicking the can down the road.” This could create liquidity problems down the line.
How to Analyze Accounts Payable as an Investor
You’ve seen the numbers, but what do they really mean? Here’s how to make sense of accounts payable in the context of the broader picture:
1. Days Payable Outstanding (DPO)
- A good way to understand how efficiently a company is managing its accounts payable is to calculate its Days Payable Outstanding (DPO), which tells you how long, on average, the company takes to pay its suppliers.
- DPO Formula:
DPO=Accounts PayableCost of Goods Sold (COGS)×Number of DaysDPO = \frac{\text{Accounts Payable}}{\text{Cost of Goods Sold (COGS)}} \times \text{Number of Days}DPO=Cost of Goods Sold (COGS)Accounts Payable×Number of Days
- A higher DPO might indicate that the company is getting favorable terms from its suppliers (good for short-term cash flow), but it’s not always a good sign if the DPO keeps growing too fast. If the company’s DPO is increasing while inventory turnover or sales growth is not, it’s worth asking: Is this company just buying time, or is it doing something smarter?
2. Compare with Industry Peers
- As with any financial metric, context is key. An increase in accounts payable might seem alarming, but if industry peers are doing the same thing, it could just be normal practice. For example, companies in sectors like retail or manufacturing often have high accounts payable as part of their business model, as they rely on supplier credit to finance their inventory.
- Comparing DPOs within an industry will give you a clearer picture of whether a company is overextending itself or just operating in line with industry norms.
3. Look for Patterns in Accounts Payable and Cash Flow
- If you notice that accounts payable are increasing rapidly but cash flow or earnings are not, this could signal that the company is having trouble generating cash or managing its finances. Be on the lookout for sharp spikes in accounts payable that coincide with declining profitability. It’s always a red flag when creditors are holding the bag for a company’s growth.
4. Pay Attention to Changes in Payment Terms
- Watch for any recent changes in the company’s payment terms. If a company suddenly extends its payment window to 60 or 90 days, it could be trying to manage short-term cash flow pressures. This move might give the company breathing room, but if it’s a consistent pattern, it could point to more systemic financial challenges.
Real-World Example: TechCo’s Rising Accounts Payable
Let’s say you’re looking at TechCo, a mid-sized tech firm that’s been showing solid revenue growth for the past few years. But when you glance at the latest financials, you see that accounts payable has been steadily climbing. In fact, accounts payable to revenue ratio has increased faster than their sales.
On the surface, this might look like a red flag—TechCo might be taking longer to pay its suppliers, which could be putting a strain on its relationships. However, when you dig deeper, you realize that TechCo has negotiated better payment terms with its suppliers as part of a strategic move to extend working capital while investing in R&D for a new product line.
While this may seem like a smart move, you’re also aware that if this trend continues unchecked, TechCo could lose out on valuable supplier discounts or, worse, risk getting cut off from key suppliers.
As an investor, you’d need to keep a close eye on whether TechCo’s cash flow is strong enough to back up its growing accounts payable or whether it’s getting too comfortable with debt (in the form of supplier credit). If cash flow doesn’t improve, you may find yourself in a risky situation where TechCo’s ability to fund its operations is on thin ice.
Key Takeaways for Investors
- Accounts payable is a key liquidity indicator: Watch for any spikes or prolonged increases that might signal cash flow problems.
- Manage the DPO: A rising Days Payable Outstanding could indicate smart working capital management, or it could point to financial stress. Know which one it is.
- Always compare with industry standards: Context matters! An increase in accounts payable might not be a red flag if it’s consistent with industry practices.
- Supplier relationships matter: If accounts payable are growing too fast, a company might risk alienating suppliers or paying higher prices in the future.
In the end, accounts payable might not have the glamour of the latest IPO or the hype of an earnings beat, but it’s crucial for assessing the financial health of a company. So the next time you see that accounts payable number, give it a second look—it might just give you the edge you need to make a smart investment decision.