Accounts payable, located on a company's balance sheet, are what the company owes its suppliers or the vendors from which it buys its inventory and other supplies. Accounts payable are a current liability and they are listed on the right-hand side of the balance sheet. They are expected to be repaid to the suppliers within one year. Accounts payable are just like the unpaid bills you have as an individual.
Just like any other asset or liability, accounts payable, your company's unpaid bills can have a big impact on profitability. They can either improve company profitability or they can cause it to really take a hit. Two primary ways that accounts payable affect company profitability are the company's relationships with its suppliers or vendors and the company's cash flow. Let's take a look.
Relationships With Suppliers
Suppliers or vendors are the businesses from whom companies get their inventory and other supplies. It is crucial that business operations maintain good relationships with their suppliers. The single most important thing a company can do to maintain good supplier relationships is to pay its bills on time. Accounts payable management, unfortunately, can get big and unwieldy. As a company grows, the number of its suppliers grows as does the invoices it has to pay. Supplier Relationship Management becomes important on the company level.
Supplier relationship management involves a mutually beneficial relationship between the company and each supplier. Good supplier relationships provide a win-win situation for the company and the supplier. Suppliers will cut good deals for the company. They will suggest new and better products to the company. They will work with the company on delivery times and policies. Good supplier relationships mean increased company efficiency. Good supplier/company relationships have to be cultivated.
If the company pays its bills on time, actively cultivates good relationships with its suppliers, doesn't cut off suppliers with no reason, and keeps lines of communication open, a good supplier should then offer the company the best trade credit terms possible. Good trade credit terms will maximize the company's profitability!
Company Cash Flow
One of the most important metrics in the financial management of a business firm is its cash flow. Cash flow comes from firm operations such as investing and financing. Profit, on the other hand, is generated from sales after all expenses have been paid. Cash flow and profit are different. If a firm does not have adequate positive cash flow every month, it can't pay its bills and it will get in trouble with its suppliers.
If a business cannot pay its bills on time, it is going to have a problematic relationship with its suppliers. However, if the company pays its bills on time, then the supplier will consider terms of sale for the company that include a cash discount if the company pays within a certain number of days. Just that cash discount, if the business has enough cash flow to pay the invoice during the discount period and get to use the discount, can have a very positive effect on profitability.
Most businesses, even small businesses, have many suppliers who provide them with inventory and other suppliers. The bigger the business gets, the more suppliers it has. Just imagine. If the business can develop a good relationship with each supplier it has and get a cash discount with each one, and have enough cash on hand to take the discount, the effect on profitability will be very significant.
Accounts Payable and Their Effect on Profitability
If you have a set of best practices in accounts payable management and you follow them, accounts payable can have quite a positive impact on your company's profitability. First, the company has to pay its bills on time. A simple best practice, but nothing else will work if you don't do this.
Second, if you pay your bills on time, you can elicit trust between you and your suppliers, regardless of how many suppliers you have. If you have trust, your suppliers will try to help you in a number of ways discussed above, including offering you discounts which will positively impact your profitability in a big way.
Third, a best practice is to try to facilitate processing of your accounts payable with a minimum of staff and paperwork. You don't need several accounts payable clerks. Smooth out your accounts payable management and you will increase your profitability by decreasing personnel and time spent on paperwork.