Bills Payable: Definition, Examples, How to Record, Pros & Cons

Introduction

Like a musical ensemble, managing bills payable in business finance requires careful timing and coordination. Some vendor payments have upcoming due dates, while others aren’t urgent. As a CFO or CEO, you must pay off these liabilities on time and optimize cash flow — all while maintaining solid relationships with vendors and partners. A strong bills payable process helps you do all that and preserve financial harmony.

Bills payable refers to the record of goods and services an organization buys from suppliers and vendors on credit. It also includes short-term loans. This article breaks down the what, why, and how of bill payables to help you enhance business performance.

What are bills payable?

Bills payables are physical records of an enterprise’s financial obligations. These business liability documents show the amount an organization owes for credit purchases of products and services. Bills payable books can also include service invoices, utility bills, and phone bills.

A physical bill of sale with a payment due date from a supplier becomes a bill payable to the purchaser. That’s why a bill payable is also known as a vendor invoice. Organizations record short-term bills payables as current liabilities or accounts payables in their balance sheets. As you pay off these bills, the payable balance decreases due to the debit entries.

Since bill payables cover both long-term bank loans and short-term expenses, it’s also known as notes payables and trade payables.

Read More: Vendor Management: What is it, Types, Process and Tools

The role of bills payable in business operations

Efficient bills payable management is crucial for fostering positive relationships with suppliers, creditors, and vendors. Plus, it reduces the financial obligations for services rendered but not yet paid. Below are some of its roles in business operations.

• Bookkeeping: Proper vendor invoice payment recording is critical for creating accurate financial statements and complying with accounting guidelines.
• Goods and services purchasing: Timely bill payments ensure a steady flow of raw materials, equipment, and inventory essential for business operations.
• Budgeting: Foreseeing payment obligations helps organizations to predict cash outflows better and allocate resources strategically.
• Supplier relationships: Timely payment of bills establishes trust and credibility, which in turn helps you secure better credit terms and discounts.
• Compliance and reporting: Organizations effectively managing bill payables better handle financial audits and comply with regulations.

Effective vendor invoice tracking helps organizations avoid having too much cash tied up in inventory or unpaid bills. As a result, they can ensure sufficient working capital and maintain liquidity for day-to-day operations.

Must Read: 10 Best Bookkeeping Software

Importance of bills payable for businesses

A bills payable account provides a snapshot of a business’s financial state at a specific time. An entry on the credit side of the bills payable account increases the company’s payment obligation, while a debit reduces the liability amount.

The more an organization owes creditors, suppliers, and vendors, the higher its liabilities. Consequently, business owners’ equity investments decrease because owner’s equity is calculated after deducting liabilities from assets. By paying vendor bills on time, a company can reduce its debts and increase the value of the business equities for its owners.

A company often decreases its liabilities by withdrawing cash to cover its outstanding obligations, resulting in a decrease in the company’s assets. However, timely bill payments demonstrate a business’s financial responsibility and can lead to additional supplier credit opportunities.

Types of bills payables

Bills payables can be of two types: wages and expenses.

• Wages refer to payments you make to employees and contractors every month.
• Expenses include bills for essential services such as water, internet, and electricity.
• Goods and services acquisition cost is the amount you owe suppliers for raw materials and other inventories.

Accounting teams differentiate payables as either vendor or customer invoices and allocate payments from relevant funds.

Quick Read: 7 Steps to Track Your Business Expenses

How to record a bill payable?

An enterprise using an accrual method of accounting records a bill payable or unpaid supplier invoice with a credit entry in the accounts payable section of the general ledger. As the business pays off debts, they enter debit entries which reduce the total payable amount.

Below are the steps to record an unpaid vendor invoice as a bill payable.

STEP 1: Review and approve a bill

Check due dates, payment amounts, and other particulars once you receive an invoice from a supplier. Approve the bill if it matches mutually agreed-upon details with a supplier.

STEP 2: Record the liability

The first journal notes the obligation to the supplier as a typical account payable entry. The debit entry refers to purchases, while the credit shows the liability to the supplier as accounts payable.

Particulars	Debit	Credit
Purchases	$5,000
Accounts payable		$5,000

STEP 3: Record the bills of exchange acceptance

The second journal records the acceptance of a bill of exchange — a legally binding written document that holds a party responsible for paying a fixed sum of money to another party at a predetermined date.

Particulars	Debit	Credit
Accounts payable	$5,000
Bills payable		$5,000

The purpose of a bill of exchange is to create a liability that reflects in the credit account. An organization records the liability as a bill payable after accepting the bill of exchange.

STEP 4: Complete the transaction after payment

An organization completes the transaction after processing invoices. While the credit entry reflects the cash payment, the debit entry denotes the bills payable entry that clears the liability account on settlement.

Particulars	Debit	Credit
Purchases	$5,000
Cash		$5,000

It’s worth noting that a bank or third party can present a bill of exchange instead of the original supplier. In that case, the payer must pay the dues to the party presenting the bill of exchange at a predetermined date.

Businesses add the payment as a debit based on the nature of the bill. They typically use expense accounts for rent and maintenance, fixed asset accounts for land or equipment, and prepaid asset accounts for prepaid bills.

Read More: 11 Best Billing Software for Businesses

Example of bills payable

Common examples include:

• Utility bills
• Rent payments
• Business loans
• Raw material bills
• Contractor invoices
• Unpaid supplier invoices
• Maintenance and repair services
• Advertising and marketing services
• Income tax, sales tax, and property tax
• Office supplies and stationery purchased on credit

Bills payables are an organization’s outstanding debts to creditors, suppliers, and government agencies. These dues reflect a firm’s short-term obligations that they must settle within 30 to 90 days.

Accounting for bills payable

Organizations use accrual accounting to record bills payable transactions in real-time, regardless of when they receive or pay cash. The accrual method enables them to track capital movement, which is essential for preparing accurate financial statements.

Since accrual accounting uses double-entry accounting, accounting teams must record transactions in terms of debits and credits. As a result, they make both credit and debit entries in the company journal.

Imagine a firm receiving $50,000 worth of raw materials on credit. They must add debit worth $50,000 and credit bills payable for $50,000. This way of balancing credit and debit transactions reflects that the organization has acquired the materials on credit but has yet to pay for them.

Particulars	Debit	Credit
Purchases	$50,000
To creditors		$50,000

The balance sheet will record the payable as liability under current liabilities. When a business pays it off, here’s what the journal entry looks like.

Particulars	Debit	Credit
Bills payable	$50,000
To cash/bank		$50,000

Learn About: Financial Accounting: Definition, Types, Functions & Examples

Bills payable in balance sheets

Analysts, creditors, and investors look at a company’s balance sheet to gain insight into its financial health. The liabilities section of the balance sheet tells them the total amount an organization owes to its lenders. Current liabilities consist of payables due within a year, while long-term liabilities contain payables due beyond a year. When an organization has excessive bills payable, it shows a growing liability.

The impact of bills payable on working capital

An organization’s working capital shows its short-term financial health. Working capital evaluates a company’s ability to pay short-term debts by comparing current assets to current liabilities.

When the outstanding amount increases, an organization experiences a temporary boost in liquidity, giving them extra cash on hand. But their accrued liabilities increase. Here’s how bill payables can influence the working capital of an organization.

• Current liabilities: When an organization owes a substantial amount of money to creditors or suppliers, its balance sheet shows it as current liabilities. The increase in current liabilities causes their working capital to decrease.
• Cash flow: Most bill payables are short-term obligations, meaning organizations must pay them within 30 to 90 days. Paying these dues limits the organization’s cash flow for day-to-day expenses.
• Working capital ratio: The working capital ratio shows a company’s short-term liquidity and ability to meet current liabilities. It is the ratio of existing assets and current liabilities. When bills payable increase without an increase in current assets, investors and creditors may view the company as financially unstable because of the decreasing working capital ratio.
• Penalties: Organizations must pay debts on time to avoid paying late fees, negatively impacting their creditworthiness. As a result, they may have to pay a higher interest rate in the future, ultimately affecting their working capital.

Enterprises must strike the right balance between payment obligations and cash flow optimization to propel their business forward.

Also, Read: Capital Budgeting: What is it, Types, Methods, Process & Examples

Bills payable in financial analysis

Financial analysts leverage bill payables to gain insights into a company’s financial obligations, liquidity, and payment practices.

A higher bills payable balance than liquid assets shows that a company struggles to meet short-term financial liabilities. Analysts also look at overdue bills to understand how promptly an organization settles supplier dues.

Delayed payment processing shows organizational inefficiency in managing the payable process. Payable data analysis can also reveal how a business has changed its payment practices positively or negatively over the years.

Managing bills payable

Efficient bills payable management is key to optimizing cash flow, ensuring financial stability, and maintaining strong vendor relationships. Organizations typically follow the steps below to manage unpaid vendor invoices or payables.

1. Set invoice payment terms: Establish clear payment due dates, early payment discounts, and late payment penalties before you start working with a vendor.
2. Track due dates: Consider reviewing payment due dates at regular intervals. You can also leverage accounts payable software for payment automation to make every payment on time.
3. Prioritize payments: Cash flow can be tight at times. In these circumstances, it’s best to prioritize payments according to due dates and relationships with suppliers. Consider paying new suppliers on time and negotiate extended terms with others.
4. Leverage discounts: Use cost-benefit analysis to weigh the pros and cons of accepting early payment discounts. Timely bill payment saves you money but can also strain the cash flow.
5. Employ a payment approval process: A transparent approval process helps your team pay critical bills on time and avoid making duplicate payments.
6. Centralize bill payment process: A centralized purchasing process doesn’t only streamline operations but also lets you save money and enjoy increased purchasing power.

Read More: Cash Flow Statements: A Comprehensive Guide

Strategies for managing bills payables

Organizations with a robust bills payable process use the following strategies to improve financial stability and manage finances.

• Review vendor contracts: Regular evaluation of supplier contracts is key to identifying discrepancies and ensuring compliance with mutually agreed-upon terms.
• Forecast cash flow: Cash flow forecasting aids in predicting when cash flow may be tight and preparing for upcoming payments in advance.
• Negotiate terms: Consider negotiating favorable payment terms based on your understanding of the financial position of your business.
• Optimize inventory: Overstocking often ties up capital. That’s why it’s essential to implement just-in-time inventory for unlocking cash that you can use to pay bills.
• Monitor payables turnover ratio: Organizations can improve processes by regularly evaluating the payables turnover ratio — which measures how quickly a company pays its bills.

Must Read: 6 Best Cash Flow Management Software in 2023

Advantages and disadvantages of utilizing bills payable

Let’s look at the pros and cons enterprises experience with bill payables.

Advantages of bills payables

Organizations use bills payable to obtain goods and services because it helps them preserve cash flow, better manage working capital, and take advantage of supplier discounts.

• Cash flow preservation: Buying inventory on credit enables businesses to preserve cash for operational purposes. Organizations can use this money for operating expenses (OpEx) or navigating financial challenges in the future.
• Working capital management: Debts with favorable payment terms enable enterprises to balance paying off debts and having sufficient funds for day-to-day operations.
• Cost-saving opportunities: When organizations pay off bills early to avail of supplier discounts, they save money and improve their working capital.
• Supplier relationships: Efficient payable management is vital for building strong vendor relationships, which may help organizations receive better terms.

Disadvantages of bills payables

Bill payables, when not managed properly, can also lead to increased liabilities, the risk of default, and cash flow management challenges.

• Accrued liabilities: Besides increasing the liabilities of an organization, unpaid dues also negatively impact stakeholders’ perception of a company’s financial position.
• Risk of default: Organizations failing to pay bills on time suffer from default risks. Plus, they may experience supply chain disruptions or negative creditworthiness.
• Cash flow management: Poor debt repayment practices may result in organizations lacking funds for daily operations.

While bills payable offer short-term financing advantages, multiple disadvantages can occur without the proper practices. Effective accounts payable management is key to maintaining a solid financial position.

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Bills payable vs. accounts payable vs. bills receivables

The key difference is that: bills payable refers to unpaid vendor invoices, accounts payable records all current liabilities, and is a category in the general ledger. On the other hand, bill receivables are invoices that are yet to be paid by customers and are classified under accounts receivables.

Bills payable show the indebtedness of an organization toward its suppliers, banks, and other financial institutions. It shows an organization’s payable dues based on bills of exchange from suppliers. Accepting a bill of exchange creates a legal obligation, meaning a buyer must pay the specified amount to the supplier by a predetermined future date.

You can find a bill payable for an organization in the bills receivable book of the supplier selling goods and services.

	Bills payable	Account payable
Basis of entry	Bills of exchange	Current liabilities
Maturity date	A predetermined date	No strict maturity date
Statutory coverage	Jurisdictional laws governing negotiable instruments	Jurisdictional laws governing general contracts
Impact of non-payment	A defaulting organization must pay penalties rising on account of dishonoring bills payables.	A supplier and organization can follow appropriate legal actions stated in mutually agreed terms.

Accounts payable records an organization’s short-term debt as a current liability on the balance sheet. It shows all debts an organization must pay off within a year. Every unpaid vendor invoice becomes a part of the accounts payable section in the balance sheet.

Bills receivable refers to the amount customers owe to a supplier for goods and services received on credit. In this case, the supplier draws a bill of exchange which becomes proof of debt once a customer accepts it.

	Bills payable	Bills receivable
Represents	Money to be paid	Money to be collected
Nature of ledger entry	Current liabilities	Assets
Cause	Credit purchase	Credit sales
Result	Cash outflow	Cash inflow

Conclusion

Establishing a centralized payable management system is essential for ensuring timely payments, minimizing manual errors, and resolving billing discrepancies. It also helps organizations to build strong relationships with vendors and optimize cash flow for tackling operational costs.

Must Read: 9 Best Vendor Payment Management Software

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