Accounts Payable (A/P)

Accounts payable (AP) is an accounting term. It is the listings on a company’s financial statement of the obligations to pay off short term debt. This is most often in the form of bills for materials and services received and short-term loans. It also includes things like accrued payroll expenses and business income taxes.

Accounts payable shows up on the balance sheet as a current liability.

In a Lean organization, the goal is to quickly turn the items behind the accounts payable entries into accounts receivable entries. AR is the money that is owed to the company.

Much of the inventory in traditional companies consists of big piles of materials has already been paid for. That has no direct impact on AP. Those lines have already been cleared when the bill was paid. If your company has extremely low inventory turns (how often the company completely clears out its inventory, on average), you are probably sitting on piles of inventory. Now there are costs associated with that inventory—taxes and insurance and rent for the space, for example. Some of those holding costs will show up on AP.

The inventory that does matter directly to AP, though, is the items that are bought but have not yet been paid for. The amount of inventory in this category is dependent on the terms the company was able to negotiate. Some companies—generally big ones with a lot of clout—may be able to get vendors to agree to 90-day terms. That means they can take up to 90 days to pay for the goods they receive. The most common terms are NET 30, meaning that the balance is due in 30 days.

When your company sits on a lot of inventory, the bills for that inventory get paid before-sometimes long before-the money comes back in as sales. When you keep your inventory low and are purchasing in more of a “buy as you go” method, the company has more free cash and speeds up the cash flow cycle.

In the best of situations, a company with extended payment terms—say 60 or 90-day terms on its bills, can get cash back before it even pays for those parts. Imagine the company orders frequently in small quantities, and the company has a JIT (just-in-time) system in place. Those parts might end up on an outgoing shipment in a matter of days, or even sooner for really Lean companies. That means a company can bill a customer right away. If the company is selling online via credit card, it can collect money immediately, and pay for the materials on that order way down the road.

As you might imagine, determining the ‘right’ level for AP is probably best left to an accountant. If you have a high AP relative to your revenue, it might be hard to access new cash for investments. But, in the situation above, it is easy to see how longer terms on AP is essentially a free loan that can help you with cash flow.

Lean and Accounts Payable

Now, the concept of accounts payable is decidedly un-Lean. It is turning what could be a simple, one-step process into one with numerous steps. Instead of just paying right away for items, the company must create new line items, reconcile those lines with payments later, confirm that parts were received, and manage any late payments.

In most situations, this falls into the necessary but non-value-added category. Again, this depends on what the accountants say is the best AP to AR ratio. Work to reduce the time spent on these process steps, though, and try not to let the AP account process drive other business processes. Sometimes, the tail tends to wag the dog.