Accounts Payable and Income Statements: Definitions and How They Differ
If you're interested in pursuing a career as an accounts payable specialist, knowing the difference between balance sheets and income statements is essential. While accounts payable might seem simple at first, it can reveal a company's current financial condition and help you locate the right amount of funds for repaying debts. If you're new to the field, understanding how accounts payable fits into a balance sheet and relates to an income statement can help you stand out from other candidates.
In this article, we define accounts payable and income statements, explore the differences between expenses and accounts payable and provide an example scenario about how accounts payable fits into a balance sheet.
What is accounts payable?
Accounts payable is a record a company keeps regarding short-term debt. Accounts payable specialists maintain this record and provide portions of it at the company's request. It can display the company's current financial obligations and help improve company leaders' plans for debt repayment.
Accounts payable typically includes:
Capital a company has pledged to pay for goods and services it's already received
Short-term debts the company has accrued for goods and services it purchased on credit
Taxes the company owes
What is a balance sheet?
A balance sheet is a record of a company's assets, liabilities and how much capital shareholders have invested at a specific point in time. Executives, financial analysts and investors use the balance sheet as a tool to reveal the current financial well-being of the company. This information can help them determine the organization's net worth and definitively understand if sufficient short-term capital and assets are available to meet their financial needs.
What does a balance sheet include?
A balance sheet typically includes two main sections: assets and liabilities. You can find accounts payable in the liabilities section. Depending on the size and scope of the company, a balance sheet may include more or less detail. They often cover the following assets:
Cash: This short-term asset is the liquid capital that a company has available.
Accounts receivable: This short-term asset includes the funds a company is owed but hasn't received yet.
Prepaid expenses: These are goods or services that companies pay for in advance to receive future benefits in the long term, such as insurance.
Inventory: This is the current value of all the stock a company has.
Property, plant and equipment: This long-term asset includes the supplies, facilities, tools and machines that a company owns.
When one company buys another, the assets section may also include an item called goodwill, which refers to the purchase price minus the market value of the acquired company's assets and liabilities. Goodwill often encompasses intellectual property, brand recognition and industry secrets.
The balance sheet also typically includes the following liabilities:
Accounts payable: This short-term obligation is a record of ongoing debts and invoices that the company needs to pay.
Wages payable: This short-term liability covers upcoming wages the company plans to pay to its employees.
Loans and other debt: This long-term obligation includes capital a company owes to a bank or other institution to repay loans.
Accrued expenses: These are funds the organization owes to suppliers in the short term for products or services they've already received.
Unearned revenue: This is short-term capital a company earns before a service or product has been delivered, also known as prepayment.
Are balance sheets the same as income statements?
Balance sheets and income statements cover distinct aspects of a business's financial situation. However, company leaders may combine the knowledge they gain from both reports to inform their financial decisions.
Companies typically maintain three financial records:
The balance sheet, which covers short-term assets and obligations
The cash flow statement, which includes cash that a business makes through daily operations, investing and financing
The income statement, which encompasses a company's overall revenue, expenses, gains and losses
What is an income statement?
An income statement shows a business's net income, profit margins, expenses and investment positions over each quarter of the fiscal year. The U.S. Securities and Exchange Commission (SEC) typically requires companies to submit an income statement as part of a regular performance report. Companies may also use income statements to help them file taxes.
Within a company, the final net figure from the yearly income statement can be integral to financial planners who need to strategize for the next fiscal year because it helps them find ways to minimize expenses and grow profits. Controlling shareholders also often decide whether to continue investing in a company based on figures from the yearly income statement.
Organizations typically use income statements to track their financial health. Dramatic changes in income statements can be a useful signal to a company's finance and accounting team that it's time to make adjustments, such as cutting the budget, changing suppliers or revising product prices.
What does an income statement include?
While the format may vary based on local regulations and the scale of the business, income statements regularly include the following:
Revenue often covers:
Primary revenue: Also known as operating revenue, companies typically earn this type of revenue through their primary operations. For example, if a company sells hats, then the operating revenue is the capital earned through selling hats.
Secondary revenue: This type of revenue comes from business activities not directly associated with daily operations. For example, if a business keeps funds in a bank account that earns interest, it's considered non-operating revenue.
Expenses typically encompass:
Primary activity expenses: When a company spends money to earn its primary revenue, it's called primary activity expenses. This may include employee salaries, sales commissions and building rental expenses.
Secondary activity expenses: This type of expense is related to secondary operations. For example, if a company pays interest on a loan, it's logged as a secondary activity expense.
Companies sometimes refer to gains as other income. Gains often include the net cash earned when a company sells a long-term asset, such as:
Losses may also come from the sale of long-term assets or unexpected expenses, which can include:
Real estate, vehicles, land or companies that depreciated to lower than the purchase price
Returned products or refunded services
Accounts payable vs. expenses
The chief practical difference between accounts payable and expenses is where they appear in a company's financial statements. Accounts payable is located on the balance sheet, and expenses are recorded on the income statement.
While accounts payable may seem similar to an expense at first, here's how they differ:
Purpose: Expenses include costs for all primary and secondary business operations, while accounts payable focuses on obligations the company has made to debtors, suppliers, vendors and creditors. For example, when a company takes out a loan, accounts payable often logs the initial capital, while expenses include any interest incurred.
Time period: Accounts payable generally focuses on short-term liabilities, while expenses can include operational costs over an entire fiscal year.
Recipient: Accounts payable is a record of funds the company plans to pay to other companies, banks and other debtors, while expenses cover costs that are essential to operations, such as internal wages and utility bills.
How does accounts payable impact the income statement?
Accounts payable specialists provide organizations with authoritative, up-to-date financial information that displays the company's current financial health, which can influence the decisions that financial planners make about the company's expenses. Understanding the company's upcoming obligations and debts in repayment can help strategists ask informed questions in an effort to positively affect the company's net income statement. These questions may include:
Does the company need to sell long-term assets to make capital available for debt repayment?
Can a portion of our secondary revenue be used to repay creditors?
Can the company find a new, more economical supplier to reduce short-term invoices and increase profit margins on products?
Related: Learn About Being an Accountant
Example of accounts payable on a balance sheet
Here's an example situation showing how to record the accounts payable on a balance sheet:
Deanna is an accounts payable specialist who works at a company called Washington Toys. One of the products the company makes is wooden blocks. During the first quarter, Washington Toys takes out a short-term loan for $10,000 to purchase pine wood from a supplier. Deanna immediately adds $10,000 to the accounts payable section of the balance sheet.
In the second quarter, Deanna checks on the loan. It's gained about $100 in interest, meaning the amount the company owes is now $10,100. Deanna lets the financial team know, and they record the interest in the expenses section of the quarterly income statement. Washington Toys pays $2,000 toward the loan, and Deanna records $8,000 in the accounts payable section of the balance sheet.
By the fourth quarter, the company has paid back the full loan amount, including interest. Deanna no longer needs to track the loan on the balance sheet, and the financial team doesn't need to record the interest accrued on the income statement. Now the company has more capital available for daily operations, employee wages and investments.
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