Companies use both cash and credit to purchase items they need to operate day-to-day business. Cash purchases require the company to pay at the time of purchase, using cash, check or debit cards. Most purchases occur on credit, enabling the company to receive the item and pay for it in the future. Accounts payable refers to the money owed for purchases made on credit. Changes in accounts payable affect the company’s cash flow, which the company reports on the statement of cash flows. Most companies report operating activities on the statement of cash flows using the indirect method. The indirect method arrives at total operating cash flows without listing each cash transaction.
Accounts Payable Activities
Accounts payable activities arise when the company purchases products or services on credit or pays for previous credit purchases. Whenever the company incurs an accounts payable, it promises to pay for the purchase on a future date. The period to pay for the purchase customarily does not extend beyond one year and is often stated in a specific number of days. Accounts payable represent liabilities for the company since it owes the money to another entity.
Statement Of Cash Flows – Operating Activities
The statement of cash flows reports cash transactions in three categories. These include operating activities, investing activities and financing activities. Operating activities include those activities that occur as the result of the company’s main line of business. Investing activities occur when a company decides to sell or purchase business assets. Financing activities refer to obtaining money to pay for business activities. Accounts payable transactions appear in the company’s operating activities section of the statement of cash flows, when using the indirect method.
The indirect method starts by listing the net income reported on the income statement. The company calculates net income using the accrual method. This method includes revenues which the company earned but not yet received, as well as expenses the company incurred but has yet to pay. Non-cash transactions included in net income are reversed. Changes in current asset or current liability balances are also recognized in this section. Accounts payable represents a current liability and changes in this balance appear in this section.
Changes In Accounts Payable
When accounts payable increases, it indicates that a company has purchased more items on credit. No cash outflows occurred for these purchases yet, meaning the company retains the cash. These purchases reduced net income by increasing the expenses for the period. An increase in accounts payable reduces operating cash outflows for the period. When accounts payable decreases, it indicates that the company purchased fewer items on credit. More cash outflows occurred to pay for previous purchases, meaning the company’s cash decreased. A decrease in accounts payable increases operating cash outflows for the period.