The old adage is that you have to spend money to make money.
But what the adage doesn’t tell you is that sometimes the spending can come after the making.
For businesses that have direct costs for the goods or services they sell, there are necessary upfront expenses before the revenue can start rolling in. But if you can buy these things on credit, the sales come before the expenses.
This is called trade payables, and it doesn’t come without risks. Read on for a complete guide on the process to get all the info you need to decide if it’s right for you.
What are trade payables?
Trade payables are short-term debts for the purchase of goods or services that are required for a business to provide their own goods or services.
If the purchase is paid right away and not made on credit, it’s not trade payable.
By buying costs of fulfillment on credit, you open up new possible ways to control your cash flow.
You get to dictate when payments leave your business, granting you a new way to manage your assets.
But trade payables is still debt. It poses risks to businesses if not managed effectively and thoroughly tracked.
Trade payables vs accounts payable
Trade payables are liabilities that are recorded as accounts payables, but not all accounts payables are trade payables.
Typically, a business will have a separate accounts payable account for their trade payables.
To be considered trades payable, what was purchased must be necessary for a business to sell its products or services. Otherwise, it falls into the regular accounts payable bucket.
Examples of trade payables
What’s considered trade payables depends on what industry a business falls into and what it sells.
For example, if a clothing retailer orders t-shirts to sell, that’s considered trade payables. But if a lawn care company orders t-shirts to turn into company clothing, that’s not considered trade payables.
If you’re trying to figure out whether something is trade payables, think about whether what you’re purchasing is used to manufacture the good or provide the service.
A coffee shop can’t sell coffee without beans or a brewing machine. When a cup of coffee is sold, the machine can be used again but the beans cannot.
This means the purchase of beans would be categorized as trade payables while the purchase of a new machine would not.
Where are trade payables reported?
Trade payables are reported on your balance sheet in the liabilities section.
Whether they’re a separate line item on your balance sheet is a different question.
Many businesses will lump trade payables in with the rest of their accounts payable. This means that any purchases made on credit are treated the exact same, regardless of their purpose.
For others, trade payables is treated as a separate account.
In this case, any trade payables transactions are categorized in the trade payables account, not accounts payable (though they are both liabilities on the balance sheet).
The expense category of a trade payables transaction also varies based on the business. Examples of where it could be categorized include inventory, cost of service, or cost of goods sold.
The benefits of trade payables
While trade payables means having debt on the balance sheet, it can serve businesses and open up new opportunities.
Consider these three benefits if you’re thinking of having trade payables in your business.
Control the timing of payments
With trade payables, you have the opportunity to pay for what goes into a good or service after the sale is already made.
For example, if a business usually sells through its inventory in 30 days and its trade payables is on net 30 payment terms, it can effectively pay for the inventory after it’s already sold through.
This means you can optimize your cash flow by having money come in before it goes out.
Improved short-term liquidity
Just as trade payables help with managing cash flow, they can also improve the short-term liquidity of a business.
Having essential purchases on credit helps keep more cash within the business. That cash can be used to tend to other debts or be reinvested in the business.
The flexibility from trade payables helps businesses put their money where it has the best returns.
For instance, maybe that cash is put into a marketing campaign which increases sales and improves short-term cash flow.
Operations require less capital
If you buy any costs of fulfillment on credit, you need less capital on hand to make big purchases necessary to your operations.
By not needing to have large sums of capital on hand, you can save yourself from turning to a loan, financing, or external investment to start generating revenue.
This allows you to keep ownership of the business internally and avoid the unnecessary interest costs that come from borrowing.
Potential risks of trade payables
Having trade payables doesn’t come without risk. Beware of the following before you start buying essentials on credit.
Missed payments can strain vendor relations
The vendors who are essential to your business’s goods or services are the most valuable and depended on. Switching to paying on credit has the potential to harm that relationship if your payments aren’t timely.
Innocent mistakes happen and sometimes payments slip through the cracks.
If you’re worried about this impacting your relationships, you might want to stick with paying bills as soon as they come in and avoid the risk.
You can also reduce the likelihood of late payments by using accounts payable software to track all your upcoming payments.
We just so happen to know of a great option 😉.
Potential fraud attempts
Invoice fraud continues to be a risk for businesses both big and small.
If you find a vendor willing to sell on credit, it could be they have an ulterior motive.
Common invoice fraud attempts include:
- Duplicate invoices
- Non-delivery
- Inflated bill amounts
- Redirecting payments
For example, you might find a vendor who sells at a lower price point and has lenient payment terms. But they say they won’t deliver something until payment is received.
This is a warning sign that they might be trying to get payment on a deal that seems too good to be true only to not fulfill their end of the bargain.
Before moving to a new supplier that sells on credit, look up reviews and do research on the experience of other buyers. Taking the time to do so could save you from an unfortunate disruption down the line.
Late payment penalties and interest
Missing a trade payables payment ultimately hurts your cash flow. Vendors will charge penalties and interest if a payment is late, cutting into your profits.
While purchasing on credit can have its benefits, you need to stay on top of outstanding payments to ensure you aren’t losing money to unnecessary fees and interest expenses.
How to record trade payable transactions
A coffee shop is placing an order with their supplier. They order beans in bulk with which they make cups of coffee, but they also buy individual bags which they sell directly to their customers.
In their accounting, bulk beans are categorized as cost of goods while individual bags are categorized as inventory.
The order they placed contains $5,000 of bulk beans and $1,000 of individual bags. As they update their accounting, they create the following journal entry:
Trade payables is credited, which, since it’s a liability, increases the outstanding balance.
Cost of goods sold is an expense account on the income statement and inventory is an asset on the balance sheet. Both accounts increase when they are debited.
At the end of the month, the coffee shop pays down the balance by check. They record the payment on their books.
This time, trade payables is debited, thus decreasing the balance and offsetting the increase from the invoice being received.
Once the payment is complete, the invoice no longer impacts the trade payables balance. If that was the only outstanding invoice, the balance would be reduced to zero.
Stay on top of debts with next level reporting
Starting to buy costs of fulfillment on credit opens up new possibilities, but also new responsibilities.
By powering up your accounting platforms, you can get more of the fresh opportunities while automating the responsibilities.
With BILL, you have a platform that automates invoice entry, simplifies approvals, and makes payments at the click of a button.
Try BILL and see how we can expedite your payables process so you’re never behind on debts.
