Wall Street Prep

Accrued Expenses vs Accounts Payable

Understand the Differences Between Accrued Expenses and Accounts Payable

Learn Online Now

Accrued Expenses vs Accounts Payable

In This Article
  • What are the definitions of accrued expenses and accounts payable?
  • How are accrued expenses and accounts payable different?
  • What are common examples of accrued expenses and accounts payable?
  • How do accrued expenses and accounts payable impact free cash flow?

Accrued Expenses vs. Accounts Payable Summary

The chart below summarizes the differences between accrued expenses and accounts payable.

Accrued Expenses vs Accounts Payable

Accrued Expenses vs. Accounts Payable

Under accrual accounting, both accrued expenses (A/E) and accounts payable (A/P) are recorded as current liabilities representing incurred expenses that have not yet been paid for in cash.

The two terms are defined as follows:

  • Accrued Expenses (A/E) — The payment obligations owed to third parties, in which the invoices have not yet been processed or are caused by temporary timing anomalies (i.e. misaligned dates).
  • Accounts Payable (A/P) — The total unmet invoices due to suppliers/vendors (i.e. the creditors), who essentially provide a form of financing to the company until the cash payment is received.

Examples of Accrued Expenses and Accounts Payable

Generally, accrued expenses correspond to the operating expense line item whereas accounts payable is typically more related to the cost of goods sold (COGS) line item on the income statement.

Hence, accrued expenses are typically projected with operating expenses (OpEx) as the driver, whereas accounts payable is projected using days payable outstanding (DPO), which is tied to COGS.

Accrued Expenses Examples Accounts Payable Examples
  • Payroll (i.e. Employee Salaries)
  • Raw Material Purchases
  • Utilities and Accrued Interest
  • Direct Labor Costs
  • Monthly Rent
  • Freight/Transportation

Accrued Expenses vs. Accounts Payable Examples

To further explain the differences, we’ll compare two different example scenarios, A and B.

Scenario A — Accounts Payable

In the first example, an invoice from the supplier that just delivered raw materials has been received (i.e. the company is billed).

The purchase of raw material does NOT immediately appear on the income statement. But the supplier already “earned” the revenue and the raw material was received, so the expense is recognized on the income statement although the company has yet to compensate them.

Here, the “accounts payable” balance increases until the cash payment is made.

Scenario B — Accrued Expenses

Now, moving to the second scenario, a company was charged for utilities for the month, but the invoice has not yet been processed and received by the company.

Even if the company wanted to, it could not yet pay the amount due since it must wait for the invoice to be sent.

While the company has access to the utilities (e.g. HVAC, electricity), the expense is incurred and the amount due increases the “accrued expenses” balance until the utility provider sends the invoice and the cash payment is then made.

Free Cash Flow (FCF) Impact

As a general rule of thumb, an increase in an operating current liability represents a cash inflow (“source”), whereas a decrease is a cash outflow (“use”).

A/E and A/P — Cash Flow Impact

For accrued expenses and accounts payable, the impact on free cash flow (FCF) is as follows:

  • Increase in Accrued Expenses and Accounts Payable → Positive Impact on Free Cash Flows
  • Decrease in Accrued Expenses and Accounts Payable → Negative Impact on Free Cash Flows

If either accrued expenses or accounts payable increase, a company’s cash flows increase as the cash remains in its possession for the time being — although payment must eventually be made.

For this reason, increases in accrued expenses and accounts payable are shown with negative signs in front on the cash flow statement since they cause cash to decline (and vice versa).

That said, if a company’s accrued expenses increase, this means that the balance of unpaid bills related to utilities and wages is increasing.

Likewise, if a company’s accounts payables increase, this means the amount due to suppliers/vendors is accumulating — which companies often intentionally do if they are able to optimize cash flow (i.e. extend days payable outstanding, or “DPO”).

Comments
guest
0 Comments
Inline Feedbacks
View all comments
Learn Financial Modeling Online

Everything you need to master financial and valuation modeling: 3-Statement Modeling, DCF, Comps, M&A and LBO.

Learn More
X

The Wall Street Prep Quicklesson Series

7 Free Financial Modeling Lessons

Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts.