What is the Difference Between Accrued Expenses and Accounts Payable?
Accrued expenses and accounts payable each refer to unfulfilled 3rd party payments, but for accrued expenses, an invoice has not been received yet.
- 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?
Table of Contents
Accrued Expenses vs. Accounts Payable Summary
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.
|Accrued Expenses Examples||Accounts Payable Examples|
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”).