Relationship Between Accounts Payable and Inventory
For a business to manage its financial position effectively, it must pay close attention to the levels of accounts payable and inventory on its balance sheet. Making sure that you pay suppliers on time could help you to acquire supplier credit to purchase additional inventory. Keeping track of inventory turnover ensures that the business does not run into a credit crisis.
Inventory and Credit
Both accounts payable, and inventory are listed on a business's balance sheet. Even though inventory is a cost, it falls under assets on the balance sheet. Accounts payable to purchase the inventory is shown as a liability on the balance sheet. Together, the assets and liabilities show the business's financial standing on a day-to-day basis. It shows how well you are managing your inventory and which supplier may be inclined to provide additional credit for more inventory because of satisfactory payments.
Payables to Inventory Ratio
A business may extend credit terms to its clients for customer flexibility. To help a business manage its payments, a supplier may provide credit terms, which may allow a business to pay for its inventory over a period of weeks. A business can calculate its inventory and payables ratio by taking the ending accounts payable from inventory purchases against the inventory at the end of the accounting period. If the inventory is too high, the business may need to take steps to boost sales.
Inventory and Payables Management
A business should keep a close watch on both accounts payable and inventory. Inventory can tie up money. If a business is investing too much money in inventory that is not turning over, the lack of sales revenue can put the business in the position of not being able to pay its accounts payable to its supplier according to the agreed terms which could result in the loss of a supplier or a poor credit rating.
Inventory and Collateral
A bank is another avenue for inventory financing. As an example of seasonal inventory, a seasonal business may have a high demand for lawn mowers during the summer season. Against the business purchase orders, a bank may agree to provide capital so that the business can purchase lawn mower inventory. The accounts payable to the bank would have a stipulation stating that the owner repays the bank from the sale of the lawn mowers. With collateral on the inventory, a bank will usually finance inventory if the business can justify paying the account within 90 days or another agreed-upon term.