Accounts Payable, Notes Payable, Long-Term Debt, And Paid-in Capital
September 15, 2007
Accounts Payable
Just as Houston Sash & Door grants its customers credit, the people who supply Houston Sash & Door with lumber and other materials sell these items on credit. When such a credit transaction occurs, it generates an account payable.
When we examine Houston Sash & Door’s accounts payable account on December 31, 2003, we note that the $65,703 it owed is rather insignificant compared to its almost $2 million in sales and is less than half of its payables as of December 31, 2002. How do we explain this? It may be that Houston, fortified with lots of cash, took advantage of cash payment discounts offered by suppliers. It also may be that business was slow toward year-end (the business may be seasonal in nature) and fewer items were purchased. There’s one circumstance, however, where low (or no) accounts payable are a problem: When the business’s credit is so bad that no one will sell to it on credit and all purchases must be made COD!
Notes Payable and Long-Term Debt
We’ve covered this one. It may be the flip side of the owner trying to prettify the balance sheet by taking out a loan to increase the cash. It may also represent a problem if the lender has a security interest in the assets, which may prevent the assets from being sold. If a note must be prepaid within a year, it should appear as a
current liability. If it doesn’t have to be repaid within a year, it should appear as a long-term debt.
Paid-in Capital
What’s left over after liabilities are subtracted from assets is the net worth of the business, which usually has two components: paid-in capital and retained earnings. The paid-in capital is what the owners contributed to the business when they started it, or put in later if the business needed more. Quite often, successful businesses start very small, with little invested capital. It’s not at all unusual for the paid-in capital to be minuscule compared to the net worth of the business.
Let’s skip over retained earnings for now. We’ll discuss this item when we discuss the income statement.
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