Q: Are payables always unpaid inventory? How does this apply for a service-based company such as a law firm or accounting firm?
A: Accounts Payable are generally linked to inventory purchases of finished goods for resale or for materials for processing into products for sale. That is, distributors and manufacturing companies customarily reserve accounts payable for amounts due for purchase of goods and materials.
Service firms, on the other hand, such as accounting firms, medical practices, and law firms, have no cost of goods sole – as a general rule. Amounts due for supplies, office operating expenses, or for the use of outside consultants and technicians are usually recorded as accrued expenses or accrued liabilities.
It is certainly possible to find an accounts payable account on the balance sheet of a service firm. If so, it raises an interesting question about what transactions such an account records.
At any rate, it is important to closely observe the trend in both payables and accruals as they represent unpaid obligations that may be a result of cash flow problems during the present operating period.
Course overview: Financial Statement Review and Ratio Analysis