A quick guide to understanding accounts payable

At its core, accounts payable (or AP) refers to short-term debts and/or obligations a business owes to its vendors, suppliers and short-term lenders for goods and services received on credit. It represents a current liability on the balance sheet and must be paid off within a specified time frame (usually within 30 days) to avoid penalties or strain on the company’s creditworthiness. Accounts payable plays a crucial role in ensuring smooth transactions and maintaining healthy business relationships.   

Serving as the bridge between an organization and its suppliers/vendors, accounts payable plays an essential role in maintaining robust relationships with them. Timely and accurate payment of bills not only ensures a smooth supply chain but also enhances the company’s reputation, which often leads to better credit terms and discounts from vendors. 

Typical accounts payable expenses are utility bills (electricity, water, gas and other utility bills essential for business operations), rent and leases (payments for office space, warehouses or equipment rentals), inventory purchases (payments to suppliers for the purchase of raw materials or finished goods), office supplies (expenses related to stationery, printer ink and other essential office materials), employee reimbursements (payments owed to employees for business-related expenses they covered) and professional services (payments to accountants, lawyers, consultants or other hired professionals). Any liability created due to delayed payment for goods or services is also included in accounts payable.

To gain a clearer understanding, let’s look at one example in detail. Say, your company wants to buy US$ 1,000 worth of office supplies from a vendor on credit. For that, you will send them a purchase order (PO), detailing what the order should contain and when it should be delivered. The PO will have a description of all goods, required quantity, prices and payment terms, among other details. The vendor will then send you an invoice for the order, and you will record this invoice as an accounts payable liability on your balance sheet. You will then have to pay your vendor US$ 1,000 within a certain period of time as mentioned on the PO. 

The accounts payable process

Accounts payable is a type of accrual accounting, wherein a business records revenue and expenses when a transaction is made, regardless of when the payment is received. In essence, the accounts payable process comprises managing a firm’s outstanding invoices and payments to its suppliers or vendors. It ensures that all liabilities related to purchases and expenses are accurately recorded and settled.

Check out 11 typical steps of the accounts payable process, where each step plays a crucial role in preventing errors, ensuring compliance and maintaining a transparent record of financial activities. 

Step 1: Receiving the invoice.

The accounts payable process starts when the company receives invoices from its vendors or suppliers for goods or services rendered (after the PO is approved). These invoices contain details such as the invoice number, invoice date, details of goods purchased, prices, quantities and payment terms.  

Step 2: Verifying the invoice.

The accountant reviews and verifies every received invoice to ensure its accuracy and legitimacy. They cross-check the invoice details against POs, delivery receipts and contracts to confirm that the goods or services were indeed received or provided as stated in the invoice. 

Step 3: Recording it in the accounting system.

The verified invoice is then entered into the company’s accounting system. Each invoice is assigned a unique reference or voucher number for tracking purposes. 

Step 4: Approving the invoice.

Depending on the company’s policies and procedures, the invoice may need to go through an approval process. This may involve routing the invoice to the appropriate manager or department for authorization, especially in cases where the purchase exceeds certain thresholds or requires additional scrutiny. 

Step 5: Reviewing payment terms and scheduling.

Once an invoice is approved, the accountant reviews the payment terms and due date. The payment is scheduled to ensure it is made within the agreed-upon timeframe to avoid late payment penalties. 

Step 6: Processing the payment.

When the payment date arrives, the accountant prepares the payment for the supplier. This process entails various payment methods, such as checks, electronic funds transfers (EFTs) or online payment platforms. 

Step 7: Making the payment.

The company issues the payment to the vendor based on the chosen payment method. The accounting personnel records the payment transaction and updates the accounts accordingly. 

Step 8: Reconciling all accounts.

The accountant performs regular reconciliation of all accounts payable to ensure that all invoices have been accounted for correctly and that there are no discrepancies or outstanding issues. 

Step 9: Reconciling vendor statements.

Periodically, the accountant reconciles vendor statements with the company’s records to identify any discrepancies or missing invoices. This helps them maintain accurate financial records and strong supplier relationships. 

Step 10: Reporting.

The accounts payable process generates several reports, including accounts payable (AP) aging reports, cash flow projections and payment summaries. These reports facilitate financial analysis and decision-making. 

Step 11: Archiving and documentation.

All invoices, payment records and related documentation are securely stored and archived for auditing purposes and future reference.

These steps allow a firm to effectively manage its account payables error-free, maintain beneficial relationships with suppliers and vendors, and ensure accurate financial reporting. 

Mastering the accounts payable process allows businesses to achieve financial success and long-term growth

By understanding the basics of accounts payable, recognizing its significance in financial management and implementing efficient accounts payable processes, companies can pave the way for financial stability and robust vendor relationships. Automating the accounts payable process further optimizes financial operations and empowers businesses to thrive in the dynamic landscape of modern finance. Efficient accounts payable management remains a fundamental pillar of success for any business, and investing in its mastery can lead to significant rewards. 

FAQs on accounts payable

What is the difference between accounts payable and accounts receivable?

Accounts payable represents the funds a business owes to its suppliers and vendors for goods and services received on credit. On the other hand, accounts receivable (AR) represents the money owed to the business by its customers for goods and services provided on credit. 

What are some accounts payable best practices?

Some accounts payable best practices include regular reconciliation, well-defined approval workflows, early payment discount utilization, open vendor communication and the adoption of accounts payable automation tools.  

What are the benefits of accounts payable automation?

Accounts payable automation offers cost savings, increased efficiency, enhanced accuracy, better compliance, improved vendor relationships and real-time visibility into financial data. 

What are the common challenges in accounts payable management?

Despite its importance, managing accounts payable is not without challenges. Manual processing, late payments, approval workflow bottlenecks and lack of financial transparency are among the common hurdles faced by companies. Identifying these issues is the first step in devising strategies for overcoming them. 

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