Accounts payable refers to any outstanding invoices or credit expenses your company owes to vendors or suppliers. While the best way to ensure you’re paying on time is to meet the vendor’s payment requirements, this can’t happen without an effective accounts payable process.
Your accounts payable (AP) process is key to ongoing operations, essentially acting as the core of your relationships with vendors and suppliers. But merely writing down numbers on your ledger isn’t enough; you also need to understand why it works the way it does and how to make your process streamlined if it’s falling short.
What is the accounts payable process?
Accounts payable is a section of a business’s accounting department responsible for processing and reconciling vendor invoices for goods and services the business received on credit. It is recorded as a current liability on your business’s balance sheet.
These invoices are a short-term obligation, but even so, your accounts payable department needs to settle each invoice within the terms stipulated by the vendor. Vendors make their own payment terms, which may include charging interest or late fees on overdue invoices.
In addition to invoices that your business owes, employee travel reimbursements may also fall under your AP ledger. In fact, any payment made on credit — as in, you have a credit card bill that needs to be paid — will be considered part of your accounts payable.
Why accounts payable is important
While the AP department is responsible for administrative, clerical, and financial tasks, its main priority is typically to ensure vendor invoices are legitimate and correct before paying and processing those invoices into the general ledger.
Depending on how your process works, the AP department may also upload those invoices to your business’s payment system to keep track of what’s pending and what’s been paid.
A stable AP system shows accountants what your business owes before you’re sent to collections or assessed interest and fees. This, in turn, helps improve cash flow, avoid debt, and ultimately save money.
An example of accounts payable
You run a small, family-owned deli in town. Your most popular menu items are sliced roast beef and honey turkey. So, you rely on this vendor to ship these items on time as often as you need them to meet customer satisfaction.
You order new meats every week to keep up with the demand, so your monthly AP ledger may look like this:
To pay your four orders in full each month, your assets (cash, accounts receivable, inventory, and prepaids) should outweigh your liabilities (what you owe each month).
Accounts payable vs. accounts receivable
The main difference between accounts payable and accounts receivable is between what you owe and what is owed to you. Here's a quick breakdown:
Take a look at BILL's page on accounts receivable vs. accounts payable for a more in-depth look at the differences.
Is accounts payable different from trade payables?
The term ‘trade payables’ is sometimes thought to simply be another name for accounts payable, but the two represent slightly different figures. Trade payables relate to debts owed to vendors for goods specifically connected to a company’s inventory, such as raw materials, supplies, etc. Accounts payable, on the other hand, counts for all of a company’s short-term debts, whether they’re related to inventory or not.
Basically, all trade payables are also accounts payable, but not all accounts payable are trade payables.
The accounts payable workflow
The accounts payable process starts before you even purchase anything because you need to guarantee that you’ll make your payments on time — otherwise, you may dig yourself into a hole of debt that will be hard to get out of.
Here’s an overview of the main steps in the accounts payable cycle:
- Receive the invoice: Ensure you’ve received the invoice after the goods receipt note. Request it if the supplier hasn’t sent it promptly after the delivery.
- Analyze the invoice: Compare the invoice to the goods receipt note and the purchase order. Ensure all three documents match and the vendor’s payment details are correct. (This is called three-way matching.)
- Invoice approvals: For larger businesses, AP invoices typically need two layers of approval. The purchasing department first approves invoices before the finance department signs off.
- Vendor payment: Payment is uploaded onto the system, and the finance department releases the payment.
- Repeat process: Conduct this process with every invoice or credit your accounting team needs to reconcile.
Are your accounts payable processes efficient?
Did you know that over half of all businesses experience cash flow forecasting problems because of their inefficient AP process?
“Efficient” may seem like a subjective term — depending on the context, almost everybody has a different definition. But when it comes to your accounts payable team, efficiency should mean one thing: That it works to effectively manage cash flow.
First, let’s define an inefficient process. If you experience an increase in AP over time, your company is acquiring more goods or services than it can handle. In other words, you’re relying on credit (the money you don’t have) instead of cash (the money you do have).
An efficient process will show a consistent and stable ebb and flow in the AP ledger. When AP goes up, it eventually goes back down (ideally within the payment due date). This means you’re paying off vendors faster than you’re buying goods and services — in other words, you only buy what you can afford.
How to improve your accounts payable process
Accounts payable departments can get overwhelmed when a business grows and there are more vendor payments to manage. This often occurs because invoice processing and approvals for financial transactions could take weeks. The good news is that your business can implement simple, practical changes to your AP process through a few simple steps.
Step #1: Reduce manual effort with AP automation
An automated solution ensures invoices are captured without manual intervention when received via email. Automation can also automatically sort invoices according to the vendor or supplier and the due date.
Although manual AP processes are less costly, they can result in errors and require significant time. This time spent could be saved using automation, meaning your AP team can reconcile a higher volume invoices.
Step #2: Improve and digitize your paper trail
Some organizations still receive or use physical invoices. However, printing invoices can result in duplicate payments, which means you accidentally pay twice for the same service. Plus, physical copies get lost all the time, which could result in your business overlooking outstanding invoices. The solution? Establish a digital paper trail and shift to a paperless environment.
Step #3: Avoid late payments and improve cash flow
As with most purchases on credit, you always want to pay on time. Doing so will avoid interest charges, late fees, and a negative relationship between you and the supplier. Be sure to check out the vendor’s payment terms or posted due date so that you can accurately track what needs to be paid first.
The importance and challenges of AP management
A basic AP workflow process benefits your business in several ways but can also create challenges. Let’s look at the value of a well-managed process and the challenges that the accounts payable departments typically face.
Importance of AP management
- Build a strong relationship with suppliers and vendors. Supplier-buyer relationships are key to running a business, and a good relationship better ensures the timely and correct delivery of those goods and services. Suppliers are more likely to provide your business with service if you pay invoices on time.
- You can avoid duplicate payments with proper AP management. An ineffective AP process can result in duplicate payments, especially if your supplier’s invoice amounts are the same. Allocating a payment to the correct invoice is crucial to avoid double payments. Some accounting teams may opt for three-way or four-way invoice processing to ensure accurate payments.
- An effective accounts payable process also reduces the risk of fraud. Tightening your invoice processing system is a great way to prevent mistakes and fraud. Your AP department ensures that the invoice is legitimate by verifying that your business placed an order and that the delivery matches the purchase order and the supplier invoice.
Challenges of AP management
- There’s a lot of paperwork involved. The AP department receives numerous physical invoices and goods receipt notes. Printing purchase orders, matching the three documents, and recording everything on your balance sheet requires tremendous paperwork.
- Without automation, it’s time-consuming. Manually processing the invoices is time-consuming, and an invoice may need to pass several approval stages before payment is released to the supplier.
- Tracking cash flow can be difficult. Besides risking late payments, a manual process makes it challenging for the department to follow the cash flow, which presents limitations to analyzing your company’s financial health.
Reduce manual effort by automating your invoice management process with BILL
Your business depends on others, and paying on time is the only way to keep suppliers and vendors on deck. But all too often, businesses pay late, lose invoices, or even make duplicate payments that don’t get reconciled for weeks.
Luckily, that’s where automated AP software can help. You can create an efficient AP process by avoiding duplicate payments and ensuring that money owed and each vendor invoice is paid on time.
AP automation software from BILL simplifies the accounting process so your business can strengthen supplier relationships, avoid late charges, and reduce storage space.