Understanding accounts payable

Introduction

Accounts payable is what your business owes, but hasn’t yet paid. You receive a bill from your lawyer, independent contractor, or software company – that’s accounts payable.

This article will help you understand all the important basics of accounts payable.

This guide is also related to our articles on understanding prepaid expenses, bank reconciliation example: step by step, and double-entry accounting: the basics.

This list includes:

• Accounts payable process
• Invoice processing automation
• Accounts payable vs accounts receivable
• Cash conversion cycle in accounts payable
• Accounts payable risk management

Let’s get started!

What are accounts payable?

Accounts payable is money you owe to suppliers or vendors for goods or services you’ve received but haven’t paid for yet.

It’s like a tab you keep open with your suppliers. Every time you order something on credit, that amount goes into your accounts payable. This is recorded in your books under the liability section because it’s money you owe.

To record an account payable, you enter it as a credit in your accounts payable account and a debit in the expense or asset account it relates to.

For example, if you buy inventory on credit, you increase (debit) your inventory account and increase (credit) your accounts payable account.

Accounts payable vs. other financial terms

Accounts receivable: This is the flip side of accounts payable. It’s money others owe you for products or services you’ve provided. While accounts payable is a liability, accounts receivable is an asset.

Accruals: Accruals are broader and include any expense or revenue that has been incurred but not yet paid or received. Accounts payable is a type of accrual, specifically for purchases made on credit.

The accounts payable process

At its core, the accounts payable process is about managing what you owe to suppliers from the moment you receive an invoice to the moment you pay it.

1. Receive an invoice: Start the accounts payable process when you receive an invoice after purchasing goods or services.
2. Verify the invoice: Check the details on the invoice carefully. Ensure they match the purchase order and the goods or services received to catch any discrepancies early.
3. Process invoice approval: Route the verified invoice through your approval workflow. Whether it’s just you or multiple departments, make sure the approval rules are clear to avoid delays.
4. Schedule payment: Once the invoice is approved, schedule the payment. Aim to pay on time to maintain good supplier relationships and take advantage of any early payment discounts.
5. Choose a payment method: Select a payment method that works best for both your business and your supplier, such as bank transfer or credit card.
6. Keep records: Maintain detailed records of all transactions, including copies of invoices, proofs of payment, and approval documents. Consider digital record-keeping for better organization.
7. Reconcile regularly: Regularly compare your accounts payable records with your bank statements to catch and correct any errors, ensuring your financials are accurate.

Managing accounts payable well means you’re keeping your suppliers happy, your financials accurate, and your business running smoothly.

Optimizing accounts payable management

Getting a handle on your accounts payable can make a big difference in your business’s financial health. Here’s how to tighten up this area for better efficiency and relationships.

Improving accounts payable efficiency

Efficiency in accounts payable isn’t just about paying bills on time; it’s about streamlining your processes to save time and money.

Go digital: Replace paper invoices with digital ones to speed up processing and reduce the chance of losing important documents.

Centralize your process: Having all your accounts payable activities in one place, whether it’s a software or a specific team, helps keep things organized and accessible.

Automate invoice processing: Automation is a game-changer. It can take care of repetitive tasks like entering data, matching invoices to purchase orders, and even flagging discrepancies. Invest in accounts payable software that automates invoice processing. This can significantly cut down on manual errors and free up your time for other tasks.

Accounts payable and cash flow

In business, you generally want to hang on to your money for as long as you can. By managing your accounts payable efficiently, you can stretch out the time before you need to pay your suppliers without souring the relationship. This can free up cash for other parts of your business.

Paying suppliers later (within their terms) extends your cash cycle, meaning you have more cash on hand to use for operations.

However, it’s a balancing act. Pay too late, and you risk damaging supplier relationships. Pay too early, and you might strain your cash flow.

Leverage early payment discounts

Many suppliers offer discounts for early payment. This can be a win-win; you save money, and they get their payment faster.

Negotiate terms, don’t be shy about asking for discounts. It’s common practice and can lead to substantial savings.

Technology in accounts payable

Technology can dramatically improve efficiency, accuracy, and security in handling your payables.

• Speed and efficiency: Automated systems process invoices faster than manual handling, freeing up your time for other business activities.
• Accuracy: Software reduces human errors, ensuring that payments are correct and accounts are up-to-date.
• Security: Advanced encryption and security measures protect your financial data from theft or fraud.
• Visibility: Real-time tracking of invoices and payments gives you a clear picture of your financial commitments at any moment.

Popular accounts payable software and tools

There’s a variety of software out there designed to streamline your accounts payable process. Here are a few standouts:

• QuickBooks: Great for small businesses, QuickBooks offers comprehensive accounting solutions, including accounts payable. Its user-friendly interface and integration capabilities make it a popular choice.
• FreshBooks: Ideal for service-based businesses, FreshBooks provides easy invoicing and payment tracking with a focus on simplicity and user experience.
• Xero: Xero’s strength lies in its cloud-based system, allowing access from anywhere. It’s known for its robust accounts payable features and integrations with a wide range of third-party apps.
• Sage: Sage offers a range of accounting solutions to fit different business sizes and needs. Its accounts payable tools are designed for efficiency and compliance.
• Zoho Books: A part of the Zoho suite of online productivity tools, Zoho Books is a solid choice for small businesses looking for an all-in-one accounting solution with strong accounts payable capabilities.

Managing risks in accounts payable

Handling accounts payable involves navigating through potential risks that can impact your business. Understanding these risks and knowing how to manage them is crucial.

• Fraud: This could range from external scams to internal embezzlement. It’s vital to be vigilant and have checks in place.
• Errors: Mistakes in invoice processing can lead to overpayments, duplicate payments, or missed discounts, affecting your bottom line.
• Disputes: Misunderstandings with suppliers over payment terms, delivery of goods, or service quality can lead to disputes, straining relationships and potentially disrupting your supply chain.

Tools to fix or mitigate these risks include:

• Segregation of duties: Make sure different people handle invoicing, approvals, and payments. This reduces the risk of fraud.
• Regular reconciliations: Match invoices with purchase orders and delivery receipts regularly to catch and correct errors quickly.
• Vendor verification: Before paying new suppliers, verify their legitimacy to avoid scams. Regularly review existing suppliers as well.
• Approval authority limits: Set clear limits on who can approve what amounts. This keeps a tight control on payments.

Accounts payable metrics and KPIs

Keeping an eye on specific metrics can help you understand how well your accounts payable process is running. Here’s a breakdown of key performance indicators (KPIs) to track and how to use this data effectively.

KPIs for accounts payable

• Days payable outstanding (DPO): This tells you how long it takes, on average, to pay your invoices. A higher number might mean you’re holding onto your cash longer, but it could also indicate potential payment issues.
• Cost per invoice processed: Understanding how much it costs you to process an invoice can help identify areas where you can save money, perhaps by automating.
• Invoice exception rate: This measures the percentage of invoices that cannot be processed straight through due to errors or discrepancies. Lowering this rate can significantly improve efficiency.
• Percentage of electronic invoices: Tracking the shift from paper to electronic invoices can show progress in automation and efficiency.

Start tracking these metrics, set your improvement targets, and use benchmark data to guide your progress.

Conclusion

Putting effort and resources into bettering your accounts payable process pays off. It can save you money, make your operations smoother, and strengthen your business. Automating invoices, grabbing early payment discounts, and tracking payments can all boost your bottom line.

Use the tools and strategies that suit your business best, and always be on the lookout for new ways to improve and save.

Next, check out our articles on online bookkeeping services for small businesses, 10 best peo companies in 2024, and understanding nonprofit accounting.

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