Accounts payable definition
The business world is all about relationships. A healthy relationship with suppliers is vital to the success of any business. Your company's accounts payable department facilitates these partnerships by ensuring timely, accurate payments, and maintaining accurate data.
If you're a business owner, you need a complete understanding of the various components of the accounts payable process.
With this in mind, we've provided an overview designed to bring you up to speed on the accounts payable definition and what you need to know to run your business effectively.
Accounts payable definition
Accounts payable (AP) refers to the payments a company owes to vendors or suppliers for goods or services.
When a company purchases goods and services from a vendor, they usually do so on credit. After the transaction is complete, the vendor submits an invoice to request payment. The total amount owed to these vendors contributes to a company's short-term debt.
Having a clear handle on these expenses is crucial to your financial management.
Accounts payable will be reflected in two important financial documents:
The balance sheet
The balance sheet records the sum of all outstanding bills a company owes its creditors. Accounts payable should be located under "current liabilities."
Companies can manage these debts by itemizing expenses. They can match the invoice numbers from the vendor to each liability recorded in the company balance books.
The Cash Flow Statement
Accounts payable will also be prominently featured in your company's cash flow statement. This accounting document will record the total increase or decrease in total accounts payable from the previous accounting period.
This is important, as your cash flow statement will provide a snapshot of your company's overall health, showing the actual amount of cash you've received and spent.
Accounts payable vs. accounts receivable
It's important to understand the difference between accounts payable (AP) and accounts receivable. Both refer to the cash that your company spends or receives, but the key difference is found in the direction that your company's money is flowing.
Payable accounts refer to the payments a business owes its suppliers. Receivable accounts refer to the money your customers owe your company for goods or services.
In other words, accounts payable refers to the money you owe others, while accounts receivable refers to the money others owe you.
Payable accounts are considered a current liability since it records the money you owe to your creditors. But your accounts receivable is counted among your financial assets, as these dollar values are typically converted to cash within one year of submitting an invoice to your customers.
Understanding the accounts payable process
When your business makes a purchase from a vendor, you usually do so on credit. Your company is responsible for issuing payment to your suppliers in the manner specified in the invoice.
For most companies, the accounts payable process can be broken down into six basic steps, which we'll unpack below.
1. Submitting a purchase order
Purchase orders are used to initiate a transaction. These documents are sent from a company's procurement department to a supplier. The order will include a list of the goods or services being requested, but it will also document the price that will be paid upon receipt.
A thorough accounts payable process will also verify that vendor information is up-to-date, creating a smooth transaction.
2. Receiving invoices
Every supplier might have its own way of sending a bill. Typically, you can expect to receive an invoice after the transaction is complete and you have received the goods or services from your vendor.
An invoice is simply a request for payment. You can think of it as a bill. But unlike a traditional bill, invoices contain additional information that's specific to the transaction and to the companies involved.
Invoices can be sent at any time, though many modern vendors are relying on electronic invoices to streamline the way they receive payments from their customers.
3. Reviewing the invoice
Next, your company's accounts payable department will be responsible for reviewing invoices and double-checking them for accuracy. This can shield your company from paying for fraudulent invoices or from accidentally paying for invoices that were submitted twice.
Invoices usually include an invoice number that can be cross-checked for accuracy. Most accounting software can help you avoid making two payments for the same invoice.
But reviewing the invoice is more than just checking the accuracy. Accounts payable personnel can also verify the details offered by the supplier, including:
- Payment terms
- Preferred payment method
- Due dates
Most suppliers will review these payment terms prior to sending their invoices. Violating these terms or overlooking the due date can result in penalties and increase the amount owed. Accounts receivable personnel, therefore, play a key role in managing a company's risk in deal with business payments.
4. Approving the invoice
Before a bill can be paid, it must be approved. In some cases, a transaction may have had prior authorization by company management. In this instance, the role of the accounts payable department is to match the invoice number with the purchase order for the requested goods or services. Ideally, this approval time should be very short in order to submit payments by the required date.
5. Paying suppliers
Once invoices have been approved, it's time to pay the bills. Your supplier will typically provide multiple payment processing options. In most cases, you can contact the supplier directly to complete your transaction.
6. Update the balance sheet
Once the order is complete, the accounts payable department will make the appropriate entry on the balance sheet. Proper data management can ensure that your company has an accurate picture of its short-term debts, which can help you to understand the way your liabilities impact the business as a whole.
What does an accounts payable department do?
A company's accounts payable department plays a vital role in helping the business manage its finances by processing invoices, paying suppliers, and taking care of other related duties. But it would be wrong to think of these employees as glorified cashiers.
Accounts payable employees satisfy additional responsibilities such as:
Distributing internal payments
Accounts payable teams don't just cover payments owed to external vendors; they can also refer to money owed within the company. Some employees may be entitled to reimbursement for goods or services purchased for official business purposes.
Depending on the organization, these reimbursement payments may be limited to larger items, while smaller items may be purchased with petty cash or the company credit card.
For example, if an employee buys a piece of office equipment and chooses to pay out-of-pocket, he or she can submit paperwork for reimbursement through the accounts payable department. Larger companies may even allot a specified amount for each department's account. Conversely, employees may pay for a business lunch by using petty cash or a company credit card.
Arranging business travel expenses
Similarly, accounts payable teams can help with travel management and logistics. This can include making advance airline and hotel reservations, as well as arranging transportation for travelling sales teams.
The accounts payable employees would pay for many of these expenses upfront while providing reimbursement for any additional expenses incurred during this travelling period. Once these fees are covered, the financial teams would also be in charge of settling distributed funds against what was actually spent on the trip.
Finally, the accounts payable department can play a valuable role in data management. Ensuring the accuracy of data on the company balance sheet provides a clear, accurate picture of the company's health and cash flow. Additionally, keeping up with a vendor's payment schedule can minimize risk by verifying that bills are paid by the due date.
Regular reporting is critical for entrepreneurs looking to forecast and plan long-term. Having a clear picture of your income and expenses can reveal cyclical patterns that impact your strategy. It can also illuminate weak spots in your resource management.
Proper bookkeeping practices can even shield your business from mistakes and fraud, which makes the accounts payable department an invaluable asset.
How to optimize the accounts payable process
Having a streamlined accounts payable process is vital for businesses of any size. But how can your business optimize this process for faster payment and enhanced access to your most important data? Your company can get more out of your accounts payable process with these key steps:
- Obtain the right documentation
Purchase orders can provide better control over the procurement process. This can be helpful in reconciling your books by matching invoice numbers with the original purchase order. When you have the right documents in place, you can accelerate the rate at which you process invoices, reducing the time spent approving payments.
Typically, businesses rely on the same vendors for multiple purchases, too. Having a centralized record of vendor information including W-9s and tax identification numbers can prevent you from having to chase down this information every time you work with a given supplier.
- Reconcile accounts daily
Never get behind in your work. Enter invoices into your accounting system on the same day that you receive them. This can keep you from forgetting about a payment that you owe and minimize the risk of submitting payment after its due date.
This is another example of why purchase orders can be helpful, as you can use them to quickly match order numbers with those on the incoming invoices.
- Practice strategic bookkeeping
One of the ways that businesses can minimize errors is by strategically managing the bookkeeping process. Double-entry bookkeeping can minimize errors by logging each transaction twice: as a debit in one account and a credit in another.
For example, if your company purchases $100 worth of goods from a local vendor, your bookkeeping staff would create an AP entry for that amount and credit that account with $100. But then, this same staff member would debit $100 from its inventory asset account.
- Rely on electronic payments
Due to the accelerated rate at which we do business, it's rarely good enough to put the check in the mail. Relying on electronic payment methods such as a debit or credit card can keep your account paid in full from the moment you receive the request for payment.
- Automate your process
Automating these essential processes can increase your company's efficiency while improving accuracy. When you use quality invoicing software, you can make sure that outstanding debts are paid in full almost as soon as you receive the bill.
When your suppliers use the right invoicing tools, you can expect to receive automated reminders to submit payment. Your internal accounting software should do the same to keep you in good standing with your vendors.
Accounting software can eliminate the kinds of errors due to human mistakes, including rounding errors or inaccurate data entry. Computerized accounting systems minimize mathematical mistakes. They can perform even the most complex calculations in the blink of an eye.
Automated solutions can provide a digital trail that can be more reliable than a paper one, too. Cloud-based solutions can provide you with access to your business account from anywhere in the world, so you're always up to speed on the health of your business.
This can also be helpful if you find your business facing any sort of litigation, as your software can supply clear documentation of payments and the dates you finalized transactions.
Change the way you get paid
Chances are that you're already well aware of the value of automation for today's businesses. The right software can make all the difference in the world, regardless of what industry you happen to be in.
That's why Invoice2go, a Bill.com company is proud to offer innovative solutions to change the way you get paid, providing invoicing tools and web-based technology to keep you in control of every part of your financial future.
For related articles, explore our blog, where we share other ways that digital technology can take your business to the next level. For questions, contact us — we'd be happy to discuss how you can leverage our tools to help your business thrive.