Accounts payable is an accounting term that refers to the liabilities your business owes suppliers and vendors. All debts and bills other than payroll fall under this category. Understanding your accounts payable and developing the cash flow to support it, then, is critical for any business’s financial health. Below, we will delve into the accounts payable process and provide tips on how to manage it effectively to support the growth and longevity of your business.
Understanding the Accounts Payable Process
Accounts payable is important to a business for a number of reasons. It can impact cash flow and business credit score. Moreover, tracking accounts payable over time can help you better understand your expenses and how they’ve grown along with your business. Of course, this insight is only available when you’ve kept adequate records of your expenses over the years.
“The accuracy and completeness of a company’s financial statements are dependent on the accounts payable process,” said Harold Averkamp, founder and content author of the accounting advice website AccountingCoach.com. “The efficiency and effectiveness of the accounts payable process will also affect the company’s cash position, credit rating and relationship with its suppliers.”
The key steps of the accounts payable process include:
- Purchase order: To kickstart a purchasing procedure, the organization’s purchasing department forwards a purchase order to a vendor.
- Receiving report: Post the receipt of the goods or services procured, a receiving report is formulated to document the shipment, highlighting any issues and damage.
- Vendor invoice: Finally, the vendor constructs and forwards an invoice to demand payment for the goods or services procured and received. When the business receives the invoice, it notes the payment terms and processes payment within those terms.
While accounts payable represents the money you owe vendors and suppliers, accounts receivable indicates how much cash you’re awaiting from unpaid invoices, which is crucial for your business’s cash flow.
Tracking Accounts Payable
Many small businesses supervise accounts payable, often abbreviated as A/P, on a monthly basis. However, as a business expands, monitoring accounts payable weekly is recommended. The augmented frequency aids small businesses in capitalizing on any early-payment discounts included on invoices and settling credits owing to inventory returns.
Below are some best practices for supervising accounts payable and ensuring your business’s finances operate smoothly:
- Maintain precise accounts payable records. Retain a detailed accounts payable log in case of payment disputes. That way, you’ll have supporting documentation if you receive a reminder about a supposedly outstanding invoice or as evidence of spending during tax time. Construct these accounting reports manually or with accounting software.
- Implement top accounting software. The best accounting software automates accounts payable and simplifies the procedure. It can schedule and monitor payments while controlling who has access to your financial data. It can also mitigate errors and expedite the accounts payable procedure.
- Stay detail-oriented. Managing accounts payable requires excellent attention to detail. Each invoice must be verified for accuracy, billing date and payment date. Invoice details must be entered correctly into the general ledger or accounting software. Employing adept accountants and bookkeepers assists in ensuring accuracy.
- Refer to original invoices. Work from the original invoice whenever feasible. Some invoices are dispatched electronically. To evade errors and minimize confusion with electronic invoices, consider using invoice management software to organize your invoices as you receive them. This can double as an unofficial accounts payable record too.
- Standardize your naming convention. Utilize the same naming convention or system every time. Adhere to a consistent, replicable procedure each time you assign an invoice number in your system. Determine a method that works for you, such as labeling invoices with the company name, month and year when saving them.
- Input every invoice individually. Input every invoice individually, including multiple monthly invoices from the same supplier. If a dispute arises, you’ll want to locate each invoice easily within your system. Combining multiple invoices into one can create confusion and make it difficult to find particular line items.
- Secure approval for all invoices. Prior to sending an invoice, secure approval from the appropriate person. The approver should differ from the staff member inputting the invoice. Ideally, keep these role assignments distinct. However, if you are a sole proprietor doing your own books, this may not be feasible. In that case, ensure you have a clear procedure for approval and entry. Maintain solid process records to support each role so you’ll be prepared to delegate or outsource this task as your business expands.
- Look for early-payment discounts. Discounts can accumulate over 12 months. Some vendors offer a slight reduction – usually a percentage of the total amount due – in return for receiving payment earlier. If you typically batch all your accounts payable invoices to review and pay simultaneously, contemplate a new system. Discover a system that permits you to identify, flag, file, and pay invoices with discount terms on a quicker timeline.
Cash flow is critical to a small business. A robust system of= managing accounts payable provides you with a transparent picture of your expenditures against your revenue, enabling better business decisions.
Examples of Accounts Payable
Accounts payable encompasses all B2B billing, in which your company is obligated to pay another company for the goods or services it provides. Here are some examples of accounts payable scenarios:
- Cleaning services: An instance of accounts payable is when Company A engages Company B to manage its cleaning needs. In this instance, Company A must dispatch regular payments to Company B in exchange for prompt and reliable cleaning services, typically on a daily or weekly basis.
- Staff uniforms: Another instance of accounts payable is when a business hires another business to manufacture its staff uniforms. This is an instance of a repeat, or periodic, business expense. Staff turnover and lost or damaged uniforms will necessitate additional orders. In this instance, Business B invoices Business A when it receives a new order, and then Business A’s accounts receivables department processes payment.
- Office supplies: Numerous companies purchase office supplies in bulk and establish automatic orders based on use frequency to ensure they never run out of essential supplies. These business proprietors often have pending payments to their office supply companies to ensure efficient workflow.
Additional accounting resources
If you want to learn more about why accounting is important to your business, further information on handling accounts payable can be found in the following articles:
Adam Uzialko also contributed to this article.