Accounts payables are outstanding bills such as contractor and supplier invoices that make up a company’s short-term debt obligations. Continue reading to understand the accounts payable process, formula, and examples.
What are Accounts Payable?
Accounts payable (AP) is the money a business owes its suppliers for goods and services purchased on credit. It is a current liability in thebalance sheet, representing the total of approved and unpaid invoices from the suppliers. Companies must pay these unpaid invoices on time to avoid defaults.
The accounts payable of a company display its short-term debt obligations and impact on cash flow. If the payables increase over time, it indicates that the company buys more products on credit. If the payables decrease, it could imply that the company is paying off its obligations faster than they purchase new goods or services on credit.
Objectives of Managing Accounts Payable Effectively
It is important to understand the importance of accounts payable to manage the liabilities and expenses of the business and leverage the opportunity for cost savings. Some common objectives of managing accounts payable effectively include:
- To make timely payments to suppliers, which helps maintain good relationships
- To maintain accurate data that ensures proper expense management, avoids errors, and supports compliance requirements.
- To research ways to save money, optimize cash flows and increase the efficiency of the accounts payable process.
Example of Accounts Payable
The following are examples of accounts payable and a typical accounts payable process:
Example 1: Let’s assume company A purchases coffee machines from Company B on credit. B determines that the amount needs to be paid in 30 days. A records the sale as a credit sale and B is a creditor with an accounts payable balance. On the other hand, B records the sale as accounts receivable.
B sends aninvoice to A 15 days before the payment due date. A tallies the invoice with the purchase order, gets the requisite approvals and processes the payment by the end of the month.
Example 2: XYZ Ltd. requires transportation of goods from their factory to their warehouses. They create a purchase order (PO) detailing the transportation service requirements, and any special instructions, along with the agreed-upon price of Rs. 50,000.
Mr.A receives the PO and carries out the transport services. Post completion of the service, Mr.A issues an invoice to XYZ Ltd. for Rs.50,000, due in 45 days. XYZ Ltd. receives the invoice and proceeds to undertake a reconciliation between the purchase order and the invoice, as well as an enquiry with the concerned department to check whether the transportation was done as per the specifications and terms outlined in the PO. If the reconciliation does not yield any mismatches, XYZ Ltd. then records the invoice in their books and Mr.A as an accounts payable creditor along with the amount owed to them.
XYZ Ltd. then undertakes the necessary reviews and approvals, based on their internal policies and procedures. Once the invoice has been approved, XYZ Ltd. initiates the payment process and makes the payment to Mr.A before the due date. Once paid, XYZ Ltd. updates their accounts payable records to reflect the as well as ensure that their financial records accurately reflect their current liabilities.
Why are Accounts Payable and its management important?
Accounts payable and its management is vital for the smooth functioning process of any business entity. It is important for any business because:
- It primarily takes charge of paying the entity’s bills on a timely basis. This is important so that strong credit and long-term relationships with the vendors can be maintained.
- Only when invoices are paid on time, vendors will ensure an uninterrupted flow of supplies and services; which in turn will help in the systematic flow of business.
- A good accounts payable process ensures there are no overdue charges, penalty or late fees to be paid for the dues.
- The organized accounts payable process ensures all that the invoices due are tracked and paid properly. This will help avoid missing payments and making a payment twice.
- It also enables business entities to manage better cash flows (i.e. making payments only when due, using the credit facility provided by the vendor, etc.)
- Frauds and thefts can be avoided to a greater extent by following a stringent accounts payable process.
For a company’s financial statements to be complete and accurate, the accounts payable balances should be recorded with accuracy. These payables must be dealt with efficiently and accurately.
If there is a double-entry of an expense or omission of a particular invoice, the financial statements will not report the correct amounts and the loss will be huge when the numbers involved are big. Hence, proper recording of the expense and tracking of the payment is necessary.
Accounts Payable Process
The AP process is receiving the invoices, reviewing their details, updating the internal records, and making payments:
- The company receives the invoice from the vendor.
- The accounts payable department matches the invoice against thepurchase order, or even goods received note (in3-way matching) or inspection report (in4-way matching), to approve the final payment.
- They get the necessary approvals from the internal departments.
- They record the invoice in an accounting system as a liability.
- Once approved, the accounts payable/finance department schedules the payment according to the payment terms and ensures sufficient cash flow remains to meet other obligations.
- The payment is processed using a cheque, credit card, or electronic fund transfer method.
- The payment is recorded in the accounting book.
What is the P2P Process in Accounts Payable
The P2P process in accounts payable is a part of thelarger accounts payable cycle, also known as the procure-to-pay or P2P cycle. It is an end-to-end process of accounts payable and involves processes from when the company decides to purchase, selecting the products to buy, and paying for them:
- The company determines the products it wants to buy and gets approval.
- It starts searching for vendors and partners and selects a few.
- It receives quotations and selects the one that matches its needs.
- It negotiates rates, credit policy, discounts, delivery, and freight charges.
- It generates purchase orders and sends the purchase order to the selected suppliers.
- The supplier confirms the order at the requested terms and conditions.
- The supplier ships the goods and informs the company.
- The company formally receives the goods, inspects the delivery for quality and quantity, and sends the invoice for approval.
- Post-approval, the company initiates and processes the payment and informs the vendor. It also marks the payment as complete.
Challenges in the Accounts Payable Process
The accounts payable process can face challenges that affect the value of the payment process. Some common challenges are as follows:
- Manual accounts payable processing can be slow and inefficient, leading to delayed payments, missed discounts, and poor vendor relationships.
- Payment errors can result from human mistakes or lack of proper invoice matching, which can cause audit risks, disputes with vendors, and financial losses.
- Manual bookkeeping can also be prone to errors and inconsistencies, making it difficult to track AP performance.
- Manual data entry can also be time-consuming and may result in errors that can feed into the system and compromises compliance. It also increases the risk of fraud.
- Different vendors have different formats of invoices, approval workflows, and delivery methods — this inconsistency can lead to discrepancies and disputes, which require manual intervention and therefore more time to process the invoices.
Automation in Accounts Payable
As the accounts payable process is vital for every organization, a lot of time needs to be invested for its successful implementation. In order to have an efficient accounts payable process, automation becomes necessary. This will minimise the time and cost of invoice processing, employee headcount and much more. Accounts payable automation will also help reduce human errors and increase efficiency.
Accounting software available in the market can streamline the accounts payable process. These eliminate most of the paperwork involved in accounting. Using electronic invoices, scanned copies of reports, email approvals, etc., will not only reduce the time involved in managing the payables but will also improve the day-to-day performance of the businesses. To add, they usually integrate with the organizations ERP. There are many other value-added services which can be availed from this accounting software. They ultimately improve business efficiency.
Benefits of Accounts Payable Automation
Automating the accounts payable process yields several benefits, such as:
- Faster invoice processing:Automation drastically reduces the invoice processing time as the same functions can now be performed with a click of a button, whether it is for invoice capture, approvals, data matching, or payment tracking.
- Lower processing costs: With faster processing times also comes lower costs. Automation reduces the need for manual data entry and paper-based processing of invoices, thereby cutting down on manpower costs and administrative overheads.
- Increased accuracy:Automation reduces manual work, eliminating the chances of human errors in data entry and calculations. It also promotes digital tracking and checks for duplicates, etc., ensuring that the data is always 100% accurate.
- Access to an audit trail:AP automation provides the management with a detailed and transparent audit trail for every invoice. Right from invoice receipt to payment, finance leaders can view all activities and transactions, thereby increasing accountability within the organisation.
- Faster invoice cycle times:Automation enables faster invoice processing, thereby facilitating faster payments and overall faster invoice cycle times. By having the opportunity to pay vendors well before the due date, businesses can take advantage of early payment discounts. This also enhances vendor relationships.
- Enhanced visibility and reporting: Automation provides real-time tracking and visibility into a business’s AP process and liabilities. This transparency enables better decision-making, cash flow optimisation, and cost control through insightful reports.
- Streamlined compliance:Digitised records promote better compliance as anomalies can be easily detected and rectified, thereby keeping penalties and government notices at a minimum.
Accounts Payable Best Practices
The accounts payable process is important for sustaining good cash flows and building strong vendor relationships. However, AP teams often encounter problems such as missing invoices, incorrect data entries, data mismatches, delayed payments, and more. Hence, it is crucial that every business implement certain best practices to improve their accounts payable process and avoid such problems from arising.
Here are the top ten best practices to improve your accounts payable process.
Key Takeaways
The accounts payable process plays a significant role in any business as it directly impacts cash flows. Efficient management of accounts payable ensures that invoices are paid on time, helping maintain positive relationships with vendors while avoiding late payment penalties. By closely monitoring and optimising this process, businesses can better control their working capital and improve their financial stability.
Further, under the Goods and Services Tax (GST) laws in India, businesses can claim input tax credit only if their vendors upload invoices on time. For this reason, it is of even more importance to maintain healthy vendor relationships and effective vendor communication.
AP Automation helps streamline the accounts payable process by reducing manual tasks, thereby minimising errors and delays. This efficiency enhances productivity and ensures that invoices are paid promptly, improving supplier relationships and potentially securing early payment discounts.
Frequently Asked Questions
What are accounts payable? Explain with an example.
Accounts payable are the sum of unpaid vendor invoices that appear in the balance sheet as a current liability. For example, if a company buys raw materials on credit, the amount owed to the supplier is recorded as accounts payable in the balance sheet.
Why is accounts payable important?
The accounts payable process plays a significant role in any business as it directly impacts cash flows. Managing the accounts payable process efficiently ensures that invoices are paid on time, helping maintain positive relationships with vendors while avoiding late payment penalties. An efficient and streamlined accounts payable process also gives businesses the opportunity to secure early payment discounts.
What is the AP process in accounting?
An AP accounting process is the steps a company must follow in recording, tracking, and paying off its supplier debt obligations.
How does the accounts payable process work?
The accounts payable process begins when the company receives invoices from its vendors. The company has to match the invoice with the purchase order, get approval from internal departments, enter the invoice into an accounting system, schedule the payment, and process the payments.
How to avoid duplicate payments in accounts payable?
To avoid duplicate payments in accounts payable, businesses must implement the following measures-
- Reduce the manual data entry of invoices.
- Maintain a detailed and up-to-date vendor database with unique identification numbers for each vendor.
- Implement a robust approval system with proper segregation of duties.
- Limit vendor payment methods. For example, only cheque or bank transfers.
- Regularly reconcile bank statements.
- Use a tool or solution that can detect duplicate entries/payments.
- Undertake AP audits frequently.
What are the four functions of the accounts payable department?
The four functions of the accounts payable department are:
- Ensure the company is processing supplier invoices and paying for the goods it was delivered.
- Optimize the company’s cash flow and take advantage of early payment discounts.
- Maintain good relationships with vendors and get suitable payment terms.
- Provide timely information on a company's liabilities for financial reporting purposes.
What is the role of the account payable team?
The role of an accounts payable team is to manage the accounts payables of a company in receiving supplier invoices, matching them with internal records, getting the necessary approvals, and paying the bills on time.
What kind of account is accounts payable?
Accounts payable is a current liability account that shows the company’s short-term debt obligations.
What is the journal entry for accounts payable? How to record accounts payable?
The following is an example of a journal entry for accounts payable. You can refer to our detailed list ofaccounts payable journal entries here.
| Particulars | Debit/Credit |
| Expense A/c | Debit |
| Accounts Payable A/c | Credit |
Is accounts payable an asset or liability?
Accounts Payable is classified as a current liability, not an asset.
How to calculate accounts payable?
Accounts payable can be calculated by adding up all the unpaid invoices from vendors at a given time. The accounts payable formula is as follows:
Accounts payable = Purchases on credit - payments to vendors
How to improve the accounts payable process?
Businesses can improve their accounts payable process by implementing certain measures.Here are the top ten best practices to improve your accounts payable process.
What is the difference between accounts receivable and accounts payable?
Accounts receivable represents the money that a business has to receive from its customers for goods or services sold on credit. Accounts receivable appears as an asset on the company's balance sheet. On the other hand, accounts payable represents the money that a business needs to pay its suppliers for goods and services purchased on credit. Accounts payable appear as a liability on the company's balance sheet.
What is invoice processing in accounts payable?
Invoice processing refers to the process of handling vendor invoices from the time of their receipt to the time of payment and recording the same in the books of accounts. It involves the receiving, verifying, approving, and paying vendor invoices.
Is accounts payable a liability or an expense?
Accounts payable refers to the money that a business owes its suppliers for goods and services purchased on credit. Accounts payable appear as a liability on the company's balance sheet.
Is accounts payable a debit or credit entry?
When goods or services are purchased on credit, the purchases account will need to be debited and the respective creditor’s account will be credited.
What is the relationship between cash flow and accounts payable?
Accounts payable impacts cash flows in various ways. It can either improve or strain cash flows depending on how efficiently a company manages the process. The timing of making payments is everything. If vendor invoices are paid on time, it can avoid late fees for the business. It also presents businesses with the opportunity of securing early payment discounts. Effectively managing accounts payable and making timely payments also results in future discounts and better payment terms. Hence, accounts payable have a direct relationship with cash flows.
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Accounts Payable is classified as a current liability, not an asset.
"}},{"@type":"Question","name":"How to calculate accounts payable?","acceptedAnswer":{"@type":"Answer","text":"
Accounts payable can be calculated by adding up all the unpaid invoices from vendors at a given time. The accounts payable formula is as follows:
Accounts payable = Purchases on credit - payments to vendors
"}},{"@type":"Question","name":"How to improve the accounts payable process?","acceptedAnswer":{"@type":"Answer","text":"
Businesses can improve their accounts payable process by implementing certain measures.Here are the top ten best practices to improve your accounts payable process.
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Accounts receivable represents the money that a business has to receive from its customers for goods or services sold on credit. Accounts receivable appears as an asset on the company's balance sheet. On the other hand, accounts payable represents the money that a business needs to pay its suppliers for goods and services purchased on credit. Accounts payable appear as a liability on the company's balance sheet.
"}},{"@type":"Question","name":"What is invoice processing in accounts payable?","acceptedAnswer":{"@type":"Answer","text":"
Invoice processing refers to the process of handling vendor invoices from the time of their receipt to the time of payment and recording the same in the books of accounts. It involves the receiving, verifying, approving, and paying vendor invoices.
"}},{"@type":"Question","name":"Is accounts payable a liability or an expense?","acceptedAnswer":{"@type":"Answer","text":"
Accounts payable refers to the money that a business owes its suppliers for goods and services purchased on credit. Accounts payable appear as a liability on the company's balance sheet.
"}},{"@type":"Question","name":"Is accounts payable a debit or credit entry?","acceptedAnswer":{"@type":"Answer","text":"
When goods or services are purchased on credit, the purchases account will need to be debited and the respective creditor’s account will be credited.
"}},{"@type":"Question","name":"What is the relationship between cash flow and accounts payable?","acceptedAnswer":{"@type":"Answer","text":"
Accounts payable impacts cash flows in various ways. It can either improve or strain cash flows depending on how efficiently a company manages the process. The timing of making payments is everything. If vendor invoices are paid on time, it can avoid late fees for the business. It also presents businesses with the opportunity of securing early payment discounts. Effectively managing accounts payable and making timely payments also results in future discounts and better payment terms. Hence, accounts payable have a direct relationship with cash flows.
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