Accounts Payable Process

Regardless of the industry, any successful business needs to know how much it owes to its vendors and suppliers. Imagine the opposite: What sort of financial chaos would it be to spend all your revenue without caring about pending commitments? You wouldn’t only lose money but also the respect of suppliers, jeopardizing the complete future of your business. 

To prevent such nightmares, you are going to get acquainted with a very specific concept. 

Accounts payable (AP)

If this is the first time your heard about AP or need a refresher on the best practices to manage accounts payable, keep reading on, it’s going to be worth it. 

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What’s Accounts Payable?

The procurement department of a company has acquired new raw materials from a supplier.  They have agreed to make a 30% upfront payment when the order is placed and the rest when the product is delivered within 45 days.  How does the company register this? As part of its accounts payable. 

In simple words, an account payable is what the business needs to pay in the short term for products and services that have already been bought.  They are a liability and are registered as a such. 

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Difference between AP and Notes payable

Notes payable, involve formal, written agreements to repay borrowed money, often including interest, over a longer term. While accounts payable generally arises from routine business operations, notes payable usually stem from financing activities or long-term loans.

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What does the AP process look like?

It can be explained in three steps. 

Invoice receipt and verification

The responsible department gets the invoice from the vendor with the details of the product acquired.  Once this is done, the next step is to actually go over the invoice and make sure that the information is correct and matches the purchase order. 

Approval 

How long does this step take it’s going to depend on the levels of authorization the expenditure requires and if the approval workflow is automated or not. 

Payment

The payment method may vary depending on what your company prefers or what has been agreed with the supplier, but establishing a payment schedule is something that every business needs to consider. Early payments could mean a discount, at the same time, paying on the due date keeps cash flow levels healthy and more satisfactory relationships with vendors. 

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Challenges in Accounts Payable

Okay, by now we have a better understanding of the importance of AP, but as with every relevant process, it’s not free of challenges. The following are the most common.

Tons of paperwork

If there’s ever a contest to know which accounting process demands higher levels of use of paperwork, accounts payable would be the winner. The reason? Still, despite some progress, done manually, managing physical invoices means spending a lot of hours going through files, double-checking details, and generally wasting time that could be allocated to other tasks. 

Data entry 

Again, another problem with doing the accounts payable process manually is that there are large amounts of data to consider, so when it comes to recording and reviewing, mistakes can happen. Imagine the issues that would arise if instead of registering $1000 as a pending payment, you miss a zero and record $100. That sounds just problematic, isn’t?

It takes too long

Sending a lengthy email asking for approval, only to get a reply that you’ll need to first get the authorization of five other people is a nightmare for any accounting department. In the case of AP, this scenario will be more common as the payment amount gets higher. Without a proper approval workflow system, managing your accounts payable could literally take ages. 

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No space for improvement 

Now, that might be a bit of an exaggeration, the problem is not that accounts payable cannot be improved, the problem comes with the manual process, if there’s no record of what is done and what has gone wrong along the way, it’s impossible to know if something could be changed to favor better efficiency. 

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The Importance of AP

Positive cash flow 

It’s kind of logical if you are aware of your incoming financial responsibilities and make payments on time, you won’t have to worry about liquidity issues. Cash will flow right where it should at the expected moment. 

Record keeping

This is special true for departments that choose to automate their AP processes.Meticulous and continuous tracking of crucial aspects like invoices, goods received, and payments dispatched is the foundation for a business to operate efficiently and effectively.

Better supplier relationships

Having an accounts payable process that works on time and makes communication and approval simple is a great step towards more loyal and happier relationships with your suppliers. 

Fraud prevention 

Yes, you read that right, good management of your AP has a positive impact on your fraud prevention efforts as it gives you the opportunity to ensure that all payments have been done correctly. 

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Alright, so now that we're familiar with the good and the bad, let's move on to the next step.

How can we actually develop an efficient AP process? 

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Best Practices for AP Optimization 

Automation 

Say it with us: Automating AP is your best decision. 

Manual processing of invoices can be time-consuming and error-prone. By automating the AP process, you can significantly reduce the risk of mistakes and speed up invoice handling.

There are two main ways to do this

Invoice Management Software: Implement an invoice management system that captures invoice details through Optical Character Recognition (OCR) and integrates with your accounting software.

Digital invoices: Encourage suppliers to send electronic invoices, which can be automatically uploaded and matched to purchase orders.

Standardize Procedures

A good process is always defined by having an established series of steps that everyone involved can follow. Standardized procedures for handling invoices and payments help maintain consistency and ensure all steps are followed correctly.

Here’s how you can achieve this with your AP process. 

AP Workflow: Define each step of the AP process, including invoice receipt, approval, and payment. Ensure that all team members are trained on these procedures. Ideally, you will want to have this procedure automated, as it will simplify communication across all stakeholders. 

Improve Invoice Accuracy

Discrepancies between invoices, purchase orders, and receiving reports can cause delays and errors. Ensuring accuracy at each step helps avoid these issues. To ensure accuracy and compliance in invoice processing, implement a three-way matching system that verifies invoice details against purchase orders and received goods or services. Additionally, regular audits must be conducted to maintain adherence to company policies and confirm the precision of the processing.

Streamline Approvals

Remember that we just talked about an automated AP workflow? Well, the approval phase is a crucial part of it. Delayed approvals can lead to late payments, affecting supplier relationships and incurring late fees. Streamlining the approval process helps ensure timely payments. The most straightforward way to do that is to rely on electronic approval systems to streamline and expedite approval workflows, you’ll appreciate the power of digital tools, compared to traditional paper-based methods is 100% more efficient, and tracking relevant information becomes a matter of only a couple of clicks. Additionally, establish and communicate clear approval deadlines to prevent unnecessary delays in the process.

Negotiate Payment Terms

If you know that you are capable of paying your debts on certain dates, wouldn’t make sense to set your payment terms with that information? Effective cash flow management is critical for optimizing the AP process. Negotiating favorable payment terms with suppliers can improve your financial flexibility.

So one of the first things you can do is to speak with your suppliers about longer payment terms to better align with your cash flow cycle.

Another good practice is to take advantage of early payment discounts to reduce overall costs.

Maintain good relationships with suppliers 

Last but by no means least, we find the importance of maintaining positive relationships with suppliers, as it can lead to better terms and smoother transactions. Good relationships are built on clear communication and reliability.

Keep suppliers informed about any issues or delays and address their concerns promptly. Share constant feedback to help them understand your needs and improve the relationship both ways.

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The Three-way match 

If you want to make sure that your accounts payable process is completely accurate and free of errors, the 3-way match is your best alternative. Fancy as it might sound. It’s just a mechanism designed to verify the precision of transactions by comparing three key documents: The PO, the receiving report, and the vendor’s invoice. 

1. Purchase Order (PO): This document contains the details of your purchase, including price, quantity, and terms of delivery. 
2. Receiving report: Here you have listed what you actually received from the vendor, it’s a confirmation of the products obtained. 
3. Vendor’s invoice: This is sent by the supplier and contains the exact due amount for the products acquired. 

What does the process involve?

• Verification: Just as the name hints, the AP department checks that expectations are clearly settled in the purchase order. 
• Receipt revision: Upon receiving the goods or services, the receipt is created. This document confirms that the delivery matches what was specified in the PO.
• Invoice matching:  When the supplier’s invoice arrives, it is compared against the PO and the receipt. The invoice amount, terms, and details must align with what was ordered and received.

Okay, so if there’s anything else you should know about the accounts payable process?

Yes, and it can be summed up in two words: Upstream and downstream

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The Flow of Accounts Payable Process

Upstream 

Think of it as the beginning point. This phase involves procurement, where the focus is on sourcing, managing the supply chain, and negotiating contracts. Here, businesses work to find the best vendors, secure favorable contract terms, and build strong supplier relationships. It’s also the stage where payment terms are set and risks associated with purchases are monitored. Essentially, upstream is all about setting up the groundwork for successful transactions.

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Downstream

On the other hand, the downstream part deals with everything that happens after the purchase. Once goods or services are delivered, this phase ensures that invoices are checked and paid. The accounts payable system plays a crucial role here, tracking what was received and making sure it matches the original purchase order. Without a solid accounts payable system, you might miss payment deadlines or face late fees, which can impact the smooth operation of your business.

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Final Thoughts: 

In conclusion, understanding the accounts payable process is crucial for maintaining financial stability and operational efficiency in any organization. By implementing effective practices such as the 3-way match, automating workflows, and setting clear approval deadlines, businesses can enhance accuracy, streamline their operations, and avoid costly errors. Regular communication with suppliers and providing feedback can strengthen relationships. The final result? A simplified and effective procurement process. 

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