How important, would you say, is accounting for businesses?
Very, but very important, right?
After all, without accounting, you wouldn’t have a clear idea of when the money must go out and when it must come in, which is quite critical if you want to maintain a healthy cash flow.
That being said, let’s talk about a special accounting concept: Accounts Payable or AP.
Why?
Well, firstly, it’s necessary, and secondly, it’s the only way you can be sure that you are paying your business debts on time.
So let’s start with the basics
What Is Accounts Payable?
Just like we hinted above accounts payable represents the amount of money your business owes to vendors or suppliers for goods and services you've purchased but haven’t yet paid for. When you receive an invoice from a supplier, that pending payment is recorded as an accounts payable liability. AP is considered a short-term liability. For example, let’s say that your company ordered certain products or hired the services of an external consultant, according to the contract agreements between you and the supplier, the payment will be concluded within 40 days after the service is provided.
Would you need to record this transaction in your current financial statements?
Yes and you should do it under the accounts payable category.
Are AP and Notes Payable the Same?
Quick answer: No
While you might be forgiven to think they are similar, notes payable are formal, written agreements that your company can use if you want to borrow money with the promise to pay it back in the future, often with interest. Notes payable typically involve more structured repayment terms and are considered long-term liabilities if they extend beyond one year.
Are AP and AR the Same?
Not at all
AR or accounts receivable handle the money that’s owed to your business, for example, it could be the pending payment of a customer that recently bought one of your products. In other words, it’s money that you will receive in a short period of time, so instead of considering it a liability as with AP, AR is seen as an asset.
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Reasons Why AP is Important
Cash flow management
What’s one of your main concerns as a business leader? Having good liquidity? Keeping a constant level of positive cash flow maybe? Well, good news for you because managing correctly your AP means that you have enough cash on hand to cover expenses when they come due. Paying bills at the right time with the right method can improve your business’s liquidity and reduce borrowing needs.
Supplier relationships
This one is quite logical if you think about it, suppliers after all are working with you to earn money so if they start seeing their payment delayed you could either suffer from a contract annulled or a decrease in quality. Paying your suppliers within the agreed timeframe is essential for maintaining strong relationships. Vendors are more likely to offer favorable terms, discounts, and overall better service if they know you are reliable.
Financial accuracy
Accounts payable plays a protagonistic role in accurately reflecting a company’s financial position. Without careful AP tracking, your financial statements can become misleading, showing an inaccurate picture of your liabilities and cash flow. Something that can become a serious problem in the long run.
Okay, now that we have understood the importance of managing your AP, let’s learn more about the process itself.
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The Accounts Payable Process
Receipt
The first step occurs when a vendor sends an invoice to your business for the goods or services provided. This invoice will contain essential details, including the invoice number, issue date, total amount due, and payment terms. With these specifics in hand, the accounts payable process officially begins.
Verification
With the invoice received, the next step for you and your team is to carefully review the information and confirm it aligns with the original purchase order (PO) and the product delivered. It’s absolutely important here to pay attention and check that all details match to avoid paying for items that weren't ordered or received.
Approval
Once everything checks out, it’s time for approval. The invoice is typically routed to the appropriate department or person responsible for authorizing the payment. Depending on the size of your company or if you are still dealing with manual processes this step can sometimes involve delays or extensive back-and-forth communication.
Payment
After receiving approval, the invoice is ready to be processed for payment. The payment method you choose will depend on the terms agreed upon with the vendor, whether it's a bank transfer, check, or another payment option.
The Three key documents
Believe it or not, the process starts a bit early when things are off by sending a purchase order (PO) to the vendor. This PO is the foundation for everything you’re ordering, including a detailed list of items, the quantities you need, and the final price agreed upon.
When your order arrives, you’ll check the shipment and create a receiving report. Counting on this report helps you document what you’ve received, noting any damage or differences in quantity so you have a complete record.
Finally, the supplier will send over an invoice to request payment for the products or services provided. That’s when your accounts payable team steps in to handle the invoice management process.
Simple, isn’t it?
Let’s move on to the challenges then
Challenges Faced by Accounts Payable
Manual processing
See? Manual processing is on top of the list of the challenges you might encounter when dealing with AP, and with a good reason, if you rely on manual processes, you’re pretty much accepting that the outcome can be plagued with data entry errors, delayed payments, and inefficiencies. The solution? It’s as simple as spelling this word: Automation.
Duplicate payments
Few things are more bothersome for a business than paying more than it should. Without a proper system in place, duplicate invoices can easily get through, causing overpayments. A mistake that can have painful consequences for your liquidity levels.
Fraud and security risks
This is part of our modern reality at any point your accounts payable operations are vulnerable to fraud, such as fake invoices or fraudulent suppliers. To protect yourself, implement strict approval workflows and vendor verification practices.
Inconsistent payment terms
Imagine this, your team is working at the office and suddenly the phone starts ringing like crazy, and there’s a large line of calls from suppliers confused about when the money is arriving. Dealing with different payment terms from various suppliers can get complicated and messy when managed manually. AP software is the best and maybe only choice to streamline this process and keep everything organized.
Cash flow issues
Okay, but what happens when the problem is not the process but…your company. Timing payments can be challenging, especially if your income isn’t consistent. Managing your cash flow and budget with a solid strategy in mind is basic to keep your business financially healthy.
Common Examples of Accounts Payable
- Office supplies and equipment: If your business purchases items like computers, printers, or office furniture on credit, those purchases are recorded as accounts payable.
- Raw materials and inventory: For manufacturers, buying raw materials from suppliers typically falls under AP, as payment is often made after delivery.
- Utilities and rent: Monthly expenses such as electricity, water, or office rent can also be recorded as AP if billed monthly and paid later.
- Professional services: Services from consultants, auditors, or legal advisors can be invoiced and recorded as AP until payment is completed.
Best Practices for Accounts Payable Management
Automate
Yes, we have been hinting at this for the entire blog but hear us on the benefits for a moment. Implementing AP automation can simplify invoice processing, eliminate manual data entry, and reduce errors. On top of that most procurement software can also integrate with your accounting software, making it easier to track invoices and payments.
Approval workflows
Remember what we mentioned about the endless back-and-forth? This is the solution. Create clear approval workflows capable of sending notifications to the right people so you can feel confident that all invoices are reviewed and approved by the appropriate personnel before they’re paid.
Negotiate payment terms
Be honest about the dates and methods that work best for your company from the beginning Sit down with your suppliers to negotiate favorable payment terms. Longer terms can give you more time to manage cash flow, while early payment discounts can save money if you have available cash.
Use AP reporting
Regularly review AP reports to gain insights into your cash outflows, identify trends, and make adjustments as needed. Many software solutions provide reporting features to help you monitor accounts payable activity in real-time.
Key Takeaways
Accounts Payable Defined: Accounts payable (AP) refers to the amount a business owes its vendors or suppliers for goods and services purchased on credit. It’s a short-term liability recorded on the balance sheet, representing bills your business has yet to pay.
Importance of AP: Properly managing accounts payable impacts your cash flow, supports vendor relationships, and ensures accurate financial records. It’s critical for maintaining liquidity and controlling expenses.
Accounts Payable Process: The AP process involves receiving, reviewing, and approving invoices, recording them as liabilities, scheduling payment, and finally making the payment. Each step ensures invoices are processed accurately and on time.
AP Is Not an Asset: AP is classified as a liability, as it represents money owed, not resources owned. That’s the case of AR-accounts receivable. AP impacts your financials by indicating future cash outflows.
Challenges in AP: Common challenges include manual processing errors, duplicate payments, fraud risks, inconsistent payment terms, and cash flow constraints. Automation and clear workflows can address many of these issues.
Improving AP Efficiency: Streamlining your AP process through automation, structured approval workflows, and strategic vendor relationships can enhance accuracy, reduce errors, and support better financial decision-making.
Vendor Relationships Matter: Reliable, on-time payments strengthen vendor relationships, which can lead to favorable payment terms and flexibility, benefitting your overall cash flow management.
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