What Are Accounts Payable?
Accounts payable are defined as what a business owes, including a business’s short-term debts to vendors, suppliers, and creditors for the goods and services the company has received and has yet to pay.
Accounts payable also refer to the business department that oversees the payment for the goods and services the company owes to suppliers and creditors.
There are two main types of accounting methods: accrual accounting and cash-basis accounting. Only accrual accounting recognizes accounts payable.
Accrual accounting focuses on anticipated revenue and expenses. Meanwhile, cash-basis accounting immediately recognizes income and expenses when the company receives money or pays out.
Examples of accounts payable include services (such as accounting and legal services), utilities, and office supplies.
Typically, a company’s accounts payable can be found under the current liabilities portion of the company’s balance sheet or chart of accounts.
A balance sheet is defined as a financial statement that summarizes what a business owns, what it owes, and the shareholders’ investments in the company.
Accounts payable are different from notes payable.
Notes payable are financial obligations represented by a written promissory note. This legal form, given by a borrower to the lender, includes the principal amount owed by the borrower, the due date, and the interest to be paid.
Meanwhile, accounts payable do not involve written agreements stating that a company should pay within a specific period. Instead, these accounts payable are listed as current liabilities.
Accounts Payable Management
The management of accounts payable is essential to any business. Increased accounts payable means the company is buying more goods and services on credit instead of paying cash.
Meanwhile, decreased accounts payable means the business is paying its debts faster than it is purchasing new goods and services on credit.
Accounts payable management affects the cash flow of a business.
Cash flow refers to the amount of cash being transferred into and out of a company. A cash flow statement is a financial statement that records the cash and cash equivalents entering and leaving a company.
Business owners may use the company’s accounts payable to control cash flow.
To increase a company’s cash reserves, business owners can delay settling their outstanding accounts in the accounts payable. However, this decision may take a toll on the company’s relationship with vendors and suppliers.
Business owners are encouraged to pay their bills on or before their due date.
To ensure that the company is paying its accounts payable on time, business owners prepare an accounts payable aging schedule.
Traditionally drafted at the end of the month, the accounts payable schedule provides a breakdown of the total accounts payable amount a business owes its suppliers.
Accounts Payable vs. Accounts Receivable
Accounts payable are the financial obligations of a company to vendors, suppliers, and creditors. Meanwhile, accounts receivable refer to the money owed by debtors and customers to a company.
Accounts Payable vs. Trade Payables
Accounts payable and trade payables fall under the accounts payable category. However, these phrases can mean different things.
Trade payables are defined as the money a business owes suppliers for inventory-related goods. These goods can be raw materials or supplies that are part of the inventory.
Meanwhile, accounts payable refer to all of the business’s short-term obligations.
Several companies choose to list accounts payable and trade payables under ‘accounts payable.’
Accounts Payable Journal Entry
According to the double-entry bookkeeping method, accountants should record at least two entries for every transaction: a debit entry in one account and a credit entry in another.
Double-entry accounting also states that the total debits and the credits listed in the general ledger should be equal.
The general ledger records, sorts, and summarizes all the transactions of a company.
Upon receipt of a vendor invoice, the accountants should credit accounts payable. As a rule, they should list a debit offset, which is typically an expense account for the goods or services purchased on credit.
When the invoice has been paid, accounts payable is debited while cash is credited. The accounts payable credit balance should be the same as the total amount of the recorded but unpaid vendor invoices.
For instance, a company purchases goods, particularly coffee beans worth $700 from Company B. The accounting entry should be like the one below:
Supplies (coffee bean)
Accounts payable – Company B
According to the accrual accounting method, the accountant should record the transaction as an expense, even if the company has not given out any cash.
Once the company pays Company B, the journal entry should look like this:
Accounts payable – Company B
It is important to note that accounts payable should be listed as a liability account, not an expense account. However, the accrual accounting method requires that the expenses associated with accounts payable should be recorded at the same time the accounts payable are recorded.
The difference between liabilities and expenses is that liabilities are financial obligations that have yet to be paid. Meanwhile, expenses are defined as the cost businesses incur to generate revenue for the company.
A supplier’s cash flow vastly improves if the company’s accounts receivable are paid sooner. Some suppliers provide cash discounts if a company settles their invoice earlier than the due date.
Some vendors include the payment terms “1/10, n/30” in their invoice. This payment term means that buyers who pay within ten days, instead of waiting for the 30th day due date, are entitled to a discount of 1% of the amount owed.
Other suppliers would offer more significant discounts, such as the “2/10, n/30” payment term. Buyers who remit the amount owed within ten days may get a 2% discount on the amount owed.
The rate at which a company settles its accounts payable in a given period of time can be calculated using the accounts payable turnover ratio. The ratio can be determined by dividing the company’s total amount of supplier purchases by the average accounts payable.
If Company A’s total supplier purchases amount to $50,000 and its average accounts payable is $4,000, Company A’s accounts payable turnover is 12.5.
A high turnover ratio means a company pays its bills fast.
If a company is behind on a payment, the company can ask the vendor to reclassify the account payable as a long-term note. This payment term is for accounts due in 12 months or more.
Typically, long-term notes involve an added interest payment. Whether a vendor agrees to a long-term note is dependent on the company’s relationship with the vendor.
Accounts Payable Process
When the accounts payable (AP) department receives the vendor invoice, the accounts payable workflow begins.
Upon receipt of the invoice, accounts payable clerks then verify its validity and check for duplicates. These accounts payable clerks then input the invoice to the general ledger and conduct a 2-way or a 3-way match.
The AP department then routes the invoice for approval. Once it is approved, payment is then processed.
2-way or 3-way matching are essential internal controls. They help the company avoid paying for supplies, products, or services it did not receive or overpaying for the goods and services it purchased.
In 2-way matching, the essential documents are the vendor invoice and the purchase order.
2-way matching verifies if the quantity billed is less than or equal to the quantity ordered. It determines if the invoice price is less than or equal to the amount reflected on the purchase order.
A purchase order is a document prepared by a company to communicate what it orders from a supplier.
A vendor invoice is a document a supplier sends a company to communicate the goods and services that the company has purchased on credit.
Some examples of vendor invoices include expensive company equipment guaranteed to last long, maintenance and repair services, and even advanced invoices for future services, such as insurance.
In 3-way matching, an additional document is required to validate the payment: an order receipt or a packing slip.
Order receipts serve as proof of payment and delivery.
The AP department checks if the prices, quantities, and terms in the purchase order match the goods that were received by the company, which is stated in the order receipt or packing slip. Then, the goods received are matched with the amount of money the company is being charged.
3-way matching may slow down the payment process, so this procedure is not recommended for small purchases and recurring ones.
A business’s accounts payable process must be efficient because it affects the company’s cash position, credit rating, and relationships with vendors.
Vendor management is also part of the accounts payable process. The department should assist vendors with their inquiries, negotiate terms, and ensure that these vendors are paid on time.
A business’s cash and current assets must be safeguarded. Hence, internal controls within the accounts payable process should be maintained.
Internal controls prevent the company from doing the following:
- Paying inaccurate and fraudulent invoices
- Paying a vendor twice
- Paying without ensuring that all invoices are accounted for
To avoid mistakes and embezzlement by abusive personnel, business owners may implement a variety of checks and balances, such as:
- Segregation of duties – ensures that no one employee can single-handedly approve a payment.
- Separation of procedures for registering new vendors and entering vouchers – this policy guarantees that an employee cannot register himself as a vendor and pay himself without approval from other employees.
A voucher is a document that vouches for an approval procedure’s completeness.
Accounts Payable Automation
The accounting process can be subject to human error, especially during data entry. Problems may also arise if invoices are printed on paper. These documents may get lost or may be duplicated.
Such issues can result in a high cost per invoice metric. Thus, several companies are turning to accounts payable automation to streamline their AP departments’ business processes.
Companies may use accounts payable software, such as Tipalti.
Tipalti has designed systems that would enhance a company’s accounts payable process. Some of the services Tipalti provides include the following:
- Touchless invoice processing – Tipalti has built-in optical character recognition technology, supported by layers of machine-learning algorithms, to scan, capture, and process invoice data effortlessly.
- Software designed for 2-way and 3-way purchase order (PO) matching – Tipalti simplifies PO automation, eliminates overspending, and strengthens a company’s financial controls.
- Tipalti Pi™ – Tipalti’s integrated payables intelligence platform is programmed to assist controllers in reducing process risks and errors proactively.
- Tipalti DetectSM – Tipalti’s integrated fraud management solution prevents fraud and mitigates risk. Tipalti offers detailed payee monitoring and tracking of a wide variety of data points to uncover potential fraudsters.
- Enhanced vendor and supplier management – Tipalti’s integrated supplier hub streamlines manual data entry by shifting the work of collecting and maintaining accurate vendor data to suppliers.
- Payment reconciliation and cost savings – Tipalti’s software allows businesses to forgo stitching bank statements and spreadsheets to reconcile payments. This enhancement enables enterprises to focus on speeding up their financial close, thereby reducing costs.
Accounts Payable Team
The job of the accounts payable department is numbers-oriented. However, for the department to run efficiently, superior communication skills are required.
Being part of the accounts payable (AP) department involves managing numbers, data, and human relationships.
Accounts payable personnel require varied skills. Their salaries and benefits depend on the extent of their work experience.
When hiring accounts payable staff, a company should look beyond what is written in a typical accounts payable resumé. Regardless of their desired AP role, an excellent hire should be:
- Knowledgeable of basic accounting and the AP process
- Skilled in data analysis
- Well-versed in data entry (fast and accurate)
- Able to maintain good relationships (with vendors and colleagues)
Examples of accounts payable jobs and their average monthly salaries include:
- Accounts Payable Manager – $6,000
- Senior Accountant – $5,900
- Senior Coordinator – $4,200
- Accountant – $3,900
- Payroll Specialist – $3,800
- Accounts Payable Analyst – $3,800
- Accounts Payable Specialist – $3,400
- Accounts Payable Clerk – $3,000
- Accounts Payable Associate – $2,900