When a business purchases services or goods from a vendor, there must be a way to track the data and pay the bill. Especially when you’re dealing with trust and credit.
A Dive Deep into Accounts Payable
Accounts payable (AP) is a universal term that describes both a business account and a department that handles invoices.
It represents a specific account in the general ledger that describes an organization’s obligation to pay short-term debts to its suppliers, vendors, or creditors. The full accounting entry of these transactions appears under current liabilities on a balance sheet.
Accounts payable are cash amounts owed to vendors or suppliers for goods or services that have been delivered but not paid for. A business’s accounts payable balance is the sum of all outstanding amounts that have not yet been paid to vendors.
Recording Accounts Payable
Accounts payable is a form of accrual accounting that requires double-entry bookkeeping. Unlike cash-basis accounting, accrual recognizes that debts are not always paid right away and therefore, must be recorded and tracked. In this case, vendor invoices are recorded as debits in a company’s balance sheet.
At any given time, the AP balance appears in the current liabilities section of the balance sheet. It is the responsibility of the company to pay off this short-term debt within a specific time frame to avoid financial defaults and late payments.
The amount payable is primarily an “IOU” (short-term liability)from one company to another business entity. The creditor party will record the transactions in their general ledger as an asset.
Cash Flow Management
Accounts payable is a significant aspect of a balance sheet and reflects how quickly a business is paying down debt. There are mainly two expected scenarios with AP:
If a company’s AP increases over a while, it means that management is making more purchases on credit than paying cash. In this case, there is less liquidity.
On the other hand, if AP decreases, it means that the company is paying off debt faster. In this instance, they may have less working capital, which can be a slippery slope for a small business. A company’s cash is important when growing a business.
Managing a liability account is vital for positive cash flow throughout the year. Companies strive to keep good cash flow by paying off AP as quickly as possible.
Early Payment Discounts
Some suppliers provide early payment discounts if a company settles an invoice earlier than the due date.
Some vendors include the payment terms “1/10, n/30” in their invoices. This payment term means that buyers who pay within ten days, instead of waiting for the day due date, are entitled to a discount of 1% of the amount of money owed.
Other suppliers 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.
Accounts Payable Turnover Ratio
The rate at which a company settles its accounts payable in any given time period can be calculated using the accounts payable turnover ratio. The ratio is determined by dividing a company’s total amount of supplier purchases by the average accounts payable.
If Company A’s total supplier purchases amount to $60,000 and the average accounts payable is $4,000, Company A’s accounts payable turnover is 15 times per year.
A high turnover ratio means a company pays its bills in a short period of time.
If a company is behind on a payment, a business owner can ask the vendor to reclassify the account payable as a long-term note. This payment term is for accounts due in 12+ months. The debt should no longer reside in a short-term expense account.
Typically, long-term notes involve an added interest payment. Whether a vendor agrees to a long-term note depends on the company’s relationship with the vendor.
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How Does the Accounts Payable Process Work?
The AP department has a set procedure they must follow before releasing payments to vendors and creditors. These guidelines help keep the processes streamlined and transparent. As business relationships grow over time, all terms and conditions must be clear.
The AP process includes:
When a company purchases goods or services, the AP team receives an invoice. It helps them keep track of quantity, current pricing, date, and other essential aspects of the transaction.
When an AP team is run manually, the invoice data must be input into an accounting system. If the business is using AP automation software, the invoice is generally scanned with a process known as OCR (optical character recognition).
It is important to ensure all invoice data is accurate and verified. Details can include vendor name, billing address, purchase order, authorization, compliance, and more. AP software typically expedites this process and sends approvals to the appropriate parties.
Once the company has received all invoices, the general ledger department must keep the records current. Depending on a company’s operating policies, updating records require management approval to keep the process transparent at every touchpoint.
It is the responsibility of the AP department to make timely payments to all suppliers, creditors, and supply chain partners. The team also prepares and reviews the necessary documents before initiating payment for invoices. To ensure everything is running smoothly, managers often conduct an audit of financial statements.
Companies need to perform all these hierarchical activities to avoid any document falsification or financial fraud at any possible point of communication. It is crucial to keep the process simple, accessible, and transparent. It establishes brand trust and strengthens business relationships.
How Management Uses AP
When firms use the indirect method to prepare cash flow statements, the net increase or decrease appears in the top section of operating activities. Sometimes management uses the AP function to temporarily manage cash flow.
For example, if a firm needs to have a higher cash reserve, it will extend the time to pay debts. In this case, the debt increases, and the delay time depends on the relationship between the company and the creditor.
However, to run a long-term business, it is always good to pay all debts on their due dates to avoid negative financial remarks.
The Role of an AP Department in a Company
The AP department has a wide variety of responsibilities beyond simply managing invoices. In large companies, accounts payable is a separate department; in smaller companies, accounts payable and accounts receivable are combined.
Regardless of the company’s size, the AP department performs these critical tasks:
Companies often require teams to travel for business, and the AP department manages these expenses. Accounts payable takes care of flight bookings, vehicle rentals, hotel bookings, and meal expenses.
Depending on company policy, the department may also process reimbursement requests and handle meal expenses for individuals traveling outside the country. Upon return from the business trip, the AP department accounts for the funds and settles all reimbursement claims.
The AP department is also responsible for managing internal payment reimbursement, distribution control, petty cash, office supplies, and sales tax exemption certificates. Petty cash covers minor expenses such as lunches and transportation.
The AP department also handles the tax exemption certificates issued to managers to ensure that sales tax is not added to business purchases.
Payments to Vendors
The department must also manage the contact information for the various vendors, Form W-9, payment terms, and more. In accordance with the company’s internal policies, the AP department either manages pre-approved purchases or verifies the procurement after it has been made.
In addition to these activities, the department also manages month-end due date reports that show the company’s current outstanding balances.
To remain competitive in the industry, companies need to reduce expenses to improve cash reserves. An AP team will devise strategies to increase profitability without taking on excessive debt.
Since AP is the point of contact for suppliers, they can also offer discounts to build a long-term business relationship. These strategies are mutually beneficial for both parties and help a company grow.
Internal controls prevent the company from:
- Paying inaccurate and fraudulent invoices
- Paying a vendor twice
- Paying without ensuring that all invoices are accounted for
To avoid errors and fraud, a business may implement checks and balances, like:
- 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 may also be required. This is a document that vouches for an approval procedure’s completeness.
Accounts Payable Automation
The accounting process is highly subject to human error, especially during data entry. Problems also arise with paper invoices. These documents can get lost or duplicated.
Such issues result in a high rate of cost per invoice metric. That’s why companies are turning to accounts payable automation to streamline AP business processes.
Tipalti is accounting software that can help a business of any size implement AP automation. The system enhances the AP process and provides services like:
- 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 – Forgo stitching bank statements and spreadsheets to reconcile payments. This feature enables speeding up financial close, thereby reducing costs.
Hiring an Accounts Payable Team
For the accounts payable department to run efficiently, superior communication skills are required. Being part of the AP team means an individual is adept at managing numbers, data, and human relationships. It’s all part of the job description.
Accounts payable personnel require varied skills. Their salaries and benefits depend on the extent of work experience.
When hiring AP staff, a company should look beyond what is written in a typical accounts payable resumé. Regardless of the 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)
- Experienced in AP automation tools
- Accounts Payable Manager – $6,400
- Accounts Payable Specialist – $3,400
- Accounts Payable Clerk – $3,000
- Accountant – $4,500
- Payroll Specialist – $3,800
- Payroll Clerk – $3,400
- Accounts Payable Analyst – $3,800
Accounts payable is an integral part of any business. It helps to make financial processes simple and more manageable. Without the AP department, business relationships would crumble and there’d be no room to establish brand trust. A company’s current assets are only as strong as its liabilities.
No matter how much we automate, AP will always require a human touch. Accounts payable teams are a vital asset to building a business and ensuring financial stability every step of the way.