The budget is a constant factor in any business setting. How do you ensure that you are buying enough quality goods and services for your manufacturing and internal operations to thrive while still keeping tabs on costs? We’re all familiar with making purchasing decisions in our daily lives, but the way entire companies do it is a field all by itself.
The accounts payable department is the group of employees dedicated to controlling costs and procurement. The process is present in almost every organization and industry, as it plays a role in reimbursing the third-party companies a business purchases from. Accounts payable is more than just paying the bills on a balance sheet, however.
Navigating the complex tasks of accounts payable requires some knowledge of how the entire process works, some of its best practices, and what tools you can use to your advantage. What exactly is all the buzz about when it comes to accounts payable?
What Is the Accounts Payable Process?
The accounts payable (AP) department completes the payments made to creditors, suppliers, and vendors whenever a company purchases new products or services on credit. AP largely deals with:
- The approval and processing of invoices.
- Ensuring that the business is able to pay off its debts.
- Showing creditors that you can organize your payment plans properly, boosting your reputation.
- Protecting against inaccurate or illegitimate invoices by verifying them against purchase orders. For instance, what the business receives from a vendor might differ from what is listed on the invoice, either in price or in quality.
A dedicated AP team largely deals with short-term debts like car leasing agencies and freelance work that gets paid off within a year. More long-term financing solutions like mortgages are usually treated separately. An accounts payable balance is sometimes referred to as a current liability account.
The AP department works with its own set of metrics to analyze the liquidity of a business. The following list are a few of them, but remember that management will also be interested in figures like average invoice processing time, average cost per invoice, and the rate of supplier complaints and discrepancies.
- AP turnover, a liquidity measurement showing how fast a company can pay off its suppliers.
- AP days, the number of days required to pay off the accounts payable balance.
- Cash conversion cycle, or how much time it takes to generate cash from the inventory.
Like with any accounting-based field, accounts payable is both document-heavy and analysis-heavy.
Buying on credit is a practice most of us are familiar with. Management often chooses to make purchases that cannot be immediately paid for since the expected return on investment is too great to pass up at the moment. Accounts payable prevents overspending and makes sure that repayment is both possible and able to be done in a timely fashion.
What the Process Covers
The exact responsibilities of AP differs depending on the size and type of the business. Some larger companies have dedicated departments while others combine the work alongside accounts receivable. Either way, there are a few basic functions of this process.
- Internal payments. Ever wondered who in the organization handles “petty cash” payments like office supplies or lunch meetings? The AP department relies on employees reporting those expenses and submitting reimbursement requests. It also steps in for qualifying transactions that are exempt from sales tax.
- Vendor payments. Interactions with vendors, from maintaining contact information to deciding on payment terms, is handled by AP, which can either look at pre-approved purchase orders or verify transactions after they complete. Other tasks can include studying IRS W-9 information and handling financial analysis at the end of each month.
- Business travel. Traveling expenses like airline fees, car rentals, hotel reservations, and other amenities are usually the responsibility of accounts payable. Distributing the right amount of funding for travel reimbursements is necessary to prevent overspending while bringing the workload abroad.
Accounts payable is also usually the catalyst for finding new savings opportunities. By recognizing patterns in the spending, it can find potential discounts. Establishing direct lines of contact and positive relationships between the company and its vendors is another potential use case.
The Accounts Payable Cycle
Understanding how the full cycle of AP works goes a long way to understanding what exactly is involved in the big picture. Breaking a complex process down into simple steps, we can think of accounts payable as:
- The business decides whether it needs to make a new purchase based on current inventory levels and creates a purchase order (PO).
- AP collects this purchase order, essentially an agreement between the client and the vendor specifying the details of the transaction (quantities, types of services used, dates of fulfillment, etc.).
- The client business creates a receiving report. The contents of the delivery are compared to the original purchase order to verify accuracy and quality of goods. Should there be any damaged units, the accounts payable department files a follow-up with the vendor.
- The vendor records an invoice specifying the goods sent and the total price to be paid. The client business receives this invoice, adds it to the ledger accounts, and performs a step known as the “Three-Way Match.”
Accounts payable teams rarely automate invoice payment at this stage because they need to check for potential overpayment or even fraud.
The Three-Way Match
The 3-Way Match is the manual way to ensure the original purchase order is in line with the final payment made to the vendor. AP compares the PO, the receiving report, and the vendor invoice.
- The purchase order details what your organization has ordered and the expected cost of the goods.
- The receiving report is what your organization has actually received from the vendor. The information is used to verify that the client has received the correct quantity of product and that the delivery is in acceptable condition.
- The vendor’s invoice comes from the supplier and shows what that vendor has billed your business.
Accounts payable compares these sources and checks whether any serious financial errors have been committed. Issues like overpayment and transaction problems are flagged early on, and auditing is easy now that the bookkeeping is already finished.
Sometimes a business might opt for a 2-way or 4-way match instead. 2-way matching only involves the invoice and purchase order, while a 4-way match adds an additional step to the Three-Way Match: inspection and verification post-delivery.
A 4-way match is naturally the more secure method that takes extra time, but it’s ideal in situations where compliance and strong controls are necessary. A 2-way match is more common in smaller companies making less important transactions.
However, the Three-Way Match generally offers the best balance between integrity and efficiency. It relies on the AP team’s ability to track down and analyze the required documentation quickly and accurately, as any delays can delay shipments and annoy suppliers.
How AP Teams Take Control of the Whole Pipeline
You can think of AP as the bridge between procurement and payment. This “P2P pipeline” goes both ways: handling “upstream” and “downstream” workflows to keep inventory stocked up and vendors satisfied with your payment terms.
When we say “upstream,” we’re mainly talking about the procurement itself: the steps taken to find the right vendors, the ideal contract terms for both parties, and the most beneficial vendor relationships.
“Downstream” refers to everything that happens after the transaction. The accounts payable system still needs to track the products and services received and compare the invoice data with the original purchase order. Not having a good accounts payable system for the job may result in missed payment due dates and even late fees.
Almost every purchase a business makes is the responsibility of the AP process with the only exception of payroll. The team handles not only the transaction but also the search for potential savings and discount opportunities.
Why Does It Even Matter?
For a task that not many people talk about, the accounts payable process contributes greatly to the company. What you can expect when you divert attention towards optimizing it includes:
- Better general management of the company’s cash flow
- Precise invoice processing to catch duplicate, missing, or fraudulent payments
- A reliable source of new raw materials and needed services for the business
- Tracking vendor details and promoting beneficial relationships with suppliers
- Avoiding missed due dates and late payments
- Early payment discounts through well-planned payments
Business administrators should always look to focus attention in an accounts payable department.
Accounts Payable vs. Accounts Receivable
Do not confuse accounts payable with a related but separate department known as accounts receivable (AR). They are both vital components of the accounting process but fulfill entirely different roles.
Accounts payable works whenever the organization orders from suppliers or service providers; it handles all the money owed by the company. Accounts receivable goes the other way; it covers the products and services your own business sells to customers on credit.
AP and AR exist because the moment you choose to purchase products rarely happens at the same time as the moment you set down the money and receive the goods. Because spending and receiving money happens on a schedule, ensuring that you are never stuck without enough to make a payment requires AP and AR to work together and coordinate budgeting.
Does it all sound incredibly complicated? The accounts payable department performs a critical business process that’s expectedly multifaceted and complex to understand. Let’s sum up the basic responsibilities.
- Receiving supplier invoices and comparing against internal purchase orders and receiving reports.
- Processing the invoice approval and ensuring timely payments.
- Uploading invoices and operating the AP automation or accounting software if applicable.
- Communicating with vendors to negotiate terms and discuss inquiries.
- Performing audits and preventing duplicate or fraudulent activity.
Once you know what it is and what the process involves, you can now see how important accounts payable is for controlling funding and connections with business partners.
Challenges Facing the Accounts Payable Process
Management is always looking for ways to make the job of the accounts payable department easier. To that end, what are the most common pain points for professionals working in this field?
- Manual data entry. The accounts payable process relies on a large amount of accurate data from multiple sources and formats. Collecting all of it for use means plenty of data entry, which, if done by hand, is error-prone.
- The paperwork. Nobody likes being stuck with a disorganized balance sheet and a stack of the company’s financial statements on a desk. But the reality is that AP is incredibly paper-heavy, with vendor invoices and incoming bills numbering into the hundreds for larger organizations. Sorting and processing paperwork is a tedious task that can take away from other, more valuable work.
- Slow workflows. The manual approval process for each invoice can be glacially slow, especially when multiple external stakeholders need to be involved.
These issues all add up to a payable process that is both slow and difficult to track the progress of. How can a business ensure that it’s going through proper expense management practices and making timely payment for all business expenses?
Best Practices For an Accounts Payable Process
All firms from the small business to the large enterprise can unlock the benefits of an accounts payable process. You might be wondering what you can do to streamline AP work and mitigate some of the issues mentioned above. The following are some best practices for the payable process.
- Use notification reminders. Take advantage of early payment discounts and avoid another late fee by setting up reminders whenever the next vendor payment is due. Pay invoices on time and look trustworthy in the eyes of your suppliers.
- Reduce paperwork. We’ll discuss the digital transformation of your accounts payable account later, but the general idea is to process the accounts payable tasks through software rather than by pen and paper. For instance, submitting invoices through capture software to automatically extract the relevant information greatly reduces the manual work required.
- Generate regular reports. Whether it’s monthly or quarterly, keep tabs on all activity over a period of time. All accounting transactions and other AP-related activities should be recorded to help administrators understand cash flow and audit any purchases made in the timeframe.
- Give control to the right person at the right time. AP often involves getting the invoice to the right party for authorization. Who exactly is in charge of authorizing a specific transaction? Have a clear answer to this question throughout the AP workflow.
- Centralize the accounts payable process. One of the biggest problems facing business accounting is the vast variety of transactions companies make. Likewise, the steps to process payment can include capturing, measuring, storing, and accessing AP-specific documentation. Having everything on a single platform enables easy management and even automation.
Organizations rely heavily on AP departments to maintain internal controls on cash flow, hence the popularity of accounting software solutions intended to optimize the accounts payable process.
What Software Solutions Can Do To Help
Software is often regarded as the silver bullet for accelerating any kind of business work, but how well does it apply to the accounts payable process? Manual expense entry might work in a small business with few vendor invoices to go through, but any type of accounting system at a larger scale will benefit from software and an automated process. AP and accounting software can offer:
- Automatic payments. Instantly file payment vouchers and vendor invoices for automatic payment later. Doing so almost guarantees that every deadline will be met. You also minimize opportunities for human error.
- Vendor management. Is your company able to quickly check on the specifics of a vendor? What is the last vendor invoice filed for a provider? Can you find the exact address? Under a software management system, tracking all this information from a single location is now possible.
- Streamlined approvals. Every step is on record when you use software. Make sure the right individuals in the company can see the relevant invoices and approve them accordingly.
- Audit and reporting features. Not a single vendor invoice goes unaccounted for when you have a solid digital audit trail in place. Reporting features also let you create cash flow statements with ease. You can also generate better financial statements, which will help the next time you’re looking for investors.
Software tools designed specifically for the accounts payable process can automate almost every step of the way, from invoice collection to payment processing.
Accounts Payable: Do It Right
Don’t think of accounts payable as a set of current liabilities just because it’s essentially a list of payments owed. In fact, AP is arguably the most vital task to optimize in today’s competitive market.
Accounts payable, when done inefficiently or with errors, can make you susceptible to fraud, seem unprofessional with your suppliers, and hesitant about the financial results of the next cash flow statement.
Put yourself above the competition by not only learning about accounts payable best practices but also adopting specialized software that can centralize and streamline the workload.