What is Accounts Payable? (Definition, Process & Examples)
Accounts Payable (AP) Defined
Accounts payable (AP) is an accounting term used to describe the money owed to vendors or suppliers for goods or services purchased on credit. The sum of any and all outstanding payments owed by one organization to its suppliers is recorded as the balance of accounts payable on the company’s balance sheet, whereas the increase or decrease in total AP from the period prior will appear on the cash flow statement.
It is important to pay close attention to your AP expenditures and maintain internal controls to protect your cash and assets and avoid paying for inaccurate invoices. Maintaining an organized and well-run accounts payable process is key so you remain aware of the effect AP has on your bottom line.
What is the Role of the Accounts Payable Department?
The role of the accounts payable department is to provide financial, administrative, and clerical support to an organization: This team is responsible for managing the entire process of accounts payable. This is a role critical to the accounting branch of the company and involves the coding, approval, payment, and reconciliation of vendor invoices.
Each responsibility of the accounts payable team helps to improve the payment process and ensure payments are only made on legitimate and accurate bills and invoices. A knowledgeable and well-managed accounts payable department can save your organization considerable amounts of time and money with regard to the AP process.
Armed with automation capabilities, AP teams can easily decide when to pay invoices (to avoid late fees or capitalize on early pay discounts) as well as how to pay (via paper check, ACH, or through virtual cards where you earn cash-back rebates). Organizations, in turn, gain more control over outgoing cash and can even transform AP from a cost center to a profit center.
Examples of Accounts Payable Expenses
Accounts payable differ from other types of current liabilities like short-term loans, accruals, proposed dividends and bills of exchange payable. Accounts payable may include (but are not limited to) things like:
- Transportation and Logistics
- Raw Materials
- Power / Energy / Fuel
- Products and Equipment
- Services (Assembly / Subcontracting)
Should any of the goods or services listed above be purchased on credit by your organization, it is important to immediately record the amount to AP. This will ensure your balance sheet is kept up-to-date and accurately reports on the total amount owed to your vendors, enabling transparency in your book keeping efforts and accounting process.
Understanding the Accounts Payable Process
A manual, paper-based accounts payable process can result in inaccurate performance and financial reporting, and prevent team members from working on higher-value activities that could contribute to your bottom line. Inefficiencies caused by inevitable human error can additionally result in late payments, missed opportunities (ex. discounts for early bill pay), and inaccurate payments that could be damaging to cash flow.
The manual AP process may also increase a company’s risk for AP fraud or business email compromise (BEC). For these reasons, it is important to have a team or accounts payable system that is up-to-date and well-run to ensure that your organization is not missing out on opportunities or reporting inaccurate financials.
The end-to-end process of accounts payable includes four distinct steps:
- Invoice Capture: Typically, invoice capture involves the manual entering of invoice data (vendor details, line items, amounts, and GL coding) into a system of record. This presents risks associated with accuracy and human error.
- Invoice Approval: Invoice approval involves the review and approval of supplier invoices. Often, someone from the AP team literally walks the paper invoice around the office to obtain the necessary approvals. This happens prior to posting as a cost in the ERP and sending payment.
- Payment Authorization: Once you have an invoice that is ready for payment, you must get authorization to make the payment. This includes the date you will submit the payment, the payment method, and the payment amount.
- Payment Execution: Following payment authorization, the invoice is paid and remittance details are sent to the vendor. Oftentimes this involves printing, signing, and mailing checks, initiating ACH with the bank, or completing credit card payments. Now the invoice can be closed out of the system and filed into various repositories.
Three major elements are typically required for execution – the purchase order (PO), receiving report (or goods receipt), and vendor invoice. However, PO and receipts are optional and are dependent on how the company runs its business.
- The purchase order, used to initiate a purchase, is sent from the purchasing department of an organization to a vendor: The PO will include a list of the requested merchandise, quantities of each item requested, and a final price for the order.
- Once the purchasing organization receives the merchandise, a receiving report is drawn up to document the shipment: This report will include any damages or quantity discrepancies associated with the order.
- Finally, the vendor invoice is sent by the vendor to the purchasing organization to request payment for the goods or services provided. Accounts payable receives the vendor invoices and begins the invoice management process.
Often accounting clerks will manually match invoice line items against the PO and/or receipt line items by comparing the documents side-by-side as a part of the invoice management process. This method is time and resource-intensive without an AP automation platform.
What is Invoice Management Process?
Also known as invoice processing, invoice management is the process by which organizations track and pay vendor invoices. This process involves invoice capture, validation, payment, and recording the payment in the company’s ERP or accounting system.
Accounts Payable vs. Accounts Receivable
Accounts receivable (AR) is the opposite of accounts payable. AR is the money a company expects to receive from customers and AP is the money a company owes to its vendors. For example, when your business purchases goods from a vendor on credit, you will record the entry to accounts payable and the vendor will record the transaction to accounts receivable.
The Relationship Between Cash Flow and Accounts Payable
For any purchasing organization, accounts payable is recorded as a short-term liability in the balance sheet. Over time, the manner by which accounts payable is handled can have a major impact on cash flow.
Accounts payable is considered to be a source of cash, meaning that if accounts payable is managed properly, organizations can take advantage of supplier agreements and increase both cash flow and cash on hand. Business managers and accountants may reference their accounts payable and manipulate their cash flow accordingly to achieve specific outcomes.
For example, your company may be starting on a new project that requires your cash reserves to be as sound and healthy as possible. In order to allocate more funds to the project, management could abstain from paying outstanding AP for a period of time: While this is okay in the short term, it is important to keep in mind that this form of cash manipulation may result in long-term damaging effects to vendor relationships or business reputation. Taking steps to automate your AP process, however, can help optimize your cash flow in a safe and secure way.
Why Automate Accounts Payable?
Every company receives invoices and makes payments to vendors. However, processing these invoices and paying bills manually requires a considerable amount of time and is particularly costly. On average, it costs $12-15 to manually process an invoice, plus an additional $5 to pay via paper check. Manual accounts payable can additionally place a strain on visibility and operational resources and can burden the accounting team.
Using accounts payable automation, organizations can improve inefficiencies associated with the manual AP process and reduce hard and soft costs up to 80%. AP automation streamlines your accounts payable process from invoice capture to payment execution and keeps your information up-to-date and ready to use. With AP automation solutions like MineralTree, your accounts payable process becomes faster, easier, and more secure – saving your organization two valuable resources: both money and time.